Did the eight days between Sunday September 14 and Sunday September 21, 2008 mark the death of the investment bank? Lehman Brothers went bust, Merrill Lynch gave up and Goldman Sachs and Morgan Stanley became regulated banks. It was part of the most catastrophic shift among investment banks since the event that created them, the Glass Steagall Act of 1933. In future, familiar terms such as the bulge bracket, the tag for elite US investment banks, will need to be redefined, end-of-year league tables will have a different look and clients and executives will need to adjust to new ground rules. But despite these changes and provided they survive the current crisis, it is likely that investment banks will exist as recognisable entities within their new organisations and investment banking as an industry will emerge with enhanced validity.
In one sense not much will change. The firms we regarded as investment banks had already become large financial conglomerates. Morgan Stanley ceased to be a stand-alone investment bank in 1997 when it merged with the consumer finance company Dean Witter. Goldman broadened away from investment banking when it expanded its trading and principal investment activities after it went public in 1999 and by 2007 less than 15 per cent of its pre-tax profits came from investment banking. The truth is that pure investment banks ceased to exist long ago. The absorption of some famous old names into banks and the redefinition of some others will make little difference to client service or market dominance. In respect of their performance as investment banks it is a matter of semantics whether such financial conglomerates include or exclude banking alongside their many other businesses.
The disruption in the market will, however, give an opportunity for other institutions to move into the investment banking space. In recent years there has been a convergence of financial services involving private equity firms, hedge funds and investment banks. Goldman Sachs, with its private equity and hedge fund businesses, is no more an investment bank than Blackstone, with its advisory experts and alternative investment funds, is a buyout firm. The blurring of such distinctions has already led alternative investment firms into investment banking territory. Firms such as Blackstone, KKR and others coming from the hedge fund end of the spectrum will no doubt see further opportunities as the existing investment banks readjust.
Much depends on the regulators’ response to the investment banks’ problems. The bail-out is so large and public opinion is so inflamed that new rules are inevitable. However, it is unwise to underestimate the industry’s powers of survival. The last time Wall Street was in the mire was between 2001 and 2003 when the dotcom bubble burst. President George W. Bush pledged “to end the days of cooking the books, shading the truth and breaking our laws”, but instead a patsy settlement with the investment banks was reached in 2003 that imposed trivial fines and minor rule changes but left their business model intact. What happened then was the industry argued that the investment banks were essential to oiling the wheels of global capitalism. They will be hard-pressed to use such arguments this time round but Washington and Whitehall are still pro-market and the investment banks, whether independent or part of larger financial conglomerates, may yet receive more lenient treatment than seems likely today.
Far from bringing about its downfall, the beating that the investment banks have taken in the market could even restore investment banking to what it once was. In the past decade advising clients on corporate finance and investment matters has been subsumed in a dash for profit involving principal investing and proprietary trading. In the hurly-burly of the bull market investment banks got mixed up between what they were doing for themselves and what they were doing for clients. While they are licking their wounds, the investment banks may well eschew some of the more esoteric structured finance products that have caused them such problems and refocus on what they used to regard as their core business. While we may have seen the death of the investment bank I would be very surprised if we have seen the death of investment banking as an industry.
The writer was group managing director securities at Schroders and is the author of The Greed Merchants and other books. His new book Chasing Alpha will be published by Bodley Head in the new year