Originally, Wall Street existed as custodians of wealth. Its' sole job was to help direct capital to its most beneficial uses.
At some point in time, these brokers of capital realized they were perched in a unique position of power. With this knowledge, Wall Street transformed into professional skimmers of wealth.
In function, Wall Street chose to become self-interested traders rather than investors in society. Is this a breach of Rousseau’s social contract? Does Wall Street owe society a fiduciary duty in exchange for the power granted to them?
I caught up with Wall Street historian Dr. Charles Geisst to find out how and when things changed on Wall Street…
Dr. Geisst: The bear market from the late 1960s to the early 70s marked the end of the old Wall Street. They at least made an attempt to look after people’s money on the wealth management or even brokerage side. They were a little bit more humane than today.
Damien Hoffman: What are the reasons for the change?
Dr. Geisst: Most of the security houses went public and that put them into the short-term mentality of keeping their investors happy. That mantra, of course, worked well for the houses themselves. Before that, they paid better attention to their customers.
Damien: That begs an interesting question. Given that they have a fiduciary duty to their investors but also as custodians to their clients, how exactly can they say they’re actually fulfilling their fiduciary duty to both since clearly their interests are not always aligned?
Dr. Geisst: Oh, I don’t think they can. For the most part, they have given up the fiduciary responsibilities owed to clients. You’ve given up when you decide to make markets for the clients in addition to doing investment banking work for them.
For example, if Goldman Sachs (NYSE:GS) or Morgan Stanley (NYSE:MS) does a new bond issue for an entity, then it’s going to be obligated to make a market in the bond afterwards. However, if they could be long or short the bond — or both — and it benefits only them, then they’ve breached their fiduciary responsibility to the client. In other words, their obligation was to provide both the primary and the secondary market. When the firm steps over the line and starts prop trading the instrument, the whole thing gets badly confused.
Damien: So how can we end the confusion with some results-driven financial reform?
Dr. Geisst: I probably would have answered the same way five or ten years ago. We need something like the Volcker proposal or Glass-Steagall. So long as any modern financial holding company — the post-1999 entities — gets the feeling there is an unlimited source of capital behind it, both from the bank which owns it and/or the FDIC, we create a moral hazard in the investment banking business as well. And this was the thing the 1933 legislation was trying to put an end to.
Damien: Dr. Geisst, thank you for sharing your insights with us today.
Dr. Geisst: You are very welcome.
Dr. Charlie Geisst is the author of Wall Street: A History.