Corporate Governance

And Then There Were Three: The End of Independent Investment Banking Firms in the United States

By J. Robert Brown

As we have said on this Blog multiple times (and written since the 1990s, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act), the elimination of Glass Steagall and the wall that separated commercial from investment banking had all but spelled the elimination of independent investment banks in the United States.  Commercial banks simply have inherent advantages, including the ability to raise funds through deposits or the market's awareness that the Fed will back them up when they are in trouble.  As the article above discussed, this happened in Great Britain.  When the barriers on commercial and merchant banking were removed, the independent merchant banks vanished. 

It comes up again on this Blog with the death watch for Lehman, the smallest of the remaining independent investment banks. Bear Stearns, formerly the smallest, is already gone, absorbed by JP Morgan Chase. That leaves four US firms, Goldman Sachs, Merrill Lynch, Bear Stearns, Morgan Stanley, and Lehman Brothers (five if you count Credit Suisse First Boston).  According tothe WSJ, Lehman continues to hemorrhage and continues to take drastic steps to remain afloat.

• Lehman Brothers Holdings Inc. said it plans to spin off to its shareholders the "vast majority" of its commercial real-estate assets, sell about a 55% interest in its investment-management division and slash its dividend 93% as it also predicted a fiscal third-quarter loss of $3.9 billion.
  

Lehman has access to funding from the Fed so its not in the same situation as Bear Stearns.  Nonetheless, the market remains pessimistic, with share prices falling 45% on Tuesday alone.  More recent stories suggest that Lehman is shopping for a white knight, with potential buyers including Bank of America, and that a buyout may be as soon as this weekend.  In other words, the venerable investment banking firm may find itself, like Bear Stearns, the subsidiary of a commercial bank.  

The issue is temporal.  If not this crisis, it will be the next.  In a financial market that allows commercial banks to engage in investment banking activities, there is no room for the independents.  For all of the complaints about litigation as a drag on securities markets, the repeal of Glass Steagall may be the most severe blow, elimininating a class of intermediaries that benefit the most unequivocally from active securities markets and therefore have the most incentive to insure their integrity and push for innovative capital raising tools.  Their loss will be damaging. 

Full post as published by The Race to the Bottom on September 13, 2008 (boomark / email).