Ep.98: Investment Bank Earnings & US Debt Ceiling Explained

Hello and welcome to episode 98 of the Market Maker podcast. And to give you an idea what we're going to cover this week, it has of course been the big US investment banks reporting their corporate earnings— some good, some bad, some incredibly ugly. So we will, um, we'll dive into those numbers and hopefully explain a little bit about the kind of composition of the banking space and why banks like GS and MS are slightly different to like, so JPM or Citi, and then where the asset managers and boutiques fit into this mix. So we'll look to explain. And then also we're going to talk about the debt ceiling, um, something that I know Piers and I have lived through in previous episodes of volatility. So we'll talk a little bit about that back in 2011, but we'll talk about it in the context of right now because the US government could default And if that did happen, that's kind of a big deal. So we'll, um, we'll discuss what the probability of that is and what the process is and so on. But before I begin, two things just to mention. One, just as we've hit the record button for this, some news has just dropped down the tape. Alphabet, or Google, they're planning to cut roughly 12,000 jobs globally, equates to around 6% of the workforce. I was just kind of tallying it up with the likes of Microsoft. I think it was 10,000, and then Amazon was 18,000, Salesforce was 8,000, Twitter 7,500. It's racking up, right?

Yeah, I mean, Silicon Valley, I mean, the unemployment rate has, uh, has spiked. Um, so yeah, I mean, it's, it's obviously a natural function of the ebbs and flows of the economic cycle. So, you know, continued job cuts at these big tech firms is definitely the direction of travel. It's not surprising, this information. But yeah, I guess, you know, they've become a little bit sort of overbloat, you know, over the last decade. And yeah, you're getting a lot, I think, a lot of incredibly well-paid sort of middle management staff that, you know, what do they do? Um, are they needed? I mean, like, Musk is— I guess Musk has set the cat amongst the pigeons, hasn't he? Strolling into Twitter and basically saying, look, this company could function on on one quarter of the staff, and he's gone ahead and done it. And I don't know, obviously time will tell whether, whether he's right or not. Um, but yeah, I think it's certainly the case that these, these big tech firms are very bloated, and, um, yeah, they need to cut some fat.

Yeah. And, and sticking with the tech theme before we get into the, the banking earnings, I don't know if you saw that Sky News report that was circulating this week It was titled Recruitment Team Unwittingly Recommended a ChatGPT Candidate for a Job Interview. So someone had submitted basically, so you know when you do these application processes, often it involves something like write me a 500-word statement about a topic that you're interested in.

Right. Yeah.

So basically they set it up and they acted as a candidate but used ChatGPT. And only 20% of the candidates at this communications company got made it through fast-tracked. Yeah, through to interviews. And top of the class, of course, was your buddy ChatGPT. So I, I was making a point of this in a post I did a few days ago because, um, already I've incorporated it into my working practice because quite often for an information gathering exercise to spark content ideas for content writing, for a large degree blog writing, it's all very much well equipped to, uh, to field those types of things. But one of the things is the allure that I can imagine that a lot of finance students a feeling when it comes to that arduous process of banking applications. And it's like, write me 300 words about why I should work at Goldman Sachs. Okay, write me 300 words. I should work at Goldman Sachs. So I guess the post I did was just a word of warning in that, I mean, look, the results it punches out are impressive. I mean, it sounds great what it writes. And it may well save you time and see you through the process quicker. But ultimately, it's a pretty rigorous testing process you go through. For one, Amplify simulations are pretty much embedded in every assessment center for top financial institutions where you will, you have to participate and your behavior will be monitored and tracked about your ability to function in a specific role. So unfortunately, the AI is not gonna come to your savior in that circumstance. So I guess just a word of warning.

Yeah.

Be prepared.

Yeah, you'll get found out in the end.

Or I won't, I'll peel my face off and actually I'm a Tesla bot. With OpenAI technology. Who knows? But yeah, let's, let's delve into these, these banking earnings then. And as I said earlier, I think one of the most, um, kind of divergence that we saw was because they reported on the same day at the same time, and that was Goldman Sachs and Morgan Stanley, who are often kind of put in the same conversation, often given their, their businesses. And how they operate. But Goldman's fell almost 8%, and they've had a pretty bumpy ride recently for a number of different reasons— consumer banking to restructuring to banking fees and everything in between. But Morgan Stanley have been operating within that same environment, and yet their shares were up almost 6%. So what happened?

Yeah, well, I mean, big kind of divergence. I guess it's— to answer that question, we need to talk about what— because they're massive institutions, these banks. And it's got pretty complex. And there's now multiple kind of divisions and elements of the bank. I think we need to kind of step back and look at the structure of these big banks in order to be able to answer that question as to why is the performance between Morgan Stanley and Goldman Sachs so different when historically they're like the same kind of business, right? They're absolute direct rivals. And so, and I think maybe we could step back even further just briefly and talk about banks. I mean, there's investment banks and then there's commercial banks, or you could even say retail banks as well, right? And I think from a sort of, let's call them consumer banks, that's the traditional format of a bank that essentially takes deposits from consumers. And for that, the bank will pay that consumer an interest, right? On their deposit. Of course, since the financial crisis, we've had interest rates at zero. So, you know, if you've, if you've opened your first bank account, uh, within the last— well, let me think— within the last 13 years, um, then you'll be thinking, what, interest on my deposit account? What are you talking about? Um, but obviously interest rates have just gone up sharply in 2022, so you might now see this weird kind of income coming into your deposit account each month. It's like, what? Hang on, right? I'm actually earning some money by depositing my cash at a bank. So that's what happens. The bank pays you, right? They pay you a deposit rate. But then of course the bank's business model on the retail and commercial banking side, the bank's business model is they then take those deposits and they lend them. They lend that money. Okay, I think mortgages, for example. So they're kind of borrowing on the short term and essentially paying a really low interest rate to borrow from the consumer, and then they're lending on the longer term— mortgages, let's say— and they're charging a much higher interest rate for the loans. Okay, and this is how historically these kind of big consumer banks, um, make money. They call that the net interest income. Right? It's the net income from that paying the deposit rate to your depositors versus earning the lending rate from your loans out into the system. And when interest rates rise, this is beautiful, this is a perfect moment for these banks because then the difference between short-term rates and long-term rates increases. So essentially the net interest income gap widens. So historically, in an interest rate hiking cycle, this is good news for these banks. Okay, so that's like the commercial or the consumer bank side. Then you've got investment banks, which is nothing to do with deposits. This is now, I think, Goldman's and Morgan Stanley. And that— and even those banks are split into kind of two big divisions, right? So when you think Goldman's, you tend think, right, M&A, you know, it's all about the investment banking division, the IBD side. And so there, they're generating fees for the services that they're providing in helping their clients raise capital, or they're helping their clients grow through mergers or acquisitions. Okay, then the other side of the bank is more on the market side, and so that's your sales and trading. Activities, the trading floor of these banks. And, and there they're earning money through fees again for services that they're providing. But the service they provide is to their financial institution clients where they're helping hedge funds and asset managers trade. Okay, they're helping facilitate their trades. They're also providing some, you know, the prime brokerage divisions, for example, are providing some advisory services to hedge funds and so on. Okay, now typically with the investment banks, those two sides, the thing is about these fee-generating parts, certainly on the IBD side, they're very cyclical because, right, how much money can you make as an investment banking division is obviously a function of, well, how many companies are looking to raise capital, how many companies are looking to make acquisitions, and obviously That goes up and down with the economic cycle. So in 2022, it was a shocker of a year because we had a downturn in the cycle. Everything was very depressed, risk appetite was incredibly low. So companies weren't looking to acquire other companies, companies weren't looking to do like IPOs and raise capital. And so this meant that the IBD side of the banks had a really bad year. Okay, we'll talk about the figures in a minute, but the way they've set up is they've got an equal and opposite side of their bank. So the trading side, the sales and trading divisions, they actually make more money when market volatility increases. So what happened in 2022 was whilst the IBD division's income dropped and dropped and dropped, Actually, the market side saw their revenues go up because market volatility stepped higher, which is typically what happens in a downturn. Yeah.

So, yeah. And with the— one of the things I remember Stephen saying in a previous podcast was about how a company like Goldman Sachs is valued, given that it sees this variance, as you say, comparative to someone like Morgan Stanley, who might have a much larger wealth and asset management business? Or take that even a step further, like JP Morgan, who's then starting to be involved in some of these commercial activities as well.

So these wealth management divisions— yeah, I should add that in. I mean, they, they are certainly now becoming bigger. I'd say over the last decade have become an ever bigger portion of these banks like Goldman's, like Morgan Stanley, Citigroup, JP Morgan. They've almost kind of taken up— it's almost like a buy-side sort of entity in terms of their asset and wealth management divisions. But the thing about— I guess the thing about Goldman's— and look, you do have to go back to the financial crisis very quickly. To just explain why Goldman's are doing what they're doing now. And actually then we'll talk about the fact they're doing it really badly. Um, go back to the financial crisis. Goldman's and Morgan Stanley were— they were like the old kind of broker-dealer format. They were the old sort of straight-up investment bank, no deposits at all. It was just M&A advisory, and then it was on trading on the market side. Okay, but what happened in the crisis was all these big broker-dealers were overleveraged and were getting killed by the big market collapse. And of course, the poster child of that crisis was Lehman Brothers that went bankrupt. They were a big broker-dealer, took too much risk, markets collapsed, and they went out of business. Prior to Lehman's collapsing, there was Bear Stearns and Merrill Lynch who were also going down that same pipe, okay? But they got bailed out by essentially being bought Um, so Bear Stearns was bought by JP Morgan. I say bought, I think they famously paid $1.

Yeah, something like that. Yeah.

And then Bank of America bought Merrill Lynch, and essentially the U.S. government pretty much forced them to buy Merrill Lynch because if they don't, they'll go bankrupt and it will create this systemic risk. And, and then Lehman's were the third one in line. And anyway Barclays were going to buy them and they got vetoed. Anyway, Lehman's went bankrupt, right? So then next— so it was Bear Stearns first, they were the most overexposed, they got bought by JP Morgan. Merrill Lynch were the second most exposed, they got bought by Bank of America. Lehman's were third most exposed, they went bankrupt. Morgan Stanley were the fourth and Goldman's were the fifth. And so now it's like, oh right, Morgan Stanley, right, you're now— basically they were on the slope with Lehman's, and they were going to go bankrupt, and Goldman's as well. It was all imploding. And the U.S. government did a deal, and what they did was they said to Morgan Stanley, Goldman Sachs, look, you need to take on a commercial banking license. If you do that, you will then be able to access our Federal Reserve overnight emergency lending window. Which will essentially give you the liquidity you need to not go bankrupt. But taking on a commercial banking license, the reason why they hadn't done that in the past was because that then opens you up to much more regulatory oversight. And they were forced to do it. They had no choice. Fine. They took on a commercial banking license. Okay. That's how it all started. I mean, fast forward a decade plus now, And you could argue taking on a commercial license and being a commercial bank is a good thing for diversification. It's certainly like when you look at 2022 as a year where M&A activity collapsed, you're like, ah, thank God for the diversification of a commercial banking side, right? So that's kind of where it all started. But Goldman's have, you know, really quite aggressively been going after this diverse commercial banking operation. And the big reason why Goldman's results were so bad was because of their botched attempt at trying to grow their commercial banking size, uh, side of the business. And actually, David Solomon, the Goldman CEO, on the earnings call— because when, when companies have their earnings reports, when Yes, they released this report with all the facts and the figures, but they also then have typically have a call, like literally an online call with investors and with their shareholders and kind of talk, walk them through the report and talk about it. And then there's a Q&A session. And one of the investors asked David Sonnenmann, what went wrong? I mean, why is this so bad? And David Solomon's response, he basically said that the firm— he admitted the firm had tried to do too much too fast in terms of their commercial banking expansion, and he said that they had lacked the talent to pull off some of the wide— some of their wide-ranging ambitions.

And like, a couple of points to add to that. Firstly, on the mishap with the commercial side, so to put some figures on that they republished new earnings figures for the last 3 years, and so showing that that particular unit, the consumer banking side, had made a loss of $3 billion since 2020. So to put that into some perspective, the other thing you mentioned there is about talent. Yeah, Goldman's have just recently cut roughly 6% of its global workforce. However, in Q4, Goldman spending on compensation and benefits was up 16%.

Yeah, you see that? This is the classic problem with these firms, like when they have these cyclical revenue— look, their IBD divisions, their revenues were down 50%, right? 50% down, but compensation went up. Because here's the problem, right? If you don't pay them— I mean, these bankers have got— they're in this situation where, look, if you don't pay me, it's almost like performance is now completely disconnected to actual remuneration. If you don't pay me, then I'm off. I'm going to do something else.

When your reference point has been '21, and 2020 when you've got a massive bonus, right?

So if you don't pay me, I'm off, thanks. Um, there's other people who will employ me. Um, and actually, yeah, more news this morning. Perhaps we'll talk about it in a bit more detail in a minute, but UBS have just kind of stepped up and going, right, we're hiring, we're aggressively hiring, or you lot that have just been really pissed off with your rubbish, your rubbish bonuses. Doors open, come on, come on over.

Yeah, um, so yeah, on that, on that point, what's interesting is there's two sides of that. So one, you're absolutely right, the headline kind of reads disgruntled. So UBS are basically headhunting disgruntled dealmakers, and they're disgruntled because of the lack of this ginormous bonus that they've become somewhat accustomed to. But the interesting thing there as well was about the shift of talent that's been coming out, apparently from the last decade, out of bulge bracket banks into boutiques. Yeah, they're actually— investment banks find it incredibly hard to retain staff, um, even at that level. So yeah, very interesting. And yeah, paying 16% increase on a year.

And these boutiques, I mean, I often think the word boutique I mean, that when you think about boutique, you think, you think about something really small.

Yeah.

And these boutiques are not small now, as you say, over the last decade. I mean, here are some names, um, like the big, the big boutiques are, um, uh, Julian Loki, um, there's one called PJT Partners, there's Evercore, Lazard, Greenhill, um, Robey Warshaw. These are the kind of bigger boutiques. And yeah, they've been running this sort of strategy of essentially allowing the big banks to hire and train new graduates, spend a couple of years, um, at Goldman's, get Goldman's to essentially pay for their training. Then you hire them after they've been there for 2, 3 years or so, bring them across to, let's say, Evercore, and then you've got, yeah, a ready-made you know, analysts with experience. So that's what's been happening. Actually, Will's over in New York at the moment. And actually yesterday— oh no, sorry, Tuesday and Wednesday we were working with Evercore. We run an M&A simulation for Evercore, and then Will was having a meeting with Julian Loki yesterday. So we're kind of— our simulations are, you know, starting to, you know, creep into that boutique M&A. Well, Yeah, boutique, it's not quite the right word, but these kind of, these more kind of standalone M&A houses where it's just less complicated, they're just straight up, they're just M&A.

Yeah.

Forget about all of this other bolt-on diversification stuff. They're just kind of keeping that kind of thing simple.

Yeah. So you almost think that, you know, in a non-finance way, if you were thinking about any job sector, a company built for purpose with one, goal. Yeah, would surely create the best pool of talent, you would have thought. Um, interesting with numbers. I mean, Evercore was only founded— or M&A transactions they've only been doing from since 1995. What do you reckon is the size, total size of dollar value of the deals that they've done?

Whatever. Cool. Yeah, since 1995. Yeah. Wow. Total value of deals done.

Yeah, total value of the M&A transactions.

That's a good question. All right, let me think. I'm going to go— I'm going to say $800 billion.

Not even close.

Is it like multiple trillions?

$4.7 trillion. Yeah, I mean, that—

I mean, I thought they might start off small. Yeah, all right.

Again, and then in terms of staff, I mean, how many staff are we talking about? I think the—

no idea.

I think the technology department of JP Morgan is 45,000 employees. Yeah, give you some context. Technology department, that's not their biggest department. Evercore have under 2,000 staff.

Is that right? Wow.

Yeah. So that, I mean, if you think about it, then you would have to say that this is like the SAS of the M&A world, right?

Yeah, they're the absolute, yeah, specialists. Let's not get distracted by, yeah, multiple divisions and diversification. And as David Solomon has said, I mean, growing your, your kind of business by diversifying is very hard. You know, doing one thing well is hard, but then trying to do many, many things well all simultaneously, then, you know, you're opening yourself up to kind of slipping on a few banana skins, which even the mighty Goldman Sachs, uh, seemingly has done.

And with Morgan Stanley, one, one final point there was they had actually record wealth management revenues. Yeah, which offset that decline in banking fees. So there's— there comes that diversification mix, right?

Protecting.

Yeah.

And I guess it's backing the right diversification horse. So Morgan Stanley have spent much more time backing that growth in their wealth management division, whereas Goldman's have been way more aggressively going after that kind of commercial bank side. And yeah, yeah, better direction.

Yeah, the problem with the— I find superficially talking, I think it's like if you're going to go into the commercial side, now you start stepping into fintech and technology. Yeah, I'm not sure that's the right horse to back. Whereas wealth, I think that's a much more alignment in terms of your client side and the platform interaction software that is required. I think it's just—

Yeah, and it's, as you say, way more aligned to your kind of core business, you know, both on the IBD side and on the trading side, right? If you're, if you've got wealthy people who are your clients, and that kind of feeds in, you can cross-sell, you know, your other products from the core part of your business. So yeah, it's way, way closer to that core.

Okay, well, let's talk about one other pocket of the, the financials space, which was asset managers. And the reason why is because the world's largest one, BlackRock, also reported. Um, they're— just to give you an idea, a sense of numbers— $146 billion of quarterly long-term net inflows, record full-year net sales of Aladdin, which might need a bit of an explanation. Aladdin's platform, it's a kind of the industry benchmark platform. Um, a couple things though, they had an 8% decrease in their full-year revenues, primarily driven by the impact of significantly lower markets and dollar appreciation. On average assets under management and lower performance fees. Um, but their revenues, EPS, both beat expectations against where the Street was, was looking. So yeah, how, how do— what's an asset manager's play here? Where do they fit in, and where are they deriving their performance from? And are they just more stable than, than what you've described from some of these other banks?

Well, So yeah, it's an entirely different setup, of course. So an asset manager will manage assets, as the name suggests. So this is where people with surplus income, wealthy people who want to invest that money, can choose to give it to an expert investor and will, so therefore will hand over their cash to a BlackRock of this world. And BlackRock will then manage it. And it depends on, look, BlackRock have got so many investment products that they're selling to wealthy people, right? And the big winner for BlackRock over the last few years has been their ETFs. So this doesn't require any management. This is not actively managed money. This is passive, right? So this is where an individual can buy, you know, a FANG ETF where they can then get themselves invested in the growth in share price of the tech stocks, for example. So there's lots of ETF products that has attracted in a huge amount of inflow, right? So when BlackRock when they report their quarterly— so they reported a quarterly long-term net inflow of $146 billion in quarter 4. What does that mean? Did they make $146 billion? What is that, revenue or profit? Well, it's neither of those. All it is is on net, that was the amount of money coming in, as in clients depositing. You could call it a deposit. It's not a deposit like you would think about JPMorgan, right? This is a deposit where they're buying one of the investment products that BlackRock are running. Okay, so the way that BlackRock generate revenue is twofold. It's through a management fee, and that will be a percentage of the assets they have under management. So this is the bit of their revenue stream that's super stable, and it's not volatile, and it's annually recurring. And these are very— this is very attractive from a revenue point of view, right? Stable, annually recurring. That fee is just a percentage of assets under management. What percentage depends on the product, right? So if you've got an ETF where it doesn't require much management at all, Well, then the percentage fee they charge is much smaller. And it might be somewhere between 0.1%, up to maybe 0.5%, right? But there are other products that BlackRock and these other asset management firms run, which are actively managed funds, which requires a portfolio manager and expertise. And they're trying to deliver a return over and above the index, right? And there they'll charge a management fee that will be higher, maybe up to 2%, okay? So how much assets they have under management directly, um, essentially computes their revenue they get for that year through these management fees. So if they— if BlackRock have got $10 billion— uh, sorry, $10 trillion under management, then, then, then fine, they're going to be charging generating huge revenues. Okay, the other side of their revenue is then from performance, where they'll take a percentage of the profit. So certainly in the actively managed funds, um, they'll take a percentage of profit, and obviously there that's much more volatile. But in 2022, you got a double whammy, negative double whammy for asset managers, because the value of the assets under management dropped Not necessarily because clients were pulling their money out, it's just the value of assets— share prices went down, and so the value of assets dropped, which means their fees dropped. And of course, performance— well, stock markets dropped, so the performance fees were much lower as well. Um, but to give you an idea, BlackRock's Q4 revenue was $4.3 billion revenue. They're the biggest asset management— asset manager in town. $4.3 billion. Do you want to know JP Morgan's revenue quarter 4?

Go on.

$35.6 billion. Almost— well, what's the math there? Not, not 10 times, but Not far off, but obviously much, much, much, much, much bigger as an entity from a revenue point of view. But JPMorgan are a big giant consumer bank, and they're a big giant investment bank. If you looked at Goldman's, who are more of an investment bank, right? Well, Goldman's revenue was $10.6 billion. So Goldman's are double— more than double BlackRock. In terms of revenue, um, but BlackRock's revenue is more stable, it's less cyclical. So you could say it's a bit more— well, yeah, it's, it's more— you could say it's more valuable from a valuation point of view because there's more stability there.

Yeah, I was just trying to have a look at, um, from a software perspective with Aladdin, which is the electronic kind of system that's been built in-house by BlackRock for their risk management division and for their users to manage their portfolios. I was just trying to see what— how that factors in, whether you get that as a freebie just through, like, when you are using their services, or—

I believe so. It's actually a good question. I don't know definitively. I'm not a BlackRock customer, but, um, so I don't know what products you need to be buying in order to qualify for that kind of system. So I'm actually not sure.

I was just looking at it. It has roughly 30,000 investment portfolios are managed through that particular platform.

Yeah. So I think that's for their more sort of premium side of their offering, which will be for people who have a little bit of expertise and perhaps want to run their own manage their own portfolio, but they're kind of using BlackRock to execute trades through, but also then, you know, using their kind of clever tech in order to better manage that money.

To conclude this, this segment then, so BlackRock would sit on the buy side, and everyone else we've discussed is more sell side. So from a young person thinking about my career from a top level, what would my working— what's the difference between working at a BlackRock or working at Goldman's from a day-to-day lifestyle point of view, work-life point of view? Like, how do they differ? It doesn't have to be Goldman's, but like investment banking to asset management.

So I would say that asset management's much more markets is more geared around markets because you're investing, you're taking risk, you're on the buy side. So that would mean that your day is going to be geared around market opening. When's the market open? So you'll tend to get into work a lot earlier. You need to be in before the open, right? And it depends what markets you're kind of investing in, but you're going to typically get in earlier. You might get in at I mean, I used to, I mean, I used to trade, um, I actually used to trade German markets. That, that those markets would open at 7 AM London time, so I, I would need to be in the office before 7 AM, before the open, and then right, we're off and running at 7. And then those markets used to kind of close, well, back in the day anyway, used to close at 4 PM. So I'd be in before 7 and then after 4 Right, I'm then, you know, tidying up, sorting things out, but I'm, I'm probably out of the door by 4:30, right? So you start earlier and you finish earlier, but it's way more intense during those hours because the markets are up and down, a lot of volatility, you're managing risk, and it's— you're right at the coalface of market volatility and you're taking risk, right? So your P&L's swinging, it's really intense. I think if you work in IBD at Goldman's, the differences are from the timing point of view, you're in much later. You're not, you know, you're not dictated by financial market hours. You're working on deals, right? And so you might be in later, you might start work at 9, even 9:30, but you're typically going to stay a lot later. So you might work till 9:30 PM, so you might do a 12-hour day. Also, you're gonna— when deals are happening, you're going to be working weekends. I mean, that's the beauty of being a trader or being on the buy side. When markets are shut— well, markets are shut, so the weekend markets aren't open, right? But when you're doing a deal and, you know, timelines are tight, then yeah, you're gonna have to work through, you know, through the night. You're gonna have to work weekends when you're— when the deadlines are approaching. And so I think the hours are longer in banking, but a lot of the time it's much less intense unless you're right up against a deal deadline. And don't get me wrong, you're going to be under a lot of pressure and it's going to be really intense. But most of the time you're not right up against a hard deal deadline. So it's just a little bit more— it's less intense. Each hour of the day is going to be less intense.

From a remuneration point of view, similar? Or is, is management more consistently stable and then investment banking a byproduct of the environment?

Yeah, so I'd say yes, that, that on the one hand that's true. So banking is more volatile, um, but as we've just discussed, it's difficult for banks to properly pay you a lot less when we're in a downturn because they're worried about losing the talent. Right. But even with that said, yeah, your, your, your income as an employer will be more volatile. But on the buy side, yeah, on an asset management— certainly an asset management firm, yeah, you'll have a more stable income. But then it depends if you're a trader. If you're a trader at a hedge fund, then actually a large portion, a much larger portion of your income is based on your performance. So it's a portion of the profits you make. So if you met, if you have a great year and make huge profits, great, you're going to earn a lot of money. But if you have a bad year and you lose money, then your, your your income's going to drop sharply. So if you're a hedge fund, I'd say that's probably where your earnings are most volatile. You then travel through the buy side, so you go into the asset management space and it becomes much more stable. Then you go across into investment banks, and on the investment bank market side, it's probably a bit more stable. But then you go to the IBD side and it becomes more volatile.

I would say high risk, high return then. Yeah, such is life.

That's right.

All right, well, look, let's, um, let's just spend 10 minutes if we can, just to have a quick chat through something else I think to put on people's radar. Uh, you mentioned before about the fact that if you've opened a bank account the last 12 or 13 years and you probably haven't been used to earning some interest on your money at the bank. Well, the debt ceiling, the debt ceiling for you and I, I know brings back memories. 2011, and I know you're going to explain what happened in 2011, but I remember because I was in Hong Kong on holiday at the end of the year, and I was being called multiple times saying, where the expletive are you? Like, you need to do your job, basically. And I was like, Really? Like, other people can't just do this for like a day or two? And, uh, I literally had to spend an entire day of my holiday covering. And this was literally on New Year's Eve, I think, when it rolled over and it was like, right, this is— we're going off the cliff, was what the fear was at the time. And, uh, yeah, brings back horrific memories of absolutely ruining my holiday at the time. But yeah, the debt ceiling, why are we talking about it? The US Treasury is now taking extraordinary measures to meet its debt obligations. It has transpired this week, and that's after the US government hit its $31.4 trillion borrowing limit. So to kick things off, what is this debt ceiling and why does it matter?

Yeah, the US then— just the debt ceiling concept has been around for over 100 years, actually. A bit of history for you. The US government set in place the debt ceiling the first time was in 1917. Prior to that, basically, this is about borrowing and spending. It's about controlling the government's budget. How much are we going to spend on stuff? And do we need to actually therefore borrow some money if we want to spend more than we're earning? Obviously governments earn through tax. If we do want to spend more than we're earning, right, we might need to borrow some money. Pre-1917, there were no controls on it. It was just the government made a decision on a case-by-case basis, right? Should we spend money on that? Should we spend money on this? You know, just case by case. Then the First World War kicked off and spending ramped, obviously on defense. And so they thought, oh yeah, actually we perhaps should set in place some rules around how much the government is allowed to spend and therefore borrow. Otherwise, this could get out of control. So they set in place this thing called the debt ceiling, which is basically an agreement by Congress. And that's the US government. And there's two parts to Congress. There's the House of Representatives and there's the Senate. And Congress has to each year essentially agree a maximum amount that their debt level can get to, just so that it's kind of kept in check and doesn't get out of control. So that's the kind of background to it. But add in the entirely bipolar, and maybe you might call dysfunctional, US political situation, then you have a big problem. And again, to simplify massively, you've got the Democrats and the Republicans, okay? And they've got very different ethos about how you run a country. Uh, the Democrats are typically— they like a larger government that has much more spending. So the government's in much more control over the economic system. They're typically spending a lot more and therefore they need to borrow in order to spend, and they'll tax more. Okay, that's like the Democrat side— big government, more in control. Republicans are the opposite. They're like small government. It's like, let's not interfere too much, let's just let this system play out, market forces and all the rest of it. So that the Republicans typically therefore like to spend less and they like to tax less. Okay, so when you've got this bipolar situation where you've got the Democrats and the Republicans and they're both equally as powerful, and at the moment you've got the scenario where the House of Representatives is controlled— there's a majority of Republicans in the House and there's a majority, majority of Democrats in the Senate— both parts of Congress have to vote through an increase in the debt ceiling, both sides, which basically means the Republicans and the Democrats all have to agree on an increase in the ceiling. But of course, for those Republicans, it's often very much going entirely against their entire political ethos to increase the debt ceiling. But that's kind of where we stand. Obviously, Biden's in the White House. That's the kind of third leg of the stool of the US government kind of makeup, and obviously Biden's a Democrat, right? So, um, this is where we stand. So each year the government has to, if they want to agree on a budget which underpins the government's entire spending for an entire year, spending on literally everything, in order to agree a budget, they essentially have to agree to increase the debt ceiling in order to achieve that budget. And periodically, if the political situation's bipolar enough and dysfunctional enough, then they don't agree and they can't agree. And the Republicans are like, no, I'm not agreeing for you, the Democrats, to spend more money and increase our debt, or I'm only going to agree to that if there's concessions and you agree to X, Y, Z of things that we want. And it becomes this political tool, this political gamesmanship. But the problem is the stakes couldn't be higher because worst-case scenario, if they can't agree and legally, therefore, the debt ceiling can't increase, Well, then literally the US government runs out of cash. And therefore, they can't do things like— well, never mind pay their staff or pay the military or pay their pensioners or stuff like that. They also cannot pay the interest on their debt. So that's bond coupon payments, which could mean that the US defaults. And if you have the biggest government on the planet with the most amount of debt defaulting, well then that's your Armageddon, right, scenario.

So if I'm a politician then, like Donald Trump, and I want to fund my wall like back in 2018, then what I would say is like, right, I'll sit here and have the longest government shutdown in US government history. I think it's 35 days. And look, you'll blink.

Yeah.

And that went on and on and on.

You remember, it's a game of chicken. And so you're right. So this is the— what the government shutdown that you've just mentioned, that's when literally, well, they hit the debt ceiling. And so, right, we need to now obviously avoid default, so we're going to close down and we're going to basically run with a skeleton crew so that we don't go bankrupt. And let's get a deal done ASAP so we can actually continue to actually run this country. And so yeah, Donald Trump forced a shutdown. Yeah, was it 35 days in the end, wasn't it? Yeah, that was the longest one.

He did 2 government shutdowns while he was president, actually.

Yeah.

The, yeah, the latter I think was the longest in history at the time. But yeah, I remember that that's all well and good from Trump's perspective to force the hand to get fund his wall. However, what then started to happen is the longer the government is shut down, the bigger the economic consequence, and it starts to compound then over time, as does then, um, how people view your government. And so it becomes then a self-defeating exercise. And then there comes that, well, then I'm not going to bargain with you. And then it goes on and on. And hence the cliff edge does become a tangible reality. So 2011, what happened there? And how do rating agencies fit into this conversation?

Yeah, well, this is very— first thing to say is this is very normal. Right, it's almost every year. And actually, here's the stat: the government— US government has agreed to raise the debt ceiling, um, 78 times since 1960. So 1960— well, hang on, what's that? That's 63 years. In 63 years, they've agreed to raise the ceiling 78 times. 49 times under Republican presidents, 29 times under Democrat presidents. Okay, so it's all the time this way. Okay, we've got to negotiate, we've got to raise the ceiling, we've got to raise the ceiling. US debt's going up and up and up. Every now and then it's different where the stakes are higher, the political gamesmanship is much greater, you know, the bipolar dysfunctional nature of Congress is at an extreme. And this is where you hit one of those moments where they, they're playing chicken with each other, and it kind of gets out of control, and they go into a government shutdown, and they're facing essentially default. And so what happened in 2011 is when— and they were talking about this kind of, yeah, the cliff, the fiscal cliff, which is where, look, guys, if you don't actually— Congress, if you can't agree, We literally will get Armageddon, right? Armageddon scenario is getting closer and closer and closer. And so what happened was that default risk started to increase. I mean, the default risk on US debt is as close to zero as you can get. It's supposed to be the risk-free asset. So if your default risk is super low, you normally have a credit rating that's really high, AAA rated. That means virtually no risk of default at all. But in 2011, the S&P, the Standard Poor's rating agency, this risk got— the default, the fiscal cliff risk, the Congress risk, if you want— got so high that the Standard Poor's said, actually, you know what? The risk of default's now tangibly gone away from zero to the point where we're going to have to now downgrade your credit rating. And for the first time ever in history, in the summer of 2011, Standard Poor's cut the US credit rating only by one notch from AAA to AA, but it was very symbolic. And markets, global markets went into kind of a panic mode because it was like, wow, okay, normally this stuff just in the end gets dealt with. But if the Standard Poor's have gone and said, look, this is different, when default risk is now getting meaningful and they've cut rating. And so suddenly markets started to price in this Armageddon scenario. Actually, maybe, maybe the unthinkable may be actually happening.

Yeah, I suppose then to, to conclude, with all of this debt ceiling talk re-emerging as it has done now, if there was a genuine threat as far as perceived to investors, this market should theoretically be going through the floor, but it's not. I mean, that's not to say we haven't declined over the last 24 hours, or really since that weaker retail sales report I think we had midweek, but that came on the context of a pretty stellar start. I think it was the best performance we've had at the beginning of the year in the last month or so in, in U.S. equities. So, um, yeah, I think Yeah, you look at the dollar, you look at yields right now, the market's not freaking out, right?

No, but it's one to— it could well be that this 2023 is another one of the— actually, this one's different and it's going to be more impactful than normal. And that's just because I don't know if you were following the House Speaker election, House of Republicans, this guy Kevin McCarthy, in the end, got nominated as the House Speaker. But it was a massive political battle to kind of engineer him into the position, okay? The concession he had to make in order to get the job— and the House Speaker is in charge of the House, basically, right? In order to get the job, the— he had to agree to allow 3 members of the what's called the House Freedom Caucus. And this is the part of the Republican Party that's like super right-wing, extreme right. So everything I was saying there about conservatives don't like to spend and borrow and tax, they like small government, no spending, no borrowing, no tax, right? Or these, the House of Freedom Caucus of death, the idea of spending more, it's like, it's like the devil worship. Okay. So, but 3 members of that caucus have been put onto what's called the Rules Committee. McCarthy had to put them on the Rules Committee to get their votes and get him over the line to become the House Speaker. This is gonna come back to bite these lot in the ass because nothing can be debated on the House floor that hasn't been signed off by the Rules Committee. So will the House of Representatives vote through an increase to the debt ceiling? Well, the answer is it's going to be way harder this year than it has been for a long time because of the political situation. So I, I would predict, and I'm definitely not alone in this, that this year the debt ceiling issue is going to be more impactful than it has been for quite a while. Um, now I'm not saying the, the US are going to default, of course, in the end.

Yeah. So the more realistic scenario then is that Biden will have to concede And so that's going to be politically harming in the short term for him.

Yeah, in a nutshell.

Yeah, it's funny, it's like, what's the point of a president?

Yeah, so it's definitely one to watch. It's a meaningful risk on the horizon and something to monitor. This is all going to play out over the next few months, right? And we're like, when we move into the summer, we get— the closer we get to the summer, the bigger an issue it's going to get. So for now, just be aware of it. It's not impacting markets today, but it's one to monitor.

Cool. Well, look, let's wrap it up there. And thank you very much if you've made it to the end episode for sticking with us. And if you have done and you haven't already dropped us a rating and a review on Spotify, Apple, wherever you listen, please do. It helps then just push out the podcast to as many people. And if you can pass it on, if you enjoy the, the episodes, to just one other person, and if everyone did that who subscribes and listens, it would make a huge difference. So yeah, please do, uh, it would mean a lot to us. So yeah, hopefully you enjoyed that episode, and we'll see you again next week. Thank you very much, Piers.

Have a good weekend.