"More important, a stiffened regulatory regime across Wall Street following the crisis is likely to reduce the use and abuse of its favorite addictive drug: leverage.
The low-interest-rate environment of the last decade offered buckets of cheap credit. Just as consumers maxed out their credit cards to live beyond their means, Wall Street firms bolstered their returns by pumping that cheap credit into their own trading operations and lending money to hedge funds and private equity firms so they could do the same. When things went wrong, however, all of that debt turned into a nightmare. When Bear Stearns was on the verge of collapse, it had borrowed $33 for every $1 of equity it held. When trading partners that had lent Bear the money began demanding it back, the firm's coffers ran dangerously low.
Earlier this year, Goldman had borrowed about $28 for every $1 in equity. In the ensuing credit crisis, Wall Street firms have reined in their borrowing significantly and have lent less money to hedge funds and private equity firms. Today, Goldman's borrowings stand at about $20 to $1, but even that is likely to come down. Banks like JPMorgan and Citigroup typically borrow about $10 to $1, analysts say.
As leverage dries up across Wall Street, so will the outsize returns at many private equity firms and hedge funds. Returns at many hedge funds are expected to be awful this year because of a combination of bad bets and an inability to borrow. One result could be a landslide of hedge funds' closing shop. At Goldman, the reduced use of borrowed money for its own trading operations means that its earnings will also decrease, analysts warn.
Brad Hintz, an analyst at Sanford C. Bernstein, predicts that Goldman's return on equity, a common measure of how efficiently capital is invested, will fall to 13 percent this year, from 33 percent in 2007, and hover around 14 percent or 15 percent for the next few years.
Goldman says its returns are primarily driven by economic growth, its market share and pricing power, not by leverage. It adds that it does not expect changes in its business strategies and expects a 20 percent return on equity in the future.
If Hintz is right, and Goldman's legendary returns decline, so will its paychecks. Without those multimillion-dollar paydays, those top-notch investment bankers, elite traders and private-equity superstars may well stroll out the door and try their luck at starting small, boutique investment-banking firms or hedge funds - if they can.
"Over time, the smart people will migrate out of the firm because commercial banks don't pay out 50 percent of their revenues as compensation," said Christopher Whalen, a managing partner at Institutional Risk Analytics. "Banks simply aren't that profitable."
iht.com
Angry yet?
Furious yet?
Right wingers keep blaming poor people who took on mortgages they clearly could not afford. They were amateurs.
These people are PROFESSIONAL BORROWERS and look what damage they created. LET THEM FAIL. |
