And Then There Was None: High Finance Finagling Takes Down Top 5 Investment Banks

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 rocked the world of high finance. By the end of May, the end of Bear Sterns was complete. JP Morgan Chase bought Bear Stearns for $10 a share, a stark contrast to its 52-week high of $133.20 a share. Then September came. Wall Street and the world watched as, in just a few days, the remaining investment banks on the top 5 list collapsed and the investment banking system went bankrupt.

Investment Banking Basics

The largest investment banks are big players in high finance, helping large companies and the government raise money through such means as trading securities in the stock and bond markets, as well as offering professional advice. in the most complex aspects. of high finance. These include things such as acquisitions and mergers. Investment banks also handle trading in a variety of financial investment vehicles, including derivatives and commodities.

This type of bank also has a stake in mutual funds, hedge funds, and pension funds, which is one of the main ways that what’s going on in the world of high finance is felt by the average consumer. The dramatic decline of the remaining major investment banks affected retirement plans and investments not only in the United States, but also around the world.

The Finagling of High Finance That Brought Them Down

In an article titled “Half Too Smart,” published on September 22, 2008 by, Princeton University Chemical Bank President Professor of Economics and writer Burton G. Malkiel provides an excellent and easy-to-understand follow breakdown of what exactly happened. While the catalyst for the current crisis was the collapse of mortgages and loans and the bursting of the housing bubble, the roots lie in what Malkiel calls the breakdown of the link between lenders and borrowers.

What he is referring to is the change from the banking era where a bank or lender made a loan or a mortgage and that bank or lender held it. Naturally, as they clung to debt and its associated risk, banks and other lenders were quite careful about the quality of their loans, carefully weighing the probability of repayment or default by the borrower against standards that made sense. Banks and lenders moved away from that model, toward what Malkiel calls an “originate and distribute” model.

Instead of holding mortgages and loans, “mortgage originators (including nonbanks) would hold loans only until they could be packaged into a complex set of mortgage-backed securities, divided into different segments or tranches with different priorities in entitlement to receive payments on the underlying mortgages,” and the same model also applies to other types of loans, such as credit card debt and car loans.

As these debt-backed assets were sold and traded in the investment world, they became increasingly leveraged, with debt-to-equity ratios frequently reaching as high as 30 to 1. This handling and trading often took place in a shady and unregulated system that was called the shadow banking system. As the degree of leverage increased, so did the risk.

With all the money to be made in the shadow banking system, lenders became less choosy about who they lend to, no longer retaining the loans and the risk, but instead slicing, repackaging and repackaging them. They sold at the lowest price. a profit. Crazy terms became popular, no down payment, no documents required, and the like. Exorbitant exotic loans became popular, and lenders dug deep into the subprime market for even more loans to make.

Finally, the system almost ground to a halt with falling home prices and rising loan delinquencies and foreclosures, with lenders making short-term loans to other lenders for fear of lending to ever-increasing entities. more leveraged and illiquid. The decline in confidence could be seen in the drop in share prices as the last of the major investment banks drowned in shaky debt and investor fear.

September saw Lehman Brothers go bankrupt, Merrill Lynch chose takeover over collapse, and Goldman Sacs and Morgan Stanley regressed to bank holding company status, with possible takeovers on the horizon. Some of these investment banks date back nearly a century, and others, like Lehman Brothers, are 158 years old. A rather embarrassing end for these historical giants of finance, destroyed by a system of deceit and shady dealings of high finance, a system that, when falling apart, may even end up dragging down the economy of the whole world.

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