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November 2001

The end of a period of excess





When the largest brokerage firm in America sends an email to all its employees offering them voluntary redundancy, it's a sign that something more than a periodic bout of investment banking blood-letting is under way. A shakeout is beginning that will reshape whole firms and sectors of the financial services industry, throw up unexpected winners and losers, make some old skills obsolete and put high value on new and different ones.
Banks have always tended to bulk up their staff in the busy times, lay them off in slowdowns and rehire them when markets pick up. It's a brutal culture that bred a mercenary outlook among bankers who cast aside loyalty to their employers and determined to take as much money as they could in the good times, while negotiating guarantees whenever possible to protect against the bad.
As the great bull run of the 1990s finally careered towards its ugly end with the technology share crash, senior executives at many firms seemed for a while unable to comprehend what was happening around them. Allen Wheat at CSFB offered the most extreme example, still negotiating multi-million dollar deals with even fairly junior members of a team of 40 debt capital markets bankers that threatened to quit for Barclays Capital this February.
Wheat left his successor, John Mack, the extraordinary task of having to ask subordinates to forgo their lucrative guaranteed deals for the good of the firm. Wheat knew he should really have been cutting costs but still couldn't seem to help himself tying in his debt team - in a falling interest rate market that was a boon for bonds - even while sharpening the knife for CSFB investment bankers elsewhere.
Some of that team have said they wanted big guaranteed money because they seemed to be the last bankers left without such a deal. By the end of 2000 it became usual for investment banks to be paying an average managing director in corporate finance $3.5 million a year and to be employing almost twice as many bankers as in 1992, at the beginning of the boom market.
The excesses built up over a long period. One anecdote from the mid-1990s is of the European bank desperate to build its investment banking business recruiting a young American banker on $1 million a year guaranteed for two years. The young banker told his employers he had become committed for nine months to a charity round-the-world yacht race. No matter, they agreed to pay him the whole two-year deal for just over a year's work.
Senior bankers indulged in similar excesses in the 1990s. At least two senior executives of financial firms in America spent so much of their time trading their personal accounts, and so little attending to their firms, that while the businesses faltered around them they each amassed fortunes of more than $150 million. One got out of the business with the regulators snapping at his heels. And this remember, was the generation of bankers that had grown up in the 1980s, during the LBO boom - the decade of greed is good - and had vowed not to be so conspicuous in its consumption.
The excess manifested itself in other ways - a restless ambition for expansion into new countries and new markets. This was not always the best use of shareholders' funds. One consultant recalls telling an investment banking head preparing to build up in Germany in the mid-1990s that his investment would almost certainly be lost. But it would be so much more fun to try it than not to bother, came the reply.
Bankers spent almost indiscriminately on technology, building systems that couldn't do what they were supposed to do, couldn't talk to other systems at their own firms and had to be junked. Latterly they threw tens of millions of dollars into new internet businesses, many of which are now being shut down within months of going live.
Now this period of extraordinary excess is coming to an end. Even the largest firms are refusing to provide new rounds of funding to internet joint-ventures they ballyhooed just months ago. Banks are doing more than enact large-scale redundancies, they are rethinking their commitments to certain countries and markets. And this may be sensible.
During the 1990s the governments of many emerging countries in Latin America, central and eastern europe and parts of Asia came to embrace Anglo-Saxon economic orthodoxy - free markets, privatization, the equity culture, corporate governance, budgetary restraint. Investment banks, particularly Americans, rode in behind this wave to lead the privatizations and sovereign bond deals.
Now, as global recession bites, investors withdraw from emerging markets, populations protest the uneven benefits of globalization and war looms, firms are rethinking the benefits of keeping offices in countries where the big deals have already been done and secondary securities markets are small.
At least in the short term the values traditionally put on different investment banking skills are being rethought. It used to be that trading revenue was dismissed as low quality and volatile and all banks strove to dominate in M&A and IPOs. Now M&A volumes have collapsed and won't recover until corporate profits and equity markets do. Companies won't raise expensive equity capital when they don't expect to see a return on it amid economic downturn. The trading firms may fare better.
Corporate defaults are soaring. Standard&Poor's suggests bond issuers will default on as much as $100 billion-worth of outstandings this year with the telecom sector leading the way. Banks will increase loan losses and provisions. Those who will win are the best traders and investors in distressed assets who understand that a new owner of an asset can see different value and bring different commitment to the original creditor which has suffered a big mark to market loss and now hates the asset.
A new wave of mergers will transform the financial services industry. In the longer term those firms that have amassed strong market share and invested in technology wisely should triumph. Big, global traders of securities with strong technology are already acting like stock exchanges, crossing customer orders internally, with full straight-through processing. Many are universal banks not pure investment banks.






Of course it’s childish, but that’s the way the two have done business ever since Dhirubhai expired

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