Backstage on Wall Street

On Saturday mornings, I like to browse and digest the current weeks issues of Time Magazine and Newsweek. I have subscribed to them since the 1980s and I have piles of old issues on paper, but no more. From this issue Newsweek is published only on iPad and other digital media. This transformation of the publishing industry is a significant sign of disruptive innovation and it will be the topic of a future blog post. However today we will once more go into the deep oceans of finance.  For this we have good company.

In this weeks issue of Newsweek magazine, the author Tom Wolfe has written an article about how the stage of world finance is changing in recent years.

The article is a really good read, as can be expected from Wolfe. It is full of facts, anecdotes and smart connections. I highly recommend it. It reminds us on how financial advice on Wall Street has been far from straight forward, but rather full of conflict, soaked in fees on top of fees, over-saturated with investment products and full of coaxing marketing campaigns. Then to top it all off, there was no fiduciary standard in place to protect retail investors, sometimes referred to as “Muppets”.

However the world of macho traders and salesmen, riddled with testosterone and being compensated with seven figure annual bonuses is changing. According to Tom Wolfe, they have and are being replaced as financiers by the Quants and their hedge funds, where May 2012 marked the dividing line between the old and the new time of high end finance.

Twenty five years ago, Tom Wolfe wrote a book that both reflected and inspired the greed culture of Wall Street in the 1980s. The book was called Bonfire of the Vanities and it describes the fictional Wall Street salesperson Sherman McCoy, a “Master of the Universe” who has it all, a Park Avenue apartment, a job that brings wealth, power and prestige, a beautiful wife and an even more beautiful mistress.  

Suddenly, one wrong turn makes it all go wrong, and Sherman spirals downward in a sudden fall from grace that sucks him into the vortex of a New York City gone mad during the yuppie era. 

The book  described a time of excess, with the unprecedented explosion of the financial markets during the de-regulations of the Reagan era, that both fueled the wealth creation in western societies of the recent decades and also lay the foundation of the demise of growth. 

The books title was a metaphor to the historical Bonfire of the Vanities, which happened on 7 February 1497 in Florence, Italy, when the city was under the rule of the Dominican priest Girolamo Savonarola. It was a purge when supporters of Savonarola collected and publicly burned thousands of objects like cosmetics, art, books and other objects that might tempt people to sin. Sadly, according to the contemporary art historian Giorgio Vasari, even paintings of the master painter Botticelli were burned.

Below is a clip with the opening scene from the movie that was adapted from the book.

Bonfire of the Vanities is considered one of three books that defined Wall Street during the 1980, together with the non-fiction books Liars Poker by Michael Lewis and Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar.

What is interesting with Tom Wolfe´s article this week is that the excess of the 1980s seems moderate, even modest by todays standards and the polarization of the society is much stronger today. Wolfe tackles the issue of where it all went wrong and how the new Masters of the Universe are the mathematics wizards and hedge fund gurus on campuses in the countryside in Connecticut and Vermont, far from the hectic Manhattan, making money on high frequency trading, as we have described in a previous blog post.

Interestingly, he story centers on Mark Zuckerberg and the apex of the history of American capitalism in the 21st century; the disastrous floatation of Facebook stock in May 2012. How the old investment banks failed with their biggest deal and how this meant the final breakdown of the old hegemony on Wall Street.

Below is an interview with Tom Wolfe, about the Bonfire and the current times.

The global financial crisis of 2008,  is considered by economists to be the worst financial crisis since the Great Depression of the 1930s. It was was triggered not by war or recession but by a crazy, man-made money machine, built on flawed mathematical models that even most people on Wall Street did not really understand themselves.

It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world and it initiated the 2008–2012 global recession and contributed to the European sovereign-debt crises.

Greedy and heedless, Wall Street firms had been turning subprime mortgages, loans made to people with low creditworthiness or little documentation, into exotic, toxic financial products that they made a fortune laundering and reselling, and they were enabled in doing so by the very ratings agencies that were supposed to police risk.

Meanwhile during recent years, a select few on Wall Street continued to make fortunes. Tom Wolfe makes an introduction to some of them in his article, but for the reader who wants to know more,  there is another book that tells the inside story.

The Big Short: Inside the Doomsday Machine is a 2010 non-fiction book by Michael Lewis about the build-up of the housing and credit bubble during the 2000s. Michael Lewis knows his subject. He was the author of Liars Poker, one of the books about the 1980s that I mentioned above.

The Liars Poker described Lewis years as a bond trader with Solomon Brothers. The new book describes a much more complex world of finance, and introduces several of the key players in the creation of the credit default swap market that sought to bet against the collateralized debt obligation bubble and thus ended up profiting from the financial crisis of 2007–2010.

The book also highlights the eccentric nature of the type of person who bets against the market or goes against the grain. What is delightful about Lewis writing is how well he explains and demystifies how things really work on Wall Street, even while creating a compelling narrative and introducing us to a cast of fascinating, all-too-human characters. If you read only one book about the causes of the financial crisis, let it be Michael Lewis’s, "The Big Short."