Too Big To Fail updated

There was a made for HBO movie called “Too Big To Fail” about the 2008 financial crisis. I recommend watching it (even though it was controversial in some circles for showing Hank Paulson as a virtual saint) especially for people who aren’t in the finance industry because it is intelligently written (based on a book) and they really got big name actors to play the part of Wall Street CEO’s.

The Wall Street Journal has an “overheard” box on the back page of the financial section and they had some interesting observations on Wall Street in 2011 on how the various players have shrunk in market capitalization.

Here are the current market caps of the “Too Big To Fail” parties:

– Lehman Brothers (Dick Fuld) – bankrupt
– JP Morgan-Chase (Jamie Dimon) – 110B (CORRECTED)
– Vikram Pandit (Citigroup) – 69B
– John Mack (Morgan Stanley) – 25B
– John Thain (Merrill Lynch) – bought by bank of America (see below)
– Lloyd Blankfein (Goldman Sachs) – 52B
– Rickard Kovacevich (Wells Fargo) – 123B
– Bob Willumstad (AIG) – 38B (resurrected by Federal Government)
– PREVIOUSLY Bear Stearns – sold to JP Morgan-Chase

In the movie Wells Fargo was treated as an afterthought. Not mentioned are two banks listed below and Bank of America is given only a small part in the movie, even though they ended up buying Merrill Lynch (I don’t even know who played Ken Lewis).

US Bankcorp 45B
PNC Financial 44B
Ken Lewis (Bank of America) 52B

The fact that these banks which are generally thought of as “regional banks” like US Bankcorp and even Wells Fargo have market caps in line or ahead of the giant Wall Street banks is a sea change in reality.

As these Wall Street companies become smaller what you are also seeing is the relative shrinking of the financial sector as a total portion of the US market capitalization. Financials returned -48% over the last 10 years vs. -17% for the S&P 500 (for the link to work change the time frame to 10 years and you can see the results).

These companies have an outsize impact on the economy of New York in particular because they pay out such a high percentage of their revenue in compensation. According to this article the compensation will drop 20 to 30% this year compared to the prior year.

In the first nine months of the year, Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America and Citigroup set aside almost $93 billion to pay employees, up from $91.25 billion in the year ago period, according to Johnson Associates. The final number, however, is not set until the fourth quarter, when firms have a clear idea of their total revenue for the year.

While employee compensation as a percentage of market capitalization is not always a good metric to use for comparison purposes, in this case it is enlightening. Much of the outsize pay (some would say obscene) that these New York traders and executives receive is justified by the profits (and high stock prices) that result from their actions. But if the banks are paying out such a high percentage of their total market capitalization in profits every year, that justification starts to take on water a bit.

As far as alternative metrics, Business Insider had an interesting article on Wal-Mart, which employs 1% of the US work force. This analysis attempted to show what would happen to the average worker if Wal-Mart plowed back all their profits into employee wages (just a theoretical case). Per the article:

If Walmart took its entire $22 billion of annual pre-tax income and used all of it to give each one of its 2.1 million employees a raise, this would amount to about $10,000 a year apiece. In other words, if Walmart decided to use 100% of its operating profit to pay all of its employees more, the average store associate’s salary would go from $20,000 to $30,000.

In an even sharper turn down the rabbit hole of linked causality, Wal-Mart itself is essentially moving off Wall Street to become a private company. This is obviously an exaggeration but Wal-Mart is using its profits to buy back stock, and much of its stock is held by the descendants of Sam Walton in the first place, so the outstanding stock metric is even lower than it appears. Wal-Mart has 3.46 billion shares outstanding but the “public float” is only 1.73 billion shares. And Wal-Mart is working hard to whittle away that public float, per this article…

Wal-Mart said on Friday that it would buy back $15 billion more of its shares to try to improve returns for its shareholders. The initiative, which was announced at the company’s annual shareholders’ meeting here, comes after a previous $15 billion repurchasing plan that was announced last year. The company bought back 244 million shares, worth about $13 billion, under that program

So there you go. Wall Street, that icon of capitalism, justifies high salaries for traders and executives on the basis of stock capitalization values that no longer support this line of reasoning. And on the other hand, the core basis for Wall Street, the raising and allocation of capital, is turned on its head as one of the largest and most well-run companies, Wal-Mart, essentially plows its earnings into a de-facto move to privatization and off Wall Street in the first place.

Cross posted at LITGM

4 thoughts on “Too Big To Fail updated”

  1. It’s worth recalling that most of the crisis came from traders investing other people’s money. Brown Brothers, Harriman, a partnership where partners money was at risk never got heavily into CDOs and did not have large losses.

  2. Steve Eisman, trying to figure out what was wrong with his trying to buy credit default swaps, managed to get a meeting with Ken Lewis and “…I had an epiphany. I said to myself ‘Oh my God, he’s dumb!’ …. The guy running one of the biggest banks in the world is dumb!” ….shorted Bank of America, UBS, etc…
    From The Big Short, Michael Lewis.

    Read that about half an hour ago and had to relate.

  3. May want to recheck the market cap of JPM. Unless I am misunderstanding where that number is coming from it looks to be about 60B off. This probably doesn’t change your point but wanted to give you a heads up.

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