U.S. stocks are slightly higher in late-morning trading on Wednesday, with the Dow Jones Industrial Average (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) up 0.09% and down 0.24%, respectively, at 11:50 a.m. EST.
Yesterday, Morgan Stanley announced it would eliminate roughly 1,200 jobs from its FICC (Fixed Income, Currencies and Commodities) unit worldwide, broken down between 470 front-office, or revenue-generating, positions, and about 700 in the back office that supports FICC. The front-office cuts amount to about a quarter of the FICC workforce.
Along with Goldman Sachs, Morgan Stanley is the sole remaining pure-play global investment bank (technically, they've been bank holding companies since Sept. 2008.) The two companies consider each other to be their fiercest rivals. So, why is Morgan Stanley ceding terrain to Goldman?
Across the industry, the FICC business, which used to be investment banks' profits engine, has suffered dramatically in the wake of the financial crisis. According to figures cited in the Financial Times, the global pool of FICC revenues fell by nearly half (46%) in 2014 to $116 billion relative to 2009.
That decline has not been without consequence; Morgan Stanley is not the first bank to scale back its FICC activity, nor is it the most significant reduction. In Oct. 2012, for example, UBS announced it was retreating from fixed income, with resulting job losses of up to 10,000.
Banks' retreat from fixed income is a result of two factors: new banking regulations introduced in response to the financial crisis that have driven down the profitability of business, and shareholder pressure in the face of volatile fixed income earnings.
On the regulatory front, banks now face more stringent capital requirements under the international Basel III framework and the Collins Amendment of the Dodd-Frank Act. Return on equity is partially a function of leverage; all other things equal, lower leverage drags that return down.
In addition, under Dodd-Frank's Volcker Rule, bank holding companies are banned from engaging in proprietary trading (trading on the company's own account), which was a major source of revenue.
With regard to volatility of results, here's an illustration: Commenting on Morgan Stanley's second-quarter earnings, The Wall Street Journal wrote in July that "the fixed-income unit's improvement also has helped put the firm on track this year to meeting Mr. Gorman's target for annual return on equity of 10% or better."
In fact, Morgan Stanley was the biggest market winner in FICC in the first half of 2015. However, shareholders were dismayed when FICC revenues fell by nearly half in the third quarter to $600 million from $1.1 billion in the second quarter.
In the face of these sweeping changes, Goldman Sachs is holding the line. At the Bank of America Banking and Financial Services conference last month, Goldman CFO Harvey Schwartz told attendees:
We are very committed to [FICC] because when we're with clients, whether they are transacting on a particular day or not, it doesn't matter to us. We know this service is important to them.
There are still going to be asset managers, there are still going to be bonds created, there are still going to be hedge funds in the world, there are still going to be clients globally who need to hedge, [there is] asset liability management.
It used to be said of Goldman Sachs that it was "long-term greedy." When competitors are withdrawing from the fixed-income business, it raises the odds that Goldman can do profitable business. And if it can't make the numbers work, that may ultimately raise an issue for regulators: A dearth of intermediaries providing liquidity in bond markets is a source of systemic risk.