And Then There Were None – High Finance Finagling Takes Down the Top 5 Investment Banks
The first of the top 5 investment banks to fall was Bear Sterns, in March of 2008. Founded in 1923, the collapse of this Wall Street icon shook the world of high finance. By the end of May, the end of Bear Sterns was complete. JP Morgan Chase purchased Bear Stearns for a price of $10 per share, a stark contrast to its 52 week high of $133.20 per share. Then, came September. Wall Street, and the world, watched while, in just a handful of days, the remaining investment banks on the top 5 list tumbled and the investment banking system was declared broken.
Investment Bank Basics
The largest of the investment banks are big players in the realm of high finance, helping big business and government raise money through such means as dealing in securities in both the equity and bond markets, as well as by offering professional advice on the more complex aspects of high finance. Among these are such things as acquisitions and mergers. Investment banks also handle the trading of a variety of financial investment vehicles, including derivatives and commodities.
This type of bank also has involvement in mutual funds, hedge funds, and pension funds, which is one of the main ways in which what happens in the world of high finance is felt by the average consumer. The dramatic falling of the remaining top investment banks affected retirement plans and investments not just in the United States, but also throughout the world.
The High Finance Finagling That Brought Them Down
In an article titled “Too Clever By Half”, published on September 22, 2008, by Forbes.com, the Chemical Bank chairman’s professor of economics at Princeton University and writer Burton G. Malkiel provides an excellent and easy to follow breakdown of what exactly happened. While the catalyst for the current crisis was the mortgage and lending meltdown and the bursting of the housing bubble, the roots of it lie in what Malkiel calls the breaking of the bond between lenders and borrowers.
What he is referring to is the shift from the banking era in which a loan or mortgage was made by a bank or lender and held by that bank or lender. Naturally, since they held onto the debt and its associated risk, banks and other lenders were fairly careful about the quality of their loans and weighed the probability of repayment or default by the borrower carefully, against standards that made sense. Banks and lenders moved away from that model, towards what Malkiel calls an “originate and distribute” model.
Instead of holding mortgages and loans, “mortgage originators (including non-bank institutions) would hold loans only until they could be packaged into a set of complex mortgage-backed securities, broken up into different segments or tranches having different priorities in the right to receive payments from the underlying mortgages,” with the same model also being applied other types of lending, such as to credit card debt and car loans.
As these debt-backed assets were sold and traded in investment world, they became increasingly leveraged, with debt to equity ratios frequently reaching as high as 30-to-1. This wheeling and dealing often took place in a shady and unregulated system that came to be called the shadow banking system. As the degree of leverage increased, so too did the risk.
With all the money to be made in the shadow banking system, lenders became less choosy about who they gave loans to, as they were no longer holding the loans or the risk, but rather slicing and dicing them, repackaging them and selling them off at a profit. Crazy terms became popular, no money down, no docs required, and the like. Exorbitant exotic loans became popular and lenders trolled the depths of the sub-prime market for still more loans to make.
Finally, the system grinded almost to a halt with the fall of housing prices and increased loan defaults and foreclosures, with lenders making short term loans to other lenders being afraid of making loans to such increasingly leveraged and illiquid entities. The decreased confidence could be seen in the dropping share prices as the last of the top investment banks drowned in shaky debt and investor fear.
September saw Lehman Brothers fail, Merrill Lynch choose takeover over collapse, and Goldman Sacs and Morgan Stanley retreat to the status of bank holding companies, with potential buyouts on the horizon. Some of these investment banks dated back nearly a century, and others longer, such as the 158-year old Lehman Brothers. Quite an inglorious end for these historic giants of finance, destroyed by a system of high finance finagling and shady dealings, a system that, as it falls apart, may even end up dragging down the economy of the entire world.