: INVESTMENT BANKS: LOSS OF PURPOSE
“Some US Bankers stuck to Strategies consistent with their Purpose; they were just not living in New York”
Within the week that started on September 14 Lehman Brothers imploded, Merrill Lynch sought refuge with Bank of America and Goldman Sachs and Morgan Stanley relinquished their exalted status as the only stand alone Investment Banks. They petitioned the Fed to henceforth treat them as commoners: they would accept a lot more regulations in exchange for government insurance, as all commercial Banks do.
These are not the largest of the Banks. Unlike City and others in that cohort, Goldman and Morgan were not carrying the heroic Purpose of making Main Street work or operating under pressure to innovate constantly to attract clients. Nor were they supposed to be just servants to their clients as the Credit Unions. Instead, clients were supposed to flock to them; they were the temples of Banking, pursuing excellence and thus setting the standards for the rest of the industry and often for Washington. These were not mere businesses expected to manage themselves well; they were Industry Leaders with the clout and responsibility to also tell others what was to be done and why. And within a week they were no more.
Some called this the death of Investment Banking, which excelled in the US after it built both whole Industries and Countries in Old Europe. In reality it was just the burial of Purpose previously pursued by these venerable institutions. They were the ones who lost the high ground of operating at the interface of competitiveness and morality, of doing well while doing good. They did not fail as managers. Goldman has not missed a single quarter of profitability. They did not perform as Leaders. The question is why?
In 1999, Morgan Stanley really ceased to be a standalone Investment Bank when it merged with Dean Witter, a finance company. Two years later Goldman ceased to be a partnership and went public. The Partners cashed out handsomely and the shareholders did even better- as the new Goldman aggressively expanded its trading and principal investing activities. Within years, investment banking accounted for only 15% of the profits of the financial conglomerate that Goldman had transformed itself into.
Many noticed the transformation but not Goldman itself or the regulator. Goldman continued to be allowed to extend credit up to 30 times its capital while commercial Banks, like The Bank of America, had to manage with leveraging their capital 11 times- as they were subject to a stricter regulatory regime.
In 2003, it seemed that the time of looking at Investment Banking had come. As some might remember, long before we experienced the credit bubble we experienced the dotcom bubble. Investment Banks had pushed the very good idea of connecting through the internet too far, as the idea of securitizing mortgages was to be pushed later. They marketed and then they sold for the worst possible reason: because they could collect upfront fees or could use leverage afforded to them by their privileged regulatory position
President George W. Bush threatened to end their days of “shading the truth”, but nothing happened. As a matter of fact, nobody enjoyed the long party of easy credit launched by Dr. Greenspan more than the Investment Banks.
So these particular Investment Banks that we all knew as the keepers of standards of “Haute Finance” have long gone. I will not write about greed as the cause of their demise. Writing about greed is always an attribution, unless one has evidence relating to actions of individuals. Instead, I will focus on questions of strategy and organization and leadership not exercised.
For some time now there has been disconnect of Purpose and Strategies pursued. Neither growth nor innovation for their own shake was strategic objectives that fitted with the pursuit of excellence.
Looking at it from the organizational perspective, it turned out that the standards of Excellence that Partnerships could pursue were too lofty for these companies, once they became publicly traded and operated under the pressure of having to show quarterly results. Even worse, pursuing what was good for the shareholders and at the same time what was good for clients and their shareholders created more complexity than their leaders wanted to deal with. Freddie and Fannie had a similar – and in their case mortal problem- dealing with complexity when they deviated from their Purpose. Except one would expect better from the two Banks that were seen in a position to advise what is right and what is wrong in the world of Finance.
However, for years now these banks have abandoned Excellence as their Purpose without confronting the consequences. Change or abandonment of Purpose amounts to Transformation. And leading a conscious Transformation is not an easy business. Suffice it to say Transformation will not be achieved overnight now, just because the Fed agreed that Goldman Sachs and Morgan Stanley are no longer Investment Banks. To paraphrase Walter Bagehot: “Honor sunk, but the Commercial Bank has not surfaced as yet.”
As for Investment Banking, it is alive and well. In recent years there has been a convergence of financial services involving Private Equity Firms, Hedge Funds, Asset Management Firms and Investment Banks. What happened last week will just give other institutions the opportunity of moving even more aggressively into Investment Banking.
Morgan Stanley and Goldman Sachs will need some time to readjust, perhaps transform themselves for good by discovering a new Purpose and sticking to it. Their respective tie ups with Mitsubishi and Warren Buffet is a first good step and sets a good example for other Banks to seek to raise capital in the private markets instead of waiting for the Government bailout.
As for Merrill Lynch it has already managed to gain a seat in the future by making a virtue out of necessity. Its acquisition produced the “You Tube” moment of the month by showing that some US Bankers stuck to Strategies consistent with their Purpose. They were just not living in New York.