William D. Cohan, an investment banker turned journalist, is the author of Money and Power, House of Cards, and The Last Tycoons. Having criticized Wall Street in his earlier books, he now comes to its defense (for the most part) in Why Wall Street Matters (Random House, 2017).
The book is short, only about a hundred pages. It reads like an op-ed piece with expansive footnotes for the uninitiated. Responding to the Wall Street bashing that prevailed, from Bernie Sanders to Donald Trump, during the presidential campaign and to the ever critical Elizabeth Warren, Cohan sets out to show “why it is important to nearly everything we hold dear, and why we wouldn’t much like to live in a world without Wall Street. … The ability of Wall Street to provide capital when and where it is needed at a fair price … is an essential fact of modern-day life.”
Cohan takes the reader on an excursion through time, starting with the early days of the physical Wall Street when it housed the colony’s slave market in a wooden shed and when, as the site of the Stamp Act Congress, it also became a center of revolutionary fervor. Today, of course, what we think of as “Wall Street” no longer exists on Wall Street, save for the U.S. securities arm of Deutsche Bank.
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He explains what commercial banks do and how they differ from investment banks. He describes how, even though financial crises are the byproducts of human nature, not Wall Street inventions, “Wall Street is particularly adept at fomenting or fueling a crisis, given how Darwinian a place it is.” He takes the reader through the formation of the Federal Reserve and the throes of the Great Depression.
And then he gets to the thrust of his argument: the problem with Wall Street firms going public. In the good old days, investment banks and brokerage firms were private partnerships. For more than 150 years Wall Street firms “relied on the prudent use of their partners’ capital to take risks—which nonetheless occasionally went awry—and to run their businesses, knowing full well that a single mistake could spell the end for their firms, as well as threaten whatever fortunes they had personally built up over the years.” But when, in 1970, DLJ convinced the New York Stock Exchange to change its rules and allow it to go public, Wall Street culture itself changed. “Although it was unlikely the founders of DLJ could have anticipated all of what its IPO would unleash over the next nearly fifty years, they must have had some inkling that by substituting a bonus culture—where bankers, traders, and executives demand to be paid for the revenue they generated in their various product lines—for the long-standing partnership culture—where the individual partners of the firm collaborated to make sure only prudent risks were taken in order to ensure there would be annual pretax profits for them to divide—Wall Street would never be the same.”
With access to public money, Wall Street’s animal spirits were unleashed. It started innovating—securitizing mortgages, creating junk bonds and later credit default swaps, increasingly with the input of quants. And then came the financial crisis, which it helped engineer.
Wall Street, and banks in general, were vilified. The public was outraged, and the government responded with burdensome regulations. Wrong, wrong, Cohan argues. Wall Street matters, and banks shouldn’t be hamstrung.
Cohan’s fix is simple. “What needs to happen—and fast—is that the leaders of the remaining big Wall Street firms need to designate the top five hundred or so top executives at their respective firms—the ones that run business lines, decide how capital gets allocated, decide who gets how much compensation and who gets promoted and who doesn’t—and along with the other members of the executive suite create a way for the bank’s creditors and shareholders to be able to go after their full net worth—everything—in the case of a meltdown. … This one simple change in the Wall Street compensation system would render Dodd-Frank and the Volcker Rule irrelevant. … The compliance culture could be rolled back considerably.” And American economic growth could pick up again.