investment Banking and the future of Wall road
The current economic meltdown has changed the face of Wall Street, perhaps forever. For decades the Power in the shop had been fueled by high-rolling investment bankers, but look what's happened in the last eight months. Lehman Brothers went bankrupt. Bear Stearns was snapped up by Jpmorgan Chase, Merrill Lynch got bought out by Bank of America, and Goldman Sachs and Morgan Stanley had to convert to bank retention companies just to stay in business. Five major investment banks . . .and then there were none.
At the starting of this year, those five firms had a combined shop value of colse to 0 billion with the top firm, Goldman Sachs, valued at nearly billion. Now the top banks, which are comparatively small boutique firms-Raymond James, Jefferies & Co, Greenhill & Co, Keefe Bruyette & Woods and Piper Jaffray-have a combined shop value of billion, a number that has shrunk by a factor of 20.
Essentially, the global economic urgency has ushered in the era of Universal banking where gigantic financial firms offer every conceivable kind of investment stock and service. Even smaller brokerage firms face being herded under the umbrellas of big banks, or else risk becoming irrelevant.
Historic Realignment of the Industry
When Goldman Sachs and Morgan Stanley opted to come to be bank retention companies it marked an historic realignment of the financial services manufactures and the end of a securities firm model that had prevailed on Wall road since the Great Depression. But why did they make the change? Partly because it's given both firms entrance to the Federal Reserve's reduction window - the same line of credit that is open to other depository institutions at a lower interest rate.
As bank retention companies, they can also tap into deposits from retail customers. The two firms had already received a temporary financial lifeline from the Fed-the primary Dealer credit Facility-the extra reserves established to bail out Wall road broker-dealers like the Bear Stearns deal in March 2008.
Even though Goldman Sachs and Morgan Stanley are now classified as bank retention companies and are part of the Universal banking model, they'll still be able to engage in investment banking activities. But after years of loose oversight by the Securities and replacement Commission, they're now faced with tighter regulations imposed by the Federal retain and they are subjected to Federal Deposit insurance Corporation oversight.
The Golden Years of investment Banking
A quick historical tell of investment banks will serve as a backdrop to the events that led to their downfall.
Independent investment banks have been colse to for a long time, but originally they were small secret partnerships that earned most of their money from offering corporate finance and investment advice, as well as some broking and other services. If you had walked into one of their offices and looked around, you might have mistaken it for a large law firm.
The success of their business model depended on the trust built through long-term relationships. There wasn't much money at risk in the early days because the firms operated primarily with the partners' own money. That meant there weren't vast sums ready to gamble on risky ventures with immoderate leverage. But the lack of working capital and a desire to orchestrate splashier deals, motivated the firms to go communal in the late 90s.
The Downfall Begins
With more capital in the coffers and a growing entrance to low cost, short-term debt, managers started to make larger, riskier capital bets-most recently those troubling and toxic mortgage-backed securities.
The regulations that had once separated investment banks from primary banks were no longer in place. That opened the way for big global banks like Citigroup and Jp Morgan to start competing with Wall road for what had traditionally been the domain of the investment banking business. This forced Wall road firms to advance their services, to use more leverage and to take even bigger risks.
When those risks led to profits, the dealmakers were rewarded with outlandish bonuses and the wheels were set in request for retrial for bigger risk-taking. Throw patchy government regulation into the mix and you have, as the saying goes, a formula for disaster.
Before long, major Wall road firms were leveraged three or four times more than accepted banks, yet they still operated under far less stringent regulations than the banks.
It wasn't until the financial urgency reared its ugly head in mid-2008 that the U.S. Fed stepped in and for the first time, allowed investment banks entrance to their discounted funds. Then when the credit urgency hit, extremely leveraged Wall road firms like Bear Stearns and Goldman Sachs found themselves in even deeper trouble. They'd already suffered huge losses with their hedge funds and high-risk ventures, but their immoderate leverage compounded their problems as the credit urgency stripped them of the capability to raise the further capital they needed to survive.
The Outlook for Wall Street
What's the outlook for those working on Wall road now? No doubt there will be less excitement and no more of the huge bonuses that dealmakers had grown accustomed to. But there are bigger concerns about whether the U.S. Will lose its competing edge and the capability to allege its Power status in the global financial system.
Some of the best and brightest might pull up stakes and head for better opportunities in the burgeoning Asian Markets, or they could flip over to the unregulated Hedge Fund market-at least for as long as those funds administrate to survive. Thousands of Hedge Funds are going out of business, bringing serious grief to investors like the huge communal pension funds, foundations and endowments that have poured billions of dollars into these secret partnerships.
If there is any good news in this economic fiasco, it's this: Main road stands to at last benefit from a better regulated Wall Street. With a more transparent financial system, a firmer foundation and a stronger business model, there might be a promising outlook for more carport and consistent growth.
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