A kind word or two about investment banks

Wall Street fact and fiction. That's the title of my last ET column. I explore some of the loose comments on investment banks in the media, especially the belief that they were undone by high leverage. No, high leverage in itself is not a correct measure of financial risk in financial firms. It was the combination of high leverage, illiquid assets and dependence on short-term funds that proved fatal. I explore other misconceptions as well.

Now, readers of this blog would know that I am no starry-eyed admirer of the go-getting culture of investment banks, no believer in their superior risk-taking skills or their repertory of talent. But I do think they had several things going for them.

• They had a more egalitarian culture than most firms. Managing directors were to be found hundreds in Morgan Stanley and other places. You did not a big budget and an army of people under you to be called Managing director. The amount of business you did and the profit you raked in was enough. A star trader hooked to a terminal could be an MD.
• They had greater employee ownership than most firms- at Bear Stearns, employee stock ownership was around 40%, at Lehman's 30%. As I have said earlier, the stock options schemes might have been better designed, they ought to have vested over longer periods. But the principle of large numbers of employees (down to secretaries) being owners is a good idea (although it's not such a great idea, from their point of view, to have all one's savings in one's own firm).
• They were quite sensitive to operating costs (other than employee costs where they went overboard). Otherwise, business divisions operated on the principle of return on capital allocated. Since their bonus numbers were linked to this, they went all out to slash costs wherever possible.
• They were more meritocratic in their orientation than firms in other sectors. Performance was recognised quickly and rewarded. Two reasons for this. Performance was easily recognisable- if you brought in an investment banking deal, everybody knew what that translated into; traders' profits are easily measured (although not always the capital to be allocated to them). Secondly, firms could not afford to disregard performers- they would simply leave in what was a highly competitive market for people.
  
• They had high burn-out rates among employees and the work-life balance was terrible. But these places gave you at least a theoretical chance of quitting when you were 40 or so and turning to other things- collecting art, kayaking, setting up a nursery. And many did.