The Future of Investment Banking
by Lisa Novak (New York City)
In an interview on Bloomberg in July, Nouriel Roubini, a professor of Economics at the Stern School of Business at NYU and Chairman of RGE Monitor, had some dire predictions about the economy. Foreseeing no end to the current financial crises, he warned, “It’s a vicious circle between a contracting economy and greater credit and financial losses feeding on the economy.”
Roubini further prognosticated that, “in a few years’ time, there will be no major independent broker dealers as their business model…is bust and the risk of a bank-like run on their very short term liquid liabilities is a fundamental flaw in their structure…”
Starting with the fire sale at Bear Sterns earlier this year and culminating this week with the shocking news of the Lehman bankruptcy and rush sale of Merrill Lynch, Nouriel Roubini’s prophesies seem to be coming true before our eyes. Now, only two of the five largest independent brokers–Morgan Stanley and Goldman Sachs–remain standing. With reports this week that Morgan Stanley is considering a merger with Wachovia, many in–and out–of the financial world are questioning the future of investment banking.
Some, like John Gapper, believe that investment banks are not going to disappear in the future, “but they will be smaller, specialized institutions, like the merchant banks of old. There are plenty of advisory firms, hedge funds and private equity funds and this Wall Street crash will create more.” Gapper, associate editor and chief business commentator of the Financial Times further commented “all of the unemployed financiers will need something to do.”
An example of this type of firm is Jefferies Group Inc., a full-service global investment banking and institutional securities firm headed by Richard B. Handler, an ex-junk bond trader, formerly of Drexel Burnham Lambert. Third-market trading companies like Jefferies, which trade over-the-counter securities not listed on a stock exchange, are less affected thus far by the financial crisis because they haven’t been involved in subprime mortgage loans.
On September 2nd, Reuters reported that Jefferies hired 25 ex-Bear Stearns bankers. One cannot help but wonder whether this is a sign of things to come and whether all the newly-jobless Merrill and Lehman people will hop into the same lifeboat as the Titanic sinks.
However, others argue that Bank of America’s acquisition of Merrill Lynch and the possible acquisition of Morgan Stanley by Wachovia portend an opposite trend: the re-absorption of investment banks into the fold of traditional banking institutions as in the pre-Glass-Steagall Act era. The law, which was enacted following the Great Crash of 1929, banned commercial banks from underwriting securities, avoiding a conflict of interest and forcing banks to choose between being simple lenders or brokerage/underwriters.
It remains to be seen whether the investment bank as we know it will, as is predicted, fade away or whether rumors of the death of the investment bank are greatly exaggerated. In any case, we can expect that any action will be accompanied by an institutionalized code of ethics for the banking industry to stave off a future breakdown of this nature and scope.
