The History of Investment Banking

1896-1929
Prior to the great depression, investment banking was in its golden era, with the industry in a prolonged bull market. JP Morgan and National City Bank were the market leaders, often stepping in to influence and sustain the financial system. JP Morgan (the man) is personally credited with saving the country from a calamitous panic in 1907. Excess market speculation, especially by banks using Federal Reserve loans to bolster the markets, resulted in the market crash of 1929, sparking the great depression.

1929-1970
During the Great Depression, the nation’s banking system was in shambles, with 40% of banks either failing or forced to merge. The Glass-Steagall Act (or more specifically, the Bank Act of 1933) was enacted by the government with the intent of rehabilitating the banking industry by erecting a wall between commercial banking and investment banking. Additionally, the government sought to provide the separation between investment bankers and brokerage services in order to avoid the conflict of interest between the desire to win investment banking business and duty to provide fair and objective brokerage services (i.e., to prevent the temptation by an investment bank to knowingly peddle a client company’s overvalued securities to the investing public in order to ensure that the client company uses the investment bank for its future underwriting and advisory needs). The regulations against such behavior became known as the “Chinese Wall.”

1970-1980
In light of the repeal of negotiated rates in 1975, trading commissions collapsed and trading profitability declined. Research-focused boutiques were squeezed out and the trend of an integrated investment bank, providing sales, trading, research, and investment banking under one roof began to take root. In the late 70’s and early 80’s saw the rise of a number of financial products such as derivatives, high yield an structured products, which provided lucrative returns for investment banks. Also in the late 1970s, the facilitation of corporate mergers was being hailed as the last gold mine by investment bankers who assumed that Glass-Steagall would some day collapse and lead to a securities business overrun by commercial banks. Eventually, Glass-Steagall did crumble, but not until 1999. And the results weren’t nearly as disastrous as once speculated.

1980-2007
In the 1980s, investment bankers had shed their stodgy image. In its place was a reputation for power and flair, which was enhanced by a torrent of mega-deals during wildly prosperous times. The exploits of investment bankers lived large even in the popular media, where author Tom Wolfe in “Bonfire of the Vanities” and movie-maker Oliver Stone in “Wall Street” focused on investment banking for their social commentary.

Finally, as the 1990s wound down, an IPO boom dominated the perception of investment bankers. In 1999, an eye-popping 548 IPO deals were done – among the most ever in a single year — with most going public in the internet sector.

The enactment of the Gramm-Leach-Bliley Act (GLBA) in November 1999 effectively repealed the long-standing prohibitions on the mixing of banking with securities or insurance businesses under the Glass-Steagall Act and thus permitted “broad banking.” Since the barriers that separated banking from other financial activities had been crumbling for some time, GLBA is better viewed as ratifying, rather than revolutionizing, the practice of banking.

Investment Banking After the 2008 Financial Crisis
The greatest global financial crisis since the Great Depression was triggered in 2008 by multiple factors including the collapse of the subprime mortgage market, poor underwriting practices, overly complex financial instruments, as well as deregulation, poor regulation, and in some cases a complete lack of regulation. The crisis led to a prolonged economic recession, and the collapse of major financial institutions, including Lehman Brothers and AIG.

Perhaps the most substantial piece of legislation that emerged from the crisis is the Dodd-Frank Act, a bill that sought to improve the regulatory blind spots that contributed to the crisis, by increasing capital requirements as well as bringing hedge funds, private equity firms, and other investment firms considered to be part of a minimally regulated “shadow banking system.”

Such entities raise capital and invest much like banks but escaped regulation which enabled them to over-leverage and exacerbated system-wide contagion. The jury is still out on Dodd-Frank’s efficacy, and the Act has been heavily criticized by both those who argue for more regulation and those who believe it will stifle growth.

INVESTMENT BANKS LIKE GOLDMAN CONVERTED TO BHCS
“Pure” investment banks like Goldman Sachs and Morgan Stanley traditionally benefited from less government regulation and no capital requirement than their full service peers like UBS, Credit Suisse, and Citi.

During the financial crisis, however, the pure investment banks had to transform themselves to bank holding companies (BHC) to get government bailout money. The flip-side is that the BHC status now subjects them to the additional oversight.

INDUSTRY PROSPECTS AFTER THE CRISIS
Investment banking advisory fees in 2010 were $84 billion globally, the highest level since 2007, while 2011 saw a significant decline in fees.

The future of the industry is a highly debated topic. There is no question that the financial services industry is going through something pretty significant post-crisis. Many banks had near-death experiences in 2008 and 2009, and remain hobbled. 2011 saw much lower profitability for many of the largest financial institutions. This directly impacts bonuses for even the entry level investment banker, with some pointing to smaller fractions of ivy league graduating classes going into finance as a harbinger of a fundamental shift.

That being said, those trying to break into the industry will find that compensation is still high compared to other career opportunities. Also, the job function of an M&A professional has not dramatically changed, so the professional development opportunities haven’t changed.

- Previuosly published by wallstreetprep.com