It hasn’t always been this way. Within the industry, it’s tempting to think that trust can be regained by reputation management. Reputation is seen largely as a function of communications or PR departments in 50% of companies in one survey.
But it goes deeper than that – deeper even than enlightened views of reputation management. There are serious structural issues that have driven down trust in the sector, and it’s hard to see how trust can be restored without directly addressing some of them.
But let’s let you be the judge of that. Here are Six Reasons we’ve lost trust in Wall Street.
1. “Wall Street” Ain’t What It Used to Be. In 1950, a discussion of “Wall Street” unambiguously meant the NYSE, the Big Board, and brokerage firms like E.F. Hutton. Today, Wikipedia says:
The term has become a metonym for the financial markets of the United States as a whole, the American financial sector (even if financial firms are not physically located there), or signifying New York-based financial interests.
That means “Wall Street” came to include commercial banking (think Chase and Bank of America), mutual funds, hedge funds, investment and trading operations like Goldman Sachs, private equity, and insurance companies like AIG. I think it’s fair to say the “new” financial businesses have had more than their share of the negative press that financial services has gotten over the years.
Many years ago, the president of GM could say – in good conscience – “What’s good for General Motors is good for America.” Can you picture Lloyd Blankfein saying, “What’s good for Goldman Sachs is good for America” with a straight face?
2. Finance Has Shifted to Zero-sum Uses. In traditional banking, borrowers create increased value with the money they borrow from lenders and put to good economic use. By contrast, in pure trading, no value is created. It is a zero-sum proposition. And the proportion of the financial sector represented by essentially pure trading has increased dramatically.
At the same time, Paul Volcker says the financial services’ share of “value-add “in the US economy grew from 2% to 6.5%. That’s not “value added” in the economic sense – it’s just an increase in price over cost. And, Volcker added, it was due not to innovation, but to increased compensation. As he famously put it, “The biggest innovation in the industry over the past 20 years was the ATM machine.”
Wall Street has increasingly focused on the “point spread,” not the fundamentals. In the NFL, they don’t let players bet on point spreads. But on Wall Street, that’s the name of the game.
The industry’s counter to such data is that they have increased liquidity, thereby lowering risk and volatility. Yet volatility in the stock market has steadily increased for decades, while the industry has gotten less efficient. And “black swans” have become part of our lexicon – we have massively underestimated risk. The value of the added liquidity is far outweighed by the risks it has entailed.
3. Finance Is a Larger Part of the Economy. In 1950, the US financial sector accounted for 2.8% of GDP. By 2011, that number had grown to 8.4%. In 2011, the financial industry generated 29% of all US profits. That proportion had never exceeded 20% in all of the 20th Century. From 1980 to 2010, the profit per employee in the financial sector of the US economy grew by over a thousand percent – far more than all the rest.
And as finance became less efficient, more profitable, and more zero-sum oriented, it also came to dominate business more. In 1937, 1 percent of the graduates of Harvard Business School went into finance. In 2008, that number hit 45%.
4. The Shift to the Short Term.
As of 2011, 60% of the daily turnover in US stock markets was accounted for by high-frequency trading something that didn’t exist a decade before. In 1960, the average holding period for stocks on the NYSE was 8 years. By 2010, it was down to 3-4 months.
In 1950, the marginal tax rate was 85%, putting a brake on short-term trading, since capital gains taxation of 25% kicked in only after 6 months.
A short-term mentality has always plagued the US in comparison to Europe and especially Asia. The shorter the timeframe, the more focused we become on transactions, and the less value we place on relationships. And that kills trust.
5. The Transactionalization of Finance. J.P. Morgan once said, “A man I do not trust could not get money from me on all the bonds in Christendom.” For several years now, we’ve had the IBGYBG problem on Wall Street: “I’ll be gone, you’ll be gone – do the deal, who cares.”
Can you say “moral hazard?”
In the Christmas movie It’s a Wonderful Life, local employees of a local bank lend mortgage funds to local borrowers, with the bank then holding the mortgage itself. By 2007, the lending was done by non-local employees of non-local mortgage companies who then resold the mortgage to non-local banks, who then securitized and sold to global investors. A relationship business had become thoroughly transactionalized. This drives down trust.
6. The Attack on Regulation. The LIBOR rate-rigging scandal shocked everyone last year. But rate-rigging turned out to be not a bug, but a feature. The chairman of the CFTC said LIBOR rates “are basically more akin to fiction than fact.” The truth is more like the Wizard of Oz saying, “Pay no attention to that man behind the curtain.”
It’s a market that turned out to be mythical – can you say “Bernie Madoff?”
The Glass-Steagall Act was repealed in the late 90s, arguably giving free reign to bankers to misbehave. The industry has fought consumer legislation governing things like credit card costs, not to mention the mix of Dodd-Frank rules.
It’s hard to trust an industry which visibly and without much embarrassment argues for more and more, after the rather remarkable feast of the last two decades.
The solutions to trust issues that I hear about most coming from the financial services industry tend to be reputation management and personal trustworthiness. I do believe that both these tools – especially personal trustworthiness – could be applied to great effect in certain financial sectors – notably financial planning, wealth management, traditional investment banking, and commercial lending.
But that’s not where the money is, nor where the biggest problems lie. And it’s going to take a whole lot more than the usual approach to reputation management to deal with them.
Until the sector can address those six areas of structural disconnect, the issues of trustworthiness will continue to dog the industry.