Mack is no Blankfein, thankfully

July 22, 2009

John Mack is being pilloried by some on Wall Street for not being more like Goldman Sachs’ Lloyd Blankfein, after Morgan Stanley reported a larger-than-expected second-quarter loss largely because of several onetime expenses.

But the “Be like Lloyd” rallying cry is mainly coming from traders with Twitter-like attention spans, who simply want Mack and Morgan Stanley to engage in the same kind of government-backed risk-taking that Blankfein’s Goldman Sachs is doing when it comes to proprietary trading.

Just how much less risk is Morgan Stanley taking on compared to Goldman?

Simply compare both firms’ so-called value at risk, an estimate of how much money a firm could conceivably lose in a day if all of its trading bets and hedges went awry. At quarter’s end, Morgan Stanley’s VaR was $154 million, compared with $245 million at Goldman.

Admittedly, the VaR is a highly imperfect way of measuring risk. If anything it underestimates risk, otherwise Lehman Brothers and Bear Stearns might still be with us. That said, however, the numbers speak for themselves: Goldman is an infinitely more risky firm than Morgan.

Sure, it must be tempting for Mack to simply pile on risk and try to replicate the outsized trading revenues Goldman churns out. Indeed, the federal government has all but given the green light to Goldman to resume its hedge fund trading ways — except now Goldman can trade with the implicit knowledge the government won’t let it fail.

That was a road that Morgan Stanley presumably could have taken as well, but the firm has instead decided to go in a more conservative direction.

Mack’s strategy of de-emphasizing prop trading as a main revenue driver and getting back to the basics of asset management and investment banking is a smart move. The trouble is it will take time for Mack’s strategy to play out, and it may not start bearing fruit until an economic recovery is under way.

For example, Morgan Stanley ranks first in advising on corporate deals. But that enviable ranking doesn’t bring in a lot of cash when deal-making stands near an all-time low.

Mack’s decision to focus less on prop trading will no doubt prevent the firm from becoming the target of all the populist outrage Goldman has rightfully earned. With some regulators starting to talk about a windfall profits tax on so-called too-big-to-fail institutions, Goldman might come to regret its heavy reliance on trading profits.

Still, short-term investors may not have the patience for Mack to deliver. That’s their loss. For investors with a longer-term outlook, Mack’s more sensible approach to risk taking and trading should prove to be a better business model. (Editing by Martin Langfield)

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