Wall Street's middlemen are being squeezed on all sides in the current market moment.
Banks and brokerage firms have stumbled lately in ways that point to bigger, structural challenges to their businesses.
The ugly reception to the 2019 crop of heavily hyped initial public offerings, the vexing clog in the overnight "repo" funding market and another sprint toward zero commissions by retail brokerage houses are occurring in separate parts of the securities industry. But all of these challenges reflect Wall Street's ongoing struggle to preserve its traditional place in markets that every day grow more thoroughly quantitative, heavily regulated and technologically "disrupted."
High-end exercise bicycle company Peloton priced its initial offering at $29 a share late Wednesday, at the top of its projected range. This pricing tactic implied the investment banks underwriting the deal, Goldman Sachs and JP Morgan, determined there was plenty of demand at that price and higher, to allow follow-on buyers to give the stock a lift.
The shares turned lower the instant they opened, and in two days as a public company Peloton has lost 13%.
Busted IPOs have happened throughout history, of course. But right now, the apparent mismatch between private-market valuations and what Wall Street firms believe public investors will pay seems extreme.
As a group, recent IPOs have buckled relative to the S&P 500, no doubt in part due to the disastrous attempt by WeWork parent We to force its way into the public markets despite a towering initial private valuation, toxic governance issues and an untested business model.
That public investors are loath to accept Silicon Valley venture-capital math for companies that have often already burned through billions isn't terribly surprising.
But why haven't the top investment banks been able to gauge true demand and a plausible clearing priced for these deals with any success? Perhaps the way active stock-picking fund managers have been sidelined by the mass movement toward passive indexing and quantitative strategies makes it tougher to assess the market?
It's unclear. And perhaps this is a fleeting losing streak leading to a readjustment of pricing patterns for IPOs. But this trend has done little to help Wall Street's reputation for market-divining acumen.
The choke-point in the vast bank-financing market that developed in recent weeks — which sent overnight rates spiking and required the Federal Reserve to inject reserves — is largely technical and not a failure of bank business strategies.
But the fact that the banks themselves were unable to smooth this market on their own partly reflects regulatory changes that have hindered the free and flexible use of their own balance sheets to service the market's cash needs and earn a decent spread in the process.
The repo, or "repurchase agreement," market — in which Treasuries and other safe securities are swapped for cash to keep the wholesale markets liquids — was never a major profit center for big banks. And the recent stress in the market arose from a few extraordinary forces: a huge jump in Treasury issuance to fund the deficit and quarterly corporate tax payments that drained cash reserves from the system among them.
But post-crisis regulatory measures and the reorienting of the big institutional securities firms away from many trading activities are part of this story. These are reasons the banking system is safer, but also a bit shallower in financial depth and less profitable on the whole.
Goldman Sachs, for example, earns 11% to 12% return on equity now, versus more than 30% in the mid-2000s, using far less leverage today and taking a fraction of the risk. Yet its shares trade right at their tangible book value, compared to more than twice that ratio a dozen years ago.
The firm is emphasizing asset management and personal loans from a sophisticated automated lending engine. This might be the right call in a business where its old competitive edges have been dulled. But the market isn't yet paying up for this version of its future.
In a far different part of the securities business, Interactive Brokers last week launched a zero-commission offering for retail investors — free trades on stocks and ETFs and other perks as well.
This is simply an extension of the commission-compression that's been going on for years. And yes, startup Robinhood has enabled commission-free trading for a few years now.
These are generally good business, together an oligopoly produced by 25 years of consolidation. But brokerage stocks trade at discounts to the market, caught between low interest rates that reduce what they earn on customer balances and price competition over a slow-growing pool of retail-investor orders.
The IPO indigestion, repo flare-ups and commission evaporation all hint that the proprietary advantages once enjoyed by central Wall Street players have waned.
The current technology-propelled economy and markets don't have as much regard for a banker's "educated gut feeling" for the right offering price.
Freely deploying capital to keep the markets flowing is no longer within the Street's power in all circumstances. And the leading online brokers nurturing their brands as a way to collect a de facto standard commission of $7.95 per basic trade is now a tough arrangement to maintain.
This economy pushes all companies to be neutral, software-based "platforms," delivering their economies of scale largely to clients who pay little or nothing, hoping to earn a return on the data and value-added extras in a "freemium" model.
Wall Street, it turns out, is no different.