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And Then There Were Two: An End to Independent Investment Banking Firms in the United States

By J. Robert Brown

With the demise of Lehman Brothers (the firm announced it would file for bankruptcy), the number of independent banking firms in the United States will have fallen from five to three.  But elimination of the weakest link only created a new weak link, with attention then shifting to Merrill Lynch.  That firm announced that it had agreed to a merger with BoA.

In other words, in one short weekend, the number of independent investment banking firms in the US fell from four to two.   We predicted this.  Indeed, it is only a question of time before the remaining two independent investment banking firms (Goldman and Morgan Stanley) are gone.  As we have observed 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 all but spelled the elimination of independent investment banks in the United States. 

Commercial banks have inherent advantages (both in raising capital and in the perceived safety of Federal Reserve Board oversight) and, particularly in times of financial crisis, business will gravitate in their direction. Back in the 1930s, commercial banks in the US were asserting domination over the investment banking side of securities activities.  Only the forced separation through the adoption of Glass Steagall prevented them from controlling that segment of the financial sector.  With the provision's repeal in the 1990s, it only became a question of time before commercial banks took over.  With JP Morgan acquiring Bear Stearns and BoA acquiring Merrill, the process is well underway. 

Is this a bad thing, to have the investment banking business effectively controlled by commercial banks?  There are no doubt a number of reasons why the US has the most vibrant capital markets in the world.  One of them has to be the existence of a class of intermediaries that profit so extraordinarily from capital market activities.  These firms have an incentive to introduce new products, encourage trading activity, and promote initial public offerings.  They are likely to take larger risks designed to profit from capital market activities, something that likely promotes liquidity and innovation.  Commercial banks, in contrast, are typically more conservatively run and profit from lending relationships.  They are therefore in a position to encourage lending relationships rather than stock offerings and may be unwilling to take the type of risks associated with independent investment banking firms.  Both of these factors may affect the liquidity and vibrancy of the securities markets. 

The disappearance of independents will damage the depth and liquidity of the US capital markets.  We hope to see the   Chamber of Commerce express the same degree of concern over this in its efforts to promote reform designed to improve securities markets as it has with the problem of excessive securities litigation.   

Full post as published by The Race to the Bottom on September 15, 2008 (boomark / email).