The End of the Independent Investment Bank
Goldman Sachs and Morgan Stanley, the remaining two of the original five big investment firms, converted into commercial banks in recent years. Taken together with the fall of Lehman Brothers and Merrill Lynch, it is clear that the age of the venerated investment bank has come to a close.
The stand-alone investment bank came about with the creation of the 1933 Glass-Steagall Act in reaction to the Great Crash of 1929. The law aimed to limit the capacity to which a commercial bank could further its own interests above those of the individual investor. Once banks were no longer permitted to underwrite stocks or bonds, they were required to choose between becoming either a simple lender or a brokerage. Firms separated as a result, launching such divergent entities as J.P. Morgan and its subsidiary Morgan Stanley.
The Act would be partly repealed in 1999 after two decades of protest from the finance industry and replaced by the Gramm-Leach-Bliley Act, signed by then-President Bill Clinton in support of deregulation. (According to the Center for Responsive Politics – a non-partisan, non-profit group based in Washington, DC – the industry earmarked over $200 million in 1998 for the purposes of lobbying.) Commercial banks were allowed to have their own investment banking divisions once again. The increased competition reduced margins for the big investment firms and encouraged them to take more risks by investing their own money.
The acquisition of Bear Stearns to JP Morgan Chase marked the first of the original five Wall Street investment banks to end following the subprime mortgage crisis. In addition to the massive amounts of debt that was accumulated, those familiar with the industry also blame reckless short-selling for the current economic quagmire the US is engulfed in. Of particular concern to government officials, such as S.E.C. Chairman Christopher Cox, is the abusive use of naked short selling, which is the practice of selling company shares hoping to buy them back later at a lower price without first borrowing them or ensuring that they can be borrowed. In a statement last Friday, Cox – a proponent of deregulation – admitted to the “fundamental flaws” of the Securities and Exchange Commission’s oversight program, which failed to properly monitor Bear Stearns before its collapse. To stabilize the global financial system, many of the G7 countries have sanctioned a temporary ban on short-selling, affecting 799 companies in the US alone.
Daniel Gross, senior editor of Newsweek, suggested that investment banks excelled in bull markets of the past due to their ability to pull together massive amounts of funds from investors. By highly leveraging these investments, they were able to make substantial profits. Commercial banks, in contrast, cannot gain funding as easily as they are forced to use depositories and the Federal Reserve which have more restrictions on leveraging. However, the current credit crunch has created an environment of weary investors and banks unwilling to lend to each other.
With funds drying up, even the most resilient investment banks are succumbing to the credit crisis. The shape of Wall Street will never be the same as the disappearance of the five big investment banks marks the end of an era.