Stock Research Wall Street Makes Fortune Sweeping Your Cash
Below is a MRR and PLR article in category Finance -> subcategory Wealth Building.
Wall Street Profits from Your Idle Cash
Summary:
As a former limited partner at Bear Stearns in NYC, I observed first-hand how brokerage firms profit from idle cash. Referred to as "The Bank," these firms capitalize on interest differentials. Despite advances in investment banking by giants like Goldman Sachs and Merrill Lynch, the fundamental practice of sweeping idle cash persists, generating massive profits for brokers while offering minimal returns to clients.Article:
Once a year at Bear Stearns, our partners' meetings served as a reminder of our dual role as a trading and brokerage firm. Unlike investment banking behemoths such as Goldman Sachs or Merrill Lynch, we identified ourselves as "The Bank," a nod to the interest-driven revenue model dominating Wall Street.
Calculating a firm's earnings was straightforward: interest earned minus interest expenses. This technique, familiar to me since my days as a Senior Accountant with Arthur Andersen, still holds true. Most clients, both individual and institutional, fail to earn competitive interest on their cash deposits in brokerage accounts. This negligence revolves around the concept of idle cash.
In the late 1970s, Merrill Lynch pioneered the Cash Management Account (CMA) to compete for this idle cash against commercial banks. Today, brokerage firms continue this practice, quietly sweeping idle cash from accounts and reinvesting it at higher rates, often paying clients as little as 1.5% interest.
Every night, firms assess available idle cash in accounts, sweeping it away while offering minimal returns. Meanwhile, these firms reinvest the same funds at significantly higher rates. This discrepancy translates to considerable profits?"Merrill Lynch alone netted $2 billion in 2006 from such activities, marking a steady increase from previous years. The larger the balances they manage to sweep, the greater the profits.
Other major firms have joined this practice. Morgan Stanley and Smith Barney (part of Citigroup) have adopted similar strategies. When questioned, Merrill Lynch stated that brokers are encouraged to discuss higher-interest options, but such discussions rarely benefit the typical client.
Charles Schwab, the discount brokerage, excels in this game. Schwab pioneered this cash-sweeping strategy long before others. Today, a close look at Schwab's financials reveals that profits from sweeping idle cash outshine brokerage commissions.
Interest rates on idle cash vary, dependent on balance size. Smaller balances, say below $100,000, often yield lower rates?"around 1.25%?"while those with over $1 million can negotiate better terms. Firms bank on clients not making that call to demand higher interest.
Frequent trading distracts many clients from noticing their idle cash balances?"they focus on gains and losses rather than accruing interest. This oversight is costly. If you're not watching your money, the person managing the sweep is, but with their interests in mind. Their bonuses are tied to how much they sweep and how little they pay you.
Reading the fine print in brokerage agreements offers little clarity, as legal jargon requires a lawyer's touch. These agreements are tiered, meaning higher balances earn more interest. But how are clients supposed to navigate this complexity?
Wachovia's approach is telling. Their customer agreement barely mentions that they aim to pay the lowest possible rate until several paragraphs in. This recalls an interaction with a GM engineer boasting about the cost-efficiency of a 50-cent jack, stressing the minimal investment in seemingly critical components.
In summary, be vigilant about your cash and who controls it.
Goodbye and Good Luck!
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