Big Banks Prized Deal with the Devil
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In case you're not aware, JP Morgan (NYSE: JPM) announced they had lost two Bills (billion) last week, sending the stock, and that of other banks spiraling downwards. JP Morgan and their CEO Jamie Dimon, who were the fiercest critics of the Volcker Rule which was designed to prevent commercial banks which citizens entrust with their hard earned money to use these deposits for trading and hedges, and with the staggering sums bet, asking us for another bailout. This of course applies to all banks deemed too big to fail, and investment banks such as Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), Citigroup (NYSE: C), and Morgan Stanley (NYSE: MS) ....
Piles of money surround you, fast cars, hot women in miniskirts display their long legs, mansions, all the things Madison Avenue convinces you are necessary to be happy.
"All this can be yours," says your host in the dashing red cape with the small horns sticking out of his skull.
"What's the catch? My soul?"
He laughs and throws his arm around over your shoulder, escorting you into the casino. "You'll have an advantage over the house," he states, "We let you cheat."
"How?" you ask dubiously.
"High frequency trading, front running, inside information." You look up and notice the signpost reads Wall Street. "Just sit back, make conservative bets, and in a ten years, you can go off and retire on some tropical island," he explains.
"I'm not signing anything in blood."
"No need," he replies, his tone still easy going but his eyes narrowing. You look out behind you, there's a million man line of 20 and 30 somethings dying just to get a glimpse of what's before you.
"Where do I start?"
"Trading desk," he replies, walking away and letting his underlings take your coat and get you situated. It feels like heaven, but it's not.
A year later you are doing well. Very well in fact. You take little risk and via the fabulous method called "cheating" you have become a real earner, but you're not at "Big Pimp" level yet, though your ego craves it. You do however have an enormous amount of chips at your command, the number entrusted to you has grown with your success. It would, however, be nice to speed things up.
This is the challenge for the investment banker. These are temptations, you go to New York, and you see the life of your ultra-rich friends around you. Piles and piles of money. The house in the Hamptons, the models, fine dining, Broadway Shows, all the cream that is offerred in modern society.
When you deal with large sums of money, all but the most principled person may at minimum feel tempted. When you see those around you making fortunes, why not follow suit. And when it's not "your" money, when the worst that will happen is that you'll lose your job, as has happened at JP Morgan, with your bonus intact, what prevents you from taking excessive risk?
Worst of all is the fact that these big banks are deemed too big to fail. Charlie Munger himself (Berkshire Hathaway) has said that we were incredibly lucky to get away with as little downside as we did following the financial crisis, and believes that the Federal Reserve acted rightly. He also believes that all the risk that banks take is completely unnecessary, and that the stock market should be a means to raise money for productive companies so they can actually go out and make products that better humanity. "We need innovations in widget production, not financial products," Munger states.
Worst of all, the big banks, because of the possibility of being bailed out by the government, have the unfair competitive advantage of lower costs of capital. It works like this: I know you have a really really wealthy Uncle, let's call him Sam, who believes that if your business were to fall apart, that the entire family would be ruined, and he'll run to lend you money and prop up the business. If you, as acreditor, knew this, wouldn't you be willing to lend me money at a cheaper rate, as there is less risk? This is anti-competitive as in a sense the government is choosing the winners.
What's worse, is that bankers, naturally, this being human nature and all, want to keep exposing themselves to risk, want to keep earning massive amounts of money, even after the first banking crisis, after all those horrific greedy bets that came so close to sending the country into a depression.
A little background- after the market crash of 1929, during which people were also leveraged to the hilt, the Glass–Steagall Act was passed, which created the FDIC and separated commercial banking from investment banking, so that in a fit of gambling and greed, employees of the big banks couldn't bet customer deposits and lose them. Banking stayed boring til 1998, when Bill Clinton repealed the law. Then of course we came really close a few years ago to causing systemic financial failure, and good old Congress opened up taxpayer pockets, and sent out huge sums of money to nurse the banks back to health.
Now there is this big battle over bank regulation, where former fed Chairman Paul Volcker stated that speculative activity by the big banks and investment houses played a big role in the financial crisis., and that the amount of risk should be reined in, and that banks shouldn't be able to trade with customer deposits.
And banks lobby against these "onerous, restrictive rules." Are they really? Do they "slow down the wheels of capitalism?" Some would argue yes, I argue that you don't want to have a bunch of steroidally charged gamblers driving around these massively leveraged turbo charged trucks around our highways, believing they're above it all, when history, time and time again has proven they are not.
Back to our story as our investment banker craves "Big Pimp" status:
"I mean, I haven't missed on one bet I have placed."
"And the idea that government should provide guard rails so that our train doesn't derail. It's absurd, it slows us down."
"Screw this. I'm the top earner over the last six months. I know for sure that roulette wheel's going to come up red. Hell, I'll hedge a little on black. 2 billion on red please."
Dealer: "Green, zero."
He wipes up the chips, you sit there shell shocked. The Big Boss comes over and nods his head.
"Well, you're going to have to leave the game. That was pretty stupid."
"Oh my God, I can't believe that just happened. There's no way, I mean statistically ..."
Big Boss nods his head. "Relax, it's nothing the taxpayer can't handle."
He speaks into his iPhone. “Get The Chumps on the line Siri.”
Siri: “Calling Washington.”
Video: If you don't know what front running is/ high frequency trading is- this video explains
funspirit is long BAC. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short APR 2012 $21.00 puts on Wells Fargo & Company, short APR 2012 $29.00 calls on Wells Fargo & Company, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.