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DAVID WEIDNER'S WRITING ON THE WALL 
Wall Street's error-oids era
Commentary: Like baseball, banks juiced, goosed and are paying for it now
NEW YORK (MarketWatch) -- This quarter's earnings season for Wall Street is like the Mitchell Report for baseball. We're finding out who was on the juice.
What investor and baseball fan hasn't felt an eerily similar sick feeling when considering what artificial performance enhancing has done to our national pastime and our national banking system? The only difference is that baseball is a game, and the damage among the banks is spelled out painfully in quarterly results and huge write-downs.
Like Barry Bonds smashing 73 home runs in a single season after only hitting 49 the previous year, Merrill Lynch earning $7.4 billion in 2006 after earning $5.1 billion the year earlier felt suspicious.
Baseball players used steroids and human growth hormone to beat the limits of their bodies. Banks used collateralized debt obligations and merger growth strategies to bulk up and post results they couldn't otherwise attain.
Now, the high has worn off. Bonds is facing perjury charges about his training practices and banks are facing investigations into lending practices.
This week three major banks are scheduled to testify. Through Wednesday, Citigroup Inc. ( C ![]()
C) and J.P. Morgan Chase & Co. ( JPM ![]()
JPM) had 'fessed up. Another, Merrill Lynch & Co. ( MER ![]()
MER) is expected to come clean with billions more in write-downs.
Citigroup, Inc
Sponsored by:
JPMorgan Chase & Co
Sponsored by:
Merrill Lynch & Co., Inc
Sponsored by:
Ballplayers have ruined their bodies and reputations and often forced themselves into an early retirement for the sake of RBI and ERA. Banks ruined their balance sheets and market values for the sake of SIVs and MBSs.
Chasing Goldman
In many cases, the temptation to risk a balance sheet over profits can be linked to a desire to keep pace with Goldman Sachs Group Inc. ( GS ![]()
GS) . Goldman is Wall Street's equivalent of Babe Ruth, Roger Maris, the Yankees or Walter Johnson.
Goldman Sachs Group, Inc
Sponsored by:
Under its former chief executive, Henry Paulson, and its current chief, Lloyd Blankfein, the investment bank has churned out a remarkable string of profitable years: $4.55 billion in 2004, $5.62 billion the next year, $9.54 billion in 2006 and $11.6 billion in its fiscal 2007.
| 'The current environment of limited liquidity, crisis of confidence and credit deterioration will spill over into 2008.' Lauren Smith, KBW |
Goldman didn't just make money, it distanced itself from the pack. In its flagship financial advisory practice, the firm took home $3.05 billion in fees last year. Its nearest competitor, Morgan Stanley, made $2.3 billion, according to Dealogic.
Goldman also ranked at or near the top in debt and equity underwriting. Its trading desk was the only major desk on the Street to bet subprime-related securities would hit the skids when they did.
The bank's share price has dutifully followed Goldman's success. Shares are down 20% from their high last fall, but are up 27% during the last 52 weeks and have doubled during the last three years.
Goldman's success has put incredible pressure on its rivals who were hoarding cash amid a Wall Street recovery. To people such as Merrill's Stan O'Neal and John Mack at Morgan Stanley, Goldman's big proprietary trading bets, its private equity success and dedication to structured products seemed sexy and profitable. So, Goldman's competitors did the same, even if they didn't quite know what they were doing.
"Mack drove a 70% jump in first-quarter earnings by increasing trading risks, profiting from investments and adding hedge funds of his own," according to a Bloomberg report in March.
As Punk Ziegel & Co. analyst Dick Bove put it in a note Monday to clients, "The pressure to invest has always overwhelmed rational investment judgments."
Records fall
We all know what happened next. The smack worked. Merrill dove headlong into subprime with its purchase of First Franklin, a lender. Morgan Stanley bought hedge funds and stepped up its trading. Citigroup did it all. New York Stock Exchange member firms made $22.7 billion in 2006 before taxes, nearly double what they made the previous year.
The party kept going in 2007; profits were on pace to match or beat 2006. Investors, like fans, didn't care how the results were being achieved. We marveled at the numbers and cashed in on the profits. It was the greatest era of profitability in Wall Street history, and what was the matter with that? The commissioners' office the Securities and Exchange Commission was looking the other way.
By 2007, the bonus pool topped $26 billion. Employment hit a high of 804,000 and Bonds had passed Ruth in the all-time home run list.
You can't, of course, trust the numbers. This week alone it's possible more than $30 billion in assets will be written down among three of the worst offenders. And like baseball, the scandal is far from over. Lauren Smith, an analyst with Keefe Bruyette & Woods, summed up the issues facing the industry on Jan. 16:
"The current environment of limited liquidity, crisis of confidence and credit deterioration will spill over into 2008," Smith wrote. "It is clear that we have not yet reached the bottom but the big unknown remains how long the current headwinds will persist."
In other words, it's going to take a long time for the industry to win back investors. Banks need to start revamping how they evaluate credit, and regulators need to put specific penalties in place against credit professionals that knowingly pass off junk to investors.
As former Sen. George Mitchell said in his report on drug use in baseball "it is now time to look to the future, to get on with the important and difficult task that lies ahead ... That is the only way this cloud will be removed from the game." 
David Weidner covers Wall Street for MarketWatch.
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