Will New York Follow Detroit Into the Dustbin of Mediocrity?

Sunday, January 27, 2008
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Once upon a time America owned the automobile industry. But after several decades of excessive taxation, onerous government regulation, union extortion, and a crushing lack of foresight and innovation, we no longer dominate an industry that we practically invented. Just as Detroit no longer claims center stage in the world automobile marketplace, soon New York will lose its position at the center of global capital markets.

Oppressive taxation and regulation, a devalued dollar, and declining private property rights: Peter Schiff on why Wall Street can no longer attract the lion’s share of new capital, and why it will follow Detroit’s path to self-destruction. Schiff correctly points out the moral hazard problem of Wall Street’s newfangled model for investment banking:

However, in the last few years Wall Street has not only screwed customers but their own shareholders as well. At one time all of our major investment banks, such as Goldman Sachs, Lehman Brothers, Morgan Stanley, Bear Stearns, Smith Barney, Shearson, E.F. Hutton, Kidder Peabody and Solomon Brothers, were private partnerships. However, during the 1990′s they all went public (of course many merged first so they no longer exist as independent firms). Goldman Sachs was the last to go public in 1999. The transition allowed Wall Street partners to cash out, transferring future risks to new shareholders. In so doing they were able to capitalize on bubble valuations, yet through lavish bonus compensation packages, still keep the lion’s share of the profits for themselves. In other words they got to have their cake and eat it too.

As a result of this transfer of risks, the business models of America’s leading financial institutions shifted, with profits coming from riskier sources such as proprietary trading and structured finance. To line their own pockets, Wall Street willingly exposed its shareholders to risks that it would never have assumed with its own capital. This moral hazard set the stage for the enormous losses shareholders are now suffering, and are a direct consequence of the phony profits booked in prior years. However, while shareholders are left holding the bag, Wall Street’s former partners, now turned employees, have already walked away with huge IPO and stock option windfalls, as well as lavish bonuses paid on phantom profits.

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