In 1987, I began my rookie assignment on the stock sales and trading desk for Morgan Stanley. A few weeks later the stock market crashed, and I learned my first important lesson about the pecking order on the Street. As a newcomer, my senses were on high alert. Across the floor, a trader named Chuck stood with a phone pressed hard against his ear as he barked out ear-piercing commands. Closer by, I found an island of serenity as the carnival of capital plunged into chaos. His name was Lou, and he was a smooth-talking senior salesman with a magnificent collection of suspenders.
Lou held a special role in the ecosystem of our department. He could get Peter Lynch, the legendary manager of Fidelity’s enormous Magellan fund, on the telephone. Morgan’s top brass would always stop by Lou’s desk on a tour around the trading floor. And Lou received the equivalent of a three-bedroom Upper East Side apartment every year by virtue of his guaranteed payout, earned on the commissions generated by his customers, an elite list of the firm’s largest clients.
Chuck, on the other hand, was belligerent and a bully. While he was exposed on a trade, he would holler at his sales team, inches from their faces, until his position was clean and his profit had been booked. Chuck and Lou were a study in contrasts, but they were the yin and yang that made our department work. Lou was envied and Chuck was hated, but we needed them both. They embodied a new and more impetuous breed, and they provided order and purpose for the toil of junior staffers like me. We all wanted to become them.
When the market crashed, everyone knew that Lou and Chuck were going to be okay. Others were less fortunate. Several weeks after the crash, a tall, expressionless guy named Bruce from the human resources department shuffled onto the floor like the Grim Reaper and escorted two young sales staffers into a back conference room to dismiss them. Junior staffers were expendable. I remember that Lou didn’t look up to say goodbye to our terminated colleagues. He was too busy cooing into his telephone for money.
This quarter-century-old flashback hit me as I was reading the news that a notorious hedge fund manager named Dan Loeb has taken a position in the shares of Morgan Stanley. Attracting an activist shareholder is a nuisance, the Wall Street equivalent of a political tracker following your every move, camera in hand.
Morgan Stanley’s shares, which briefly traded below $10 a share after being stung by a nearly $9 billion mortgage trading loss in 2008, popped 8 percent to over $22 on Friday on an earnings report that delivered the first solid evidence of a profit turnaround. But the stock still trades at nearly 20 percent below book value, a crude measure of the net liquidation value of the firm’s assets. Stated another way, the stock market’s present assessment is that this venerable brand—a company that innovated many of the products and strategies that define what it means to be a modern securities firm—has no sustaining franchise value. Morgan Stanley is priced to be worth more dead than alive.
What is most intriguing about Mr. Loeb’s investment foray is that he clearly intends to push for value creation by homing in on a very touchy subject—Wall Street compensation. Mr. Loeb’s premise is simple: the firm’s employees are overpaid.
There was a time when it would have been absurd—heretical, even—for an outside shareholder to challenge the wisdom of the Masters of the Universe who call the shots at Wall Street’s big banks. But that was then. Morgan Stanley’s current chairman and CEO, James Gorman, is neither tone-deaf nor ignorant of history. He must recall how Phil Purcell, the first CEO of the merged Morgan Stanley-Dean Witter, ended up with his head on the chopping block when his autocratic reign ignited an employee and shareholder revolt.
Mr. Gorman, a cerebral Australian who previously managed the retail brokerage business at Merrill Lynch after a stint at the consulting firm McKinsey, has little loyalty to the testosterone-fueled twins named big risk and big pay. He has spoken frequently of the need to reduce compensation costs, and he personally reached out to Mr. Loeb to welcome him aboard as a shareholder. Morgan Stanley also recently announced a double dose of retrenchment: major job cuts that would target higher-earning staffers and a bonus-deferral plan that would extend payouts to high earners over three years. Translated, this means that high-octane types like Chuck are going to get fired while other big producers like Lou will have to stick around and be productive for a number of years before being able to spring for the new apartment. The fashion of the Street is changing again, and Mr. Gorman is emerging as the leading designer.
It appears that Messrs. Loeb and Gorman have both concluded that the way forward is a strategy of addition by subtraction. Shrink the amount of capital and personnel costs tied up supporting trading books and businesses that earn a poor or volatile return and use that money to invest in higher return or more stable businesses. The firm’s recent deal to acquire control of the Morgan Stanley Smith Barney retail brokerage joint venture is one example of this strategy at work. Or, lacking better alternatives, the firm can use the money to buy back stock in the marketplace at a discount from book value, an action that should drive up the share price by increasing the net assets supporting a smaller number of shares that remain outstanding.
The biggest source of flaccid bloat in the current Morgan portfolio was once its most profitable business. But now a fix is needed for FICC, which trades the fixed-income, currency and commodity products that give the division its acronym. This area of the firm is still clogged up with illiquid, multiyear contracts on derivatives, swaps and other complex products that everyone seems to understand only so long as they are appreciating in value. This is also the area that hatched the mortgage trade that nearly sunk the firm back in 2008. But Gorman’s weed-whacker is clearly hard at work: the risk-weighted assets in the business have declined by over $100 billion in a little over a year, and the risk pool will fall much further in the years ahead. On a trading basis, the firm has lowered its value-at-risk from $108 million to $78 million over a comparable period.
The skeptics inside and outside the firm are grumbling about unintended consequences. “You will lose your best people and harm recruiting if you cut comp,” they say. “A diminished market presence in one business affects the trading flows in another,” is another gripe. Then there’s, “Is Morgan Stanley to become a firm without a soul, a place with a culture more akin to an Amazon fulfillment center?”
Back when I became a partner at Morgan Stanley, there was a process by which new entrants to the firm’s most coveted position were indoctrinated into company culture and traditions. Speeches were usually delivered by retired partners, who were housed offsite in a suite of offices we called Jurassic Park. In Jurassic Park the phones never rang, so these former titans were only too eager to regale the young guns with tales of honor and brilliance that always concluded with the admonition to conduct “first-class business in a first-class way.”
I’m not sure if the culture-carrying exercise was meant to inspire us or to warn us. These events typically dragged on long enough for the newly anointed young guns to begin getting antsy. Wrap it up, we were all thinking, there might be a big deal going down back on the desk. While the business might once have allowed for relationship-building over long lunches, we were a more ravenous breed, scarfing down quick meals while talking into the telephone. To be found eating in the partners’ dining room was a certain career hex. Much better to work on earning a nickname—like The Hammer, a volatile partner who once slammed his telephone so hard onto his desk that he ended up wearing a plaster cast. The markets were rollicking, and Chuck and Lou were rolling. They were the future, and to mimic their behavior was to plan for a long and lucrative career.
The Street is a marketplace, constantly evolving. So perhaps it is no surprise that when I was coming of age in the business, things sped up and lessons were forgotten. It is hard to recall there was a time when a corporate CEO would have to call his investment banker to get a price quote on his own stock, a simple information request that revealed the banker’s privileged information advantage. Today money zips around in a digital world, prices are transparent and profits are measured in real time. This is a good time to rely more on process rather than people in constructing a firm that is built to last.
Mr. Gorman is swinging the pendulum back toward a more sober, less aspirational and more reliable business posture. He appears entirely comfortable that something and someone might be lost in the process. But the firm will survive, its profits will improve and the company’s stock price will trade back up to book value, and beyond.
Morgan Stanley is leading the Wall Street banks into a new era. These still-too-big-to-fail financial giants will become the utility stocks for a new generation, tightly regulated, prized for stability and rewarded for an ability to wring small and predictable gains from a broad portfolio of financial products. Thrill-seeking investors will shun these stocks, and shareholders will stand at the annual meeting to ask when the dividend will be raised. And then, somewhere down the line when things are calm, the pendulum will swing again and a new CEO will decide that the business really needs a little more Chuck in its blood.
Scott Sipprelle is a former managing director of Morgan Stanley. He is also a former hedge fund manager who closed his Copper Arch Capital in 2007, months before the global financial markets collapsed. He is currently a venture capitalist.
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