Giving Up the Ghost of the Ghost of J.P. Morgan

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While being
raised in rural Minnesota, we learned that "giving up the ghost"
meant some person or animal had died, was no more and had passed.
Today we are learning that this is no longer the case when the phrase
is used in conjunction with the animal known as "investing
banking" — at least in the minds of those who work on Wall
Street in New York City and on Pennsylvania Avenue in our nation's
capitol.

The best history
of the rise of investing banking in America is Ron Chernow's book,
The
House of Morgan
. This chronology (voted in several polls
as one of the 100 best nonfiction books of the twentieth century)
of J.P. Morgan and the bank he left behind traces developments for
over one hundred years from the late nineteenth century onward.

At the beginning
of this financial era, there was a mismatch between America's opportunities
to grow its economy and the available capital in this country to
finance that growth. Most surplus capital at the time was in Europe
and J.P. Morgan took the lead in helping foreigners allocate this
scarce capital to America's most worthy railroads, manufacturers
and so forth during this timeframe.

Without people
like Morgan to pass judgment on America's emerging industries, money
from foreigners would simply not have been made available to fund
these enterprises. As a result, railroads and manufacturers made
repeated visits to America's investment banking houses — as opposed
to the bankers seeking them out — to argue why their businesses
were worthy of obtaining this capital.

Ron Chernow
recently summarized the role played by Morgan and his ilk in an
op-ed article he had publish in the September 28, 2008 edition of
the New York Times: "They rendered America an invaluable
service by reassuring European investors that they would receive
an adequate return on their investments, securing an uninterrupted
flow of capital" to this country at a time when our economy
sorely needed it.

The original
House of Morgan and other investment banks originally served only
the most creditworthy clients whether they were industrialized nations,
blue-chip corporations or millionaire families. The Glass-Steagall
Act of 1933 forced the full-service banks of the past to choose
between commercial and investment banking. The House of Morgan was
split, for example, into two separate entities — a commercial bank
(J.P. Morgan which later became Morgan Guaranty) and an investment
bank (Morgan-Stanley).

Most
of the capital from such splits, however, was retained by the commercial
banks. This was in no small part due to fact that the need for investment
banking services was so diminished during the Great Depression.

Although only
the "ghost of J.P. Morgan" in the form of thinly capitalized
investment banks survived World War II, they continued to exert
a near mystical influence in American finance far beyond their real
worth to the country's leading businesses. Companies like DuPont,
I.B.M., General Electric, United States Steel and General Motors
thrived in the initial decades after 1945 primarily because of the
devastation caused by the preceding war in Europe and Asia.

American companies
became so successful that they grew big enough to finance expansion
from their own retained earnings. As the United States — and, later,
the rest of the industrialized world — boomed, other borrowing options
that did not require the services of investment banking firms became
at first viable and then commonplace.

In the last
three decades prior to 2008, traditional underwriting services at
investment banks have been systematically replaced by ever more
volatile and risky businesses promoted by the remaining firms. Examples
of these enterprises have included increased trading activities
(for stocks, commodities and derivatives), hostile takeovers, leveraged
buyouts, junk bond issuances and prime brokerage services for hedge
funds. Rather than allocate investment capital as they once had,
investment banks had ever-greater needs to raise it for themselves
to finance one risky venture after another. Chernow says, "Where
the old Wall Street stuck to the most prestigious clients, the new
Wall Street engaged in an unseemly race to the bottom." How
low would they ultimately go? How about the packaging of subprime
mortgages (what James Grant of Grant's Interest Rate Observer
calls "junk mortgages") into collateralized debt obligations
(CDOs) rated AAA by friendly rating agencies?

Why "save"
Bear Stearns, Merrill Lynch and Morgan Stanley and/or subsidize
commercial banks to take them over? Who needs these clowns anymore?
Let them go the way of buggy whip manufacturers. They long ago stopped
serving their original useful purposes. Any important remaining
services they provide will be assumed by some other parties. Their
best talent will surely find employment elsewhere. Why cannot public
policymakers like Henry Paulson see these obvious facts? Oops! That's
right…Paulson was the head of one of those "leading" investment
firms at one time himself. And the fact that the head of Merrill
Lynch once worked for him might explain while that firm was bailed
out and Lehman Brothers was allowed to fail. So it goes.

November
13, 2008

Kirk
W. Tofte [send him mail] is
the manager of the BWIA Private Investment Fund and the author of
Be
Principled and Grow Rich: Your Guide to Investing Successfully in
Both Bull and Bear Markets
. He lives in Des Moines, Iowa.

Kirk
W. Tofte Archives

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