Every business has its “tribes.” Those are the groups that form based on their job functions that compete for power in the company. Different companies in the same business can be very different based on the top leadership, and which “tribe” they come from.
A clear example is the advertising business. I’ve heard ad agencies described as being “account driven” or “creative driven” for decades. All that means is whether the individual company tends to be run by the marketing and client relationship management “account” people, or by the writers and art directors, the “creatives.”
Unless there is a major coup, the outgoing top management team nearly always replaces themselves with people from their own background, so the character of a given company can survive many generations of changes among the individuals filling the top roles.
On Wall Street, there are three main tribes that lay claim to the power at most shops, although a couple of smaller shops have succeeded with a member of one of the minor tribes at the helm. Those three tribes are the trading, banking and sales departments.
Other smaller tribes include the research “geeks,” systems, legal, risk management, compliance and accounting. Traditionally, the support groups, also called cost centers, seldom get the top spot at any Wall Street firms, unless the firm has been shut down or nearly so, in which case regulators, major shareholders or other outside forces might put a lawyer, accountant or a risk manager in charge.
When I came to Wall Street in the 80’s, the biggest trading shop was Salomon Brothers, now the institutional side of Citicorp. Legendary traders always dominated Salomon. They got paid more than anyone else at the firm, and they typically decided the strategies that would determine what kind of financing business the bankers pursued and what kind of accounts the sales force looked to sell to.
It’s no surprise, then, that Salomon became the first major MBS trading house or that they were investment bankers for the first CMOs. Even before they launched the CMO business that squeezed more profit out of mortgage pass-throughs, Salomon launched the business we call the Treasury Strip to squeeze more trading profit out of the humble Treasury Bond.
The idea of Treasury Strips first occurred to an analyst, Gerry “Gig” Snider, but it was Gig’s boss Marty Liebowitz that convinced the partners that ran the Treasury trading desk to create new securities by “stripping” the semiannual interest payments off the 30-year Treasury bond to sell them separately.
At that time, the yield on the 30-year Treasury bond (the Long Bond) was quite a bit higher than the yields for shorter Bills and Notes. If you could get an investor to take the stripped off coupon payments at significantly lower yields than the whole undivided bond was selling for, you could make an arbitrage profit while selling the final principal repayment as a 30-year “zero coupon bond” at a slightly higher yield than the Long Bond.
It took a little while for the market to realize that the price volatility risk was higher for the zero coupon bond, so at first the market treated the new securities as a kind of free lunch.
As was common in a firm dominated by the Trading Tribe, each deal was executed as a trade when the profit was accounted, and the bankers and analysts that created the legal structures for the trusts and the supporting analysis for the sales force were all treated as well paid support staff for the traders.
Others known to be trader-dominated were Bear Stearns, and our shop at Becker. When I joined Becker, Lehman was on its way to becoming a trading shop as the investment banking partners who sold out to American Express began to cash out and leave.
Gradually Lehman became a trading house once the bankers that had defined its culture were mostly gone. Before it got there, Lehman had to suffer through a bad idea that was quite popular among financial companies at the time.
Amex management thought they could take Lehman, splice it to a retail brokerage called Shearson, and then cross-sell all kind of services like credit cards, banking and asset management to both retail and institutional clients. The concept was called a “financial supermarket,” and it worked horribly, mainly because of tribal warfare.
There was an attempt to splice Lehman to Shearson, a retail “wire house” by Amex management as part of a move during that time to develop financial “supermarkets.” Fortunately for the traders at Lehman, the retail side of the shop more or less withered away, and the American Express owners got frustrated eventually and spun out their holding in Lehman.
My second stop on Wall Street was at Prudential-Bache, another attempt at the supermarket idea. The retail brokerage Bache Halsey Stuart was supposed to create some kind of synergy with Prudential Insurance, perennially the number one or number two insurance company in the US.
The Bache culture was dominated by retail brokers (Sales Tribe), something that didn’t change after Prudential Insurance reinforced that culture by hiring George Ball as CEO from E.F. Hutton, another retail stock brokerage.
As we tried to build up an institutional business around our new strength in CMOs and mortgage securities, we regularly had situations where a retail broker in a branch would call George Ball directly to claim commissions on trades we did with banks, insurance companies, or other institutions based on the fact that the broker had golfed for years with the bank president, etc.
There have also been successful boutiques dominated by the research tribe, usually on the strength of investment banking deals, trades or commissions that get assigned by grateful investors to those research shops.
The big shops that are dominated by traders, sales people or bankers nearly always try to make it hard to pay the research shops their small slice of the pie, but big customers could and did insist often enough to keep some quality research shops alive right into the 1990’s.
The research shops even got a breath of new life when Wall Street got caught offsides after the dot com meltdown. Part of the major Wall Street shops’ settlement with the authorities over their insincere pitching of any dot-bomb idea they could find was to agree to pay for independent stock research for their customers.
While power and money are different, Wall Street deals in money, so much of the power distribution is directly done through distribution of money, in all its forms. The most obvious is paychecks, but there is also allocation of capital and expenses at play.
Imagine my surprise, for example, when the 25% profit-share bonus pool I thought my mortgage finance group at UBS had earned was essentially taken away. As I sat with the head of Fixed Income, he explained that my group, with its four people and three PC’s, had accrued over $12 million in systems cost.
With the magic of allocated costs, a huge mainframe computer and its small army of programmers were assigned to our business line. This, in spite of the fact that I had vehemently insisted a year earlier that no usable program would ever come out of that group or that machine.
I first ran into a powerful Systems Tribe at Prudential-Bache. The head of systems had joined the firm just a month before I did. He was a consummate politician who repeatedly told the story how he had quit IBM after more than 20 years of success to come “fix the problems” at Pru.
This didn’t ring true for me, since I knew people who worked at IBM at a much lower level than he had, and none of them ever left, because the payoff from retiring at IBM was so attractive.
On the other hand, our firm had been an all-IBM shop for its entire history until 1982, when the retail sales force had made the “mistake” of buying some PC’s from one of the firms that got into that business before IBM did.
In a brilliant move, our Pru-Bache head of systems went over the head of even our chairman to make a presentation to the Board of Directors of our parent company, Prudential Insurance.
He came back from that presentation with a new title – “Chief Information Officer,” a seat on our company’s board, and a firm-wide policy that no computer would be bought by anyone without his department’s approval. I admired the audacity and sureness of his move, even if I felt it would be bad for some business units.
Our firm’s IT budget soon flew right past $100 million a year on its way to several times that amount only a few years later. That’s when I realized how the Systems Tribe, and other cost centers worked.
In those departments, importance to the firm is defined by the size of the budget, the number of employees, and the involvement they had in every facet of the money-making parts of the firm.
By their very nature, systems departments promote empire-building. After all, if the budget was one tenth the size and the function was done by a handful of people in a company with thousands of employees, there certainly wouldn’t be a seat on the board for the Chief Information Officer.
I did eventually escape the clutches of the systems department, but only by getting another job and resigning. Pru said they would meet the offer of the other firm to keep me.
Imagine their surprise when I told them matching the offer didn’t include getting a raise. To keep me, they just had to agree to do CMO deals and to let my department have any computer not manufactured by IBM.
We did our first two lead-managed CMO deals in the next two weeks, and I walked a purchase order through the entire firm to order a Digitial Equipment mini-computer for a million dollars the day my two weeks’ notice was ending. I stayed and succeeded for several more years at Pru-Bache.
Back to the tribes. Goldman, Morgan Stanley, First Boston and Lazard Freres were dominated by the investment bankers. Trading and sales basically reported to them, and got paid less than the top bankers.
Merrill was like Pru-Bache, and it had a strong retail broker tribe that ran the firm for a number of years even after it became a major force in the institutional business. Even when it was the norm for Wall Street firms to take large principal positions in bond deals, Merrill was famous for carrying light inventories, and pushing the entire firm to make sure that turnover (sales) was number one priority.
Merrill changed, much to its chagrin, when it decided to move into the CDO business, and used its own balance sheet to get deals done. Merrill became number one in the business in 2004, just two years after hiring Chris Ricciardi from Credit Suisse (First Boston).
As they rolled along in the number one position again in 2005 and 2006, Merrill became known in the CDO business as the firm that could put newly-formed asset managers in business. The widespread joke about these newly minted fund managers was that they consisted of “two guys and a Bloomberg.”
Still, if the new manager was willing to take a low management fee and let Merrill handle everything: structuring the deal, trading and “warehousing” the bonds that would be in the CDO trust, and finally selling the bonds, it was a great way to get into the second hottest sector of money management with a billion or more dollars in assets right away.
In a throwback to its retail brokerage roots, it seems Merrill still has some sales tribe members in its branches that can get themselves into any and all ways to make money.
Springfield, Massachusetts realized in 2008 that its cash management account owned three floating rate CDO bonds that were sold to the city as safe AAA bonds by Merrill retail brokers in the Albany, New York branch office. Those bonds were worth about ten cents on the dollar less than a year after the city bought them.
Merrill moved quickly to pay back the investment, but that didn’t stop the Commonwealth of Massachusetts from looking into how Merrill allowed brokers in the Albany branch to sell very complex derivative securities to one of New England’s least financially sound cities.
I do give Merrill credit for one thing with their emphasis on sales. The only really perfect hedge is a sale ticket. Unless, of course, you are forced to buy that barking dog back a year later.