The first of the top 5 investment banks to fail was Bear Sterns, in March 2008. Founded in 1923, the collapse of this Wall Street icon shook the world of high finance. By the end of May, the end of Bear Sterns was complete. JP Morgan Chase bought Bear Stearns at a price of $ 10 a share, a stark contrast to its 52-week high of $ 133.20 a share. Then came September. Wall Street and the world watched as, in just a few days, the investment banks that made the top 5 list fell and the investment banking system was declared bankrupt.
Investment banking basics
The largest investment banks are big players in the high finance arena, helping large companies and the government raise money through means such as trading securities on the stock and bond markets, as well as offering advice. professional on the most complex aspects of high finance. These include things like acquisitions and mergers. Investment banks also handle the trading of a variety of financial investment vehicles, including derivatives and commodities.
This type of bank also has participation in mutual funds, hedge funds, and pension funds, which is one of the main ways that what happens in the world of high finance is felt by the average consumer. The dramatic fall of the remaining major investment banks affected retirement plans and investments not only in the United States, but also around the world.
The high finance settlement that brought them down
In an article titled “Too Smart in the Middle,” published on September 22, 2008 by Forbes.com, the Chemical Bank President’s economics professor at Princeton University and writer Burton G. Malkiel provides an excellent and easy breakdown. to follow what exactly happened. While the catalyst for the current crisis was the collapse of mortgages and loans and the bursting of the housing bubble, its roots lie in what Malkiel calls the breaking of the link between lenders and borrowers.
What it refers to is the change of the banking era in which a bank or lender made a loan or a mortgage and that bank or lender maintained it. Naturally, since they held onto debt and its associated risk, banks and other lenders were quite careful about the quality of their loans and carefully weighed the likelihood of repayment or default by the borrower, against standards that made sense. . Banks and lenders moved away from that model, towards what Malkiel calls an “originate and distribute” model.
Instead of having mortgages and loans, “mortgage originators (including non-banking institutions) would have loans only until they could be grouped into a complex set of mortgage-backed securities, divided into different segments or tranches with different priorities in entitlement. receiving payments on the underlying mortgages, “with the same model also applies to other types of loans, such as credit card debt and auto loans.
As these debt-backed assets were sold and traded in the investment world, they became increasingly leveraged, with debt-to-equity ratios often reaching as high as 30 to 1. This turn and this deal often took place in a murky and unregulated system that came to be called the shadow banking system. As the degree of leverage increased, so did the risk.
With all the money that could be made in the shadow banking system, the lenders became less selective about who to make the loans, as they no longer had the loans or the risk, but instead divided them into chunks, repackaged them and they sold them to took advantage. The crazy terms became popular, no down payment, no required documents, and the like. Exorbitant and exorbitant loans became popular, and lenders scoured the depths of the subprime market for more loans to make.
Eventually, the system nearly came to a halt with falling house prices and rising loan defaults and foreclosures, and lenders who make short-term loans to other lenders fear lending to increasingly leveraged entities. and illiquid. The decline in confidence could be seen in falling equity prices as the last of the major investment banks drowned in shaky debt and investor fear.
In September, Lehman Brothers failed, Merrill Lynch chose acquisition over collapse, and Goldman Sacs and Morgan Stanley retired to bank holding company status, with possible acquisitions on the horizon. Some of these investment banks date back nearly a century, and others, like 158-year-old Lehman Brothers. A rather ignominious end for these historic financial giants, destroyed by a system of financial deals and shady deals, a system that, as it crumbles, may even end up dragging down the entire world’s economy.