Some Musings on Investment Bank Profits

Toni Geylin09by Toni Geyelin

 Associated Press

Interesting article in this week's Financial Times, highlighting comments made by Larry Fink, founder of BlackRock —one of the major investment management firms that pioneered mortgage-backed securities in the United States. Apparently, Fink criticized the “luxurious” returns reported this quarter by a number of Wall Street firms (taking particular aim at Goldman Sachs).

With less competition, Fink observes, the remaining firms are taking advantage of market conditions to charge huge fees for services. This includes profiting from the very rich spreads (the difference between the bid and the ask or buy and sell quote on a stock or bond) on even the most basic of trades. Mr. Fink added that he is seeking ways to reduce those spreads and save his client’s money. Bravo! While we recognize Mr. Fink is clearly a player, this is about the first time we have heard someone go on the record as thinking about the client and not the bonus pool! In fact, the financial community forgot about the client some time ago.

The biggest culprits continue to be the investment banks, almost more for historical reasons than anything else. In the good old days, investment banks were partnerships. The capital of the institutions belonged to the partners and they were able to allocate it to the deals they wished to see done. They could choose the risks they wished to take and those they did not wish to take, and they would put their own capital at risk to fund the chosen deals. At the end of the year the partners got together to decide how to distribute profits, including how much would be reinvested back into the firm. Generous payouts in the good years and sometimes no payouts in the bad years: that was the norm. In general, salaries were on the low side but bonuses could account for 75% (or more) of an investment banker's annual compensation.

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