Tuesday, July 22, 2008
end of the broker/dealer model?
The problem, he says, is that broker/dealers use the same model as banks -- borrow short and lend long -- only they borrow on even shorter timeframes, use more leverage, and don't have the kind of government backstop banks enjoy.
In the wake of Bear Stearns' demise, which showed how brokers are vulnerable to a "run on the bank" if they can't get overnight funding, the Fed temporarily opened its discount window to brokerage firms. But making that option permanent means submitting to the same kind of regulation and capital requirements as banks; that, in turn, means a very different business model -- and much lower profitability -- for Wall Street firms, whose current business model is "not viable," he says.
the difficulty i have with this call is that the broker/dealer model has a long history, as does borrowing short (even wholesale) and lending long (and illiquid). i think roubini deeply underestimates the reckless love of profit that motivates the i-bank model (or, for that matter, the unregulated hedge fund).
that's not to say disasters will not proceed from them. the infamous year 1929 saw the collapse of levered investment pools in a horrifying credit squeeze that ultimately undid 19th-century capitalism. but the basic model that roubini disavows here is still operating today.
the trouble the four independent broker/dealers are in is certainly a result of their business model, but more exactly is the result of overlevering their business model into an asset deflation. it may very well threaten and eventually end the independent existence of all four as it did bear stearns -- but that does not mean we will not see the permanent eradication of levered finance.
probably roubini isn't suggesting anything so profound as a change in human nature -- indeed i imagine his point is simply that this crop of broker/dealers is as dead as the bank of the united states. but levered finance will be back, regardless of what wickedness this way comes.