The disturbing things that happened yesterday
Two things came to light yesterday, each of them disturbing in their own particular but not totally unrelated way.
In the first place, Pali Capital, a private owned US-based broker dealer with a 60 person office in London, said it would cease operations.
In the second place, JPMorgan banking analysts issued another of their worrisome reports highlighting the costs to banks of the wave of new regulations about to come crashing through their vestibules.
The Pali Capital affair goes to show that start-up broker dealers with big ambitions may not be all that. It underscores the vulnerability of smaller firms to an exodus of staff (Pali struggled to raise capital because many of its star salespeople, analysts and traders, had left). More particularly, however, it illustrates the perils of paying too much, on a fixed cost basis.
According to the Wall Street Journal, Pali 'lavished' its employees with guaranteed compensation, which it was then obliged to pay, regardless of their performance. When revenues weren't forthcoming, pay couldn't be reduced downwards, and everything went wrong.
Pali's predicament is instructive because banks too have increased fixed costs. Most have hiked salaries substantially. And this leaves them vulnerable to supply shocks in the future.
JPMorgan analysts suggest a seismic supply shock is approaching in the form of government regulation of the banking sector. Even if bonuses are reduced to zero, they calculate that the price of banking products would need to rise 26% to maintain currents returns on equity in the face of the regulatory onslaught.
Needless to say, there may be another solution. Some of the people whose higher salaries now make them a burdensome fixed cost could be made redundant. Simple. It's disturbingly hard to believe that banks won't go down this route when the time comes.
