Why It Is Important To Understand Investment Banking


Since the economic crisis began, liberal politicians and activists have led an assault on financial institutions, blaming them for many issues effecting the economy. The situation has become so vindictive that uninformed people are calling for draconian changes, including the breakup of large institutions to ameliorate the “to big to fail” risk, along with a plethora of other regulations that would emasculate institutions that have driven the economic growth of our country since the Industrial Revolution.

Much of the outrage is based upon populist myth and not supported by facts. Frequently, I wonder whether the critics, in fact, understand what activities investment banks are engaged in. In an effort to debunk some of the most inane exaggerations, I will delineate the diverse roles banks play in our economy using Morgan Stanley (MS) as an example. It is a preeminent investment bank that is at the epicenter of the turmoil surrounding new regulatory proposals. An efficient operating banking industry is beneficial to every American and business. Without it, commerce would suffer, as would the economy. The issues and facts outlined in this essay will, hopefully, give the reader a base which will be helpful as he or she considers the issues impacting the banking community.

Dating back to 1924, MS is a global financial services firm that provides products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. The company has offices throughout the world and about 60,000 employees. In the fiscal period ending December 31, 2010, MS posted consolidated total revenues of $38 billion and net income of $4.7 billion.

MS has three business segments- Institutional Securities, Global Wealth Management and Asset Management.

Institutional Securities provides financial advisory and capital-raising services to corporate and institutional clients globally. It conducts sales and trading activities as principal and agent and provides financing services for institutional investors. Specific activities of this business segment include raising all types of capital as an underwriter, providing corporate and institutional clients with advisory services on key strategic matters and providing loans to selected corporate clients. Additionally, the company conducts market-making activities on securities and futures exchanges.

Global Wealth Management provides comprehensive financial services to clients through a network of global representatives. As of December 31, 2010, the company held nearly $1.7 trillion in client assets. Products include a comprehensive array of financial solutions and brokerage covering various types of investments provided to individual investors and small-to-medium sized businesses and institutions.

Asset Management offers a diverse array of equity, fixed income and alternative investments and merchant banking strategies to corporations, pension plans, endowments, foundations sovereign wealth funds, etc.  

MS is subjected to a plethora of regulation and laws that limit the scope of its activities and the manner in which it does business with its clients. Most recently, a provision of the Dodd-Frank Act (the “Volker Rule”) prohibits the company from engaging in proprietary trading beginning in 2012. This law effectively limits the company from investing in certain types of assets that are deemed to be overly risky. Additionally, other aspects of Dodd-Frank will subject MS to more rigorous supervision by the Federal Reserve.    

Compensation received by banks for their services is high reflecting its valued service to clients, and so employees are handsomely rewarded in good times. In recent years, a significant portion of compensation has been paid in the form of stock with multiple year vesting.

Investment banks and commercial banks are the cornerstone of our economy. Commerce would come to a standstill without the services being provided by these institutions. Everything from working capital loans to finance inventory to much more complex financing of acquisitions that streamline industries and eliminate waste are provided by banks.  

The impact that banks have on Middle America is similarly staggering. Consider that banks finance homes, cars and appliances, companies that employ Americans, inventory needed to create consumer products, as well as airplanes and computers; and the list goes on and on. Additionally, these same institutions advise pension funds and the like that safe keep the money that Americans are depending upon for retirement. The bottom line is that a healthy banking system is in the best interests of all Americans.

It is true that excessive behavior occurs, and sometimes rogue employees defalcate. It is also true that from time to time, banks exceed their authority or maximum risk limits. It is for these reasons that oversight by regulators is important and valuable. But to suggest that the banking system be dismantled is utter insanity. Even the most liberal people in Washington understand this will never happen regardless of the outlandish and inane populist calls to do so by the president, OWS or anyone else.

Hopefully, the aforementioned description of MS will be helpful as you decide where you stand on the issue of bank regulation in this country. I hope you now have a sense that Morgan Stanley is much bigger than its mortgage operation.

Photo Credit: Slick vic