“£1m isn’t rich anymore”: The rise and fall of investment banking
October 4, 2012
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
~ Henry Ford
Investment banking has, in recent years, resembled a casino, and the massive scale of gambling losses has dragged down traditional business and retail lending activities as banks try to rebuild their balance sheets. This was one aspect of modern financial liberalisation that had dire consequences.
~ Vince Cable
In the summer of 2006, I went on an extraordinary journey across the United States. I was working for a fund that invested in debt securities, most of them issued by financial institutions. We had bought in to the big players, with hundreds of millions invested in Barclays and Credit Suisse on this side of the Atlantic, JPMorgan and Goldman Sachs on the other. But there was a world of American banks we simply didn’t know, based in the endless plains of the Midwest or in sleepy Southern cities. Other funds, we’d heard, had been aggressively snapping up the debt of these smaller banks, but we needed to see them first hand. We booked flights, packed our button-collar shirts and khaki suits (to blend in better with the locals); I researched the best restaurants in Atlanta, Buffalo, Charlotte. It was the high point of the boom years and still, looking back on it, there seems something thrilling in being there at the beating heart of things, jetting out with millions of dollars to spend investing in these abstractions – subordinated bonds, credit default swaps: figures on a computer screen.
We flew out in late August. Our road trip across the US was preceded by meetings with the usual suspects in New York – dinner with Bank of America, breakfast with Morgan Stanley. Then off into the unknown. Yet, as we made our way from Cincinnati to Cleveland, from Milwaukee to Minneapolis, one thing became clear: the banks we were visiting, many of them a fraction of the size of their New York-based peers, weren’t all that different from each other, or from their big brothers in the Big Apple. This was the era when everyone wanted to be Goldman Sachs, and every mom-and-pop bank in every small farming town suddenly had to have a securities operation, a debt trading and derivatives team and a swish new logo. We heard the same thing in every bank we visited – a focus on trading, an eye for acquisitions, a burgeoning fixed-income division. Whereas, once, retail banks would talk to you of their clients, now it was all about bespoke correlation trading models, cleverly hedged mortgage servicing rights, their desire to be viewed as full-service financial institutions.
Two examples – in Cleveland, we met with bankers from National City Corporation, at the time the seventh-largest bank in the US. We heard how the firm had been founded in 1845 to finance trade along the Cuyahoga River, whose rust-brown trickle now wended between abandoned railroad cars, scrapyards and slag heaps below us. They told us that National City had made America’s first ever mortgage. We then heard how, over the past several years, the company had vastly increased the amount of proprietary risk it was taking, holding on to the mortgage loans it originated rather than selling them off as other banks did. How it was using exotic derivatives to hedge its portfolio. How it had its eye on extending its New York branch to handle better the large amount of capital-markets business it was doing. During the 2008 crash, the company was investigated and put on probation by the US Securities and Exchange Commission before being sold for a pittance to the Pittsburgh-based PNC Financial Services, the National City name removed and the company rebranded.
We also visited a bank called Marshall & Ilsley in Milwaukee. In a silver tower overlooking this grey, rather drab city, a couple of excitable young executives told us that they believed M&I (they flashed their recently redesigned business cards) would soon be challenging the likes of Goldman Sachs and Morgan Stanley as one of the country’s major financial players. Formed in 1847 and formerly an agricultural lender, it had survived previous financial crises by sticking close to home, making loans based on solid relationships with its customers: it was a proper, old-fashioned retail bank. In 2010, M&I was sold at a knock-down price to Bank of Montreal after a string of ill-advised investments went bad. It was clear there, and wherever we went that summer, that the cautious, utility-like nature of traditional banking had been forgotten in the rush to turn small-town lenders into investment banking franchises. We left America wiser, if not richer.
Two years later, almost to the day, I was in the US again. I had meetings scheduled with all of the major investment banks: Lehman Brothers, Goldman, Morgan Stanley, Merrill Lynch. I flew in over the weekend and, all day Sunday in my hotel, I barely stepped away from Bloomberg TV. Some time while I was over the Atlantic, news had filtered out that Lehman was going to go bust. One of the “too big to fail” institutions was going to be allowed to do just that. Instead of heading over to the company’s midtown offices, I arranged to meet some Lehman traders in a bar just off Broadway. We had lunch and they shook their heads and spouted bitter platitudes, then we got drunk and talked about the good times. That same day, Merrill Lynch avoided a similar fate by selling itself to Bank of America (as Bear Stearns had done with JPMorgan to save its own skin six months earlier). A week later, the remaining two major investment banks, Goldman Sachs and Morgan Stanley – after emergency regulation by the Federal Reserve – became bank holding companies, meaning they could get access to emergency federal funds and avoid going the way of their peers. The era of the investment bank was over. Under the stress of a collapsing market, all of the arguments the investment banks (IBs) had used to roll out to justify their business models – diversified income streams, geographic diversity, employing the smartest guys in the room – withered and died.
Arguments about “casino” banking continue to rage: in the UK in 2011 the Vickers report recommended ring-fencing investment banking from retail operations, and in the US the Volcker Rule will prevent banks with retail operations from making the sort of risky proprietary investments that went so sour for National City Corp. What is clear is that the concept of the “bulge bracket” bank is under heavy scrutiny – the once-feted model that all those small US banks strained towards which said that bigger was always better, and that it was sensible for the same institution to handle your mortgage, your insurance needs, your speculative derivative investments and your share trading, while also dealing in commodities, advising on mergers and acquisitions and carrying out a host of other financial services. Now the likes of Barclays, RBS, Citigroup, BNP Paribas and a host of other names more usually associated with retail banking are left with hypertrophied, redundant investment banking operations that belong to a bygone age.
With increasing focus on those still brave enough to call themselves investment bankers, the story of these one-time titans of the markets has lurched from scandal to catastrophe. JPMorgan – previously aloof from the struggles of other banks – got tarnished by the inexplicable actions of the London Whale, a rogue trader at its proprietary investment office. The former Barclays boss Bob Diamond’s intransigence and lack of remorse marked him out as an avatar of the era of selfish capitalism. The London Interbank Offered Rate scandal in which Barclays was implicated – where traders manipulated one of the key interest rates to line their pockets – looks as if it will leave few in the industry untarnished, with further evidence of impropriety at HSBC and Standard Chartered.
We have had the emotional resignation of Greg Smith, the disillusioned derivatives director whose letter of farewell – “I knew it was time to leave when I realised I could no longer look students in the eye and tell them what a great place this was to work” – made it sound as if he had expected to join a children’s charity rather than Goldman Sachs, the bank that Matt Taibbi ofRolling Stone famously described as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”.