Investment Banks Get No Respect
Business, Government, Investment Banks, Regulation
Robert Arvanitis explains that their utility and functions have changed.
This begins with the historical merchant banks. These were firms that helped fund the Age of Exploration, and grew along with their clients during the Industrial Revolution.
A merchant banker was knowledgeable in one or more lines of business, put his own money into investments, and gathered more investors based on his own reputation. A merchant banker was the finance department for his clients. He not only lent and invested, he advised on markets, delivered correspondent services, knew the broader economy, and participated in the risks.
That was a lot of hard work, and a lot of sincere risk taking, and the merchant bankers were well-respected. …
as government grew, it had a baleful impact on banking. Government imposed increasing regulation, it set ever more complex tax schemes, and it used capital markets for its own deficit financing. The classic â€œelephant in the bath tubâ€ of economic distortions.
By the 1970s, the investment banks, starting with Drexel, responded to these new signals. Investment banks began to disintermediate the commercial banks, with high yield bonds. Here, the investment banks acted as agent, not principal. They matched borrowers to investors but took no principal risk. That removed the need for capital, but also left the investors with both the default and liquidity risk. This further detached banks from clients, and in fact made them competitors in trading.
It turned out there were more â€” and more profitable â€” opportunities in arbitraging tax and regulation than there were in actually serving businesses. …
[T]he new-style investment bankers sold bonds to investors, and then traded against both the investors and the issuers, making a relatively safe turn on each sale. Or else they read the tax code, and fabricated deals that were tax-deductible debt for the IRS, but counted as regulatory capital for the other parts of government. Thatâ€™s easier and more profitable than actually building something.
In short, rather than solving real challenges, todayâ€™s investment banks work to exploit the growing incoherent web of government intrusions on the market. Profitable, yes, but not worthy of our respect.