Monday, March 17, 2008 0 comments ++[ CLICK TO COMMENT ]++

What's Wrong With Investment Banks?

I ran across an excellent opinion piece in Fortune that talked about the problems with investment banks (on a side note, there is also an interview with Paul Krugman, an economist, who thinks the housing mess can get much worse). Written by Shawn Tully, the article, titled The end of Wall Street as we know it, points out three root problems at Wall Street firms.

Everyone should consider the three issues that I quote below before investing in any investment banks. I think the article is very good at identifying why investment banks are often better at enriching employees than shareholders.

The three big weaknesses of Wall Street are deeply embedded in its culture.

First, firms rely far too heavily on trading as opposed to solid, reliable fee-based businesses favored by big commercial banks. As we'll see, one type of Wall Street trading is consistently lucrative. The rub is that firms always blow it on the risky trading.

Second, firms embrace leverage levels so dangerous that even the best risk management can't prevent a collapse.

Third, an outsize share of the gains go out the door to CEOs, CFOs and traders when times are good­­ - or rather, when firms get lucky - ­­leaving shareholders with far less wealth when markets go sour.
(source: The end of Wall Street as we know it, Shawn Tully, Fortune)

I'm just a newbie and haven't observed Wall Street for many years but I can identify the aforementioned issues at the root of many of the problems with the Wall Street investment banks. One can more easily understand how a top 5 Wall Street investment bank like Bear Stearns can collapse so quickly by considering the three points mentioned in the article. Bear Stearns, for example, wouldn't have faced half the problems it ran into, if its leverage was much lower.

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