JD: Not Just the Protagonist of a Show I Used to Like

I’m at law school.  It’s finally sunk in, and it’s worth mentioning.  Many of the topics on this blog correspond with my past lives as a business student and technology investment banking analyst.  As a legal student, my current interests won’t simply vanish, but I do except to perceive the world in an increasingly altered fashion.

Already I have noticed just how retrospective law is compared to the forward looking natures of technology and financial analysis.  I can imagine former colleagues condescendingly spurning the legal field’s lack of velocity and disengagement with the “real world.”  Yet, I also already recognize the potential benefits of applying the rigors of thorough legal analysis to non-legal matters.  Having read dozens of cases already, parsing analytical discourse into the issue at hand, logical reasoning, and actionable theses is becoming second nature.  The skill of “pattern recognition” that venture capitalists and portfolio managers so proudly tout can be comprehensively honed in the pursuit of a juris doctor.

The distinctive feature about the study of law, of course, is the Socratic method.  It is alive and well a couple of millennia after the bearded sage last donned a toga.  The method is captivating, but it is also mentally taxing.  Some professors seem to employ it to make a point for the benefit of teaching, but others ask students questions seemingly to satisfy their own whims.

While it does help gradually reveal kernels of wisdom, the Socratic method in the legal field today might be less illuminating than in the past.  Reading century old cases, it is apparent that the law has evolved from primarily reflecting the collective moral compass to becoming more about functionality and establishing objective rules.  That means when reading older judicial opinions which rely less on the precedents of preceding cases and more on logical statements of morality, the conclusion is usually too obvious.  Then, when listening to classmates answer questions about these same cases, the kernel revealed is sometimes anticlimactic.

There is a tendency to want to jump ahead to the implied rule.  Perhaps, our primal sensitivity has eroded (or never existed), and in a jaded modern world, we immediately want to drill down to the detached, secular answer.  It is on this front that I will need to adjust most.  I will be forced to value the path to wisdom and not only the results, or risk being miserable for three years.  It is a mindset I happily espoused as an undergraduate, and hopefully, I can ease myself back into that disposition.

I was always fascinated by law school.  As funny as it sounds, attending law school has always been more of a dream than learning or practicing law.  Now that I am here, it is great to hear spirited discussions about legal controversies and public policy.  It is just funny to realize how only a couple of years as a working stiff can change one’s view on things.

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The Problem(s) with Wall Street

Wall Street is no longer a street in Downtown Manhattan. It hasn’t been for some time now. Wall Street has actually weaved its web across most of New York City. It is no longer just the banks. Its appendages include hedge funds, private equity firms, wealth managers, and any other type of financial/investing house that may have sprouted in the past couple of decades. However, when it comes down to our current mess and whom tax payers are bailing out, the blame indeed does revert to the traditional salestraders, investment bankers and bank execs. They are the ones that took on misunderstood, levered off-balance sheet risks to satisfy their hedge fund clients. They are the ones that provided a secondary market for bad mortgages, incentivizing brokers to give out a loan to any potential homeowner that would seek it. Now, there are many to blame including perhaps, the SEC, which may not have oversight when it comes to hedge funds and private equity shops, but which is absolutely in charge of maintaining the appropriate regulation over banks to provide shareholders transparency. Yet, even with so many to blame, there is no question in my mind about how broken the Wall Street system really is.

I seem to have vilified investment banks and refered to them as “they.” Unfortunately, I myself am a member of the industry. I have only been involved for about a year and a half now, meaning I really have nothing to do with most of the ills that spurred this historic collapse, but I am a cog in this ‘broken’ machine and am obligated to at least offer some insight into the repairs needed. So here is an initial list:

  • Short-term Gratification:  As with any public corporation, banks are rewarded for short-term results quarter-by-quarter rather than on long-term performance. Banks, however, facilitate capital so that an overreaction to good or bad short-term market conditions has a much more severe bullwhip effect for our whole economy than a typical company whose overreaction is slightly more isolated to its industry and supply chain. More broadly, banks are encouraged to maximize profit in boom cycles even more so than other companies because employee attrition is so high, and many employees are looking to grind for money over short bursts of time rather than build a career. Employee attrition is so high in the industry because people recognize the need to be opportunistic regarding their resumes and financial wealth. In other words, they want to maximize their bonuses during the boom times. Unless clawbacks become a reality, this is where the currently popular term, ‘moral hazard,’ comes into effect. When playing with other people’s money and having only upside, why not aim for the quick happy ending?
  • Incentive Structure:  Bonuses on Wall Street are not like typical bonuses. Besides being much bigger than in the typical corporate job, they are also much more than just a year-end cherry on the top. Bonuses are considered part of one’s expected compensation. There is no way, especially at the junior level, that people working at an investment bank would work 80+ hours a week for just their base salaries. The amount of verbal [and physical if you count lack of sleep] abuse involved would not justify it. Bonuses are based on revenue, and on Wall Street revenue is largely based on volume and size of transactions. This explains why employees may push irrational trades and transactions for the incremental revenue. One solution is giving more stock to employees, and while banks do implement this, it worked better in the old private partnership models. Now that banks are public, however, there are still plenty of non-employee shareholders onto whose shoulders employees can push risk.
  • Client-Facing Business: While Goldman Sachs, JPMorgan and other banks have used proprietary trading essentially to the effect of having in-house hedge funds, Wall Street is still a client business. Whether it is bending over backwards to produce an M&A analysis at 4:00 AM on Saturday for the VP of Corporate Development so that he can use the phrase, “The acquisition of ‘xxxx’ company is accretive,” on slide 27 of his presentation to the President of Corporate Development, or executing an MBS trade worth millions while having no idea about the true risk profile of the security, the client is always right. Banks want to make money and cater to the client’s every single need. The current crisis largely stems from the latter case in which traders had no idea what they were trading but could not say no to the client. Maybe a refresher course from middle school health class would help: “No means no.”

The following points might not have prevented a financial crisis, but are still flawed facets of the financial services industry:

  • S&T vs. IB:  Sales and trading and investment banking advisory are two distinct aspects of the Wall Street business model. Traditionally, sales and trading desks have been responsible for  acting as an intermediary to ensure buyers and sellers can get trades done, and they would get paid for this service. As mentioned, more recently some traders have also traded as investors/speculators taking risk onto banks’ balance sheets, essentially making bets that assets would increase in value and make the bank money that way. Investment banking advisory groups, on the other hand, give clients advice on M&A, IPOs, restructuring, etc. In boom times both segments do well, but traders often see more upside. Trading is what caused banks to take on undue risk in this last collapse. In these down times, though, both traders and bankers are punished via layoffs and lower pay. There is probably more nuance involved than this, but somehow it doesn’t all quite make sense.
  • Analysts vs. MDs: Analysts are the lowest rung on Wall Street. In investment banking advisory they are chimpanzees, jumping and clapping on command. That guy doing that M&A analysis at 4:00 AM before, well, that was an investment banking analyst (i.e., me). The Managing Directors (MDs) bring in the deals and have the relationships that generate business. So maybe they do merit the millions a year, like any good agent would in other fields. The analyst makes his $60K base and hopes to make a bonus of anywhere between $20K and $100K (perhaps, closer to $0 these days). The analyst is only in his early to mid 20s. Plenty of money at that age right? Maybe, but you do have to factor in the average of 80-90 hours a week, the cost of living in Manhattan, and the workplace abuse. There are people between analysts and MDs with MBAs that check work and manage deals to ensure execution, and they are paid somewhere between $100K and a couple million. The problem with the model is that analysts do everything—from the initial financial analysis and company presentations to binding and couriering books—but are not incentivized with the appropriate financial upside or long-run career path. I don’t know what the solution is because truth be told, most analysts are just using the position to save some money and go do something else. Perhaps, the people in between should shoulder more responsibility since they hope to be on career paths to become MDs. The fact that one has his or her MBA does not justify sitting on one’s hands and having his or her analyst do all the work so that it can be passed onto the MD, who originally sourced the business.

Some of this was just venting, but hopefully, there were some sage (or moderately useful) words, as well. Here’s to Wall Street fixing its woes so that maybe the rest of the ‘normal’ folks can fix theirs.