Investment banking - a history

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Graduate high-fliers have alwaysbeenhighly sought after by investment banks and this year another crop willjoin the great names of international finance.

It's a tradition that goes back many decades, but in that time the banking world has been transformed almost beyond recognition.

A listof the top firms to work for in the City of London of 30 years ago bears little resemblance tothe same list today. Where the old names do appear, in many cases they have new owners. For the most part it has been a story ofthe eclipse ofthe British firms and the arrival offoreign ones, mainly American but also European.

The British merchant banks, as they were known, were mostly established in the nineteenth century. Many of the founders were immigrants, as the names attest - Rothschilds, Schroders, Kleinworts, Hambros etc. They chose London to set up shop because it was easily the world's biggest financial centre and most international trade was denominated in sterling.

One of the most celebrated names was Barings, founded earlier than most of its rivals in 1763. It helped to finance much of the development of Latin America, including the Panama Canal, and was involved in the Louisiana Purchase whereby the US bought a vast area of land from France.

The power of the banks was immense. Wellington's armies in Spain, for example, depended on funding from Rothschilds. The banks also handled bond issues by companies and governments and as time went on they carried out what would be recognisable today as mergers and acquisitions and asset management.

As global dominance shifted to the United States, powerful banks grew up there as well. Again, many were founded by European immigrants. Lehmans was set up in Alabama in 1850 by three brothers from Germany who initially traded cotton. They soon bought a seat on the New York stock exchange. In 1869 another German, Marcus Goldman, established a firm in New York to deal in commercial paper. He was joined by his son-in-law, Samuel Sachs, and Goldman Sachs was born.

Perhaps the greatest name in banking a century ago, and one of the most prominent figures in American history, was J. Pierpont Morgan. His firm, JP Morgan, financed the US railroads as they opened up the country and was behind some enormous industrial mergers, including the creation of US Steel in 1901.

The years after the First World War were critical ones for US banks. They suffered in the Great Depression and in 1933 the Glass-Steagall Act prevented investment banking and commercial banking from being carried out by the same institutions. This led to the creation of another famous name - Morgan Stanley. It was established by two JP Morgan partners (one of them J. Pierpont's son) to handle securities, as JP Morgan chose instead to focus for the time being on commercial banking.

Before the Second World War, and for many years afterwards, British banks remained dominant in Britain, just as American banks did in the US and European banks were all-powerful in their own countries. This was hardly surprising. The era of globalisation had not yet arrived (or at least the modern version of it - arguably a form existed in the nineteenth century, presided over by Britain)

As the world recovered from the devastation of the Second World War, the old British merchant banks at first thrived. They built up their businesses by taking advantage of increasing trade and capital flows, as well as company mergers within Britain. A new name appeared to rank alongside the famous old ones - SG Warburg, founded in 1946.

In the US, the banks prospered even more. They were aided not just by the size of the American economy, but by increasing competition with each other. The abolition of fixed brokerage commissions in 1975 played a key part in this trend and led to a series of banking mergers.

Gradually the Americans began to expand abroad. Goldman Sachs, for example, opened offices in London in 1970 and in Zurich and Tokyo in 1974. The investment banking world was starting to change.

The 1980s was a time of great dynamism among American investment banks, as hostile takeovers and high yield 'junk' bonds came to the fore. They continued to push into both Asia and Europe, aided in London by 'Big Bang' in 1986. This introduced comprehensive deregulation which forced many UK firms to merge and left others vulnerable to takeover - not just from America, but from elsewhere in Europe.

There, banking was highly regulated (even today this is only just starting to change) and a few huge players had the financial muscle to go shopping for the relatively small investment banks in London .

Perhaps some of the London banks were not hard-headed enough to survive. Philip Augar, a former broker, wrote in his best-seller 'The Death of Gentlemanly Capitalism' that as late as the early 1980s 'the atmosphere in the City of London was reminiscent of jolly japes at boarding school...or the junior combination room of an Oxford College in the 1950s'.

It was sometimes too easy to get hired because you seemed the right sort of chap, rather than because of what you could do.

Since 1989, Deutsche Bank of Germany has bought up Morgan Grenfell, ING of Holland bought Barings for one pound following its collapse, SBC of Switzerland snapped up Warburgs, and Citigroup of the US bought the investment banking arm of Schroders.

Other UK banks have also been bought, though some remain independent and continue to prosper. Meanwhile the big US and European banks have steadily expanded in their own right in London so that they are now the main players.

Elsewhere, some of the European banks have established a significant presence in the US and foreign banks have also expanded into Tokyo, which has had its own version of 'Big Bang'. The Glass-Steagall Act in the US has been repealed, allowing different kinds of banking to once more be carried out by the same firms. The globalisation of investment banking is well and truly underway, though it is by no means complete.

The British firms may have largely disappeared. But by welcoming banks from abroad, London has ensured that it remains the investment banking centre of Europe.