Michael Lewis on the end of Wall Street

Good read in Portfolio from the author of Liar's Poker on perhaps finally witnessing the end of Wall Street that he'd forecast after his days at Salomon Brothers.

Both Lewis and James Surowiecki of The New Yorker emphasize that one of the amplifiers of this recent financial blood bath was the decision of investment banks to go public. Surowiecki wrote:

All, then, seemed good. But, for Wall Street firms, going public was a deal with the devil, because it meant exposing themselves to what was, in effect, a minute-by-minute referendum, in the form of the stock price, on the health of their operations. This was fine as long as things were going well—the higher the stock price, the richer everyone got—but, once things started to go bad, that market referendum started to look like a vote of no confidence. And that made the problems that the companies were already facing much, much worse.

That’s because the entire edifice of Wall Street is built on confidence. Investment banks rely on short-term debt to run their businesses, and their businesses consist of activities—trading, dealmaking, money management—that depend on people’s faith in their ability to honor their obligations. As soon as the customers and creditors of a company like Lehman start to wonder whether it might collapse, they become less willing to lend or to trade, and more likely to demand their money back. The perception of weakness exacerbates the reality of weakness. And although there are myriad measures of a company’s health, nothing looks scarier than a stock price that’s heading toward zero.

All companies, of course, worry about how their stock is doing. But for most the stock price is a product of performance, rather than a cause of it. If Procter & Gamble’s stock plummeted tomorrow, people would still keep buying Tide. By contrast, if an investment bank’s share price tumbles, it not only wrecks people’s confidence but also can lead to credit-rating downgrades, which provoke a further decline in the stock price, and so on. The downward spiral can be stunningly fast and near-impossible to escape. Lehman’s assets were not significantly more toxic last Monday, when the company filed for bankruptcy protection, than they had been a week earlier. And, technically speaking, the bank may not even have run out of money, since it had access to an emergency liquidity line from the Federal Reserve. What Lehman did run out of was credibility. It couldn’t remain a going concern because creditors and customers no longer trusted it. Why would they, when its stock price had fallen nearly eighty per cent in the previous week? The less faith the market had in the possibility of Lehman’s survival, the more remote that possibility became.

One of the risks of going public is having your stock price govern your decision-making as a company. Managing the morale of employees becomes more difficult. Even if things are going well for the company, if the stock price is low, attrition becomes a concern.

Going public isn't just about cashing in on stock options, as someone once noted about free lunches.