Investment Banking: The Future

Disclaimers first: I work in a publicly listed investment bank. Hence any criticism directed towards employees of investment banks in this series of articles I hope to write over the next 6-18 months is also applicable to me.

The financial upheavals that have occurred since mid-2007, particularly the events of this year, have forced me to rethink my beliefs about the functioning of financial services firms and the desirability of changing their structure / state of regulation. I am of course fiercely libertarian, and do not easily come around to accepting the interference of the state in economic affairs or personal freedoms. But this crisis has confronted me with plenty of evidence that the something has gone profoundly wrong with the working of the financial services industry (especially investment banks). I have given much thought over the last 3 months as to what exactly is broken and how it ought to be fixed. So far, I have few answers, but I continue to think and read what others have to say.

Two very interesting articles have come to my attention this week. One is "The End of Wall Street's Boom" by Michael Lewis, of "Liar's Poker" fame, in a long article in Portfolio.com. The other is an Op-Ed piece in the NY Times ("Our Risk, Wall Street's Reward") by another Street insider, William Cohan. Among other things, both argue that the crucial problem that has arisen in the functioning of investment banks is that they have transformed from being private partnerships to publicly listed corporations (Merrill in 1971, Bear Stearns in 1985, Morgan Stanley and Salomon Brothers in 1986, Lehman in 1994, Goldman in 1999, to name the most prominent). This has created a serious principal-agent problem where shareholders (owners) cannot control their agents (executive managers who run the firms) as the latter go on taking gargantuan risks or fleecing clients regardless of the longer-term impact on the firms' reputation and capital. I have lately come to believe that publicly listed investment banks are conduits for transferring money from shareholders and national treasuries (in the form of the inevitable bailouts) to employees with probably incommensurate benefits for the economy. Whether the nature of the conduit that I postulate and whether the probably are true is something that I need to investigate further to uncover. Even if these are true, the solution of the problem will need more thought...hopefully I will write more on this topic this year and the next.