The financial services industry has been a sector where change is a constant factor, and perhaps very few organizations have inspired as much awe, intrigue, controversy, and curiosity as the global investment bank. Investment banks have such a storied history and currently sit amongst the fast-paced flow of global capital and trade. Investment banking, as the term suggests, deals with the primary function of assisting the capital market in its function of capital intermediation which means the movement of financial resources from those who have them to the ones who need to make use of those resources for generating GDP. Let’s take a deeper look at the history of investment banking and how it has evolved over the years.
Before the Great Depression of 1929, investment banking was in its golden era, and the industry was in a prolonged bull market. The market leaders at this time were JP Morgan and National City Bank, and often stepped in to influence and sustain the financial system. In fact, JP Morgan has been personally credited for saving the country from the calamitous panic in 1907. Afterward, excess market speculation, primarily from the banks using Federal Reserve loans to boost the markets, led to the market crash of 1929, thus sparking the Great Depression.
Along with the stock markets, the nation’s banking system was in shambles during the Great Depression, with 40% of banks either being forced to merge or failing altogether. The Glass-Steagall Act also known as the Bank Act of 1933 was enacted by the government in an effort to rehabilitate the banking industry through the erection of a wall between commercial banking and investment banking. The government also looked to provide separation between investment bankers and brokerage services to avoid any conflicts of interest between the “desire to win” investment banking business and “duty to provide fair and objective brokerage services.” In other words, this was the government’s way of preventing the temptation by an investment bank to knowingly promote a client company’s overvalued securities to the investing public in an effort to ensure the client company would use that investment bank for any future underwriting and advisory needs. These regulations became known as the “Chinese Wall.”
Due to the repeal of negotiated rates in 1975, trading commissions ultimately collapsed, and trading profitability declined. This led to the squeezing out of research-focused boutiques and thus began the trend of an integrated investment bank that provides sales, trading, research, and investment banking all under one roof. The late 70’s and early 80’s also saw a rise in the number of financial products like derivatives, high yield, and structured products providing lucrative returns for investment banks. The late 90’s also saw a facilitation of corporate mergers hailing as the last gold mine by investment bankers who assumed the Glass-Steagall Act would collapse leading to a securities business overrun by commercial banks. The act did fall apart, but that wasn’t until 1999, and the results were not as disastrous as people anticipated.
The 1980’s saw investment bankers start to lose their “dull” image and take on a reputation of more power and flair, enhanced by a flood of mega-deals during these wildly prosperous times. These exploits of investment bankers came to life even further through popular media. Investment banking became the focus for social commentary in pieces like “Bonfire of the Vanities” by Tom Wolfe, and “Wall Street” by movie-maker Oliver Stone. Then, as the 1990s came to a close, an IPO boom took over the perception of investment bankers. In fact, in 1999 alone, 548 IPO deals were done with most of them going public in the internet sector. As mentioned previously, the Glass-Steagall Act ended in 1999 through the enactment of the Gramm-Leach-Bliley Act (GLBA) which permitted “broad banking.” Since then, GLBA has been viewed as ratifying, rather than revolutionizing the practice of investment banking.