Trying To Make Sense of The Brokerage Bust

Fifty to a hundred thousand high paying jobs are going to go up in smoke in NYC before this is all over. It’s a mess for this city, tax revenues are going to be down, real estate prices are going to be down, restaurants will fail, etc, etc. We’ll get through it for sure, we always have, but it’s going to suck for a while. As my friend Mo said, "I sure wish Bloomberg would get another four years because we are going to need him"

But beyond all that, is this really that bad? I’ve been thinking a lot about what Howard said on tech ticker last week (roughly 3:35 min into the video).

"the brokerage business is changing, this is what’s going on, ….. the stock broker as we know it is gone, hedge funds are making markets, we are witnessing the destruction of an industry"

Those of us who work in the tech business are used to this sort of thing. Capitalism is darwinism and technology driven darwinism has impacted the tech industry more than any other. Where is DEC now? Where is Wang now? Where is Novell (not dead yet)?

But technology driven darwinism is hitting every industry these days. People tend to think of the newspaper or music business when they think of industries that are being destroyed by technology, but we have to admit the same thing is happening to the traditional investment banking and brokerage industry.

Andy Kessler, a former wall streeter who moved to silicon valley and never looked back has it right when he wrote this the other day:

Analogies only go so far, but Wall Street got caught in the same
wringer (as airlines). Deregulated since 1975, balance sheets grew and grew as money
got thrown at the profitable business of trading stocks and bonds,
investment banking and money management. In the cheap-money period of
2002 to 2007, Wall Street’s thirst for capital saw no limits.

Inevitably, too many players and a bit of technology in the form of
electronic trading squeezed the profitability of Wall Streets
bread-and-butter businesses.

… With profits fading in baseline
businesses, firms discovered the trick of using their huge capital to
borrow short term cheaply and lend long in the form of subprime
mortgages.

Traditional banks can get away with this because they borrow short
term from their depositors, who are usually loyal and lazy, happy to
keep their money in the bank, under-earning, in exchange for perks like
free checking and ubiquitous ATM machines.

Investment banks have no such luxury of stupid people to borrow from. Instead, they
borrow from one another and from institutional investors: all
short-term paper. When the subprime "easy money" loans turned toxic,
the short-term facilities fled for safer ground. Hence the flushing
sound you are hearing all over Wall Street.

So now Wall Street consolidates. Should you care? Not even for an
instant. I spent 20+ years on Wall Street, competing against scores and
scores of firms, always wondering what they all really did. E.F.
Hutton. Shearson, Drexel. Heck, I even worked for PaineWebber in my
early days (daze?) on the Street. All gone. And nobody misses them.

The true money-makers all find jobs elsewhere. The worker bees in
the middle tier see disruption, but are eventually absorbed into the
reconstructed Wall Street. The bottom tier goes to work at Foot Locker.

That last bit about footlocker is harsh but maybe true. The rest I totally agree with. Hedge funds are taking over more and more of the asset management and trading business. Technology is taking over more and more of the sales and clearing businesses. The brokerage business is being redefined, rebuilt, and reorganized.

So let’s not flip out too much about this brokerage bust. It’s going to hurt in the short term here in NYC and the effects will be felt on main street and even in the venture business. But in the long term this is all good. That’s why we need to be careful with all of this bailout activity. It’s not just moral hazard, it’s propping up bad businesses that need to fail so talent and capital can move to more productive efforts.