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Monday, April 07, 2008

Fortune's Must Read Articles on the Wall Street Bailout

If you don’t subscribe to Fortune, I strongly recommend forking out five bucks and buying the latest issue on how to fix Wall Street. Bethany McLean’s column alone is well worth a Lincoln.

Ms. McLean, who is best known as the reporter to first sound the alarm about Enron, revisits a McKinsey & Co. report issued approximately a year ago saying that regulatory burdens were hindering the competitiveness of the U.S. markets. These lines are worth quoting verbatim:

“McKinsey wrote that over-the-counter derivatives “help foster the kind of continuous innovation that contributes heavily to financial services leadership.” (Tell that to Bear Stearns.) McKinsey also complained that higher capital requirements for U.S. banks would put them at a “competitive disadvantage.” (Hello, Citigroup!).

Ms. McLean notes that the McKinsey report was backed by New York Senator Chuck Schumer, who now believes that more regulation is needed. Ms. McLean is extremely charitable; she might also have noted that the folks at McKinsey also celebrated Enron for that company’s innovation before it collapsed as well.

Shawn Tully’s article “What’s Wrong With Wall Street and How to Fix It,” is a first-piece of expository journalism and deftly explains the inner and conflicted workings of Wall Street. His explanation of the reckless risks Wall Street firms take with leverage is especially impressive: According to Tully, since 2002, the leverage of the five biggest Wall Street firms, measured by assets as a multiple of equity, jumped to 41 from 30. That means if a firm’s portfolio is leveraged at 33 to 1, it takes a mere 3% drop to wipe out its entire capital.

Mr. Tully admirably reports as fact an open secret that has long been known: Wall Street firms use intelligence they get from executing institutional client trades for their own trading benefit. The “intelligence” is euphemistically known as “color.” Mr. Tully says the rise of automated trading makes it easier for big institutional clients to trade anonymously, but experts in algorithmic trading I’ve spoken with say that’s not necessarily the case. Still, I commend Mr. Tully for his insightful piece of analysis.

Finally, legendary columnist Allan Sloan weighs in with a commentary that if every American taxpayer were required to read, Congress would be forced to clean up Wall Street once and for all.

Still, I have one quibble with Fortune’s latest issue: It doesn’t examine the formidable obstacles individual investors face getting retribution for Wall Street’s wrongdoing. The subject matter could easily fill an entire issue.

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