The Reformed Broker
Joseph Giannone has a story up at Reuters that is undoubtedly coursing through the inboxes of brokerage firm employees across the country right now. In it, he captures some recent commentary from ex-Thundering Herd chief Lyle LaMothe, a Merrill Lynch broker-turned-executive who did his best to put on a brave face and make the B of A - Merrill Lynch combo work.
LaMothe ultimately threw in the towel last spring and has now set himself up as a consultant to the RIA industry. He is a sympathetic figure in the battle for the heart and soul of Wall Street as the wirehouses get more biggerer and focused on corporate profitability over the satisfaction of their brokers and clients.
LaMothe says brokers who are selling the entire bank - rather than being totally focused on wealth management - will not provide the best possible planning and investment advice.
The largest firms still enjoy great advantages, including scale, brand name recognition and a wide array of capabilities. But that lead could be squandered, he said.
"But unless these organizations find a way to deliver all these services seamlessly, and if talent continues to leave, they will lose their advantage.
A few points are in order here:
1. It's too late for the wirehouse model, the people have spoken. Assets and talent are slipping through the now-permeable membrane of the Financial-Industrial complex as pros and their clients wake up to the fact that investing advice should be paid for, not investing products. Giannone cites the following mind-blowing stats from Cerulli:
* Independent brokers and RIAs oversaw 35 percent of total U.S. client assets in 2010, up from 29 percent in 2007.
* Independents will boost that share to 40 percent by 2013 while that of the "wirehouses" will decline to 35 percent.
2. Nobody wants to be a salesman of products anymore, the most creative and conscientious brokers have left the "system" for the freedom of RIAland, where they can work only on their clients' behalf.
3. The "Reputation" thing is over - everyone knows that Merrill Lynch lost $39 billion OF THEIR OWN MONEY in 2008, the idea that the organization should be worthy of managing anyone elses money is so satirically delicious that it just has to be fattening.
4. There is no longer any technological advantage to working at a wirehouse, RIAs have access to any tool they want thanks to the web, the cloud and custodian broker-dealers they place assets with like Schwab, TD Ameritrade, Fidelity etc.
5. There is no longer any marketing advantage to working at a wirehouse, the commercials aren't working anymore, I don't care how many wedding toasts the brokers do for their clients' daughters. The words Morgan Stanley or Merrill Lynch used to be an "Open Sesame", they raised assets and magically brought in new accounts with just their being uttered in the right setting. Now the reaction to them falls somewhere between weary half-recognition of their continued existence and guarded disdain for, well, their continued existence.
6. The supermarket sucks. No one wants to cross-sell and no one wants to be cross-sold to. Please don't take my word for it, ask around. Sandy Weill's Frankenstein Bankenstein concept from the Travelers-Citi-Smith Barney menage a trois was DOA, it just took awhile for people to notice.
7. Those insanely rich deals from 2009 when the wirehouses made a mad grab to hang on to their disgusted and jaded producers begin rolling off this year. There will be many more breakaways than there will be prisoner exchanges (moving from one wirehouse to the next for a stoopid big signing bonus).
LaMothe, you did your best and I'm glad you've seen the light - bigger was never better, it just looked like it was. But the fact that you think this model has any future at all is counter-factual, even though the sentiment certainly is touching.
Sorry boys, the die is cast.
Funny story - I'm on the air today at 12 noon for the opening segment of Fast Money on CNBC. The topic is Apple ($AAPL) for a change and the stock is up like $25. And the talk turns from "maybe people should take profits" to "hey, imagine what happens if there's a blow-off top and Apple pulls the rest of the market down?" Keep in mind that Apple is once again like 16% of the QQQs and 10% of the S&P. It's also a psychological leader for obvious reasons.
I'm long the stock for customer accounts so I'm certainly not thrilled - but wouldn't ya know it, not 5 minutes later the stock loses half its gain on the day and by the end of the show, it's negative on the session. And right on cue, the rest of the market is dragged lower with a sinking Apple as anchor.
I have no idea if that's my fault, possibly the last ten points up in the stock were on fumes and profit-takers just needed any excuse. If this is the case, I hope Apple longs will forgive me.
Regular readers know I'm post-political, I find both parties to be equally useless and distasteful and Obama in particular to be well-meaning but misguided.
So don't take this as a partisan shot, just take it as frustration with something that I think could be a mess for the equity markets.
The President released his fiscal year 2013 budget this morning, he's looking to raise tax revenue as a percentage of GDP to 20.1%. And among the various ways he seeks to do that, a serious hammering of the investor class is on the menu...
- The capital gains rate will rise from 15% today to 23.8% next year. That's because the Obama budget assumes the pre-2001 capital gains rate of 20% for investors earning more than $250,000 per year. On top of this, the Obamcare surtax on investment will raise this rate to 23.8%. Separately, capital gains earned as "carried interest" will be taxed at ordinary income tax rates.
- The dividends rate will raise from 15% today to 43.4% next year. The Obama budget proposes taxing dividends for investors making more than $250,000 per year at ordinary income tax rates, which will rise to a top rate of 39.6% under the budget. In addition, the Obamacare surtax on investors will combine to nearly triple the tax rate on dividends in just one year.
- The real tax rate on capital gains and dividends is actually even higher than this. Since taxes on dividends and capital gains are a cascaded double taxation on savings, the rate is actually far higher than this. Before being taxed to investors as capital gains and dividends, the money first faced taxation as corporate profits. The U.S. has the highest corporate income tax rate in the developed world at 35%. When factoring this in, the Obama budget is actually proposing a capital gains tax rate of 50.5% and a dividends rate of 63.2%. That would leave U.S. employers and savers at a severe competitive disadvantage.
What impact would this have on the stock market - especially in light of the fact that cash-rich corporations are finally paying out dividends and people are in need of that equity income more than ever?
It's been over for the small broker-dealer model for awhile, but a hundred-year-old industry doesn't merely go away quietly and all at once. There were companies manufacturing typewriters and word processors into the late 90's and I'm sure the toga weavers were hard at work for decades after the fall of the Roman Empire.
And so it goes here in the early dawn of 2012 as two of the most well-regarded boutique broker-dealers have been extinguished against the backdrop of a raging bull market for everyone else...
The 2012 surge in the stock market hasn't been positive for everyone on Wall Street: Hundreds of small brokerage firms on death watch.
Trading volumes and commissions are at their lowest levels since 2007. And so far this year, three small but well-known brokerage firms have already had to call it quits.
The swift unwinding of WJB Capital Group, Ticonderoga Securities and Kaufman Brothers has left investors to wonder who's next. Representatives from WJB, Ticonderoga, and Kaufman did not return calls for comment.
Trading is now done at fractions of a penny, often with little or no research exchange between institutional brokers and their clients. Buyside shops have brought research in-house at very little cost (unemployed analysts are practically swinging from the rafters here in NYC). In addition, single stock selection has been de-emphasized a great deal as fund flows have turned from the open end actively managed fund complex to the passively managed ETF snackbar. When the average holding time for a security is measured in water drips from a faucet, why should anyone bother to care about how this quarter's free cash flow stacks up against next quarter's estimate?
And if the research isn't generating trades, and the trades that are getting done are subject to commission deflation (2 cents a share!) and on top of all that the firms can't supplement by making markets at a decent margin thanks to decimilization - well, what exactly is it...ya do here?
There are 4066 smaller brokerage firms left. I'm rooting for you guys, but it won't be easy.
Yesterday I linked to Gabriel Sherman's sprawling State of Wall Street piece in New York Magazine. There was one particular quote about the hedge fund industry's own little mini-crisis - anonymous of course - that deserves a highlighting here as quote o' the day...
“We used to rely on the public making dumb investing decisions,” one well-known Manhattan hedge-fund manager told me. “but with the advent of the public leaving the market, it’s just hedge funds trading against hedge funds. At the end of the day, it’s a zero-sum game.” Based on these numbers—too many funds with fewer dollars chasing too few trades—many have predicted a hedge-fund shakeout, and it seems to have started. Over 1,000 funds have closed in the past year and a half.
Sherman points out that there were 600 hedge funds in 1990, ten years later there were 4000. Now there are almost 10,000, a few thousand more than anyone really has any use for. The barriers to entry have basically disappeared (raise a million bucks, spend a third of it on admin stuff and you're in the game). But all of the data says that the bottom half of the industry is starving - virtually all of the flows have been going to the biggest funds out there for a few years now.
When Sherman says that the hedge fund industry is just as overbuilt as the credit and housing markets were, I completely agree.
I'm not proud of everything I learned to do in my retail brokerage days. I was almost too good at the job, which scared me and shook me to my core (which I like to think is a moral core). Because the job is based on salesmanship over stewardship, subterfuge over transparency.
I exorcised all of my demons in the forthcoming book Backstage Wall Street, but today I have a little bonus for you. There was an item in Registered Rep about how Morgan Stanley and Smith Barney advisors are fiending for their allocation of Facebook shares, the biggest piece of IPO product they've seen in like forever.
I have no idea how these brokers will parcel out the meager amount of shares they get, but if I were a broker, this is how I'd sell Facebook:
Step 1: I'd call all my best clients and tell them I have a limited amount of shares but my manager will only apportion Facebook IPO stock to the largest accounts. I would then forward them incoming transfer paperwork and tell them they needed to send in their other brokerage accounts to be above level X.
Step 2: I'd call all my midsized accounts and say the same thing. None of them would be getting any shares but I'd be able to raise a ton of assets with the longshot promise.
Step 3: I'd put my junior broker on the small accounts to do the same thing. Then I'd have him call all qualified prospective leads morning, noon, and night - the pitch would be something like this:
"Now obviously, when a hot deal like Facebook comes along, the lion's share goes to our biggest and best accounts. But we always keep a small amount aside for newer clients as a show of good faith that we intend to grow this relationship and look out for you when opportunities arise. If we can get you any of Facebook - and remember, we're not promising for sure that we can - how would you like your new account to be titled? Joint, individual or corporate?"
We'd open a slew of new accounts. The day of the deal, we'd say "The bad news is I couldn't get you any shares of Facebook, we had to take care of exisiting clients first. The good news is, my analysts just came out with a conviction buy rating on NVidia, ticker symbol NVDA. Pick up a thousand shares with me today and the next time a hot offering comes along, I promise I'll be able to take care of you." With that spiel, we'll convert probably 1 out of 5 of those new accounts to an actual trade, cowboy up!
Step 4: I'd go back to the all the other accounts the night before the deal and start breaking up what I was given by the selling group manager, even if it was only 5000 shares. Literally, everyone would get a hundred shares - that way I could keep everyone happy with the fact that I did my best and at least I came through with something.
Step 5: The day after the Facebook IPO went public, I'd call all the midsized accounts that didn't send in new assets to qualify, point to the Facebook share price and show them how much money everyone made. I'd ask for incoming transfers again.
The net result of this would be a few million bucks "new money" raised, the selling concession on the Facebook shares (figure 5% of however much I was given to book) and a slew of new clients opened based on the bait-and-switch pitch my junior broker closed them with.
Tada! And that's how it's done, folks.
And don't laugh...as we speak there are hundreds (thousands?) of guys doing exactly that right now. I'm glad to be "reformed."
Regular readers here know I've been talking about this phenomenon for two years now - the Emperors have been found to have had no clothes all along and what was seen by America in 2008 cannot be unseen. They couldn't even manage their own money, so now, post-crisis, we are way less inclined to allow them to manage ours.
It's all over but the crying and a new cycle won't change that. People who really believed that their work was worthy of an automatic seven-figure annual salary are finding that they are replaceable or even superfluous now that banks are going to be regulated and held responsible for their actions going forward (we hope). The simple fact of the matter is that Wall Street's megabanks without leverage and a cyclical bull market are nothing special and now everybody knows it.
Banks have always had occasional bad years, but the sense on Wall Street is that this bad year is different. Over the past several weeks, I have had wide-ranging conversations with more than two dozen senior Wall Street executives, traders, bankers, hedge-fund managers, and private-equity investors. And what emerged is a picture of an industry afflicted by a crisis it would not be flip to call existential.
Read the whole thing, this is key.
The Emperor never had any clothes to begin with - just a good spot in an up-cycle with cheap cost-of-capital and an endless capacity to leverage it. Toss in a hint of government influence and a dash of deregulation and you get an amazing profit machine, until it's all taken too far.
But now we see how these banks look in a recovery without the extraordinary tailwind of the mid-aughts. And it ain't nothing spectacular.
Now bonuses are being chopped by up 60% and even the junior levels at the big investment banks are seeing position cuts. Because there was never any alchemy or magic at work to begin with and the new rules and realities lay this truth bare for all to see.
The banks have a certain amount of equity, the capital they can use to generate profits. But there is now less that they can do with that equity and this fantastic explanation from DealBook shows how that affects these companies:
On Wall Street, much depends on a financial performance metric, return on equity, which effectively measures the profits a bank was able to generate on its capital. If a bank made $1 billion in profits on $10 billion of equity, its return on equity would be 10 percent.
In the middle of last year, Goldman Sachs’s target for return on equity was 20 percent, though the firm has since retreated from setting a target, citing the uncertainty in its business. Its actual return last year was only 3.7 percent, compared with 33 percent in 2006. Morgan Stanley managed 4 percent in 2011, compared with 23.5 percent in 2006.
Analysts estimate that Goldman effectively pays 10 to 15 percent for its capital. As a result, in 2011, the firm did not even cover the cost of its capital.
When I go on TV and explain to people that this incontrovertible fact keeps me out of the i-bank stocks, I get a lot of pushback still. If you want the other side of my trade, then you have to believe that the rules are going to loosen up fairly soon so The Street can once again activate the dancefloor.
I doubt this will be the case. If the economy improves these banks will do okay, but think about all the areas that will do so much better.
Man, has this game gotten tough. Anyone who tells you it's easy is a charlatan.
Even the supposed "best and brightest" in the hedge fund industry are struggling - and the investors are saying hasta la vista.
Here's Steve Eder at the Wall Street Journal:
Hedge-fund investors, rattled by lackluster performance, yanked more money from the industry than they added during the final months of 2011, data released Thursday showed.
The $2 trillion hedge-fund industry saw net investor withdrawals of about $127 million in the fourth quarter, according to data by Hedge Fund Research Inc. It was the first time investors had collectively pulled out more money than they put in since the second quarter of 2009, when the markets were still digging out of the worst of the financial crisis.
While the net withdrawals amounted to a tiny portion, 0.007%, of the industry's total assets, the pullback signals that some investors are losing patience. In each of the past three years, hedge funds' average returns have trailed the benchmark stock indexes, including the Standard & Poor's 500-stock index.
The amounts are small, but the chasm between large funds and small is widening.
It's not enough to just be a hedge fund anymore. Now you have to actually perform. Big shift.
I mean, that's the headline - is it not? Jobless Claims are a noisy number for many reasons but when taken as a trend, they are meaningful and they are leading jobs indicator if not a leading economic indicator.
Sure, it's one piece of the puzzle, but a 3rd grader can understand this concept - less people claiming unemployment benefits is a good thing.
Here's the AP with this morning's report:
The number of people seeking unemployment benefits plummeted last week to 352,000, the fewest since April 2008. The decline added to evidence that the job market is strengthening.
Applications fell 50,000, the biggest drop in the seasonally adjusted figure in more than six years, the Labor Department said Thursday. The four-week average, which smooths out fluctuations, dropped to 379,000. That's the second-lowest such figure in more than three years.
Plenty to dislike out there, but not this.