Wall Street Layoffs? Don't Blame the Government

Washington never finds many friends on Wall Street - or Main Street, for that matter. But the thing we can't blame Washington for is the fact that Wall Street investment banks may have to do layoffs this summer. The banks are just suffering the consequences of a messy world economy, not regulatory policy.

A Wall Street Journal article today makes the case that Wall Street is due for another big round of layoffs, particularly in its trading businesses.

Trading is the business in which banks help clients trade stocks, bonds and other securities. It's the business you think of when you see the floor of the New York Stock Exchange, where the floor traders call out names and prices of stocks - except now, most traders sit at a bank of computer screens. They still like to yell, but mostly they're calling out profanities, and it's for recreation, not profit.

The Journal's story is remarkably similar to a New York Times story last week.

What both stories have in common is one thing it may be good to clear up right now: both cite bank executives claiming that "regulation" is cutting into their profitability and forcing them to lay off traders.

This reasoning is highly suspect. At the very least, it would be nice for these bank executives to provide some specific proof of regulations that have allegedly hurt their profitability.

For one thing, we should ask: what regulations? Almost nothing has changed for banks, in terms of regulation, since the financial crisis. The Dodd-Frank regulatory reforms are not even fully written yet, much less enforced. The only part of Dodd-Frank that banks have even attempted to comply with is the so-called Volcker Rule. The Volcker Rule will limit how much banks can take risks with their own money, which is called "proprietary trading," because they're trading for their own, or proprietary, benefit. Volcker wanted banks to remain middlemen, at a time when they seem to be going further down the path of becoming big speculators. The reason Volcker insisted on this is that when banks talk about taking risks with "their own money," it's not actually theirs. It's ours; banks help move money for pension funds, university endowments, retirement funds and bank accounts.

Nearly all the banks actually sought to comply with the Volcker Rule by spinning off or selling their proprietary trading businesses. So there are very few official proprietary traders left on Wall Street. Banks who wanted to outstmart their regulators moved their proprietary traders to other sections of the bank, where their gains (or losses) wouldn't be as obvious.

Some of the bank executives cited in the stories claim that the regulatory culprit is actually the fact that banks may have to become better capitalized and use less debt to fund themselves. There are several ways this will happen. There are the rules set by the Basel subcommittee; the FDIC will require big banks to be better capitalized and have less debt in order to absorb any losses in the next financial crisis; and Dodd-Frank will also require banks to hold capital.

The only problem? Most of those requirements won't kick in until around, oh, 2019. The FDIC and the Basel committee just announced their decisions last week. So it's hard to believe that those changes - so recently announced, and to be enforced so distantly in the future - have impacted the last three months of trading results.

No, the reason for Wall Street layoffs is simply this: Wall Street is doing less business.

The best take on it may actually be from New York Magazine's Daily Intel: "Insufficiently massive profits prompt Wall Street layoffs."

The truth seems to be that banks are making less money in trading because there is simply less trading. There is less trading because the world - and the markets - look a lot riskier, so investors are pulling back. Investors pulled $4.3 billion from U.S. equity funds in the past week, and $27 billion over the past nine weeks - all of which saw money leaving the fund business.

KBW, an investment bank known for its research on other banks, wrote a research report today on what to expect from Wall Street's profits. KBW says there will be a trading slowdown. Here's why:

"Similar to [the fourth quarter of 2010], elevated concerns regarding sovereign risk coupled with concerns regarding global economic growth caused investors to scale back risk-taking strategies, resulting in poor volumes across Wall Street trading desks...The recent volatility and economic concerns appear to have translated into changes in investors' appetite to assume risk. As a result, the rebound in trading in the first quarter appears unlikely to hold over the near term, as European sovereign and macroeconomic growth concerns significantly impacted trading volumes this quarter."

What that means, to you and me, is the investors are more worried than ever by the health of individual countries and their ability to survive. The big culprit here is the Eurozone - the Greek default, Spanish banks, the return of Ireland's troubles. An entire continent is looking like a sketchy investment.

The U.S. also has "sovereign risk." The debate over the debt ceiling is really one about whether we're going to pay our bills on time, as a country. The creditworthiness of the U.S. is a big issue for investors - particularly those who own Treasury bonds, but also for anyone who works in the stock market.

At the same time, most countries are growing pretty slowly right now. Inflation is on the rise, as are food prices, and manufacturing is not ticking up fast enough to push countries ahead. Investors are not sure where to put their money, so they're not deploying it. That means the banks aren't making fees - thus less revenue, and thus layoffs.

KBW indicates the problem is pretty serious. The bank predicts that trading in fixed-income, currency and commodities will be down approximately 35 percent for all the big banks this quarter. KBW also predicts that equity, or stock, trading will fall by somewhere between 10 percent to 13 percent ("the low double digits.")

An interesting factor here: a lot of what is happening to banks now is the bill that they're paying for the financial crisis. Controversial Wall Street analyst Meredith Whitney predicted way back in the fall of 2010 that banks would have to reduce their staff in trading and other businesses simply because banks don't work the way they used to.

Ain't that the truth.

About the author

Heidi N. Moore is The Guardian's U.S. finance and economics editor. She was formerly the New York bureau chief and Wall Street correspondent for Marketplace.

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