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Monday, March 30, 2009

How Wall Street got where it is

In the never ending quest to figure out what went wrong with Wall Street, this article from last September, Newsweek: Wall Street’s Unraveling: How greed and fear collapsed the market's business model, by Robert J. Samuelson, gets into the nature of the situation in an easy to understand way:

First, financial firms have moved beyond their traditional roles as advisers and intermediaries. Once, major investment banks such as Goldman Sachs and Lehman worked mainly for their clients. They traded stocks and bonds for major institutional investors (insurance companies, pension funds, mutual funds). They raised capital for companies by underwriting—selling—new stocks and bonds for the firms. They provided advice to corporate clients on mergers, acquisitions and spinoffs. All these services earned fees.
Second, Wall Street's compensation is heavily skewed toward annual bonuses, reflecting the profits traders and managers earned in the year. Despite lavish base salaries, bonuses dominate. Managing directors with 15 years' experience can receive bonuses five to 10 times their base salaries of $200,000 to $300,000.
Finally, investment banks rely heavily on borrowed money, called "leverage" in financial lingo. Lehman was typical. In late 2007, it held almost $700 billion in stocks, bonds and other securities. Meanwhile, its shareholders' investment (equity) was about $23 billion. All the rest was supported by borrowings. The "leverage ratio" was 30 to 1.

Read the whole thing. [Via.]

Posted by Marie at March 30, 2009 10:40 PM


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