Ah Investment Banking. Such an image problem (warning: sweary). Just check out David Enrich’s two excellent recent stories for the WSJ about the antics of the interdealer brokers and their IB trader counterparties, complete with Lady Marmalade’s (do NOT Google “Lady Marmalade Party” at work) Orgasmic Love Swing and enough sordid details to keep a tabloid in business (they were also manipulating LIBOR at the time, but hey, SEX PARTIES are easier to explain). These people are basically the sort of adolescent pondlife who are most at home swigging alcopops at a busstop, left to babysit the global economy. With predictable results.
Still, outrage-friendly as it is, Investment Banking is no more than part of the story, and probably not the most important stuff. (Outraged lefties: Feel free not to read any further, or to read and misunderstand it. However, if you do by the end feel that this is a defence of Investment Banking As It Has Been Practiced, please write your concerns down on a piece of paper and put them somewhere safe for the day when I may be interested. Somewhere safe where the sun probably doesn’t shine).
As a starting point, let’s look at Lehman Brothers, if not the Westerplatte of the crisis, certainly the Operation Barbarossa. When Lehman filed for Chapter 11 in the US in September 2008, it unleashed chaos. Not the least of the chaos was the filing for bankruptcy of LBIE – Lehman Brothers International Europe – the firm’s main European operation, based in London. This was dead centre for all the firm’s hedge fund trades, but also for its derivatives and currency trading with insurance companies and mutual funds and the rest of what is known in the industry as “Real Money”. In Too Big To Fail, when Evan Handler (playing Lloyd Blankfein of Goldman) reports “people panicking because they can’t get their money out”, this is what he’s referring to (around 48s in the trailer below). LBIE was probably the purest bit of so-called “casino banking” within Lehman, attracted to the UK by the country’s
disengaged, clueless regulators exciting pro-business climate.
When Lehman credit default swaps cleared a couple of months after the bankruptcy, Lehman debt was worth 8.7c on the dollar. Markets in the various bits of Lehman took a while to develop, but for most of the intervening time, LBIE debt has been one of the runts of the litter.
But that’s changed now. Not only has PWC already paid out 25p in the £ on unsecured claims , but the odds are that unsecured creditors will get all their money back, complete with penalty interest. This is after taking out over £600m in fees for their own services. Owners of securities custodied at LBIE as prime broker (Prime Brokers are to hedge funds what mafia bookmakers are to US gamblers) will fare a little, but probably not much, worse. More to the point, there’s a pretty strong correlation between how casino/investment bank a bit of Lehman was and how high the recovery values are. In the US, Lehman Financial Products has already paid out 100c/$ on claims. Claims on the Holding company – that owned the whole thing – have returned around 15c so far, and are changing hands in the mid-20s. Claims on LBI and LBCC – two broker-ish bits of the whole – come somewhere in between.
There’s a couple of conclusions here. The first, narrow, one, is that Lehman were actually pretty good bookies. Lehman positions were frozen Jurassic-Park-Mosquito style in mid-September 2008. Foreign exchange and derivative contracts were broken off and values fixed at the break date. Now there are qualifications here – not least six years of ultra-loose money and bank bailouts – but there’s at least a prima facie case that LBIE could have been a viable business had it been separated out, and the world could have been spared at least part of the intervening chaos. European regulators who appear intent on continuing with the “plucky amateur” approach to bank liquidation should maybe take a long hard look at the lessons here.
But the broader conclusion is that trader antics aside, the main role of Investment Banking in the crisis was less as a loss-producing force in itself, but in a) channeling funding to the wilder banks on the periphery and b) the produce-and-sell model of spreading the losses far and wide via structured products. For all the financial innovations of the last decades, we still have developed no surer way of losing money than lending to deadbeat debtors, usually against property. Structured Products and other IB innovations allowed one loss to be enjoyed time and again by a much wider group of creditors, but it was rubbish lending at the heart of the problem.
In Europe it’s noticeable that the crises come in two bags. In the periphery, ordinary, decent banks needed no assistance from investment bankers/casino capitalists in blowing up. AngloIrish and the Spanish Cajas generated their losses the old-fashioned way. The role of investment bankers here was confined to channeling money (especially from the core) to them. In the core however, the role of investment banking was more toxic. Essentially all of the Core European banks which have gotten into trouble did so with help from newfangled products as a vehicle to transfer losses from Nevada, Andalucia and Limerick to savers. ING, Depfa, Fortis, UBS all needed bailouts, but not for loans made in their home jurisdictions. The UK, unlucky country capable of catching smallpox in a chicken pox outbreak, was unusual in managing both. HBoS, Northern Rock and Bradford and Bingley were all bog-standard homegrown lending disasters. Only in RBS did structured products play a major role.
The role investment banks played was in funding the disastrous peripheral banks and helping those banks to pass the risks on to the savers of the Core. “Casino banking” seems to have regulated itself better than many realised. It’s the customers who needed looking after.
There’s a really interesting piece pretty tangental to the above here on Dealbreaker about the various games played with Lehman in bankruptcy.