Even among economists and finance gurus, there is disagreement about the financial rescue package that the US Congress approved last week. A very well argued viewpoint, which does not agree with the Treasury’s plan, is here. But the one thing everyone agrees upon is that Wall Street is going to change forever.
While legislators and companies look at what this means for the economy and for their businesses, most people, particularly students who are looking at a career in Finance, wonder about what this means for them. What follows in this post applies more to developed markets like the US and Western Europe. In developing markets like India, the same trends will manifest but I expect that the effect of the underlying economic growth on the financial sector can more than compensate for it.
In the near term, lasting at least two years but possibly more, employment in the Capital Markets will shrink. The accompanying chart is from a paper by Kemal Dervis. Those two lines in the chart are going to come down, quickly and painfully. The number of employees working in the Financial Sector is going to come down sharply. There will be a surfeit of experienced talent looking for jobs that aren’t there. That’s not good news for a graduate or MBA who’s looking to enter the workforce.
There are going to be changes that are more long-term as well. First, let’s look at the things that aren’t going to change.
In an earlier post The Worth of a Job, I had hypothesized that
If the person in a job can directly impact the company’s profit in a significant, measurable way that job will get paid more than someone in a job that doesn’t.
A finance job in the capital markets still fits this to a T. The advanced skills – in math and logic – are always going to be in short supply. So there’s no danger that finance whizzes entering the workforce won’t be able to make enough to move out of their parents’ house.
But some things are going to change. The focus is going to shift to fee-generating businesses – asset management, corporate advisory, trading on behalf of clients. Banks and publicly traded companies will not have anything close to the size of their own portfolios that they have today. Deleveraging and new regulations are going to take care of that.
Over the counter derivatives will shrink as banks and companies prefer exchange-traded instruments. That’s another big chunk of jobs that employed some of the smartest quants.
Outside of the banks it’ll be interesting to see how the less regulated hedge funds respond to these changes. Will they step into the vacuum and take on the mantle of financial innovation from yesterday’s investment banks? I doubt that. Leverage is certainly going to come down in hedge funds as well. And while they don’t have depositors, they do have pension funds as investors. I don’t think regulators will allow their current highly leveraged, black-box, lightly regulated status to continue. In this interconnected world of finance, size, by itself, determines the damage you can do if you fail. You don’t have to be a bank or a public company to hurt Main Street.
But the biggest change is going to be just the total number of jobs in capital markets. If the share of the EVA of the Financial sector comes down from the nearly 15% to say 10%, that could, all else remaining the same, bring down the number of jobs by a third. That kind of compression will seriously impact the intake of new employees into the industry.
So if you are thinking of a career in high finance, my advice will be to either get very, very good at it. Or keep your options open.
6 am pacific 
Yes. Finance industry has long been putting up with too much mediocrity – just like tech sector of yesteryears when anyone who could spell `code’ got a job.
But those hoi polloi needn’t worry for some time, up until Hank Paulson’s bailout plan is executed. The irony is, Paulson will not be able to find *clean* asset managers to run this (the bailout auctions) that don’t already have distressed assets on their own books; there’s simply no one else to do it. Hiring people to fix the very problem they helped create will be an issue though.
It makes room for B-School syllabus to be revised to include lessons from this era of hard knocks – that calls for significant reduction in weightages for complex algebra and calculus and load in more of common sense diktats like `never allow mismatches of long:short maturities or that of asset-liability’; never keep an asset off balance sheet if it is paid for out of recognized income, Leverage should be restricted to the extent of reasonable multiples of underlying asset etc…!
I agree with you in the structural changes that will sweep Wall Street.
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Krishna,
“that calls for significant reduction in weightages for complex algebra and calculus”
IMO that would be a mistake 🙂
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Are we going to bail out everyone now? These economists seem to know what the hell they are talking about, however not one of them predicted this mess.
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Basab,
Why do you think Warren Buffet said “If Calculus or Algebra were required to be a great investor, I’d have to go back to delivering newspapers” ?
The single biggest fallacy propagated by B-school curriculum is that the relative efficiency of markets are amenable to predictability thro algebraic models. Their redundancies (especially the emptiness of VAR calculations) have been exposed time and again and still those hollow theories continue to figure prominently in B-School syllabus, unmodified.
How else do you think the word `toxicity’ creeping into structured finance 🙂
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Would love to learn how all this impacts a business such as yours? Or any other that relied heavily on the high end finance space (IT services for that matter)? Impact on growth/bottomline/investor expectations? Rethink in strategy?
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Hedge fund model will be definitely under pressure after the storm settles down. Money might start moving into traditional investment managers, the Fidelitys and PIMCOs of the world. Leverage ratios will have to come down at Hedge funds and they will have difficulty generating the out-sized returns and fees of the past.
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Very true, Basab. A lot of stat-arb fundas just die in this kind of market – and we can see how that’s hit the likes of Citadel. But those jobs are not going away – and neither is stat-arb or any kind of market-neutral strategy, because they still provide the “perception” of lower risk.
While prop books die and leverage dwindles, the MBAs are going to take anything they get. So I’m likely to see reports on how the put-call parity in rangebound markets statistically tends towards the mean unless it crosses the 2-SD level. Or something like that which is phenomenally awe-inspiring, and someone is going to pay for it or give someone their portfolio to go earn the megabucks.
It’s going to be fun, the next two years. If we get a good bond market, convertibility and exchange traded credit derivatives, there will be a lot of MBA jobs.
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Akhil,
Our target user at Gridstone is anyone who does company research. There are lots of folks outside of capital markets who research public companies. In capital markets we have a differentiated strategy which we hope will help us win share even in these troubled times.
In general, any company selling into Capital Markets will feel the pain. Correction – I should have said, will feel the pain more than other companies. After all, we are talking about a recession across developed markets. Everyone will feel the pain.
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Both deregulation and consolidation are likely to play a major role in changing high finance jobs. Professionals who can move out of their siloed areas expertise and think out of the box would benefit. Eg. If an Insurance company has got acquired by a bank, how can newly created synergies be exploited? Change management abilities would be sought after and risk management professionals would be in greater demand.
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It seems to me that we’ve had an excess of algebra and calculus and not enough common sense scenario planning and basic controls. Sub-prime mortgages are supposed to be at the root of this. The delinquency rate is supposed to be 6% or thereabouts. Algebra and Calculus helped smart investment bankers construct CDOs where the super senior tranches were supposed to be super safe with AAA ratings. The concept is simple enough – the first delinquencies hit the lower tranches so the senior ones get hit only when the default rate is really high or so the theory goes. But did no one foresee that the senior tranches might lose their pristine ratings once lower tranches actually started losing? And that this would trigger a sell-off and a downward spiral? Or did the boring operations guys in back office see it only to get shouted down? See http://www.economist.com/finance/displaystory.cfm?story_id=11897037
More Complex math anyone? Sure – we’ll continue to need that in niche areas. But hopefully demand for plain-speaking, forceful, common-sensical guys who look at the big picture and connect the dots will go up also.
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