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Investment banks: underwriting, deals and trading
· Institution or agency
Fact, law or dataA rule, statute, definition or measured number.
Firms that help companies and governments raise money and do deals: underwriting securities, advising on mergers and trading.
See it on the Money & Finance map →How it works
Investment banks underwrite new stock and bond issues, buying the securities and reselling them to investors for a fee; IPO fees often run 4–7%. They advise on mergers, make markets and trade for clients and themselves. Glass–Steagall kept them separate from deposit-taking banks from 1933 to 1999. In 2008 Lehman Brothers failed, Bear Stearns and Merrill Lynch were sold, and Goldman Sachs and Morgan Stanley became bank holding companies under Fed supervision.
Why it matters
They are the plumbing that turns savings into corporate funding; their heavy borrowing and trading put them at the center of the 2008 crisis.
Think of it like
Like a commercial broker who sometimes buys the building to resell it: arranger, adviser and, at times, principal.
Facts, rules and data
SEC filings, league tables of underwriting fees, the Glass–Steagall and Gramm–Leach–Bliley laws, and the Financial Crisis Inquiry Commission's 2011 report.
Debates and risks
Whether reuniting investment and commercial banking in 1999 helped cause 2008 is debated; Lehman and Bear were standalone investment banks.
Connections (7)
▸Glass–Steagall Act (1933) and its 1999 repeal separated deposit banks from Investment banks: underwriting, deals and tradingFact, law or data
The connection
The act gave firms a year to choose: take deposits or deal in securities. That split created a separate investment-banking industry. J.P. Morgan & Co. chose deposits, so partners founded Morgan Stanley; First Boston spun out of a Boston bank. Goldman Sachs and Morgan Stanley stayed securities firms until becoming bank holding companies in 2008.
When and why
Signed by Franklin Roosevelt on June 16, 1933; Morgan Stanley opened in September 1935.
How we know
The statute's Sections 16, 20, 21 and 32; firm histories; Fed orders from 1987 to 1997 that gradually let bank affiliates underwrite securities again.
Debates and risks
Whether the wall reduced risk or merely shaped the industry is debated; standalone investment banks Bear Stearns and Lehman still failed in 2008.
▸Investment banks: underwriting, deals and trading underwrite Initial public offerings (IPOs)Fact, law or data
The connection
Investment banks run the IPO: they advise on timing and price, draft the SEC filing, market shares to big investors on a roadshow, gather orders, and set the price. In a 'firm commitment' deal they buy the shares and resell them, earning a fee, typically about 7% on midsize deals, plus an option to sell 15% extra.
When and why
Wall Street firms such as Goldman Sachs, Morgan Stanley and JPMorgan lead most large US IPOs; Morgan Stanley led Facebook's in 2012.
How we know
Every prospectus names the underwriters and their fees; economists Chen and Ritter documented the clustering of fees at 7% in 2000.
Debates and risks
Whether banks underprice IPOs on purpose to reward favored clients with first-day gains, and why fees stay clustered at 7%, is debated.
▸Investment banks: underwriting, deals and trading packaged and sold CDOs: repackaged mortgage debtFact, law or data
The connection
Investment banks bought mortgage bonds, pooled them into CDOs, paid rating agencies, and sold the tranches to investors worldwide, earning fees at each step. Many also kept the 'super-senior' slices they could not sell, believing them safe. Those produced some of the crisis's biggest losses: Merrill Lynch, Citigroup and UBS wrote down tens of billions.
When and why
New York and London, 2004–2007; leading underwriters included Merrill Lynch, Citigroup, Goldman Sachs and Deutsche Bank.
How we know
The Financial Crisis Inquiry Commission report and the banks' own writedown disclosures; the SEC's 2010 Goldman Abacus case showed how one deal was assembled.
Debates and risks
How well bankers understood the risks they kept or sold, versus being fooled by their own models, is still argued.
▸Lehman Brothers bankruptcy (Sept 2008) ended the era of big standalone Investment banks: underwriting, deals and tradingFact, law or data
The connection
After Lehman failed and Merrill Lynch was sold, investors doubted any firm funded by overnight loans could survive. Within a week, Goldman Sachs and Morgan Stanley became bank holding companies, gaining Fed lending in exchange for Fed supervision and tighter rules. Wall Street's big independent investment banks were gone.
When and why
New York, September 15–21, 2008; Bear Stearns had already been sold to JPMorgan in March.
How we know
The Fed's approval orders of September 21, 2008, converting Goldman Sachs and Morgan Stanley into bank holding companies.
Debates and risks
Smaller independents such as Jefferies, Lazard and Evercore survive; whether the conversions really reduced risk is debated.
▸LIBOR rate-rigging scandal involved traders at Investment banks: underwriting, deals and tradingFact, law or data
The connection
The rate submitters and the traders worked at the same global banks. Derivatives traders, holding positions that gained or lost millions on tiny rate moves, asked colleagues who submitted their bank's rate to nudge it, and coordinated with traders and brokers at other banks.
When and why
Trading desks in London, Tokyo and New York, roughly 2005–2010, at Barclays, UBS, RBS, Deutsche Bank and others.
How we know
Regulators published traders' messages in settlement papers, and prosecutors in the US and UK charged individual traders.
Debates and risks
How far up each bank the knowledge went is disputed; few senior managers were charged.
▸Investment banks: underwriting, deals and trading originate and package CMBS: conduit loans pooled into commercial mortgage bondsFact, law or data
The connection
A bank's conduit desk makes loans and holds them in a warehouse, hedging rate risk, until it has enough. It pools them with other lenders' loans in a trust, hires rating agencies and sells the bonds, earning the spread between loan rates and bond yields. Since 2016 it must keep 5% of the risk, or a qualifying B-piece buyer must.
When and why
Big banks such as Goldman Sachs, Morgan Stanley, JPMorgan, Wells Fargo and Citi, plus non-bank lenders, originate most conduit loans.
How we know
Each deal's prospectus names its loan sellers and underwriters; Dodd–Frank's risk-retention rule took effect for CMBS in December 2016.
Debates and risks
Whether 5% risk retention improved loan quality, or mainly raised costs and shrank the market, is still argued.
▸Eurobonds: international bonds sold offshore since 1963 were pioneered by London Investment banks: underwriting, deals and tradingFact, law or data
The connection
Investment banks arrange bond deals: they set terms, buy the bonds from the issuer and resell them to investors. London merchant banks, led by Siegmund Warburg's S.G. Warburg, built selling groups across Europe for Eurobonds; by the 1970s, US and Swiss firms such as Credit Suisse First Boston dominated the business.
When and why
London, from 1963 through the 1980s; Credit Suisse First Boston often topped the underwriting league tables in the 1970s and 1980s.
How we know
Deal prospectuses and 'tombstone' advertisements listing underwriters, industry league tables, and biographies of Siegmund Warburg.
Debates and risks
Whether the Eurobond market's light regulation encouraged later excesses in offshore finance, or mainly lowered borrowing costs, is debated.