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Now that Wall Street blew up the global economy in its search for fun and profit, it is finally having to eat its own cooking in the form of more modest profits. Of course, the slightly chastened Masters of the Universe seem constitutionally unable to recognize that their own actions might have something to do with the fix they are in. Yes, the immediate aftermath of the crisis looked just dandy, as super low interest rates and official confidence building led to some lovely trading opportunities, which in turn produced record bonuses in 2009 and 2010. But as the Fed flattened the yield curve and the economy has stayed stuck in low gear, investors aren’t keen on taking risk, even if negative real interest rates leave doing nothing as an unattractive option.
An article at Dealbook gives some insight into the distress on Wall Street (yes, Virginia, uncertain bonus prospects have this way of focusing the mind in banker-land). Lloyd Blankfein predictably makes “new regulations” the top scapegoat for Goldman’s reduced profit outlook, along with an uncertain market outlook. Ahem, the securities business has always been highly cyclical, but the Greenspan and Bernanke puts did such a good job of dampening the downside that the industry seems to have forgotten what a normal downturn looks like, let alone the sort of barely-averted Great Depression that we are working through.
So the current party line is that Goldman will be using more technology and cutting expenses to cope with the new normal. That sounds great until you dig into the nature of IT at big trading firms. There is a long, seldom told history of ambitious projects gone awry, as in multiple hundreds of millions of dollars poured down sinkholes. I’m hardly close to it, but even I know of a a major effort to build a fixed income utility in the 1990s was a total loss. Goldman had another major fixed income initiative in the later 1990s, to build a fixed income client portal. My understanding is that that was a costly flop. And remember, Goldman really is pretty well managed by securities industry standards.
Blankfein did make a sensible comment that was picked up in the Financial Times writeup of the same presentation: “Our industry has a long history of letting too many people go at the bottom of the cycle and hiring too many at the top.” But I heard firms making the same sort of statements in the last really bad downturn (the early 1990s) and they all (even Goldman) eventually started getting rid of people that they would have liked to have kept (this was acknowledged by headhunters: being fired in that era was not stigmatized if you were mid level. The firms were keeping the senior folks and the cheapest, the analysts and associates, and going through everyone in between with a howitzer).\
But how does IT help ameliorate this situation? Blankfein wasn’t terribly specific except in given the impression that the firm intends to use more automation on the sales and trading side of the business. From the New York Times:
In the firm’s equities business, for instance, Mr. Blankfein said that 60 to 70 percent of shares are now traded through “low-touch” channels, without the direct involvement of people. Electronic execution accounts for significant portions of activity in the firm’s cash fixed-income business as well, Mr. Blankfein said at the conference, which is intended to give Wall Street analysts a broad look at the industry.
The commitment to new technology is part of a broader effort to streamline the investment firm. With regulators imposing stricter requirements on big firms, the former ways of Wall Street now look less desirable.
“For the first time, it’s clear that size and complexity come with a higher cost,” Mr. Blankfein said.
An ex Goldman informant gives a sanity check:
I only know bits of the history but, to me too, this does look like standard-issue CEO BS about IT.
In fact GS’s 70% zero touch, or anyway “low” touch, doesn’t sound that spectacular. I sorta think I remember that, in equities, GS had already attained that level when I was there; a decade ago now.
But perhaps Blankfein’s definition of “low” touch is more stringent now, or perhaps he excludes touches by Ops. Or he isn’t including GS’s voluminous Prop Trading side (or whatever they call it now, presumably not that any more), which has been heavily automated for a long time.
Most likely the Ops side just got left behind in the budget stakes by the sales and trading binge of the noughties, and now looks more than usually precarious and expensive. That’s what usually happens in the boom and aftermath. Time for a huge failed Ops IT project again, I imagine.
Back in the 01/02 downturn the IT horror was GS’s very ambitious all-in-one web-based Prime Brokerage offering, which, looking back now, must simply have had the effect of exposing, to a pack of talkative and demanding hedgies, glitches in some of GS’s really not so bad, but still not 100% reliable, internal systems. Cue high level management concern…heads rolled…
In the infrastructure downstream of trade execution I doubt if all that much has changed in the last ten years, and that is what will keep the level of ‘touch’ obstinately high. Lloyd probably still thinks it’s all about execution, not downstream processing. That’s what I would expect: he’s a trader.
However the amount of investment that would be needed to make a serious dent in the remaining high touch 30% is pretty daunting, and it’s as much to do with middle and back office as with execution. Getting to low touch is obviously all about making the trade lifecyle data driven.There’s no mystery about that, but actually doing it gets terribly hard, quite early on. For instance to make progress from the 70% figure one would probably have to rework, more or less radically, international settlement and custody interfaces, stock master data, and counterparty master data. One would also modify or rebuild the numerous front, middle and back office systems that actually use the data. For a big bank, that comes to many $100millions and north, a size of project that always screws up; far too many moving parts, too much risk with core IT, and all for a cloudy and remote ROI anyway. That is part of why banks gravitate towards tactical solutions, not strategic ones.
In fact often you’ll find that the data that you need in order to automate simply doesn’t exist. Creating the data typically requires other banks, and other players (custodians, exchanges, even legislators, for instance) to move in a similar direction at the same time. I bet it never happens.
Straight through processing has been an industry buzzword for as long as I can remember. I think it’s just something CEOs talk about after their latest weary look at their ops headcount and legacy IT budget, when they’ve already concluded that there’s not much there that they can cut. GS have an additional self-imposed constraint: they try very hard, as a matter of longstanding corporate doctrine, not to respond to a downturn by mindlessly slashing headcount. They don’t like the IP loss and the inevitable rehiring when the cycle turns. They prefer a regular annual decimation, pour encourager les autres, and leave it at that. But they must still address costs, so they will always look towards tech investment when business is quiet.
In other words, this looking for a better, cheaper IT solution is yet another exercise in hope over experience. But unless Goldman has a super costly technology fiasco, it’s unlikely word of a failure will leak out; botched technology projects tend to be pretty well hidden. But it would manifest itself, if weak revenues persist, in eventual deeper headcount cuts, the very outcome Blankfein hopes to avoid.
Of course, distress for Wall Street producers, even if it is painful for them, is so mild compared to what ordinary people experience that the greater public won’t get much gratification from retrenchment among the financial classes. One can only hope that the new normal in finance also leads to newfound humility, but I would not hold my breath.