The Land of the Free

“At pet stores in Detroit, you can buy
frozen rats
for seventy-five cents apiece, to feed
your pet boa constrictor”
back home in Grosse Pointe,
or in Grosse Pointe Park,

while the free nation of rats
in Detroit emerges
from alleys behind pet shops, from cellars
and junked cars, and gathers
to flow at twilight
like a river the color of pavement,

and crawls over bedrooms and groceries
and through broken
school windows to eat the crayon
from drawings of rats—
and no one in Detroit understands
how rats are delicious in Dearborn.

If only we could communicate, if only
the boa constrictors of Southfield
would slither down I-94,
turn north on the Lodge Expressway,
and head for Eighth Street, to eat
out for a change. Instead, tomorrow,

a man from Birmingham enters
a pet shop in Detroit
to buy a frozen German shepherd
for six dollars and fifty cents
to feed his pet cheetah,
guarding the compound at home;

and a woman from Bloomfield Hills,
with a refrigerated Buick
wagon, buys
a frozen police department Morgan
for thirty-seven dollars
for her daughter who loves horses.

Oh, they arrive all day, in their
locked cars, buying
schoolyards, bridges, buses,
churches, and Ethnic Festivals;
they buy a frozen Texaco station
for eighty-four dollars and fifty cents

to feed to an imported London taxi
in Huntington Woods;
they buy Tiger Stadium,
frozen, to feed to the Little League
in Grosse Ile;
they buy J.L. Hudson’s, the Fischer Building,

the Chrysler Freeway, the Detroit Institute
of the Arts, Greektown,
Cobo Hall, and the Tri-City
Bucks Roller Derby
Team. They bring everything home,
frozen solid

as pig iron, to the six-car garages
of Harper Woods, Grosse Pointe Woods,
Farmington, Grosse Pointe
Farms, Troy, and Grosse Arbor—
and they ingest
everything, and fall asleep, and lie

coiled in the sun, while the city
thaws in the stomach and slides
to the small intestine, where enzymes
break down molecules of protein
to amino acids, which enter
the cold bloodstream.

— Donald Hall, Poem With One Fact¹

* * *“What we have here, is a failure to communicate.”

I wonder whether Dearborn will ever understand that rats are not delicious in Detroit.


¹ Donald Hall, The Town of Hill. David R. Godine, Boston, 1975, pp. 13–15.

© 2011 The Epicurean Dealmaker. All rights reserved.

If the Phone Don’t Ring, You’ll Know It’s Me

As a dashing, handsome, witty, and debonair man-about-town, you might well imagine, Dear Readers, that I receive copious quantities of correspondence begging a minute of my precious time to address some issue or other. Often, it is some tyro who has read my work here, soaking up the reflected glory and excitement of the world of high finance while simultaneously eliding the irony, sarcasm, and disgust which naturally comingle therein. Said tyro is almost always looking to “break into” my industry, after having read my semi-ironic paean to investment banking (but missing the irony) or talking with his shell-shocked peers who already cling tenuously to 100-hour-a-week waterboarding slots at überbanks.

Notwithstanding its own not-insignificant challenges and the social opprobrium currently attached to investment banking by society at large, it’s hard to blame the poor dears:

Unlike, say, 99.6% of all other jobs available to a wet-behind-the-ears idiot in proud possession of little more than an expensive college degree, becoming an investment banker fresh out of college is a huge rush. Depending on what role they perform, new entrants just weeks into the job can participate in billion dollar underwritings, multi-billion dollar mergers, complicated cross-border restructurings, or devilishly complex trading programs, all the while possessing a level of experience formally known in the industry as “jack shit.”

In what other industry, I ask you, can a 22-year-old who just stopped wetting the bed three weeks ago participate in a deal which runs for weeks on the cover of The Wall Street Journal or the Financial Times? To be sure, he is probably doing little more than making copies, getting coffee, and trying not to look as stupid and lost as he feels, but at least he is in the room. Contrast this, if you will, with a fresh McKinsey recruit tasked with interviewing shop floor supervisors to develop a human resources inventory for a ball bearing manufacturer in East Bumfuck, Illinois. Or a pre-law student who spends 80 hours a week in a windowless basement cross-checking sale-leaseback contracts for a patent dispute in Moldavia. On average, young investment bankers spend less time traveling that management consultants and more time sleeping than corporate attorneys. Plus, they get to tell their friends and family that they carried Bruce Wasserstein’s bags. What could be better?

Unfortunately, from their perspective, many of the youngsters who contact me fear they do not possess the “right” degree from the “right” school which they believe will magically open the secret door into this wonderland of fun. Often they have tried and failed to pursue the standard on-campus recruiting paths or have come up short with the fearsome Human Resources harridans who guard the gates to Analyst or Associate recruiting. And so they reach out to Yours Truly, pleading for fifteen minutes of my time on the telephone or in person to give them the key to investment banking Valhalla.

For the avoidance of doubt, and for the benefit of the 20 hapless supplicants feverishly typing emails to me in response to this post, let me make this perfectly clear:

No. Nope. Unh-unh. HELL NO.

I don’t do phone calls or meetings. Haven’t any of you seen Enemy of the State?

* * *

By the same token, it is a waste of electrons to send me your resumé. To whom would you suggest I send it? “Oh, uh, hi, Jerry at Goldman Sachs. I, uh, just happened to find this fascinating resumé lying on the fax machine. Would you mind taking a hard look at it? Wait. What do you mean? No, I don’t know anybody named ‘TED’. Why do you ask?” Consider my carefully defended pseudonymity an impermeable barrier to contact, referrals, or recommendations in the real world. Sorry, but that’s just the way it is.

However, as partial recompense for your pains, and to show I am not a completely heartless bastard, I am happy to share with you here the same advice I give aspiring applicants to my industry under my own identity.

First of all, having a degree in finance or economics from a top-ranked college or business school is not a sine qua non to get hired into investment banking. But I’ll not kid you: it helps. Especially now, when the industry is under severe pressure to retrench. Why? Because it acts as an easy screen for harried recruiters to winnow down the hundreds if not thousands of job applications they receive to a more manageable horde. Taken separately, a degree from a top school shows that other demanding institutions have deemed you worthy in the past, and a degree in finance, economics, or accounting shows you have an understanding of (and possibly a love for) the basic tools and concepts of our trade. Beyond that, they tell us almost nothing about whether you have the drive, passion, and capacity for our business. The only way we can find that out is by throwing you into the fire itself.

For I have seen dozens of top-ranked Ivy League graduates flame out (or worse, fizzle) over the years, mostly due to lack of energy, drive, or commitment to do what has to be done. Not because they weren’t smart enough; no, they were just too lazy or too entitled to get down in the mud and wrestle with the alligators, which is why we hire young cannon fodder like you in the first place. Survive the alligators, and you have a chance to rise into the haughty position of power, influence, and respect you feel you deserve. Don’t survive, and we’ll toss your mangled corpse out the back door onto a trash heap like a used Kleenex.

Did I mention investment bankers are heartless bastards?

* * *

What does it take to succeed in my business? You have to be really smart (don’t kid yourself on this one: it’s a high hurdle), determined, aggressive, and indefatigable. You have to be quick on your feet, too, because change is ever present in investment banking, and you have to be able to adapt to wildly different situations and volatile personalities. You have to learn how to work with financial statements, accounting concepts, and spreadsheets. You have to be good with people. You have to be a quick learner, because no school can teach you what you need to know and how to do it: investment banking is and always will be an apprenticeship business. And you have to (learn to) love the business. If you don’t, you’ll burn out: it’s just too hard and demanding.

Nowhere in that litany, you will notice, did I say you need a finance degree or an Ivy League diploma. Those help getting in the door, but they tell us little about whether you will be a good hire. So, what do you do if you don’t have the kind of credentials which almost guarantee you will get a first round interview? You have to be creative in your approach, flexible and clever in your campaign, and you have to convincingly demonstrate the traits of successful investment bankers I have enumerated above when you get in the door.

Reach out to people you know, ask for recommendations to senior bankers from your friends and family, request informational interviews with these bankers (but not unreliable, curmudgeonly pseudonymous bloggers), and go show them you have what it takes. Don’t give up. It will be very hard. But if you can get in the door, you will have proved to yourself and your employer that you have all the tools you need to make a positive impact.

And maybe one day, if you are smart, hard-working, and very, very lucky, you’ll be kicking some prissy Princeton prima donna the HR geeks sent you to interview out on his ass because you can’t trust him to bring back your coffee order from Starbucks correctly.

Good luck, campers.

* * *

(Oh, and one more thing. If you really want to stand out, it helps to be a girl. Just sayin’.)


© 2011 The Epicurean Dealmaker. All rights reserved.

A Hard Rain’s Gonna Fall

“Have you ever stood and stared at it? Marveled at its beauty, its genius? Billions of people just living out their lives. Oblivious.

“Did you know that the first Matrix was designed to be a perfect human world, where none suffered, where everyone would be happy? It was a disaster. No-one would accept the program, entire crops were lost. Some believed that we lacked the programming language to describe your perfect world, but I believe that, as a species, human beings define their reality through misery and suffering. The perfect world was a dream that your primitive cerebrum kept trying to wake up from. Which is why the Matrix was redesigned to this: the peak of your civilization. I say your civilization, because as soon as we started thinking for you it really became our civilization, which is of course what this is all about.

“Evolution, Morpheus, evolution. Like the dinosaur. Look out that window. You’ve had your time. The future is our world, Morpheus. The future is our time.”

— Agent Smith, The Matrix

Things must be getting pretty ugly on the trading floors of big investment banks worldwide, O Dearly Beloved. If you still have any friends or acquaintances desperately clinging to such formerly gainful employ, you would be kind to spare them a tear or a LinkedIn invitation or two. I am sure they would appreciate the gesture.

You wanna know how I know that? Well, if the constant drumbeat of articles trumpeting the death of proprietary trading and its enabler, mountains of cheap capital, weren’t enough, how else could one explain this?:

One of the mysteries of investment banking is why M&A is held in such awe. Advisory bankers swan around like they own the place. They have the nicest suits. The senior ones are also difficult to fire, insisting they nurture the crucial relationship with corporate clients (in spite of perhaps not having done a deal in years). M&A activity in 2011 could fall 5 per cent below last year’s volumes despite a strong start, according to Keefe, Bruyette & Woods. Against a backdrop of declining activity, there are three good reasons why M&A should be brought back to earth.

Or this?:

Meanwhile, [M&A] prima donnas take home bank. But do they make profits for their firms? Or is the big money in the deal add-ons, like providing financing to pay for takeovers? We’ll never know for sure, but our money is on the drones and not the guys in pinstripes.

In my day, we used to call such patently bought and paid-for hit pieces “advertorials.” I hope the FT’s Lex team and DealJournal’s writers got nice honoraria for their troubles, or at least a couple of beers or so. Because as reporting goes, both pieces are complete and utter bullshit.

* * *

Not that I disagree with most of the facts and assertions both articles present,¹ mind you. Mergers and acquisition revenues have always been volatile and highly cyclical; they are tightly tied to the business cycle and trends in financial markets. They are also without doubt tiny in relation to the enormous revenue from the sales and trading (capital markets) side of the house at integrated investment banks. This has been true for more than a decade, ever since the capital markets divisions of global investment banks looked at the tsunami of cheap liquidity flooding the world financial system and decided they would like a taste. No M&A or corporate finance banker in the business longer than six months would attempt to deny this. Why else do you think so many major integrated investment banks—the Great Vampire Squid preeminent among them—are run by short-sleeve-wearing, onion-cheeseburger-eating troglodytes from the trading floor?²

But given this very power and earning disparity between the advisory and capital markets sides of the business, why did the leading organs of financial journalism on both sides of the Atlantic feel compelled to chew up column inches with snarky attacks on M&A bankers? Why pick on the little kid? Whence also the frat bro sniping at “nice suits” and “pinstripes,” as if knowing how to knot a tie or deigning to wear nice clothes more than twice a year were somehow sins against “authenticity” or some such puerile bullshit? What’s the fucking point?

I’ll tell you what the fucking point is: everyone on the trading floor of every leading investment bank is about to get fucking fired.

* * *

Now of course that is untrue, and a gross exaggeration (although one my rough-hewn compatriots on the turret phones can appreciate). But it is no exaggeration to say that the capital markets gravy train of the past ten years or so is coming to a rapid, screechy, and highly painful end. The Volcker Rule, Basel III, and the re-emergence of actual, functioning risk management from the bowels of the Chinese opium den where it has been languishing for the last decade will see to that. Gone are the days of 60-to-1 leverage, compliant regulators, risk-loving shareholders, and politicians who could afford to turn a blind eye to an industry which used implicit government backstops as collateral in the global casino. This will put massive pressure on revenue, profits, and compensation in capital markets divisions everywhere. And if there’s one thing senior investment bank executives know how to do when faced with compensation pressure, it’s fire people. Lots of people.

The other thing senior managers know how to do is fight for a bigger share of the bonus pool, especially when said pool is shrinking faster than homeowners’ equity in Nevada. Hence the perennial resuscitation of tired old arguments and clichés about bankers on the advisory side of the house—that they are prissy peacocks who add no value and steal credit for revenues properly earned by sales and trading—in order to preserve one’s own subordinates’ share of the compensation pie. Of course, when sales and trading was demonstrably bringing in many multiples of the revenue that advisory was, capital markets executives had little need for such arguments. They could just point to their profit and loss statements and tell senior management how much they expected to keep. As far as they were concerned, the midgets in M&A could suck it. But now that the worm has turned, and steroid-fueled sales and trading profits from structured products and proprietary trading are evaporating in the noonday sun, capital markets managers have been reduced to jawboning and badmouthing their colleagues in the press.

So congratulations, Lex and DealJournal, you’ve just been reduced to shills for traders in their internal bonus discussions. You might want to check your sources’ business cards to see which division they work for. As if you don’t already know.

* * *

The other major criticism or insinuation our beloved fourth estate sock puppets parrot for their sales and trading overlords—that M&A and corporate finance bankers’ claim to add value via access to corporate clients is untrue—is no more than tendentious, uninformed bullshit. For one thing, the reason so many of us wear nice suits and ties is because we actually meet with real, live clients on frequent occasion. This is in strong contradistinction to most of the denizens of the trading floor, whose primary contact with people outside their own firm consists of punching a preprogrammed button on their turret phone and talking to their similarly Dockers™-clad counterpart over a Plantronics headset. Unlike the hedge fund and institutional investor counterparties investment bank traders deal with—who trade promiscuously with everybody on Wall Street and who don’t give a rat’s ass whether they like or even trust the trader in question, as long as he completes trades as he said he would—getting corporate clients to do transactions requires building trust and rapport over many years. This is absolutely the case in pure M&A, where no capital markets financing or derivative transactions are involved, but it is also true in more general corporate finance contexts.

I have stated time and time again that, notwithstanding the delusions of so many of my peers, there is no service or product on Wall Street which is not completely commoditized. This is true of M&A advice, but it is particularly true of any product or service flogged from a capital markets desk. Proprietary products can be and are reverse-engineered within weeks, if not days, and plain vanilla shit like high yield bonds, interest rate swaps, or initial public offerings are a dime a dozen. There is literally almost nothing Goldman Sachs can do that Morgan Stanley, JP Morgan, Bank of America, or even short-bus rider Citigroup can’t do equally as well.

Hence, Lex’s assertion,

Perhaps clients would buy other products because they are excellent in their own right and not because of an introduction from advisory.

is on its face ludicrous. First, because no bank has any monopoly on excellent products for any length of time. Second, because there is no-one on the capital markets floor of any big investment bank who has close, proprietary relationships with corporate issuers which would encourage said issuers to agree to do deals with him directly. That is not his job. It is the job of the corporate finance or advisory banker to make the introduction to the product guy. It is the product guy’s job to structure, issue, and sell the resulting product. They work together.

In a similar vein, Lex’s uncritically repeated assertion that some M&A “standalone cost-income ratios... can be as high as 400 per cent” is just dumb. If any coverage or advisory banker truly got paid four times the actual revenue he or she brought in, rather than getting fired on the spot, he or she must have some really indiscreet photos of the CEO with a well-oiled goat. Part of the advisory banker’s job—as opposed to, and often in addition to, pure M&A advice—is to give his or her client access to the entire range of products and services the bank offers. If that client transacts capital markets deals with the bank, the coverage officer who made the introduction deserves some of the credit (and pay). Saying otherwise is like saying a Boeing salesman doesn’t deserve to be compensated for selling planes because he doesn’t actually build them. That’s just stupid.

* * *

In any event, my entire industry faces a very painful restructuring as the high-octane profits of structured products, proprietary trading, and massive trading volumes driven by global uncertainty ineluctably dry up. In such an environment, where capital is no longer either cheap or plentiful, business lines which can make money using minimal capital necessarily acquire greater power and prominence. Given that pure M&A uses exactly no capital, it is only natural that M&A bankers will reacquire some of their old influence within investment banks. When financing is tight, it’s hard to argue with an infinite return on capital.³

Of course, I continue to maintain that integrated investment banks live or die by the inextricable cooperation of their advisory and capital markets arms. We are tied together at the hip, and that which hurts one of us will hurt the other, too. So I take no particular pleasure in noting the imminent demise of thousands of my capital markets brethren across the industry. I just take care to note that my fellow sentient programs and I expect a rather larger share of the pie than before.


¹ Chronologically, the Lex article appeared earlier, and it provides the meatier substance of the two. The DealJournal piece does little more than parrot Lex and toss in a few jejune Americanisms (“take home bank”) favored by the 20-something tyros who staff the nether regions of big banks, presumably for the benefit of native readers unfamiliar with language heard outside the lacrosse field. Not that I’m judging or anything.
² I kid, I kid. But, really, I have to get some digs in of my own, don’t I? You should know by now that I’m no saint.
³ It is also no matter of indifference in today's environment that when an M&A banker screws up or fails to close a deal, he loses only time and a potential fee. When a prop trader or structured products banker screws up, he can blow a hole in the side of his bank larger than all the revenues earned by all of his compatriots all year. And when a whole industry of capital markets bankers screw up, it can blow a trillion dollar hole in the side of the global economy. Or so I hear.

© 2011 The Epicurean Dealmaker. All rights reserved.

A Victim of Soycumstance

[The Stooges are about to attend a fancy ball]
Moe: “Now then, gentlemen, remember your etiquette.” [Gives both Larry and Curly a slap.]
Larry: “What’s that for?”
Curly: “We didn’t do nothin’!”
Moe: “That’s in case you do when I’m not around!”

— The Three Stooges

Bloomberg published a nice piece earlier this week which supports my long-held belief that the term “investment banking management”—like “military intelligence” or “legal ethics”—is, in the trenchant phrase of Raymond Chandler,¹ “an expression which contains an interior fallacy.” In other words, an oxymoron.

Authors Michael Moore and Max Abelson do a creditable job illustrating how the toxic relationship between Colm Kelleher and Paul Taubman, co-heads of Morgan Stanley’s Institutional Securities Group (corporate finance and M&A, plus capital markets)² is creating all sorts of fallout for that division. Kelleher is the hail-fellow-well-met Irish Oxford graduate who runs Morgan’s sales and trading operations, and Taubman is the weedy, quiet loner who leads the investment bankers. I have seen working relationships between similarly mismatched personalities work out very well over the course of my career, with complementary skill sets and different management styles combining synergistically to produce results beyond the capacity of either party alone. Of course, such success stories depend at their root upon the parties in question respecting each other’s different styles and abilities and working together explicitly for the greater good. This does not appear to be the case in this instance.

Interestingly enough, Morgan Stanley’s ISG seems to be turning out near-record results and taking market share, so a naive outsider might question whether its co-heads’ feud matters, or, what is more, might even be good for the division. Certainly this is what the Aspergers-addled technocrats who populate the executive ranks of most investment banks measure and value to the exclusion of all else, so I can understand how CEO James Gorman might consider his lieutenants’ squabbling an unimportant sideshow.

If so, he is dead wrong.

* * *

Put aside, for a moment, the not inconsiderable problem that the tension and infighting between Kelleher and Taubman is, sadly, the norm rather than the exception when it comes to interactions among senior executives at investment banks. This is much more than an issue of incompatible personalities. For one thing, investment bankers and traders who are hard-charging, capable, and, dare we say it, psychopathic enough to climb the slippery pole and get within reach of the top tend to have sharp elbows, short tempers, and little patience for those who oppose their wishes. Given furthermore that Taubman and Kelleher seem to have been put in implicit if not explicit competition for the top job, and the Bloomberg article indicates they both want it, such a set up would make it hard for Mother Teresa and her twin sister to get along.

Whatever its sources, the competition and bad blood at the top of their respective organizations cannot help but trickle down to Kelleher’s and Taubman’s subordinates. These will line up sensibly behind their leaders and take their tone of interaction with colleagues across the functional divide from the top, if only in the interest of self-preservation. This is Organizational Dynamics 101. The result will be inadequate communication, counterproductive political maneuvering, and willful lack of cooperation between investment banking and sales and trading at all levels. Traders will fall back into the venerable habit of regarding investment bankers as foppish, ineffectual parasites in suits, and investment bankers will resuscitate their ancient scorn for capital markets folk as barely literate, knuckle-dragging troglodytes. In addition to being unhelpful and untrue, such behavior never ends well.

For investment banks in general derive the greatest source of their power, value, and privileged position in the economy from the fact that they straddle the markets for capital, operating on both the supply and demand side. Investment banks serve the suppliers of capital—investors—by delivering new investment opportunities and products through underwriting new issues and originating new securities and by helping them reallocate their investment portfolios through making markets in securities and other financial instruments. This is done on the sales and trading, or capital markets, side of investment banks. Investment banks also serve the users of capital—corporations, governments, and the like—by selling their securities to investors and by helping them reallocate their business portfolios via mergers and acquisitions. This happens on the corporate finance and M&A, or investment banking, side of the same banks.

Each side of the bank derives a substantial part of its revenue, access, and value from the other side. Sales and trading and investment banking share information (subject to confidentiality restrictions), access to each other’s clients, and revenue from transactions arranged between them. Banks act as middlemen, and we make our daily bread by mediating transactions across the capital user–capital provider divide. This is core to what traditional investment banks do. It is a network business. Accordingly, anything which weakens the network—especially between capital markets and investment banking—seriously undermines the business.

I have sounded this warning before:

Notwithstanding what they like to tell you, investment bankers don’t really sell “ideas.” They sell connection, and access, and they are successful to the very extent they can maintain themselves in the flow of market information. Investment banks derive their market power and importance by maintaining dense and robust information networks across the numerous markets they participate in. This makes them better traders, better investors, and better advisors.

In the overall scheme of things, a successful bank should prefer to have strong networks, rather than strong bankers. Take a banker with excellent network connections out of his or her supporting environment, and he or she becomes dramatically less effective. Allow individual bankers to weaken the network by hoarding clients, refusing to communicate, or actively undermining their rivals within the firm, and you weaken the bank materially. Encourage the hiring and creation of “superstars,” and you shift power away from the bank into the hands of individual mercenaries. All of these things make an investment bank less valuable to its clients, as well.

I don’t care if Morgan Stanley’s investment bank had a blowout quarter. If Taubman and Kelleher are wasting time, energy, and opportunity pissing on each other’s shoes, they are fucking up. Morgan Stanley could do better.

* * *

Now I don’t mean to minimize the real structural conflicts between investment banking and sales and trading. They each serve different client bases with different needs and objectives. They each make money in different ways. The desires of their respective clients are rarely in sync, and sometimes the way each division makes money conflicts directly with the goals and profitability of the other. It is not so simple as one firm, one income statement.

Underwriting new securities is one area where corporate finance and capital markets cooperate directly, to source capital for issuers and sell securities to investors. But even there the alignment of interests is not complete. The corporate finance client wants to issue securities at as high a price as possible, and the capital markets clients want to buy low. This tension plays out daily in internal discussions between the bank’s departments, and believe you me it can get pretty heated on occasion. Market making is a capital markets business line independent of corporate finance, but it does have potentially positive (or negative) secondary effects on the latter, since a firm’s market position trading certain securities can affect whether bankers can win a particular piece of underwriting business or not. Be the number one trader of social networking stocks, for example, and your bank stands a good chance of leading Groupon’s IPO. Be number 15, and you can forget it. Corporate finance always wants sales and trading to make deep and active markets in certain areas, but capital markets often pushes back, because market making requires capital, and capital is expensive. The influence runs the other way, too: a bank which is active and successful in originating or underwriting securities in a particular market is far more likely to become the “axe” in that area. This drives greater sales and trading volume and, hence, greater capital markets profits. But if a bank has little track record issuing securities into a particular market, it becomes difficult for sales and trading to make money there independently.

You can see the potential for conflict even among pure agency business lines like underwriting and market making. This conflict is thrown in stark relief when an investment bank begins to assume a principal position in a particular trade. The example cited in the Bloomberg article is where Morgan Stanley’s capital markets group tries to sell derivatives in connection with a security underwriting, like interest rate or currency swaps on a bond issuance. But, as Bloomberg points out, while such a “deal can bring in significant trading revenue, it can also place the bank in the position of being a counterparty to a client it just advised.” Let me tell you something: as a corporate finance banker and advisor, this gives me the heebie-jeebies. I always worry my sales and trading guys are ripping my client off, and I shudder to think what would happen to the multi-million-dollar relationship I have carefully cultivated with my client over many years if things go pear-shaped. This is true of any transaction where an investment bank assumes the role of a principal—whether trading counterparty, lender, or direct investor. From a corporate finance banker’s perspective, the risk usually isn’t worth the potential gain, especially since all the profits from such proprietary trades seem to magically disappear into the capital markets budget before corporate finance gets its cut.

* * *

In fact, the organizational dynamic between a traditional investment bank’s sales and trading and investment banking divisions resembles nothing so much as an iterated prisoner’s dilemma. This is a game theoretic formulation of a situation in which two parties, who have some interests in common and some in conflict, must decide whether to cooperate or compete for desireable outcomes. Those readers among you who share little sympathy or liking for my profession will be delighted to learn that the traditional formulation used the example of two criminals:

Two men are arrested, but the police do not possess enough information for an arrest. Following the separation of the two men, the police offer both a similar deal—if one testifies against his partner (defects), and the other stays quiet (cooperates), the betrayer goes free and the cooperator receives the full one-year sentence. If both remain silent, both are sentenced to only one month in jail for a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose to either betray or remain silent; the decision of each is kept quiet. What should they do?

Sadly, perhaps, for those of you who would prefer all investment bankers to be thrown in jail, there is a fairly well-established solution to this dilemma, especially when it occurs over and over in an extended game of multiple rounds of unknown number. The best strategy appears to be a variation of “tit-for-tat,” in which a participant is nice, retaliatory, forgiving, and non-envious. I will leave it as an exercise for my Clever and Esteemed Readers to determine whether these behaviors strike you as consistent with the personality of your average investment banker.

In any event, the material point is that, like the traditional prisoner’s dilemma, the interaction between capital markets and corporate finance can, with proper focus and strategy, be elevated from the suboptimal, default outcome of mutual betrayal and non-cooperation into a stable, cooperative solution that benefits both parties. And if, in the case of Morgan Stanley (and investment banking generally), the participants are not wise, patient, or sensible enough to arrive at the best solution themselves, it is the job and obligation of senior management to drag them there kicking and screaming, or fire their sorry asses and promote somebody else.

Sounds to me like James Gorman needs to give a couple of guys a dope slap or two.


¹ Playback.
² Throughout, I employ industry-standard but often confusing terminology, in which “investment banking” = “corporate finance (and M&A)” and “capital markets” = “sales and trading.” Oh, and “investment bank” means the whole damn firm. Alles klar?

© 2011 The Epicurean Dealmaker. All rights reserved.

A Grave in the Clouds

In memoriam, September 11, 2001:

If thou didst ever hold me in thy heart
Absent thee from felicity awhile,
And in this harsh world draw thy breath in pain,
To tell my story.

— William Shakespeare, The Tragedy of Hamlet, Prince of Denmark

* * *

Bear witness • Honor • Never forget.


© 2011 The Epicurean Dealmaker. All rights reserved.