Can the Buy Side Take on the Sell Side?

By James Kwak
The Economist did not like 13 Bankers: “A broader perspective would have led to more nuanced conclusions. The origins of America’s financial ‘oligarchy’, for instance, might have more to do with campaign-finance rules and political appointees than banks’ size. The faith that Messrs Johnson and Kwak put in merely capping the size of banks is misplaced.”*
But a reader pointed us to the Economist columnist who goes by the name of Buttonwood (the site of the founding of the New York Stock Exchange), who seems a bit more favorable. In a recent column criticizing the rent-seeking of the financial sector, Buttonwood seems to tell broadly the same story:
“Something has clearly changed within the past 40 years. Banking and asset management used to be perceived as fairly dull jobs, which did not attract a significant wage premium. But after 1980, financial wages started to climb much more quickly than those of engineers, another profession that ought to have benefited from technological complexity.
“Around the same time, banks became more profitable.”
He even nods toward breaking up the banks:
“At the moment, governments are wading in with all kinds of levies and regulations, which will probably have unintended consequences. Rather than tackle the big problem (for example, by breaking up the banks), they waste their time on populist measures like banning short-selling.”
In the end, though, Buttonwood endorses a different solution: getting the buy side (investment funds) to take a stand against the sell side (investment banks):
“Paul Woolley . . . has published a manifesto which he believes should be adopted by the world’s biggest public, pension and charitable investment funds. Among other things, he proposes that the funds should adopt a long-term investment approach, cap annual portfolio turnover at 30%, refuse to pay performance fees or invest in alternative assets such as hedge funds and private equity, and invest only in securities traded on a public exchange.”
In other words, the buy side should realize that its getting screwed by the sell side and start looking after its own interests.
I would love it if this were to work. But I’m not optimistic. Because while the institutions that make up the buy side and the sell side have different economic interests, they are populated by the same set of people who believe the same things. Pension fund managers are not suddenly going to acknowledge that they can’t beat the market in the short term and shift to low-turnover, long-term investing, because that would undermine their own claim on a piece of the action. You become a manager of a big fund by beating the market, and you beat the market by taking on extra risk and getting lucky. You’re willing to put money into fancy hedge funds and private equity funds because it’s not your money, so you get a chunk of the upside (a better job, more funds to manage, more money) and none of the downside (no one will blame you for putting money into Goldman’s hedge fund, even if it doesn’t do well). The people whose retirements depend on the pension fund’s returns have one set of interests. But the people managing that fund very often have another.
* For the record, we did discuss both campaign finance and especially the problem of political appointees who are friendly to Wall Street at some length — a lot of Chapter 4 and a chunk of Chapter 6.