The Battle for Wall Street

Behind the Lines in the Struggle that Pushed an Industry into Turmoil

Richard Goldberg

• Publisher: Wiley
• Year: 2009
• Print ISBN:
  9781118836750
  9780470222799
• eBook ISBN:
  9780470446812
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Finanzwesen

An insider's look at the changing balance of power on Wall Street

The Battle for Wall Street follows the struggle for power between two giants: the sellers, traditional commercial and investments banks; and the buyers, upstart hedge funds, private equity firms and the like. The battle is about winning the hearts, minds, and – yes, the wallets – of global investors. This battle is still running its course, and with the insights of industry veteran Richard Goldberg, who has had a front row seat, readers will gain a detailed understanding as to what, exactly, is going on within this dynamic arena, specifically the forces behind the shift of power from the old sell side gatekeepers to the new buy side players.  The book will play out in three acts: Act One will examine the instruments of change – liquidity and financial technology – along with their influence on the sell and buy sides. Act Two will look at the agents of change – hedge funds, private equity, financial entrepreneurs, endowments, exchanges and sovereign wealth funds – and their impact on the sell and buy sides. In Act Three, Goldberg will take out his crystal ball and walk through the strategic implications for the winners and losers in this battle, against the dramatic backdrop of the subprime mortgage crisis and the resulting shakeup of global firms like Bear Stearns.

But Wall Street isn't simply about institutions or corporate battles. It's a landscape dominated by personalities. Goldberg's unique access to major players will bring this book to life with amazing anecdotes and stories about the financial generals who have left their mark in The Battle for Wall Street.

Part One

INSTRUMENTS OF CHANGE

Chapter 1

Sea of Liquidity

Can you have too much money, so much that you spend it unwisely? Can having less money give you a competitive advantage over those with more?

I think the answer to these questions is “definitely yes.” And before you tell me that I’m crazy, I’ll explain. No, I’m not turning in my Wall Street name tag just yet and taking a vow of poverty.

It’s just that money, in the form of the sell side’s balance sheet and liquidity, can make the sell side act in ways that are open to debate.

One of the strengths of the sell side has been its lofty liquidity position, specifically its access to capital. That’s why the buy side has made many withdrawals from the sell side’s ATM since traders and speculators first negotiated a truce they called the Buttonwood Agreement, which laid the groundwork for the New York Stock Exchange.

The sell side readily financed the needs of the buy side because it enjoyed the transaction fees it was getting in return. What it didn’t fully realize was that it was supercharging the buy side’s growth by providing it with the deadliest weapon—liquidity.With liquidity as their ammunition, hedge funds and private equity funds became formidable competitors.

It was as though the sell side was providing weapons to the buy side, which the buy side used to its advantage to propel its growth. It was a battle the sell side didn’t quite realize it was entering. Today, it’s too late for the sell side to do anything about it—except play its own hand while emulating its progeny.

I saw the sell side from a front-row seat, and a question pops up. Did it act downright “liquidity silly” during the rise of the buy side? If you want to understand the Battle for Wall Street, liquidity is a good place to start.

Overplaying Your Ammunition

The summer of 2000 was filled with news about the presidential election as well as some heavy-hitting stories about sell-side firms merging with each other: UBS merged with Paine Webber;¹ JPMorgan merged with Chase;² and AXA Financial sold its majority stake in Donaldson, Lufkin & Jenrette (DLJ) to Credit Suisse.³ These skirmishes within the larger Battle for Wall Street demonstrated sell-siders duking it out amongst themselves.

These deals filled not only the airwaves, but also the hallways of my old firm.We were involved particularly with AXA, which sold its majority stake in DLJ to Credit Suisse—a timely move, by my calculation.⁴ By divesting itself of DLJ (which was a major sell-side player), AXA got out of one meaningful sell-side business just as the buy side was starting its ascendancy. It wisely decided to shift its focus toward the buy side.

A few months after AXA sold DLJ, it acquired Sanford Bernstein, a major money management firm, which it subsequently combined with its existing Alliance Capital Management.⁵ Today, Alliance Bernstein is a major player in the buy-side business of money management.

Looking back at the Credit Suisse/DLJ transaction today, it paid about $13.7 billion for . . . what?⁶

That transaction—any transaction—is debatable. On one hand, Credit Suisse acquired a number of quality businesses. Three come to mind: a leverage finance business (funding companies with a greater-than-normal debt-to-equity ratio)⁷ ; a high-yield bond business (offering bonds rated below investment grade)⁸; and a merchant bank (providing investment bank services to multinational corporations).⁹

On the other hand, a good deal of what is bought on Wall Street is talent: the human capital at the firms being acquired.Yet, some of the talent Credit Suisse set out to acquire—the people who were part of the DLJ franchise—left after the merger.

And where did they go? A healthy number went to the buy side. After all, the size of a combined organization like Credit Suisse/DLJ may not have been a selling point. Two primary benefits offered by a big organization like Credit Suisse—technology and liquidity—were becoming more available to the buy side just as Credit Suisse was plunking down its billions.

Whereas the AXA buy-side expansion in the early 2000s was timely, the Credit Suisse/DLJ timing in 2000 may have been off from both a technology and a liquidity angle.

Technology was becoming less expensive and more powerful, and the information that could be gleaned from it was better and broader. One of the edges that investment bankers had—information—was being eroded by the technology, which made that information much more readily accessible. (I’ll cover this explosion in technology in the next chapter. Actually, explosion is an understatement—it was more like a line of cannons blasting its way through a crumbling Maginot line.)

And the buy side was building up its liquidity. While the sell side still had an edge, it was quickly being eroded. The folks at the investment banks saw this happening and were heading for the doors. Those investment bankers who stayed home saw that the sell side had more liquidity than it could usefully deploy.

A quote that is often attributed to Wallis Simpson, Duchess of Windsor, says, “You can never be too rich or too thin.” I don’t know about the thin part, but I believe you can be too rich, and it is possible that the sell side was in this position, to its detriment.

For example, did NationsBank (now Bank of America) and General Electric overplay their balance-sheet and liquidity positions in acquiring sell-side firms? NationsBank bought Montgomery Securities,¹⁰ while General Electric bought Kidder Peabody.¹¹ Today, both sell-side firms are history.

Let’s look at the sell side’s misusing its liquidity to win business.When giving advice on mergers and acquisitions or capital markets, a number of firms tend to give away liquidity as well. They do this by telling a prospective customer that, if hired to manage a deal, they will provide more attractive funding as well.

The buy side, however, doesn’t get involved with those types of deals. It doesn’t finance its customers, and can be smarter with decisions regarding its use of capital. As such, it can avoid this liquidity trap.

Bottom Line

In the liquidity race, the sell side should be a step ahead of the buy side, but recently it does not seem to be using this benefit to its advantage. When it stretches the liquidity band and/or the balance-sheet band, and tries to overreach for, say, market share or earnings, either band can snap back. When it does, the sell side stumbles; it falls a step behind the buy side.

I call that a fall from grace.

The King

There is an aphorism in the business world that has become so widely used that it’s now a cliché: “Cash is king.”

While this phrase may sound trite, no one I know on Wall Street disputes its accuracy or relevance. Cash, or should I say capital, is the lifeblood of every business. A company’s growth, even survival, depends on it. This is one of the primary reasons that the sell side was the king of the financial world for so many years: It provided corporations with windows on capital or—to use the more technical term—liquidity.

Liquidity

“Liquidity, in the financial sense, is a measure of the ease with which one asset can be traded for another. Land . . . is usually considered the least liquid of investments. Alternatively, cash is the most liquid.”

Source: John Steele Gordon, The Great Game. New York: Scribner, 1999, p. 186.

Companies are always keen for fresh capital to increase their profits and, ultimately, their valuation—whether it’s their stock price (if they’re publicly traded) or their franchise value (if they’re privately held).

For a long time, it was impossible for companies to go directly to investors for capital because investors were often fragmented and scattered. Sell-side bankers justified their fees, in part, by being the ones who could coax money from investors, gather it all in one place, and make it available to corporations. They were like the generals of mercenary armies, able to bring together men and materiel—for a price. These investment banking generals are navigating through a very different battlefield in 2008, which I will cover later in the book.

They could have said, “We have the sales relationships, we know where those with money are located, we know who likes to invest in autos or aerospace or technology or whichever industry you are in, and we alone have the wherewithal to make your deal happen.”

The investment bankers of the sell side held the keys to the vault—always a good position to be in. In this vault was access to the public and private markets, as well as the sell side’s own capital, which the sell side used to create liquidity that, in turn, was used to hold sway over the buy side.

And these investment bankers had—and have—additional powers at their command. The brains, brawn, and capital to create secondary markets were theirs. They knew, better than anyone else, which investors held which stocks and bonds, and they had relationships with many of them.They understood the markets best, had the skills needed to value companies, and knew how various types of issues were traded. They had the sophistication and institutional structure required to raise money for virtually every type of company, using any type of asset class.

Hedge Fund

“An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short, and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).”

Source: Investopedia, www.investopedia.com/terms/h/hedgefund.asp.

Sounds good, right? Wrong. And we can thank liquidity for that.

In this Battle for Wall Street, liquidity has played a major role. Historically, the sell side was a bridge to investors’ capital. But with greater liquidity, the buy side has been able to gather an investor capital base that was unthinkable in the past.

For example, a half dozen guys could set up shop in Greenwich, Manhattan, or wherever, pull out their electronic Rolodexes, make some calls to moneyed folk they know, and raise hundreds of millions of dollars or more to start a hedge fund. Not that long ago, such an enterprise would have been impossible.

What was also at one time unthinkable—explosive hedge fund growth—is today a fact. In the last 20 years, the number of hedge funds has grown from 100 to approximately 10,000, and their assets under management have gone from $20 billion to several trillion dollars. ¹² That’s a lot of hedge funds and a lot of assets; thank you, liquidity.

As an example of how active—and important—hedge funds have become, there was a time when investment bankers, underwriting securities, refused to allocate part of their offerings to hedge funds because these funds were considered to be hot money, “flippers,” rather than long-term players. Today, the investment bankers are singing a different tune: one of their first phone calls is to the hedge funds.

Bottom Line

The rise of hedge funds to their current pinnacle of prominence is due, in part, to the expansion of liquidity and the buy side’s embrace of it, as well as its ability to use it to its advantage. There’s more to liquidity than just the rise of hedge funds.

Long Live the King

Liquidity creates progeny. Collateralized mortgage obligations (CMOs) are an example. Before CMOs, commercial banks typically handled mortgages. Now, mortgages are sliced and diced into tranches (single stages within a series of staged investments) based on different risk and yield levels.This has had the effect of increasing the variety of risks and ...

Table of contents

• Title Page
• Copyright Page
• Dedication
• Acknowledgements
• Introduction
• Part One - INSTRUMENTS OF CHANGE
• Part Two - AGENTS OF CHANGE
• Part Three - IMPLICATIONS OF CHANGE
• Notes
• About the Author
• Index