Monday, June 13, 2016

Fifty Years of Extraordinary Change

By Roy C. Smith
Last week I attended the 50th reunion of my class at Harvard Business School. There were 650 who graduated, 120 have died, and of the rest, 340 (including many wives) attended the reunion. There were only six women in our class. 
We were told that in 1966 about 6,000 MBA degrees were awarded in the US (almost none anywhere else) – now it’s about 200,000 in the US and a large number abroad. Most of the core courses of our day are still taught, but there are fewer of them and more electives.
We were trained to be managers of large manufacturing corporations (“masters of business administrator”), but by the time of our 25th reunion, half the class identified themselves in a survey as being self-employed, working in small businesses or members of partnerships. Big business was not for them after all. 
Many of us were attracted to finance, which as an industry, probably changed more than any other during our 50 years.  Just as we were settling into our new careers (at an average starting salary of $11,000), the 1970s struck – the Dow Jones was the same in 1979 as it was in 1969, but the intervening years were plagued by inflation averaging nearly 8%. In 1971, the gold standard was abandoned; in 1973, the first oil crisis occurred; and in 1975 Wall Street was paralyzed by the forced introduction of negotiated commission rates. In 1979, the Volcker interest rate “shock” was engineered by the Fed to kill inflation  -- through this action led to the deep recession of 1981 and the S&L and Banking Crises of the 1980s.
So, for the first fifteen years or so, financial careers might have seemed pretty bleak, but out of all the difficulties of the 1970s came, a wave of innovations and a relaxation of competitive rigidities that enabled many financial firms to grow and prosper. Securitization, LBOs, junk bonds and derivatives were invented; new SEC rules such as shelf-registration allowed bankers to bid for business normally tied to “exclusive” relationships with other bankers.  The Eurobond market opened up and globalization of capital sources and investment opportunities abounded, especially in “emerging market” countries that previously had been considered as below the standards required to use capital markets.  
The world changed too. In 1979 Deng Xiaoping began China’s economic transformation; Margaret Thatcher brought “privatization” (of government owned businesses) and free-market policies to the UK. The EU was formed and the euro introduced, the Berlin Wall fell and the USSR voted itself out of business. First Japan, then China developed into Asian superpowers.
It wasn’t all easy – there were periodic financial crises along the way, but market economics prevailed and before we knew it, half the world’s population had bloodlessly changed their economic systems from ones oriented to socialist principles to capitalistic ones. And, the period from 1950 to the present became the longest uninterrupted time of peace and prosperity in Europe, North America, Russia, and China in modern history.
By 2016, global financial market capitalization was $300 trillion (over 3% of world GDP) and capable of generating market forces beyond the capability of any government to contain. In 1966, global market capitalization was well less than $1 trillion. In 2016, daily trading in foreign exchange was $5.3 trillion; in 1966 it was lass than $25 billion. In 2016 world trade was 33% of world GDP; in 1966 it was about 2%.
The daily volume of trading on the NY Stock Exchange was about 2 billion shares in 2016, up from 9 million in 1966; commissions had been reduced from about 1% of trade value to only 2-3 cents per share, but the NYSE’s share of trading in listed stocks fell to less than 20% as new technologies and trading platforms were introduced. 
Today, the cost of capital is largely determined by capital market activity; it is lower and more users have access to it than at any time in world history. Powerful economic linkages, and the extraordinary acceptance of markets (as judged by their use) despite some continuing political objections, leads us to believe that the system of market economics by which the world governs itself is here to stay.   
The firm I joined in 1966, Goldman Sachs, then had about 20 partners, with capital of about $20 million, and employed about 500 people. Fifty years later, Goldman’s public market capitalization is $62 billion and it employs 34,000. Still, the market value of the firm is about 3000 times greater than in 1966 but its headcount is only 85 times greater, which demonstrates the importance of computer and other technologies to all financial firms.
In 1966, Goldman Sachs had no foreign offices at all; today it has 61, 33 of which are in emerging market countries.
Despite all this growth in the industry, the fifteen largest US commercial and investment banks of 1966 have essentially disappeared – all but one (Goldman Sachs) have been acquired by other firms or failed, though some of the more prominent names have been retained. Today these thirty firms are boiled down into five – JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley, all buy Goldman the survivors of many large mergers that erased all traces of the cultures of the original firms.
The same thing happened in the City of London – for the same reasons. Globalization, deregulation and technology pushed all of the clearing banks, merchant banks, jobbers and brokers into mergers that consolidated the industry into just a few hands.
All in all, the world of global economics and financial services has been transformed far beyond anything we might have imagined in 1966. We are back into a bleak period, like the 1970s, with lots of reorganization and restructuring to come, but what the next fifty years in economics and finance is probably just has unpredictable as it was fifty years ago.

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