Tuesday, September 23, 2008

Michael Lewis on banking fees

This is an article by popular Wall Street writer, Michael Lewis from back in April 2002. In light of the events of the last year, I will reprint it in its full brevity, and let the reader figure out its relevance to what has happened in the financial industry.

How Banking Fees Corrupt Wall Street, By Michael Lewis Commentary. Michael Lewis, the author of "Liar's Poker" and "The New New Thing," is a columnist for Bloomberg News. The opinions expressed are his own.

Berkeley, California, April 18 (Bloomberg) A report this week that Goldman Sachs Group Inc. declined General Electric Co.'s request for a $1 billion line of credit was the most-read article on Bloomberg. Small wonder.

The world's largest corporation, warned by Moody's Investors Service that its credit rating might slip if it didn't line up more backing for its short-term borrowings, had asked the world's toniest investment bank to lend it money and was turned down. Amazingly, this was treated by many not as a warning signal about GE but as a problem for Goldman Sachs.

The general view, implicitly accepted by the 11 banks and Wall Street firms that bowed to GE's credit demands, was that any firm that didn't give GE what it wanted would be excluded when it came time for GE to dole out its huge banking fees. As the former head of corporate bond research at Deutsche Bank AG put it, "If you say no to GE, you get banished to the underworld."

This is a perversion of the way capital markets are supposed to work. In essence, GE, along with many other big US companies, has been demanding that Wall Street firms extend lines of credit they otherwise would not, in exchange for future banking fees.


The logic of the Wall Street response -- we have to do X, even though it doesn't make financial sense, or we will miss out on a payday down the road -- rings a bell. It's the same argument that these same firms made to themselves when they compromised their stock market research. In doing so, they exhibit their usual willingness to transform the allocation of capital into a system based on kickbacks.

We are now living through one of the great cleanups in U.S. financial history, second only to the one that followed the Crash of 1929. A lot of the more sordid Wall Street behavior of the recent past was the result of breakneck pursuit of exorbitant banking fees.

A few days ago, for instance, New York State Attorney General Eliot Spitzer released snippets of Merrill Lynch & Co. e-mails in which analysts discuss their efforts to curry favor with potential banking clients.

In one, former Merrill analyst Kirsten Campbell declared flat- out that "the whole idea that we are independent from banking is a big lie." In another exchange, an investor asked former Internet analyst Henry Blodget what was interesting about GoTo.com Inc., which Merrill was then plugging to its investors, "except the banking fees." Blodget's response: "nothin."

Protecting the Fees

But we know all about that game. We also know that most of what is being proposed by the regulators no longer troubles the investment banks.

Wall Street firms don't care if they need to forbid their analysts from owning stock in the companies they analyze. They don't care if they are required to pay a lawyer to be present when their analysts and their corporate financiers meet. They don't care if they need to append a few more lines of fine print to the end of brokerage reports, declaring their investment banking interests. They certainly don't care if they need to add even more disclaimers to prospectuses that no one reads.

What they do care about is preserving their fees. And yet no one has breathed a word about these.

Investment banking fees are a curiosity for anyone intimate with the inner workings of a securities firm. Investment banking is not rocket science and investment bankers are nearly as plentiful and fungible as dollar bills. Yet while the typical fee on a bank loan has been driven down to .01 percent of the total, the typical fee for arranging a securities transaction remains stuck as high as 7 percent.

Full-Service Shops

Why? Why don't big companies such as, say, General Electric, play Wall Street firms off one another and drive down the fees? At first glance, this would appear to be a good example of market failure.

But then you see what the investment banks do for the big companies to get the fees -- lie to the investment public on their behalf, extend them credit when they shouldn't get it -- and it all makes a bit more sense.

The big fees are a tool used by big companies to manipulate the investment banks. They are not "earned" so much as "doled out." And because they are vastly in excess of what the work is worth in a competitive market, they cease to function as fees for honest service and begin to look more like bribes.

Whether a business model based on a system of bribes and kickbacks makes sense for Wall Street firms in the long run I do not know. But in the short run, the firms seem to feel that the fees are worth sacrificing their reputations and balance sheets. Even Goldman Sachs in turning down GE was not repudiating the system. Goldman officials were just upset they weren't getting a big enough cut of the take.

You want to clean up Wall Street? You want to minimize the number of future newspaper stories that expose systematic corruption in high finance? There's an easy solution: Regulate banking fees.

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