It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
~ Henry Ford
Investment banking has, in recent years, resembled a casino, and the massive scale of gambling losses has dragged down traditional business and retail lending activities as banks try to rebuild their balance sheets. This was one aspect of modern financial liberalisation that had dire consequences.
~ Vince Cable
In the summer of 2006, I went on an extraordinary journey across the United States. I was working for a fund that invested in debt securities, most of them issued by financial institutions. We had bought in to the big players, with hundreds of millions invested in Barclays and Credit Suisse on this side of the Atlantic, JPMorgan and Goldman Sachs on the other. But there was a world of American banks we simply didn’t know, based in the endless plains of the Midwest or in sleepy Southern cities. Other funds, we’d heard, had been aggressively snapping up the debt of these smaller banks, but we needed to see them first hand. We booked flights, packed our button-collar shirts and khaki suits (to blend in better with the locals); I researched the best restaurants in Atlanta, Buffalo, Charlotte. It was the high point of the boom years and still, looking back on it, there seems something thrilling in being there at the beating heart of things, jetting out with millions of dollars to spend investing in these abstractions – subordinated bonds, credit default swaps: figures on a computer screen.
We flew out in late August. Our road trip across the US was preceded by meetings with the usual suspects in New York – dinner with Bank of America, breakfast with Morgan Stanley. Then off into the unknown. Yet, as we made our way from Cincinnati to Cleveland, from Milwaukee to Minneapolis, one thing became clear: the banks we were visiting, many of them a fraction of the size of their New York-based peers, weren’t all that different from each other, or from their big brothers in the Big Apple. This was the era when everyone wanted to be Goldman Sachs, and every mom-and-pop bank in every small farming town suddenly had to have a securities operation, a debt trading and derivatives team and a swish new logo. We heard the same thing in every bank we visited – a focus on trading, an eye for acquisitions, a burgeoning fixed-income division. Whereas, once, retail banks would talk to you of their clients, now it was all about bespoke correlation trading models, cleverly hedged mortgage servicing rights, their desire to be viewed as full-service financial institutions.
Two examples – in Cleveland, we met with bankers from National City Corporation, at the time the seventh-largest bank in the US. We heard how the firm had been founded in 1845 to finance trade along the Cuyahoga River, whose rust-brown trickle now wended between abandoned railroad cars, scrapyards and slag heaps below us. They told us that National City had made America’s first ever mortgage. We then heard how, over the past several years, the company had vastly increased the amount of proprietary risk it was taking, holding on to the mortgage loans it originated rather than selling them off as other banks did. How it was using exotic derivatives to hedge its portfolio. How it had its eye on extending its New York branch to handle better the large amount of capital-markets business it was doing. During the 2008 crash, the company was investigated and put on probation by the US Securities and Exchange Commission before being sold for a pittance to the Pittsburgh-based PNC Financial Services, the National City name removed and the company rebranded.
We also visited a bank called Marshall & Ilsley in Milwaukee. In a silver tower overlooking this grey, rather drab city, a couple of excitable young executives told us that they believed M&I (they flashed their recently redesigned business cards) would soon be challenging the likes of Goldman Sachs and Morgan Stanley as one of the country’s major financial players. Formed in 1847 and formerly an agricultural lender, it had survived previous financial crises by sticking close to home, making loans based on solid relationships with its customers: it was a proper, old-fashioned retail bank. In 2010, M&I was sold at a knock-down price to Bank of Montreal after a string of ill-advised investments went bad. It was clear there, and wherever we went that summer, that the cautious, utility-like nature of traditional banking had been forgotten in the rush to turn small-town lenders into investment banking franchises. We left America wiser, if not richer.
Two years later, almost to the day, I was in the US again. I had meetings scheduled with all of the major investment banks: Lehman Brothers, Goldman, Morgan Stanley, Merrill Lynch. I flew in over the weekend and, all day Sunday in my hotel, I barely stepped away from Bloomberg TV. Some time while I was over the Atlantic, news had filtered out that Lehman was going to go bust. One of the “too big to fail” institutions was going to be allowed to do just that. Instead of heading over to the company’s midtown offices, I arranged to meet some Lehman traders in a bar just off Broadway. We had lunch and they shook their heads and spouted bitter platitudes, then we got drunk and talked about the good times. That same day, Merrill Lynch avoided a similar fate by selling itself to Bank of America (as Bear Stearns had done with JPMorgan to save its own skin six months earlier). A week later, the remaining two major investment banks, Goldman Sachs and Morgan Stanley – after emergency regulation by the Federal Reserve – became bank holding companies, meaning they could get access to emergency federal funds and avoid going the way of their peers. The era of the investment bank was over. Under the stress of a collapsing market, all of the arguments the investment banks (IBs) had used to roll out to justify their business models – diversified income streams, geographic diversity, employing the smartest guys in the room – withered and died.
Arguments about “casino” banking continue to rage: in the UK in 2011 the Vickers report recommended ring-fencing investment banking from retail operations, and in the US the Volcker Rule will prevent banks with retail operations from making the sort of risky proprietary investments that went so sour for National City Corp. What is clear is that the concept of the “bulge bracket” bank is under heavy scrutiny – the once-feted model that all those small US banks strained towards which said that bigger was always better, and that it was sensible for the same institution to handle your mortgage, your insurance needs, your speculative derivative investments and your share trading, while also dealing in commodities, advising on mergers and acquisitions and carrying out a host of other financial services. Now the likes of Barclays, RBS, Citigroup, BNP Paribas and a host of other names more usually associated with retail banking are left with hypertrophied, redundant investment banking operations that belong to a bygone age.
With increasing focus on those still brave enough to call themselves investment bankers, the story of these one-time titans of the markets has lurched from scandal to catastrophe. JPMorgan – previously aloof from the struggles of other banks – got tarnished by the inexplicable actions of the London Whale, a rogue trader at its proprietary investment office. The former Barclays boss Bob Diamond’s intransigence and lack of remorse marked him out as an avatar of the era of selfish capitalism. The London Interbank Offered Rate scandal in which Barclays was implicated – where traders manipulated one of the key interest rates to line their pockets – looks as if it will leave few in the industry untarnished, with further evidence of impropriety at HSBC and Standard Chartered.
We have had the emotional resignation of Greg Smith, the disillusioned derivatives director whose letter of farewell – “I knew it was time to leave when I realised I could no longer look students in the eye and tell them what a great place this was to work” – made it sound as if he had expected to join a children’s charity rather than Goldman Sachs, the bank that Matt Taibbi of Rolling Stone famously described as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”.
A vampire squid. Photograph: Carl Chun/Wikimedia Commons 
Behind these headlines, a more insidious danger threatens the investment banks. They are finding themselves sidelined by increasingly sophisticated (and, crucially, unregulated) hedge funds and private equity firms, which are happy to avoid the banks’ hefty fees and trade directly with one another, or to originate, underwrite and distribute corporate finance deals without allowing the investment banks their usual cut. KKR, for instance, one of the leading private equity firms, has found itself listed along with more traditional investment banks on a number of recent equity offerings, the 2010 bond placement for Manchester United a high-profile example. Citadel, a hedge fund, has become one of the major options market makers. “Boutique” investment banks such as Greenhill are winning mergers and acquisitions business from their larger peers. Given the fear of further lurches in the markets, fewer trades are being done than at any time since the crash, and now the investment banks are finding themselves under threat from erstwhile clients. It is no surprise that earnings at Morgan Stanley and Goldman Sachs – and at the investment banking divisions of other financial houses – have dropped significantly over the past year.
If we are not quite writing the epitaph for the industry yet, the hiring of the retail banker Antony Jenkins as CEO of Barclays – replacing Diamond, with his thuggish investment banker’s style – does seem to mark a significant turning point. It was once the case that retail bankers were the unloved stepchildren of the “bulge bracket” institutions, patronised and scorned in equal measure. The CEOs of the big banks were almost always from the investment side of the business; when they weren’t (Fred Goodwin, the former boss of the Royal Bank of Scotland, comes to mind), they acted like children allowed to stay up past bedtime when in the presence of their racier, wealthier colleagues. It is clear that, attacked by regulators and nimbler competitors, losing the good staff and firing the bad, the trading floors of the investment banks will look very different in ten years’ time. As we mark the fourth anniversary of the financial crisis, it is worth looking back – and forward – and attempting to understand how the banks got here, and where they go next.
The birth of the IBs
Investment banks came into being, in the words of Lord Rothschild, to move “money from point A, where it is, to point B, where it is needed”. In Babylon 3,000 years ago, in ancient Greece and in Rome, in the rolling hills of Renaissance Tuscany, bankers followed this simple principle, pooling funds and investing them where capital was required. The sophisticated financial machine of the modern investment bank, however, was a product of the 19th century. A specific historical moment, the 1803 Louisiana Purchase, brought high finance on to the stage of world politics, and gave financiers a first taste of the power they would enjoy over the coming centuries.
With an expensive war against Britain looming, Napoleon Bonaparte decided to sell the territory of Louisiana, a vast area of land stretching from New Orleans in the south to Canada in the north, from the Mississippi in the east to the Rockies in the west. The government of the original 13 states struck a deal at $15m – roughly $230m at current prices. To raise this, they paid $3m down in gold and called on the British bank Baring Brothers to finance the rest (even though the money would be used to fund war against Britain). It was easily the largest real-estate transaction ever carried out, and Francis Baring, the head of the firm, enlisted the help of Hope & Co of Amsterdam to help raise the money. Baring persuaded the United States to issue bonds to cover the remainder of the purchase price. Napoleon then sold these bonds to Barings and Hope & Co at a discounted price of $87.5 per $100. The British bank and its Dutch partner turned a substantial profit on the deal, and multinational investment banking was born.
In Europe, the first investment banks – usually referred to as merchant banks – were family firms structured as private partnerships that lent to governments and corporations to finance wars, to cover shortfalls in taxation and to fund capital expenditure. The great names of 19th-century banking – Rothschild, Warburg, Lazard, Schröder, Montagu and Baring – swiftly grew into multi-strategy financial powerhouses, lending to mill owners in the north of England, shipbuilders in the Mediterranean, financing the expansion of the railway networks across Europe and the activities of the East India Company in Asia.
After the Louisiana Purchase, Barings was the pre-eminent European bank, soon rivalled by the transcontinental might of N M Rothschild, whose offices in London, Paris, Vienna, Frankfurt and Naples allowed it to control the flow of capital across Europe. The banks vied for control of various markets, Hamburg-based Warburg dominating the trading of currencies; the Rothschilds known for their investment in railways and in the building of the Suez Canal; Samuel Montagu & Sons acquiring specialised expertise in the bullion markets. HSBC was established in 1865 to finance – among other things – the opium trade.
In the US, the investment banks emerged from the vast financial drain put on both sides fighting in the civil war. Having failed to sell bonds directly to investors, the federal government hired the financier Jay Cooke to manage the first large-scale retail marketing of securities. Cooke employed 2,500 salesmen to float $830m of federal government bonds to the general public. With profits from the bond sale (Cooke was given between 0.375 per cent and 0.5 per cent commission on every dollar raised), his firm financed the construction of the Northern Pacific Railway. He overstretched himself, was hit hard by the Panic of 1873 and, after a scandal that led to the resignation of the Canadian prime minister, he was declared bankrupt. His son-in-law Charles D Barney took over the running of the company and built it back up into the major investment bank that eventually formed half of the securities firm Smith Barney.
Police fight to restore calm during a panic on Wall Street, 1863. Photograph: Getty Images
With support – both financial and strategic – from banking families in Europe, many of the great US investment banks were founded by German-Jewish immigrants around the middle of the 19th century. Largely excluded from retail banking (because of the stipulation that retail banks receive a charter from Congress and the consequent early dominance of the industry by establishment figures such as Alexander Hamilton, Aaron Burr and Thomas Philipps), Jewish immigrants followed the models of the Rothschilds and the Barings, establishing private partnerships that financed the westward expansion of the US. Goldman was founded by the German-born Marcus Goldman in 1869, joined by his son-in-law Samuel Sachs in 1882. Kuhn Loeb, one of the great forgotten names of investment banking that provided much of the capital for the building of the US railway system, was established in 1867. Lehman Brothers and Salomon Brothers were also born in this era, as were the now-forgotten Bache & Co and J&W Seligman & Co.
Besides these German-Jewish firms, the 19th century brought, in its latter half, the establishment of “Yankee Houses”, the most prominent of which was Drexel, Morgan & Co, founded in 1871 by John Pierpont Morgan and swiftly renamed JPMorgan. Other Yankee banks included Brown Brothers & Co (which had been around since 1818 but did not rise to prominence until the 1850s as one of the leading financiers of the cotton industry), Chase National Bank (which carried out its investment banking activities through Chase Securities Corporation and was part owned by the Rockefeller family), Close Brothers (founded in 1878, and which later moved its headquarters to London), Paine & Webber and Roosevelt & Son (a big Wall Street name before the family rose to political power).
In the 1890s and the early years of the 20th century, these young investment houses – Jewish and Yankee – helped to populate the New York Stock Exchange, Lehman and Goldman Sachs underwriting hundreds of stock issuances for firms such as Sears, Roebuck, Woolworth, Macy’s and Studebaker. The speculative frenzy of the Roaring Twenties led to a surge in the equity markets and a great expansion in public stock ownership. New investment banks were formed to capitalise on the seemingly endless flow of money coming from Wall Street: Merrill Lynch, Bear Stearns, Dean Witter and Dillon Read all came into their own in this period.
According to the historian Steve Fraser, the author of the magnificent Wall Street: a Cultural History, the investment banks initially provided a significant service to the US economy. “They played a critical role in stabilising and consolidating a highly competitive and internecine system that was producing, with numbing regularity, panics and depressions and all the economic, social and political problems that flowed from that,” he tells me. “The investment banks, Morgan in particular, created the first publicly traded corporations – streamlined, highly competitive organisations in the railroad industry to start off with, and then in all these other industries, including steel and farm machinery and electrical manufacturing and so on. They developed a reputation as stewards of an economy that had been out of control and which they now exercise control over – in their eyes – in a disinterested way.”
It was only once their hegemony was confirmed that the investment banks began to abuse this power. JPMorgan’s reputation oscillated between “Morgan the Financial Gorgon” and the hero of a stable economic system, while the banks had become – according to Fraser – “controllers of the major flows of liquid capital in the country, able to control whole industries, block innovation if it threatened their holdings, discourage new entrants to the industry, exercise enormous political power”.
All this while, on the horizon was lurking the first great test of the thriving markets, a crash that put many of the banks out of business and led to an extraordinary shake-up of the financial system.
The ’29 crash and Glass-Steagall
At the beginning of September 1929, 79 years before another financial crisis that would put paid to a handful of the most venerable Wall Street institutions, bankers were celebrating. The Dow Jones Industrial Average, the index that measures the value of the leading stocks in the American market, had enjoyed six years of uninterrupted growth, with a fivefold rise in the value of these companies.
As it would 79 years later, the asset bubble that had inflated over the 1920s started with a huge rise in the value of property, particularly in Florida. In the words of the great chronicler of the crash, John Kenneth Galbraith, there was “the conviction that God intended the American middle classes to be rich”.
The rise in the stock market had led to the launch of a number of mass-market investment vehicles, designed to give everyday investors easy access to the market. Among these funds was the much-trumpeted Goldman Sachs Trading Corp. Other banks used the speculative bubble to drive frantic mergers and acquisitions (M&A) activity, Dillon Read putting together rescue financing for Goodyear Tyre & Rubber and finessing the acquisition of Dodge Motors by Chrysler. JPMorgan, meanwhile, turned its attention overseas, investing in a number of institutions in the emerging markets of the day, most notably the Bank of Central and South America.
When the crash hit on Black Thursday, 24 October 1929, the banks reacted swiftly. In the face of a stock market down 11 per cent, Wall Street convened a meeting of senior bankers, who attempted to halt the slide by buying up a host of blue-chip stocks. They briefly managed to restore calm, but on the following Monday the rout continued. By 29 October, more than $30bn had been wiped off the value of the stock market and Wall Street was in the grip of panic. It was another 30 years before the losses from the rout were recouped.
Crowds queue outside a savings bank on 24 October 1929. Photograph: Getty Images
Many investment banks failed in the years following the crash. Those that survived did so by focusing their attention on strategies away from the stock markets. Lehman Brothers began specialising in venture capital, investing in a number of successful start-ups in the 1930s and 1940s. Goldman Sachs Trading Corp, over-leveraged and poorly diversified, went under in 1932, severely tarnishing the firm’s reputation. Sidney Weinberg, the new senior partner at Goldman, steered the firm away from trading stocks and towards the M&A business for which it is still best known. In all, 9,000 banks failed during the 1930s, of which many – as would be the case 75 years later – were small local banks that had overextended themselves in the speculative bubble of the previous decade.
Again, the chosen course of action mirrors the response of regulators to the financial crisis of 2008. The Banking Act 1933 sought, among other things, to separate the banks’ investment banking from their retail activities. Although retail deposit losses in the Great Depression were less severe than is often thought – only about 4 per cent of total customer deposits were lost, with an average recovery at the failed banks of 80 cents in the dollar, according to Federal Deposit Insurance Corporation (FDIC) records – it was clear that speculative activities, especially of the smaller banks, had placed their customers’ cash at risk. In the same burst of regulation, Franklin D Roosevelt’s newly elected government initiated the FDIC, a scheme to underwrite deposits against losses. But it was the so-called Glass-Steagall Act, named after the two Democratic legislators who sponsored the proposal, that made the headlines.
The act had far-reaching effects for the whole of Wall Street. The banks were forced to split their operations into investment and retail banking subsidiaries. Retail banks – those regulated by the Federal Reserve (and whose deposits were therefore covered by the FDIC) – were unable to underwrite or distribute stocks or bonds, to invest directly in equities, or to act as market makers for debt securities. The banks were given some time to implement the changes required by Glass-Steagall, yet such was the depressed nature of the markets following the crash that many simply wound up their securities operations. Others split their firms as dictated by the new law, JPMorgan most notably hiving off its investment banking arm Morgan Stanley in 1935. As a result of this legislation, a new generation of investment banks was born, and for the next six decades there was a clear separation – in the US at least – between retail banking and investment banking.
In Europe the picture was rather different. The merchant banks had always held themselves aloof from the plebeian practices of retail banking. It was not until 1974, when Midland Bank purchased Samuel Montagu & Co outright, that the two business lines were merged under one roof. Only after the liberalisation of the financial markets in the City during Big Bang in the mid-1980s (deregulation that the Thatcher government implemented to allow British banks to compete with their more sophisticated US peers) that the European retail banks began to ramp up their investment banking operations.
Big Bang, boom and bust
Big Bang was as much a change of philosophy as a change of the structure of the market. The competition injected by the Thatcher government into the trading of stocks and shares percolated through to all corners of the Square Mile. The London Stock Exchange had become a cartel, dominated by the old British banking houses. They were making money from the cosy set-up, but the City’s dominance of the financial markets had faded over the postwar years; its well-fed bankers sitting slumped in the armchairs of their Pall Mall clubs, watching bewildered as their Wall Street peers went from strength to strength.
The US had had its own version of Big Bang – known as “May Day” – as long ago as 1975, when fixed commissions for share dealing were scrapped and competition was injected into the market. Goldman Sachs, with its philosophy of “long-term greed” (a phrase coined by its visionary senior partner Gus Levy), was king of the two main strands of investment banking – M&A and securities trading. Morgan Stanley was also flourishing, leading the market in the underwriting debt issuance, opening offices in London and Tokyo and relaunching Morgan & Cie in Paris. With Lehman, Merrill Lynch, Bear Stearns and a host of other US firms making large amounts of money from their European activities and the sudden reawakening of London as a financial centre, it was time for the British and Continental banks to get back into the investment banking game.
They achieved this largely by acquisition, the European banks making significant profits during the 1980s and 1990s (save for a few dry years during the downturn of the early 1990s) and spending this cash snapping up investment banking concerns. Many venerable US houses fell to the European buying wave, First Boston, Dillon Read and Paine Webber among others.
London’s financial renaissance merely emphasised the hamstrung position of mammoth US retail franchises such as Citibank, Wachovia and Bank of America, still subject to the interdictions of Glass-Steagall. The great benefit of combining the racy investment banks with their more pedestrian retail peers was that the retail banks – precisely because they were unexciting – were viewed as safe bets by the credit markets, and thus could borrow much more cheaply than investment banks. The deposits provided a buffer in the event of, say, a large trading loss. This, of course, was precisely why regulators wanted the two areas separated in the first place.
It was the Clinton administration, source of many of the short-sighted regulatory missteps that paved the way for the credit crisis, that finally dispensed with the Glass-Steagall Act and allowed US retail banks to (re)embrace their investment banking franchises. In fact, Glass-Steagall had been flouted or circumvented for several years, most notably in the tie-up between Citicorp and Salomon Smith Barney in 1998. But after Clinton’s edict – “The Glass Steagall Act is no longer relevant,” he declared in 1999 – the banks went on a spree.
Bill Clinton (R) and his treasury secretary Robert Rubin (L) in 1999. Photograph: Getty Images
While retail banks were forming themselves into more aggressive, speculative businesses, the investment banks also made moves that would increase their risk profiles. Beginning with Merrill Lynch in the early 1970s, through Bear Stearns and Morgan Stanley in the mid-1980s (when Lehman entered into an uncomfortable, decade-long period under the wing of American Express) and finishing with Goldman Sachs in 1999, the investment banks abandoned their established ownership structures and moved from private partnerships to publicly traded companies. Under the old model, the partners were on the hook for the firm’s losses: creditors could, in theory, come after the personal assets of the partners. Once the shares were publicly held, the investment banks were limited liability companies like any other. This necessarily altered the in-house attitude to risk.
The 1990s had provided a striking example of what investment banking looks like when it goes bad. Drexel Burnham Lambert, led by the charismatic Michael Milken, was one of the great success stories of the 1980s. Racking up enormous profits, paying fantastic salaries (Milken earned $550m in fees in 1987), the firm turned junk bonds into a thriving, heavily traded market. For a short while, they were the new Goldman Sachs – every banker wanted a Drexel business card, every investment bank wanted a junk bond trading unit. Then a series of investigations into the firm’s practices led by District Attorney Rudy Giuliani exposed widespread fraud. Milken denied any wrongdoing, but in 1988 Drexel was hit with a $650m fine – at the time the largest ever penalty for securities fraud. The company limped on but was forced to declare bankruptcy in February 1990.
If the 1980s and 1990s were decades of crazed mergers and acquisitions activity – as retail banks rehitched themselves to the investment banks they thought they’d lost for ever – the first seven years of the new millennium were just crazed. The Japanese banks, briefly powerful in the 1980s before bad real-estate loans refocused them on their home markets, returned to the fray. Nomura in particular flexed its muscles, buying up much of Lehman Brothers after the bankruptcy. HSBC expanded aggressively into the US, buying America’s biggest finance company, Household International, for £9bn in 2002 and becoming the second-largest sub-prime lender in the process.
The tug of love between Barclays and RBS for the Dutch investment bank ABN Amro (where I briefly worked) was the apex of this reckless period of financial history. The suitors were uninterested in the company’s retail assets, and wanted only the complex, derivatives-centred investment banking arm. Eventually “Sir” Fred Goodwin’s RBS won, and for a shade under $100bn. Then, within months, the financial crash hit and the business was worth – optimistically – half of what RBS had paid.
It was clear to me, thinking back to that trip around the US in 2006, that there was a kind of fever infecting the bankers we met. They had come late to investment banking but in those days of ever-rising markets they could do no wrong, and the trades they put on were always the right ones, and they persuaded the once-conservative senior management teams of these small-town banks to allow them to ramp up their speculative, risk-laden enterprises. Goldman Sachs and the other investment banks represented a perfection of the dream all those bankers had – that of being players in the major leagues, of living magazine-bright, metropolitan lifestyles, of making a name for themselves. There was very little evil in the crash of 2008 – the cartoon-character portraits of investment bank villains plotting the downfall of the financial markets are comforting, but wrong. It was small-time greed, stupidity and dumb optimism.
The crisis flushed out those upstarts and pretenders who, for a brief moment – had thought they might be the next Goldman Sachs. Now the question is whether even the titans of the industry can survive.
Given that I’m no longer on the inside (and haven’t been for a few years now), I thought I would speak to a friend from my own banking days to get a sense of how it feels to be working in the City in 2012. My friend, the Banker, managed to be at once enormously successful and yet a thoughtful and intelligent critic of the world that had made him so rich. The managing director of the investment banking division of a big British bank, he sells bonds and derivatives to a wide range of international clients. After swearing me to anonymity, he allowed me to place my Dictaphone on the table at the noisy bar where, once every few months, we meet to drink and reminisce.
The sun sets over London. Photograph: Getty Images
We talked for a while about what it had been like to work together during the maddest, strangest period in financial history – first in the boom years and then in the dark days of the crisis, when we’d spent long hours in this same bar, trying to come up with a way out of the unfolding nightmare. I asked the Banker how much has changed since those times – whether he and his colleagues think about themselves differently since the financial world crumbled around them.
“I’m not sure all that much has changed,” he said, “in terms of what we’re doing day to day and in how clients perceive us. The big difference is how the non-banking world perceives the banking world. I think what has changed within a bank like ours is we’ve gone on a PR overdrive. Banks are trying to take huge steps to change public perception, whether it’s through the way we do business, or through charity work.”
Already by the time I left the City in 2010, it was a different world from the one I’d joined eight years earlier. Compliance, corporate social responsibility, bankers’ pay – there was a paranoia surrounding anything that might lead to an appearance in the Wall Street Journal. “There are now more questions asked before you complete a transaction than ever before,” the Banker told me. “Every bank has whole new layers of suitability committees, risk management committees. Everyone’s petrified of, say, a Dutch pension fund losing money on a trade they do with them. We’re so much more careful than we were.”
I still keep a file on my computer of emails sent to me by friends in the City when they were fired in 2008 and 2009. So many of them reminded me of that moment in Up in the Air where George Clooney, a professional “firer” called in by large firms to make their employees redundant, looks down at an accountant’s CV, sees that he trained as a chef, and asks him “How much did it take to buy you away from your dream?” One of my friends went to South Africa to become a game warden, another to California to teach high-school baseball.
I asked the Banker how many more would lose their jobs in the industry, and whether, indeed, the job market in the City might pick up. “It depends on the continued severity of the downturn,” he said. “Banks are behind the curve. They haven’t fired as many as we first thought they would, and the reason for this is 2009. In 2009 there was so much liquidity pumped into the system by central banks that asset prices reinflated very, very quickly. It was called the ‘Bazooka’, when the Fed pumped this cash in, and no one knows what or when the next ‘Bazooka’ will be.
“Everyone is worried about being understaffed when it comes – the next Tarp [the Troubled Asset Relief Programme, the plan under which the US government bought illiquid assets from the banks] or whatever. The year 2009 was very good for investment banks; we were all making money again.” (We were speaking before the latest round of quantitative easing in the US and before Mario Draghi’s bond-buying exercise in Europe, moves that – if not the “Bazooka” the Banker was hoping for – have managed to bring some small measure of cheer to the markets.)
“And also, banks are behind the curve because every week you have a different problem. So you just had UBS with their rogue trader, Barclays and LIBOR, HSBC – you’ve now got Standard Chartered. And the investment banks realise that each of the crises they’re not involved in, it’s a chance to grow market share, to benefit from the fact that the others are firefighting.” I asked him whether he was happy in his job; whether he thought of packing it in, as I had done, leaving the financial world now that it had been so terribly tarnished. He thought for a while before answering, spinning his beer mat on the table.
“Bankers don’t deserve and won’t get any sympathy, but if you think through the numbers: if you’re earning £1m a year, after tax that’s £500,000; after the amount that’s in stock that you can’t access for three years, that’s £300,000; and you’ve got to educate three kids privately. Bankers aren’t wealthy any more. And now people in traditional industry are earning more than bankers. But bankers can’t move to industry because of how tainted they are. I mean, if you were announcing your next CEO, if you were Marks & Spencer, for instance, would you want it to be a banker?
“What are the options for bankers now? Hedge funds aren’t up to much. Private equity is really struggling – they’re surviving off pretty slim management fees. So all the traditional jobs that bankers might move to are closed off. And being a banker, you don’t have the skillset to really innovate . . . most of us are no good at anything other than our own specialities within the world of banking. If you want to be an entrepreneur in the UK, you really need to innovate and bankers just aren’t smart enough.
“I think about it the whole time. If I lost my job, what could I do? I can sell stuff [bonds and derivatives], I don’t have any product knowledge. All I know is banking, how to form relationships. I can’t do anything else.”
It was getting late and the room was filling up with City workers, their tired faces animated as they approached the bar. We finished our drinks and I asked the Banker if he felt any sense of optimism about the industry, whether he thought that we might have put the worst of the financial woes behind us. He shook his head. “In terms of the markets, China is really slowing down for the first time, and that’s at the forefront of our minds. Now slowing from 9 per cent to 7.5 per cent is still 7.5 per cent growth, but it’s where we go from here. And there are numerous other problems that have been plastered over and are now coming to light. The capital markets are basically closed at the moment. It’s so, so depressed, just the amount of trading going on. It’s harder to get clients to get sign-off for trades, and there are simply fewer trades to do.
“In five years’ time, we could still be having the same problems in the euro; you could have low growth in the emerging markets; unless banks outside the US are forced to mark-to-market their assets on their books, you could have a more entrenched, systemic credit crisis, where no one’s willing to lend to anyone else; and at some point inflation will come back to knock back any recovery we do have. So things look bleak for investment banks as they currently stand.”
The mergers and acquisitions market is the quietest it has been since 2003. RBS talks of selling off the investment banking arm it fought so hard to build. Others will surely follow, particularly if the crisis in the eurozone claims more victims. New regulations – the Volcker Rule in the US, the British response to the Vickers report – will bite hard at the investment banks when they come, further trimming slim profit margins. Even the banks’ big new client base – the sovereign wealth funds – is inherently less profitable than the hedge funds of the pre-crash world.
There are tough times ahead for the IBs. But they have been here before. Goldman Sachs came close to bankruptcy after the failure of Penn Central Transportation Company in 1970; Morgan Stanley only just avoided going the way of Lehman (or at least Bear Stearns and Merrill Lynch) after the credit crisis. Both have survived, albeit as bank holding companies rather than de jure investment banks, and both, I imagine, will find a way of eking out life until the markets pick up, just as Lehman and Merrill and Bear Stearns did during the barren years of the 1930s. Whether they will ever again be the kings of Wall Street – whether Wall Street and the City will continue to sit at the heart of our financial world – this is less certain.
We hear of the possibility of the investment banks upping sticks from their usual homes, London and New York, and relocating to Hong Kong, Geneva or Dubai. Already they are concentrating their efforts in the Bric countries (Brazil, Russia, India and China) and in other growth areas such as Indonesia and Pakistan. But if the crisis of 2008 taught the investment banks one thing, it was that being based in a developed economy with the support of a sympathetic government is of enormous benefit to the banks. Without the intervention of the Federal Reserve in 2008, Morgan Stanley and Goldman Sachs would not have survived.
A number of banks, Goldman among them, looked at moving substantial segments of their European operations from London to Switzerland in 2009 and 2010 when the 50p income-tax rate was instigated but met with substantial resistance from the bankers they were trying to move. Despite the tax rise, it seemed bankers were unwilling to leave their Kensington town houses, their Cotswold cottages, the schools at which their children were educated, the restaurants at which they ran up five-figure bills. London is continuing to attract the wealthy from all over the world, as shown by its property prices. Many of the banks do more business with Russians in London than in their Moscow offices. The City seems poised to become the largest base for renminbi trading outside Asia, bringing the Chinese in to join the Russians, oil-rich Middle Easterners and countless others in the casinos and clubs of Mayfair, the boutiques and serviced apartments of Knightsbridge.
While emerging markets represent an opportunity for the banks, countries such as Indonesia require an enormous investment that won’t bear fruit for perhaps a decade. So the banks are having to spend heavily in these capital-constrained times in the hope of reaping rewards much further down the line, and so as not to lose out to local banks or the Chinese and Indians, former emerging economies whose banks are looking to move outside their old markets. For the moment, the investment banks will spend as much in new markets as they have to in order to stay competitive, and bankers will keep to the familiar streets of London and New York.
The Shanghai skyline, with the Shanghai World Financial Center, China's tallest building, centre. Photograph: Getty Images
Regulation might remain a threat to the banks, but many who watch the banks and their regulators closely, including Steve Fraser, aren’t convinced that any of the laws will come into effect. “The Volcker Rule is right now only talk,” he says. “Very little has actually happened. Whether the rage that has been directed against [Wall Street] since the meltdown will translate into vigorous political reform is, I think, still a very open question. Without a persistent mass movement pushing in that direction, I’m sceptical. Because the reforms that took place during the Depression era, even the creation of the Federal Reserve in 1913, but certainly Glass-Steagall, wouldn’t have happened without mass pressure from below.”
The Occupy protests aside, there is nothing like the public anger against the banks today that there was after the 1929 crash. It may be that, quietly, the banks are allowed to carry on operating exactly as they did before the crisis.
But that may not be enough. The risk remains that the major investment banks are disintermediated – cut out of the equation in many of their most profitable business lines. Whether it’s hedge funds facing each other directly on trades, private equity firms setting up M&A franchises, the continued existence of the shadow banking system or the growth of the financial nous of banks from the Bric nations keen to keep their business to themselves, the likes of Goldman Sachs and Morgan Stanley (and the investment banking arms of the retail banks) will find themselves scrapping for what little business there is in a depressed market with a group of well-financed, nimble competitors. In the words of the Banker: “You eat what you kill as an investment banker. We got fat in the good years. Now there’s less and less to eat, and a lot of us are going to starve.”
Alex Preston is the author of “The Revelations” (Faber & Faber, £7.99) and is a regular contributor to the New Statesman.