Satyajit Das : Mr Smith
Goes toLeaves Wall Street
By Satyajit Das - Naked Capitalism
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Investment banks feared that the separation of client business and trading with its own capital would limit their ability to compete. Under CEO Lloyd Blankfein, Goldman Sachs embraced the conflict, emphasizing intelligence from trading with clients and other banks to place bets with its own money.
Major investment banks sought to become “flow monsters”, capturing a dominant proportion of trading volumes to assist their proprietary activities. To achieve this, banks used cross subsidies to attract certain clients. Execution or market-making and credit facilities to finance large hedge funds that were a source of significant trading volumes were provided at subsidised prices. In an insidious process, this created pressure to increase trading volumes even further as well as increasing reliance on proprietary revenues to meet shareholder return targets.
The best research was channelled to support proprietary trading. Client research increasingly became devalued, evolving into mere puffery – a sales aid for selling products or the firm’s inventory to the clients. Products were designed and sold to assist investment bank’s proprietary traders to take positions, sometimes at the expense of clients unaware of the risks.
The shift was cultural as well as economic. In her 1999 book Goldman Sachs: The Culture of Success, Lisa Endlich, a former Goldman Sach employee on the trading side, makes snide comments about the “feeble and hidebound” traditional investment banking culture, with its focus on the client. The trader culture, which Endlich celebrates, involves a transactional business model which is isolated from clients and highly results oriented. Deals and profits dominate at the expense of client interests and relationships, a practice known as “scorched earth banking”.
The success of the trading model can be seen from the fact that the path to the executive suite of an investment bank these days originates in the trading room. Both current Goldman CEO Lloyd Blankfein and his deputy Gary Cohn traded metals earlier in their banking careers.
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