Snakes and Ladders: Investment Banking on the Brink

Intellectuals solve problems, geniuses prevent them.
Albert Einstein

By Martin Hesse, Thomas Schulz, Christoph Scheuermann and Anne Seith

DER SPIEGEL: For decades, investment bankers have held the key to untold riches — but now they’re being laid off by the tens of thousands. As the crisis forces the industry to search for a new identity, is it ready to mend its ways?

The suicide victims chose a location with symbolic significance. Last fall, only a few weeks apart, a businesswoman and a banker went to the Coq d’Argent, an upscale restaurant and hot spot in the world of London high finance, located on the top floor of a shopping complex, to end their lives.

The woman put down her purse and jumped from the restaurant’s cozy rooftop terrace. The banker, an investment specialist, jumped into the building’s atrium around lunchtime.

The “City,” the casual term the financial center uses in reference to itself, was shocked. The suicides are the most glaring expression of an apocalyptic mood that seems to have gripped all of London. Hospitals are reporting a high incidence of patients with alcohol problems, while top restaurants are fighting for every customer.

The crisis has struck at the heart of the financial center. In 2012, banks began to downsize their investment banking activities. For years, the area had been seen as a playground for those seeking instant riches and guaranteed success, and it provided tens of thousands with sometimes exorbitant incomes.

October 30 would become a horrific day for the financial district after the Swiss bank UBS announced that it was slashing 10,000 jobs in the sector. On one morning alone, the bank’s London office let hordes of bankers go. Some were intercepted at the entrance, still carrying their coffee in to-go cups, only to be shown the door a short time later with a piece of paper filled with instructions.

All he felt was hate, says a 51-year-old who was among those affected by the recent layoffs. For him and others like him, the chances of finding a new job are slim. The competition is also doing its utmost to downsize. Morgan Stanley plans to lay off 1,600 employees in the coming weeks, Lloyds is cutting as many as 15,000 jobs worldwide, and Deutsche Bank has just eliminated 1,500 jobs in its investment banking division.

An era seems to be coming to an end, the era of an industry that led us to believe that what it did was useful. In reality, though, it was lining its pockets by conducting more and more reckless transactions and involving itself in increasingly insane deals and products. Senior executives say the business is merely shrinking to a healthy level and characterize it as something like a catharsis.

As former investment bankers search for new identities, arrogance is being replaced with humility. It’s important to “improve the way we operate as an organisation,” Antony Jenkins, the new CEO of the major British bank Barclays, wrote in a memo to employees. Anshu Jain, co-CEO of Deutsche Bank and the former head of its investment banking division, has promised “cultural change.”

While conducting research for this article in Frankfurt, London and New York, SPIEGEL kept hearing the same phrase: “The party is over.” The authors met with current and former investment bankers around the world and spoke with them about their sudden decline, their convictions and their self-image. They were told how the industry had become more and more powerful since the 1990s, and how it gradually disconnected itself from the rest of the world in the belief that it could use formulas and financial models to calculate away all risk.

After the scandals of the recent past, many insiders were shaken and introspective. But hardly anyone would admit to having made mistakes. Indeed, all of their actions were informed by the logic of a culture that has developed such perverse incentive systems that it will probably take more than a few years to regulate it back to health.

‘The Normal Ones and the Nuts’

Like most of the people we interviewed, a man we’ll call Peter Burger was adamant about not being identifiable and insisted on using a pseudonym. And, again like most of our interviewees, he did not conform to the image of the carefully groomed and impeccably dressed investment banker. Burger has a crew cut and wears an off-the-rack suit. With a chuckle, he admits that he only pulled it out of the closet for the interview.

Now he is sitting in a Frankfurt steakhouse, drinking a beer with his rare steak and talking about his industry. “There are two types of investment bankers, the normal ones and the nuts,” he says. “The nuts haven’t heard the news yet. They’re still out buying cars for six-figure sums.”

Burger leaves no doubt that he doesn’t consider himself one of the nuts. But he does buy and sell securities for his clients, making him one of the most notorious representatives of his species: a trader.

In another conversation, a management consultant from the industry develops a typology of sorts: “There is indeed the poker player type in the business, with a tattoo under his shirt, a considerable ability to cope with stress and a short attention span whose goal is to maximize profits in the short term without regard for what’s moral.” And then there are the gifted salespeople, he adds, who can persuade customers to buy securities that make sense — as well as those that don’t.

Finally, there are the super-brains: Mathematicians or nuclear physicists who became investment bankers, partly because of the intellectual challenge. These people made the most money because they came up with the formulas for highly profitable structured products, which were then sold millions of times before the crisis.

All of this has little to do with traditional investment banking, say so-called M&A consultants and IPO specialists. They arrange mergers and acquisitions, plan initial public offerings and embody a completely different kind of banker. They come complete with a broad job profile and multiple foreign languages, and they’ve often had years of training in management consulting firms. In fact, the people working in the trading rooms are about as foreign to them as car salesmen are to professors.

The divides don’t just exist between traders and advisers, but also between the German- and English-speaking worlds. In London and New York, people often get into investment banking at 22, pass through three to five levels of management and, by their early 30s, may have reached the position of managing director, the level just below the executive board. In good times, they can enjoy seven-figure annual incomes.

“In London, everyone is like the nuts we have here in Germany,” says Burger, a more down-to-earth man. “Cold lone wolves, and extremely unpleasant.” There is more money at stake in London, he adds, and the people who work there see themselves as lying at the center of the universe.

The Wild Times

Frank Meier (also a pseudonym) still remembers how he first came into contact with this world 20 years ago. It fascinated him.

It was the 1990s, and Germany’s traditional banks wanted to finally get involved in this new, exotic business that promised such tremendous profits. To do so, they lured their first employees away from American competitors, such as Lehman Brothers and Merrill Lynch.

Meier is a friendly man, polite in an almost old-fashioned way, with a pocket square in his sports coat. Nevertheless, he says, the “high-flying investment bankers” impressed him when he was a young man because they were so different from the “stolid” German bankers, “who were virtually unapproachable.”

The adventurers from the United States drove Aston Martin convertibles instead of the usual Daimler sedans, slapped everyone on the back and addressed each other by their first names. More importantly, they earned small fortunes with every deal.

At the time, everything seemed possible in investment banking. Politicians worldwide celebrated the industry in their unconditional faith that the market could regulate itself without onerous regulations. In 1986, then-British Prime Minister Margaret Thatcher initiated the measures to deregulate financial markets known as the “Big Bang.” The United States gradually followed suit until, in 1999, it finally repealed the Glass-Steagall Act, which had prohibited investment banks from doing business with private customers because of the high risks involved and to protect the latter’s savings.

Now that it had been unfettered in this manner, the financial market grew at a tremendous pace, and investment banks became giants with branches all across the world. Goldman Sachs alone increased its total assets in a decade, from $152 billion (€114 billion) to more than $1 trillion. In 2006, the average Goldman Sachs employee was making $622,000.

Not surprisingly, the industry attracted some of the most gifted talent, people who were allowed to unleash their creativity. In 1998, a team headed by JPMorgan banker Blythe Masters took apart dubious loans for the first time and repackaged them into securities, which were then sold. And, to the astonishment of German bankers like Meier, the resulting risk was purged from JPMorgan’s books.

Meanwhile, in Germany, the industry’s glamorous soldiers of fortune were almost effortlessly raking in millions through the privatization of government-owned companies, such as the airline Lufthansa, and acquisitions, such as the merger of the mobile communications giants Mannesmann and Vodafone. Since the invention of Excel, everything under the sun can be calculated on a grand scale, says Meier. “You could model cost synergies and construct scenarios.”

It only gradually emerged that the bankers, with their murky forecasts, were often wrong. In fact, studies now show that every other merger was a failure. Nevertheless, the volume of such transactions increased tenfold from 1990 to 2007, to almost $4 trillion worldwide. Investment bankers, it would seem, can be very convincing — especially when they’re banking on high fees.

Conforming to Clichés

The cost of the 2007/2008 financial crisis, which is estimated to be in the trillions, provides a sense of the price of excessive growth. So does a conversation with someone who got out of the business: Rudolf Wötzel, the former head of Lehman Brothers’ M&A business in Germany.

Wötzel quit the job in 2007 out of concern that it was destroying him. Today, he runs a hostel for mountain hikers in Switzerland. His hair is longer than it used to be, and now he’s wearing jeans and a black-and-white plaid shirt. Still, he hasn’t become completely detached from his old world. “I’m on my way into the valley again,” says Wötzel. He wants to share his experiences with others. “Not everything about investment banking is bad,” he says. “But the industry needs to fundamentally change and publicly express its social and economic role in a self-critical and constructive way.”

Wötzel believes that a monoculture has developed in the industry, starting with recruitment methods. “In their recruitment,,” he says, “investment banks focus on a handful of elite universities, which produce similar, streamlined types of people.”

The investment banks show the candidates glossy brochures depicting the rosy side of the business, and then they roll out the red carpet. But, once on the inside, they discover that things are very different.

“Suddenly the glamorous image is no longer sustainable, and it quickly becomes evident how one-sided the career mechanisms are,” says Wötzel. Those who deliver the biggest deals and the most impressive spreadsheets, and are the most skillful at playing the political game, are the ones who succeed. This leaves a mark on people. “Once they have been in investment banking for 10 or 20 years,” he says, “they begin to conform to the cliché.”

Some who remain in the business say that people like Wötzel are losers who couldn’t stand the pressure. On the inside, the winners are seen as “outperformers,” and yet many have checked their realistic self-perception at the door. “As a result,” Wötzel says, “100 percent of recognition has to come from the outside, through bonuses and promotions, while intrinsic motivation falls by the wayside.”

The machine in which Wötzel worked made the banks rich and made it easier for the rest of the world to live on borrowed money. In the end, however, it began to destroy itself, generating one scandal after another.

Banks manipulated the LIBOR interest rate, which affects financial transactions worth hundreds of trillions of dollars. They foisted risky assets on customers and became involved in money laundering and tax fraud. Traders like Kweku Adoboli (UBS), Jérôme Kerviel (Société Générale) and Bruno Iksil (JPMorgan Chase) gambled away billions through risky transactions, either on their own or with their departments.

Former German President Horst Köhler once described the financial markets as a monster controlled by investment banks. Since 2008, politicians have been trying to tame the monster and assume control.

For instance, they want banks to set aside more capital as collateral for risky deals in the future, which means that many areas will hardly be profitable anymore. Banks and bankers are to be forced into a tighter corset — but they are fighting back. The United States recently — and yet again — cast doubt on the chances of seeing new rules introduced. There is also heated debate worldwide over tighter regulation of bonuses, which are sometimes exorbitant.

“It gets to be less and less fun every day,” says trader Peter Burger, who believes that the proposed regulations are almost as excessive as the banks’ former dealings were.

Bankers are especially upset over the move to sharply curtail personnel costs. There is no other industry in which workers cost as much as in investment banking. “This is the only industry in which labor has exploited capital,” jokes one adviser.

For this reason the mass layoffs at UBS — which is completely abandoning large portions of its investment banking business following the appointment of Axel Weber, the former president of Germany’s central bank, the Bundesbank, as supervisory board chairman — are seen as a warning sign for the entire industry. It is “as if Daimler stopped making sedans,” says the head of the German division of a major US investment bank.

The Safer Survivors

US investment bank Cantor Fitzgerald has already had to reinvent itself once before. It lost three-quarters of its staff, a total of 658 employees, in the 9/11 terrorist attack on the World Trade Center in New York.

Today, Cantor Fitzgerald has 1,600 employees in 30 offices around the world. The company survived not only the 9/11 disaster, but also the recent financial crisis. “We’ve just gotten much bigger and better,” says CEO Shawn Matthews. One reason for this is that Cantor primarily deals in bonds, a sector that’s booming now that companies with insufficient access to credit are raising more and more capital through bond issues.

Is this what the investment bank of the future looks like — Cantor’s modest office on the fourth floor of a nondescript office building in Manhattan?

Matthews says that his industry has to find its way back to how things still were in the 1990s, when bankers were compensated differently and such large amounts of debt were not in play. Things only became dangerous, he says, when investment banks transformed themselves from private partnerships into publicly traded companies. As a result, managers no longer felt that they were putting their own money on the line whenever they took major risks.

Cantor Fitzgerald is a privately held partnership with only a limited amount of capital at its disposal, and Matthews is visibly proud of that. “We don’t have to worry about the pressures of quarterly (reporting),” he says, “so we have the ability as a group to determine how we can build long-term wealth.”

Matthews is convinced that many small and mid-sized banks will completely disappear, partly because — for the first time in decades — the “next big thing” that would enable investment bankers to stir up the financial world isn’t visible on the horizon. In the 1990s, it was derivatives and, most recently, it was complex mortgage-backed securities. But now the financial wizards seem to have run out of ideas.

“So you start to look at it from the standpoint of what is the new Wall Street,” says Matthews. “It’s still a great place to have a great living, (a) good lifestyle, the ability to clearly carve out a significant career, but not the world that was kind of the illusionary world that was created by infinite leverage.”

But that place is still a long way away.

Smaller, but Still Plenty Risky

Roland Berger, a German management consulting firm, estimates that another 25,000 jobs will be slashed in the coming years as the entire industry rebuilds itself.

“The trend is fundamentally toward the sale of simpler, industrially produced products,” says Markus Böhme, an expert with Berger. These instruments are known as “plain vanilla,” which is industry jargon for mass-produced and therefore requiring far less personnel.

But will the world of investment bankers truly become less risky?

“The investment banks will get rid of the traders, but not the books,” warns Michael, a 35-year-old who worked as a trader of “exotic” products in London for 10 years after training to be a software engineer.

In the wild years, UBS’s balance sheet, for example, was inflated with hedging transactions and bets worth 560 billion Swiss francs (€450 billion/$600 billion). The competition argues that downsizing the portfolio will be about as easy as shutting down the Chernobyl nuclear power plant.

Indeed, only a select group of experts understands what exactly is still lurking in the books of investment banks. “The formulas are simple; it isn’t very high-level math,” says Michael, “but you have to see the risks.” The trick, he adds, is to recognize all contingencies.

Many investment bankers who are losing their jobs are also moving to hedge funds, where they now place their bets in the hidden world of the shadow banks. Others are looking for loopholes and new areas in which to ply their trade. Investment bank Goldman Sachs, for example, is engaging in risky deals for its own account, despite its insistences to the contrary. The bank’s financial jugglers are circumventing a ban on such transactions in the United States by simply making bets for longer terms, which are not covered by the law.

Meanwhile, players such as JPMorgan are getting involved in the commodities market in a major way. Of all people, JPMorgan banker Blythe Masters, who became world-famous for the role she played in inventing the first credit derivatives, now heads the bank’s global commodities division.

Things haven’t changed much in the latest preferred sector of many investment bankers: At first, the banks only hedge against risks, but then they sell these risks and, to do so, they invent new and increasingly complex methods. Eventually, the volume they move around on the financial markets becomes so big that they acquire overwhelming influence. “If you ask me, this is the next scary thing,” says one banker.

So is the system incapable of being reformed? Frankfurt personnel consultant Andreas Halin, who has been in the business for many years, answers the question with a telling comparison.

“Money is like saltwater,” he says. “The more you drink, the thirstier you get.”

Translated from the German by Christopher Sultan

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I am a successful Commercial Investment Real Estate Broker in Arizona now for 15 years and I worked with banks and their commercial REO properties for 3 years. I am also a commercial Landspecialist in Phoenix and a Commercial Landspecialist in Arizona.

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Walter Unger CCIM

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