Do Investment Banks Lend Anymore? Or is that a Thing of the Past?

The investment banking profession has been given a bad rep the past few years. Today, the public views these professionals as overpaid, greedy bankers – overly concerned with short-term profits and unapologetic for the havoc wrought from risky lending that contributed to the financial crisis. Yet, there was once a time when investment banks did what they were originally intended to do: raise debt and equity for corporations eager to grow. The role of investment banks has always been integral to the expansion of the American economy. In any economic system, some individuals or institutions hold excess capital while others are in need of capital investments. The investment bank serves an absolutely vital outlet where those holding excess capital are matched with those in need of capital. Thus, the investment bank, acting as the intermediary connection between the two, allows capital to be channeled to where it can be used most effectively (the parties in need of capital). In return, the individuals and institutions that borrow capital pay the lenders for the opportunity to borrow (an interest rate). The investment bank adds social value acting as the intermediary. The banks have facilitated immense economic growth as those corporations borrowing money have expanded operations, hired workers, and invested in research and development.

The problem today is that the banks like Goldman Sachs, Morgan Stanley, Deutsche Bank and many others no longer serve the same function they once did. Instead of raising capital and debt for corporations, many banks have shifted their focus to proprietary trading (trading on their own accounts) and commission based trading (creating marketplaces and trading for their clients). What we typically think of as investment banks are no longer investment banks – they are dealers and traders. For example, take a look at the revenue breakdown of Goldman Sachs by business activity. In 1999, investment banking represented 33% of net revenue. Last year, investment banking represented only 11%, and in a dramatic shift trading/dealing accounted for over 76% of Goldman’s net revenue. Why are we still calling Goldman Sachs an ‘investment bank’ when it doesn’t lend money anymore?

Goldman Sachs Revenue by Business Activity, 1999 & 2009

Justice for Securities Fraud Raises Red Flags

For the past two decades high net worth individuals, with the help of Deutsche Bank, avoided U.S. government taxes. From 1996 through 2005 these individuals evaded approximately $6 billion in individual income taxes through tax shelters constructed by Deutsche Bank. Yesterday, Deutsche announced that it would settle the civil investigation for $553 million and admitted its wrongdoing in illicitly aiding clients in tax fraud. The $553 that Deutsche must pay represents the fees that the Bank collected from the transactions it facilitated plus a $149 million civil penalty. No Deutsche Bank executives were prosecuted; no employees are serving jail time.

This year Giuseppe Spera of Middletown, CT was also involved in criminal activities. He was accused of stealing $170,000 in cars from an auto dealership that he worked for. He was arrested by Middletown police, and as part of a settlement, he is expected to spend three years in prison.

The contrast between these two crimes raises concerns about the equity of our justice system. In looking at the Deutsche crimes it is unavoidable to not be alarmed by the absolute scale of the fraud – billions of dollars of fraudulent reporting leading to hundreds of million dollars of revenue for Deutsche. Guiseppe Spera, on the other hand, embezzled $170,000 of cars from his dealership employer. A crime, inexcusable, but also on a very different scale. Think about how society as a whole suffered as a result of these two crimes.

Our justice system’s punishment for the two crimes is also troubling because they create a startling dichotomy. Justice should serve two purposes: 1) Does the punishment fit the crime (i.e. “a proportional response” and 2) Does the punishment deter future criminal activities? In answering both of these questions, financial regulation and enforcement seems to be inadequate.

What can the tax deal tell us about our country and values?

A lot of information can be derived from examining a country’s tax policy. What values and ideals does the country espouse? What are the country’s short and long-term fiscal goals? How does tax policy affect class structure? Last week the President reached a tentative agreement with Republican leaders on a tax deal. Below I highlight two major aspects of the deal focusing on the conclusions we can draw about our government’s societal values.

• 1. A 2% cut in taxes that are used to fund Social Security (FICA). This is one of the more “populist” of the tax policies. It is an across the board tax cut that will give individuals at all income levels a slight boost in take-home pay. The implications, however, are interesting. There is widespread agreement from both parties that our Social Security system is underfunded and in need of reform. This policy, while decreasing federal withholdings, undoubtedly adds pressure to an already fragile public support system. It seems as if the government is in essence undermining the need for Social Security and advocating the use of individual retirement planning (i.e. IRAs, 401(k)s, etc.) in lieu of the public system. Americans do not have a history of responsible savings behavior so it is doubtful that individuals will divert the 2% in social security tax cuts towards private savings. More likely, the result will be an increase in short-term consumption and the deferral of important public policy decisions like social security reform until a later date.

• 2. The estate tax will be lowered to 35% with an exemption on the first five million dollars. This is one of the more troubling of the recent policies: the tax rate is in effect being lowered from 55% to 35% and the exemption is being raised from $1 million to $5 million. The estate tax serves an important purpose in our society, preventing the perpetuation of wealth from one generation to the next. More than ever, income inequality has reached unparalleled levels. Globalization, technological advancements, and stock market rallies have not benefited the country equally. In fact, the richest one percent of Americans now earns 24% of the country’s income. This is a one-sided policy that benefits the rich. It will increase income inequality, add to our deficit, and remove strong incentivized charitable behavior, which previously existed due to a high estate tax.