March 24 (Bloomberg) -- Wall Street bond trading is heading back to the 1980s, when private partnerships and independent firms dominated the market.
Jon Bass, who traded debt five seats from Salomon Brothers Inc. Chairman John Gutfreund and later helped run fixed income at UBS AG, joined equity broker BTIG LLC to help start its credit operation last month. BTIG, with a pool table and gym adjoining its seventh-floor midtown Manhattan trading room, is one of more than 50 credit dealers seeking to take advantage of the widening gap at which securities are bought and sold.
Smaller firms are emerging from the wreckage of the world’s largest financial companies, which are conserving capital following more than $1.2 trillion of writedowns and credit losses since the start of 2007. They’re luring traders with a shot at $500,000 commissions for two days’ work as banks that accepted federal bailouts retrench and slash bonuses.
“I don’t mean to dance on anybody’s graves here, but it’s just this incredible opportunity to reassemble a securities firm that does business the right way,” said Lee Fensterstock, chief executive officer of one of the firms, Broadpoint Securities Group Inc. in New York. “That business is going to lead with brain as opposed to capital. We’re not planning to run big balance sheets or big leveraged positions.”
Bear Stearns, Lehman
Broadpoint, whose shares have outperformed Citigroup Inc.’s by almost 51 percentage points this year, has added more than 240 people since September 2007. They include traders from Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co., which either collapsed or were absorbed by bigger banks amid the worst financial crisis since the Great Depression. Cantor Fitzgerald LP, the closely held securities firm, has hired 100 people in the past six months from banks, including UBS and Bear Stearns.
Just as when Gutfreund, 79, walked the aisles of Salomon’s trading floor, BTIG’s principals aren’t secluded in their offices during the day, said Bass, 46, who most recently headed fixed-income client management at UBS.
“Back then it was motivating to see the person running the firm in the trenches,” Bass said. “It’s getting back to basics.”
Partnerships including Bear Stearns and Morgan Stanley went public in the 1980s, and many closely held firms disappeared into larger banking institutions by the end of the next decade. The trend accelerated after Sanford “Sandy” Weill’s creation of New York-based Citigroup and the 1999 repeal of the Depression-era Glass-Steagall Act, which had separated commercial and investment banks.
After Federal Reserve Chairman Alan Greenspan reduced interest rates at the start of the decade, banks borrowed inexpensively to buy long-term assets including subprime mortgage securities, said Michael Aronstein, Oscar Gruss & Son Inc.’s chief investment strategist.
‘Free’ Liquidity
“When liquidity became free, five or seven years ago, that changed the Street: You could trade $500 million of anything in a second,” said Shawn Matthews, chief executive officer of Cantor Fitzgerald & Co. in New York, a unit of Cantor Fitzgerald LP.
“It has to go back to a time where it looked and felt like it was in the ‘80s,’’ Matthews said. ‘‘How many 28-year olds can you put in positions to trade $2 billion?’’
Morgan Stanley’s trading profits rose to records in 2006 and early 2007 when its leverage, the ratio of assets to shareholder equity, rose to 33 times. The New York-based firm reported a record $2.9 billion of revenue from fixed income for the second quarter of 2007.
Banks traded their own investments alongside client orders, ‘‘combining hedge funds, which is what these places turned into, with customer-oriented businesses’’ and creating conflict-of- interest concerns, Aronstein, 55, said. ‘‘The fact is it ended in tears.’’
Subprime Losses
Losses in June 2007 at two Bear Stearns hedge funds that invested in subprime mortgage securities led to the firm’s government-arranged takeover by JPMorgan Chase & Co. of New York in March 2008. Six months later, Lehman Brothers filed for bankruptcy, and Charlotte, North Carolina-based Bank of America Corp. acquired Merrill Lynch as the world’s largest brokerage suffered almost $19 billion in net losses tied to mortgages.
New York-based Goldman Sachs Group Inc., which was the world’s biggest and most-profitable securities firm, and Morgan Stanley, converted to bank holding companies. Each received $10 billion from the U.S. government. UBS and Citigroup lost more than $138 billion and governments globally have intervened to protect the financial system from collapse.
‘Partnership Mentality’
‘‘If Wall Street had kept the partnership mentality we wouldn’t be in this mess,” said Matthews, 42, of Cantor Fitzgerald. “The universal bank model is wounded, if not destroyed.”
After financial institutions eliminated more than 284,000 jobs and slashed pay, smaller firms are hiring salesmen and traders who wouldn’t have considered boutiques during the boom, Fensterstock, 61, said.
Banks were paying “huge amounts of restricted stock,” to keep employees, he said. “Because of the decimation firms are either out of business or with the stock performance of a Bank of America or a Citigroup, that’s no longer a factor. You have this perfect storm,” he said.
Citigroup shares have tumbled 94 percent to $3.13 from its peak of $56.41 in December 2006. Bank of America has fallen 86 percent to $7.80 from $54.90 in November 2006.
Fensterstock, who ran PaineWebber’s worldwide sales and trading in the early 1990s, said commission-based compensation, known as eat what you kill, is an “extremely important” aspect of the boutique model.
Broadpoint wants to put about half of its trading revenue into employees’ pockets, with 30 percent to 40 percent for salesmen and 10 percent to 20 percent for traders, he said.
Banks Lower Pay
Some salesmen at the largest firms, which are reducing compensation as business slows under the glare of government oversight, saw their compensation fall from $2 million in 2007 to just their base salary of $150,000 in 2008, with no bonus, according to Michael Maloney, president of Wall Street recruiting firm Maloney Inc.
“All the A-level and B-level salesmen will make more money on commission,” Maloney said. “I know one salesman who made half a million dollars in his pocket in 48 hours. He could gross $500 million at Citibank and he’s not going to get paid a dime.”
For all the opportunity, many of the 50 start-up boutique dealers in New York won’t succeed, he said.
“They just don’t have enough critical mass,” Maloney said. “A lot of people are just setting up firms where they have a Bloomberg and five or six people they used to work with.”
Walking the Aisles
BTIG, which had five employees in 2002, plans to add at least 26 more salesmen and traders for investment-grade bonds, high-yield and distressed debt, said John Purcell, 50. With Bass, Purcell is co-head of global fixed income at the 270- person firm and ran global fixed-income syndicate at Citigroup.
ICP Capital, a boutique investment bank set up in 2004, has almost doubled its staff since last year’s second quarter to 74 people, including Patrick Russell, 40, the former co-head of residential mortgage trading at Morgan Stanley, said Carlos Mendez, a senior managing director at ICP.
John Costas, the former head of UBS’ investment bank, and Michael Hutchins, who previously headed the debt unit of UBS, are starting a financial services firm preliminarily named VinsonForbes.
Bid-Ask Spread
A shortage of trading capital at the biggest banks has increased the gap between how much they pay to buy or sell fixed-income securities. The so-called bid-ask spread has almost doubled to 19 basis points in the past six months, according to data compiled by Bloomberg.
Those spreads will narrow in the next couple of years, and banks will attempt to win back business through financing, said Adam Yarnold, 33, who trades residential mortgage securities and distressed bonds backed by consumer loans at Braver Stern & Co. in New York. The firm has 15 traders and salesmen.
“The next 12 to 24 months will be make or break for the smaller shops,” said Yarnold, a former army ranger who helped run Deutsche Bank AG’s residential mortgage-backed securities desk in New York until July. “There will be a high mortality rate but the boutiques that make it will win big.”
Gutfreund, the former chairman of Salomon Brothers, said the resurgence of smaller firms has only to do with greed and necessity.
‘Always Money’
“The motivation is always money,” said Gutfreund, the president of Gutfreund & Co. in New York. “The reason people are leaving is because they need the money and a job.”
U.S. Senator Christopher Dodd last month proposed restrictions on executive compensation at companies that received money from the government’s financial rescue fund. U.S. House Democratic leaders voted March 19 on a 90 percent tax on executive bonus payments by companies receiving more than $5 billion in federal bailout funds. New York Attorney General Andrew Cuomo has also criticized Merrill Lynch for paying $3.6 billion in bonuses for 2008.
“The talent is streaming out of the doors of the big firms,” Bruce Foerster, a former Lehman Brothers managing director and now president of South Beach Capital Markets in Miami said. “As the best and the brightest leave, they will tip their hat to Senator Christopher Dodd. Bright people won’t want to be at places where the government is.”
To contact the reporters on this story: Caroline Salas in New York at csalas1@bloomberg.net; Pierre Paulden in New York at ppaulden@bloomberg.net
Last Updated: March 24, 2009 00:00 EDT
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