MUJTABA ZEESHAN 11387
INVESTMENT BANKS: A MAJOR PLAYER IN
FINANCIAL CRISIS OF 2008

OBEJECTIVES…
• What is an Investment Bank
• Historical perspective
• Organizational structure
• Functions
• Role of Investment banks in Financial crisis of 2008 (using a research paper ‘Causes of
The financial Crisis’ by Viral V. Acharya and Matthew Richardson)

WHAT IS AN INVESTMENT BANK
BANK INVESTMENT
• Place where deposits are being
piled up
• under financial management these
are institutions that accumulate
deposits of money and acts as an
intermediary between borrowers
and lenders.
An act whereby an investor puts up his
money to acquire an asset or an item,
holding it for a certain period, in the
hope that it will generate income, or
appreciate in future

• Investment Bank is an institution that is meant
for creation of capital for corporations with the
help of issuing securities (equity and debt
capital), a process known as underwriting
(discussed later).
What is an Investment Bank

TOP 10 INVESTMENT BANKS OF THE WORLD
RANK BANK NAME FOUNDED HEADQUARTERS REVENUE(in
Billion) 2012
PRODUCTS
1 JP Morgan Chase 2000 270 Park Avenue,
Manhattan, New
York, New York, U.S.
USD 97.03 Commodities, consumer banking, corporate banking, credit cards, finance and
insurance, foreign currency exchange, global banking, mortgage loans, risk
management, treasury services, underwriting
2 Bank of America Merill
Lynch
2009 Bank of America
Tower, New York
City, United States
USD 25.14 Investment banking
3 Goldman Sachs 1869 200 West Street, New
York, New York, U.S.
USD 41.664 Asset management, commercial banking, commodities, investment banking,
investment management, mutual funds, prime brokerage
4 Citigroup 1812 399 Park
Avenue, Manhattan,
New York City, New
York,U.S.
USD 70.17 Credit cards, consumer banking, corporate banking, investment banking, global
wealth management, financial analysis, private equity
5 Morgan Stanley 1935 Morgan Stanley
Building, New York
City, New York, U.S.
USD 32.03 Investment banking, asset management, commercial banking, prime brokerage,
investment management,
retail brokerage, commodities
6 Deutsche Bank 1870 Deutsche Bank Twin
Towers,
Taunusanlage 12
Frankfurt
Hesse, Germany
EUR 33.70 consumer banking, corporate banking, finance and insurance, investment
banking, mortgage loans, private banking, private equity, savings, Securities, asset
management, wealth management, Credit cards
7 Barclays 1690 Canary
Wharf, London, Unite
d Kingdom
EUR 24.691 Retail banking
Commercial banking
Investment banking
Investment management
8 Credit Suisse 1856 Paradeplatz 8 Zurich,
Switzerland
CHF 23.97 Investment and private banking, asset management
9 UBS 1854 Bahnhofstrasse 45
Zürich, Switzerland
CHF 25.443 Investment Banking, Investment Management, Wealth Management, Private
Banking, Corporate Banking, Private Equity, Finance and Insurance, Consumer
Banking, Mortgages, Credit Cards
10 Wells Fargo 1852 San Francisco,
California, U.S.
USD 86.08 Consumer banking, corporate banking, credit cards, finance and insurance,
foreign currency exchange, investment banking, mortgage loans, private banking,
private equity, wealth management

HISTORCIAL
PERSPECTIVE

1896-1929
• Investment banking was in its golden era before the Great Depression
• JP Morgan and National City Bank were the market leaders
• JP Morgan is personally credited with saving the country from a calamitous
panic in 1907 when the New York Stock Exchange fell almost 50% from its
peak the previous year
• After World War I stock markets showed a booming trend during 1920s
• Excessive trading of stocks on margin
• Excess market speculation, especially by banks using Federal Reserve
loans, resulted in the market crash of 1929, sparking the great depression.

1929-1970
• During the Great Depression, the nation’s banking system was at the brink,
with 40% of banks either failing or forced to merge
• The Glass-Steagall Act enacted in 1933, isolated the activities of insurance
companies, securities companies and Investment banks to avoid the conflict
of interest between the desire to win investment banking business and duty
to provide fair and objective brokerage services.
• Most large banks split into separate entities e.g JP Morgan split into three
entities: JP Morgan continued to operate as a commercial bank, Morgan
Stanley was formed to operate as an investment bank, and Morgan Grenfell
operated as a British merchant bank

1970-1980
• Trend of an integrated investment bank, providing sales, trading, research, and
investment banking under one roof began to take root
• In the late 70’s and early 80’s saw the rise of a number of financial products such as
derivatives, high yield an structured products, which provided lucrative returns for
investment banks

1980-2007
• In the 1980s, investment bankers had shed their dominating image. In its
place was a reputation for power, which was enhanced by a rush of mega-
deals during wildly prosperous times.
• An IPO boom dominated the perception of investment bankers.
• In 1999, 548 IPO deals were done with most going public in the internet
sector.
• Gramm-Leach-Bliley Act enacted in November 1999 repealing Glass-
Steagal Act, hence removing the separation that previously existed between
Wall Street investment banks and depository banks

ORGANIZATIONAL STRUCTURE
FRONT OFFICE MIDDLE OFFICE BACK OFFICE
1. Investment banking:
• Helping customers
raise funds in capital markets
• giving advice on mergers and
acquisitions (M&A)
1. Risk Management: analyzing
different types of risk associated with
the bank especially credit risk and
market risk
1. Operations
2. Sales and Trading:
• Buying and selling products
(stocks & bonds)
• Market making
2. Financial Control: tracks and
analyzes the capital flows of the firm,
the global risk exposure and the
profitability and structure of the firm's
various businesses
2. Technology
3. Research:
• reviews companies and writes
reports about their prospects,
often with buy/sell ratings.
• covers credit research, fixed
income research,
macroeconomic research, and
quantitative analysis, all of which
are used internally and externally
to advise clients
3. Corporate treasury: responsible
for an investment bank's funding,
capital structure management, and
liquidity risk monitoring

FUNCTIONS OF INVESMENT BANKS
1. Investigation:
• A company that desires to raise money will approach an
investment banking firm for its assistance. From that point on,
that investment banking firm is known as the manager or lead
investment bank in the process. The manager will provide two
investigations, or type of analyses, for its client:
a) Legal analysis
b) Market Analysis
The manager will begin preparing a prospectus i.e., a financial
disclosure brochure used to help sell the issue

2. Underwriting:
• Purchasing an issue of securities from a firm and selling it in the
secondary market
• “Assuming the risk of loss”, the eligibility of a customer to receive
their products
• The investment banker assumes this risk by underwriting the
securities offering. In a typical underwriting, the investment banker
underwrites the issue by buying the securities at a discounted
price from the company.
• The investment bank will then mark-up the securities to the full
retail price and try to sell the securities to the investing public
• Underwriting spread is the earning of investment bank

CONTINUED…
• Investment banks place their own capital at risk by using their own money to buy the
issue. Plus frequently borrow money from commercial banks to raise part of the funds
necessary for the purchase
• Even then though, the investment bank may not have enough money to bad the entire
issue or, perhaps, the bank may not want to assume this much risk. If stock prices fall
during the period of sale, the investment bank will be making a loss on the transaction.
• So the investment bank may reduce its risk by inviting other investment banks (i.e. a
Syndicate of banks) to participate in the underwriting called Underwriting syndicate.
• If they are not able to find enough investors, they will have to hold some securities
themselves
• The services of an underwriter are typically used during a Public Offering
• Initial public offering (IPO) is one type of public offering
• Most public offerings are in the primary market, that is, the issuing company itself is
the offerer of securities to the public.

3. Selling:
• Each of the investment banks will likely have its own sales
force. However, additional brokerage firms may be invited to
help sell the issue in return for a commission on the sale.
• These brokerage firms are known as the selling group.

THE THREE FUNCTIONS CAN BE SHOWN AS LAYERS, AS IN
THE FOLLOWING DIAGRAM

ROLE OF INVESTMENT BANKS IN
GLOBAL FINANCIAL CRISIS 2008

BRIEF OVERVIEW OF THE CRISIS…
• The 9/11 terrorist attacks on World Trade center caused US
economy to plunge
• People lost confidence in stocks and switched to property
investment
• Alan Greenspan Chairman of FED lowered interest rate to 1%
which was a drawback for investors but essential for borrowers
• High investment in property gave an idea to the Wall Street,
Connecting Investors and Home owners through MORTGAGES

• Traditionally when a home owner made mortgage payment, it went to the
lender

• In the new system, lenders sell the mortgages to Investment banks

• Investment banks combine all sorts of mortgages and
loans to create complex derivatives called CDOs

• Investment banks sold the CDOs to investors

• Which meant that the payment from home owners was going to the Investors

• Investment banks paid the Rating Agencies to evaluate the CDOs, majority getting a
AAA rating

• Lenders were not interested if the borrowers defaulted so they started to make
Riskier loans: SUBPRIME MORTGAGES
• Neither the Investment banks were interested, the higher CDOs they sold, higher
profits they made
• Rating Agencies were paid by the Investment banks, they had no liabilities if their
ratings of CDOs proved wrong
• The investment banks preferred Subprime loans because they had high interest rate
• Which resulted in PREDATORY LENDING that is borrowers were needlessly placed
in expensive subprime loans and many were given to people who could not repay
• SEC removed leverage limits on borrowing of Investment banks and was not
regulating the activities of investment banks

SOMETHING UNETHICAL…
• Betting against the securities they sold, CDOs telling the customers that they were
high quality investments
• Plus insuring the very security they were speculating on, through the organization
called American International Group(AIG) by purchasing a derivative called Credit
Default Swap (CDS)

• An investor who purchased a CDS from AIG paid a quarterly
premium to them
• If the CDO went bad, AIG promised to pay the Investors the losses
• Speculators could also buy CDS from AIG betting against CDOs
they didn’t own

• Lehman reported losses of $2.8 billion and forced to sell off $6 billion in asset
• Lehman stock lost 73% of its value as the credit market continued to tighten
• Lehman reported that it had been in talks with Bank of America
and Barclays for the company's possible sale
• According to Bloomberg, JPMorgan Chase & Co. provided Lehman
Brothers with a total of $138 billion in "Federal Reserve-backed advances."
• The cash-advances by JPMorgan Chase were repaid by the Federal Reserve
Bank of New York for $87 billion on September 15 and $51 billion on September
16.

RESEARCH PAPER
• ‘Causes of The financial Crisis’ by Viral V. Acharya and Matthew Richardson)
• Identified 2 major reasons:
1. Placing assets under off-balance sheet so that there is no need of capital buffer against
them
2. Regulations allowed banks to reduce capital required to hold against assets, if they were
AAA or Fannie/Freddie securities.

ONE MIGHT WONDER WHY THE BANKS WOULD CREATE AND
THEN RETAIN THE RISKS OF ASSETS SUCH AS SUBPRIME
MORTGAGES!
• CDOs were divided into tranches of AAA, BBB and so on
• Taking AAA had both ways:
1. Reduced their capital requirements, and they (or other investors) earned
the higher premium commanded by the risky nature of subprime assets.
2. Losses would only occur if a large number of subprime mortgages got hit at
once, so that even the AAA tranche of a CDO got hit. This would in fact
bring the financial system to its knees. (Banks were betting that this would
not happen, but eventually it did!)

CONCLUSION
• The failure of the likes of Bear Stearns and Lehman Brothers, which invested in the
securities created out of these mortgages, led to severe counterparty risk concerns that
paralyzed capital markets and thus caused the worldwide recession.
• Standing behind the collapse of the investment banks was the systemic failure of
securitization market, which had been triggered by the popping of the overall housing
bubble, which in turn had been fueled by the ability of these firms, as well as commercial
banks, to finance so much housing stock in the first place

THANK YOU!