Is Wall Street Shrinking?

Articles:
Wall Street Journal, BofA Readies the Knife, by Dan Fitzpatrick
CNN Money, More Layoffs Looming on Wall Street, by Maureen Farrell

The Wall Street Journal reports that Bank of America is planning to cut $5 billion in costs by the end of 2013, including the elimination of about 30,000 jobs.  CNN reports that their major competitors will probably follow suit.

Is Wall Street shrinking?  Well, it depends how you measure it.  If you look at the number of people employed, yes it is.  Those of us who are producers and even consumers of financial products have seen great increases in efficiency over the years--everything from online brokerage, to ATM machines, to exchange traded funds, to decimalization have allowed Wall Street to service investors more cheaply than ever before.  As the below chart shows, the number of people dedicated to finance has barely budged since 1998 (the first year that the Bureau of Economic Analysis makes figures available), and is now trending downward.

To the extent that Wall Street is part of the "overhead" of our economy, and produces no real wealth, that is good news.   (Although this is little consolation if you are a BofA teller who gets laid off).

But look at the green line on the graph.  This is the percentage of GDP that is produced by the financial industry, which has been going nowhere but up for decades. Except for a few down years, GDP has been steadily increasing over those years, so we are seeing finance making up a steadily larger piece of a steadily growing pie, and doing it without employing more people.  In other words, some people are making a lot more money.  And who are these people?  Shareholders?  You wouldn't know it by me!  Tentatively (until someone proves me wrong) I think we are talking about individuals with out-sized compensations: hedge fund managers, traders, C-suite executives, lawyers.

And again, to the extent that financial services produce no real wealth, and are part of the overhead of our economy (which I believe is the case), this is done at an overall cost to our prosperity as a society.  How has this happened?  I guess that a big part of the answer is "financial innovation", which is a fancy word for getting more people to borrow more money at a higher cost than ever before.  For individuals this means things like new types of mortgages, home equity loans, and credit cards.  On the corporate side there are things like securitization, over the counter derivatives, credit default swaps, all generating hidden fees and spreads which over the years have greatly outpaced any efficiency gains coming from automation and downsizing of clerks.

I believe Wall Street needs to shrink more and become more efficient.  But I hope that the next arena for efficiency gains will be fees, spreads and six or seven figure bonuses, not just clerks' salaries.

FHA Sues Banks: Bad Timing?

Articles:
Wall Street Journal, U.S. Sues Big Banks Over Home Mortgages, Nick Timiraos, Robin Sidel, Ruth Simon
The Economist, Fannie Mae and Freddie Mac: Self Harm

The Economist notes that the two U.S. Government Sponsored entities, FNMA (Fannie Mae) and FHLMC (Freddie Mac) which have a mandate to encourage home ownership in the U.S., mainly by guaranteeing mortgages, have received around $140 billion from U.S. taxpayers.

Their regulator, the Federal Housing Finance Authority (FHFA) has said that they are legally required to conserve assets and protect taxpayers from further losses.  In this spirit, apparently, they have filed suit against 17 banks, for failing to adequately disclose the risks of $196 billion in mortgages which they sold to Fannie and Freddie during the housing bubble.

There may be some sense of justice here.  The banks made a lot of money during the boom (and paid out huge bonuses) by loosening credit standards and making all manner of risky loans.  Why should taxpayers have to shoulder losses when the banks are still around to pay out?

But the problem is, it's bad for the economy.  The banks are in bad shape now, especially Bank of America, which recently received $5 billion in capital from Warren Buffett.  The last thing they need now is a huge open-ended liability coming from the federal government.  The Bush and Obama administrations made a conscious decision that the best way forward out of the recession was to keep the banks alive, recapitalize them and prop them up.  Now the Obama administration is kicking them when they're down.   As a result, they can be expected to re-trench and cut back on risky lending, which will slow the economy further.

I'm not sure if the President approved these lawsuits because of populist political considerations, or if it is just an example of the left hand not knowing what the right hand is doing.  But if the goal is to strengthen the economy and create jobs, it sure looks counterproductive to me.

Its easy to criticize the decision to prop up the existing Wall Street system that was made a couple of years ago.  But that was the decision that was made, and we can't have it both ways.  Wall Street can't be the savior and the villain at the same time.

Here is the picture (again from The Economist) that tells 1,000 words:

Buffet Buys a Stake in Bank of America

Story: Yahoo News, Warren Buffet to Invest $5 Billion in Bank of America, Ben Berkowitz and Joe Rauch

One of the big stories of the day was the announcement by Warren Buffet that his company, Berkshire Hathaway would make a $5 billion investment in Bank of America.  Over the last several weeks we have watched shares of BofA go down to levels not seen since the financial crisis, due to its ongoing exposure to liability from bad mortgages from Countrywide Financial, which Bank of America bought in 2008.  There have also been rumors that BofA has large amounts of exposure to European banks.  Other financial institutions have followed BofA down, though to a lesser extent, with Citigroup in particular (which I hold in my portfolio) taking on the appearance of a "BofA lite".  (See below chart from Yahoo Finance: BofA is the blue line; Citi is green).

3 month chart from finance.yahoo.com

The announcement of the deal, which Buffet --now said to be the third richest man in the world with a net worth over $50 billion-- thought up while in the bathtub, caused BofA stocks to jump considerably, along with the other financials.

5 day chart from finance.yahoo.com

As of this writing, the Dow Jones Industrial average has followed the European markets downward, and is now off by about 130 points or just over 1% -- which used to be a lot, but could change in the blink of an eye  in these recent weeks of high volatility.  But the financials are a bright spot, at least today, with BofA up by over 10%, and Citi up by just under 5%.