After the passage of the Dodd-Frank financial reform bill, there was a collective feeling of ‘what now?’ in regards to the fate of Wall Street firms. Although a cloud of uncertainty had been lifted from over the sector, the implications of corporate restructuring due to the bill were potentially damaging. Financial stocks have lagged this latest market leg higher, and we are starting to see a reason why. Thanks to new regulation (and a steady outflow of capital from the equity markets) the pie is shrinking for Wall Street. But when it’s all said and done, maybe that’s not the worst thing in the world.
The Volcker Rule, although watered down in its final form, was the most game-changing inclusion in the legislation, precluding big banks from proprietary trading and owning large stakes in hedge and private equity funds. The rule does not officially take effect for several years, thus firms are expected to undertake the necessary changes over time. Most companies though, have wasted precious few months in making preparations. Each firm has come up with its own solution for best dealing with the Volcker Rule, but most have shared at least one common denominator: fewer employees.
Bank of America, according to a person briefed on the decision this morning, is already planning to eliminate up to 30 proprietary trading jobs, or almost one-third of its proprietary trading division. JPMorgan has revealed plans to move proprietary traders into its Asset Management division in order to salvage some of their prop trading desks, reported the New York Times on Monday. Goldman Sachs will reportedly dissolve or spin off its proprietary trading teams entirely. Credit Suisse recently forked $425 million for a stake in Swiss bank York Capital (a deal that is compliant with the Volcker Rule, which allows banks to own hedge fund managers while limiting the investment of the bank capital in funds itself). Despite strategies to deal with the impending regulations, these firms have already seen an exodus of talent to private equity firms and hedge funds, such as Blackstone. But many think that when the dust settles, not every cute puppy will be able to find a new home.
While much of the direct result of the Volcker rule will be a reshuffling of the financial services sector, the end result of increased regulation will be significant retrenchment within the industry. Meredith Whitney, prominent banking analyst of Meredith Whitney Advisory Group, forecasts that by the first quarter of 2011 we will see a reduction is 80,000 jobs in the financial services industry.
THE CASE OF DE SHAW
Following $7 billion in redemptions in the past few months, esteemed quant hedge fund DE Shaw is cutting 10% of its work force, which, in this case, represents 150 of the brightest math geniuses around. Many have purported that job cuts in the financial services industry would be mainly limited to secretaries and back room staff, but these across the board cuts include partners and portfolio managers as part of a long term strategic review by the company. The decision was clearly not taken lightly, which makes it that much more telling. Perhaps (gasp!) the opportunities for quantitative exploitation of our financial markets are reaching a head, or is becoming saturated to the point that further expansion in that space is darn near impossible.
Although slightly off topic, it is interesting to consider the possible implications of DE Shaw’s massive redemptions, per ZeroHedge. Given the rally in equities over the past few months, it is also fair to presume many of DE Shaw’s losing positions were bearish ones, and the unwinding of those positions contributed, at least in part, to the acceleration of the rally. Many market participants have been left wondering, “who continues to buy this stuff?” Now, we have an example of at least on type of example. Hedge Fund titans like David Tepper of Appaloosa and Bill Gross are mindful that you must always be mindful of the Fed, and the implications of its actions, when developing a core investment strategy, but the recent the recent ramp up in equities (to the detriment of quant funds like DE Shaw) shows the dangers in setting such a precedent for market manipulation by our great central bank. It seems that is the current environment, the only way to deliver consistent returns is by essentially front-running the Fed.
CONCLUSION
Thanks to increased financial regulation and its many implications, Wall Street is being forced to adjust to a new reality (for now). Many feel that it is only a matter of time before the quant geniuses at places like DE Shaw and Goldman Sachs engineer ways to circumvent current regulation, or that political currents will see to it that recent regulations are not even at enforced at all. But maybe, just maybe, a retrenchment in the financial services industry isn’t such a bad thing after all. Right now, the best and brightest math and science minds are attracted to finance because of the oversized bonuses. Sooner or later, if we as a country are going to remain innovators and compete with the likes of rising world super-power China, America’s great quant minds needs to engineer something besides the ultra-sophisticated financial instruments that got us in this mess in the first place.
