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Evolution of Investment Banking: From Glass-Steagall to Dodd-Frank

Explore the history and impact of investment banking, from Glass-Steagall to Dodd-Frank Act. Learn about underwriting, IPOs, mergers, and more.

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Evolution of Investment Banking: From Glass-Steagall to Dodd-Frank

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  1. Chapter 13 and Chapter 14- Part I -Investment Banking

  2. What is Investment Banking • 20th century term, in 1930th • Refer to business of helping other business creating securities. • Issuing stocks • Issuing bonds • For corporation, government, or non-profit orga. • Share similarity with consulting firms • Differ from commercial banks • Not taking deposits, not making loans

  3. What does Investment Banking do? • Underwriting: IB knows who are potential buyers of those securities. • IPO • first sale of securities to the public. • Seasoned offering • additional issue of securities already trading. • Bought deal: IB bought shares and sell in market • Best efforts: IB did not buy but give best efforts • IB solves moral hazard issue • IB is familiar with the new company and do due diligent • Trust is very important in this business • IB bankers are usually well spoken and well dressed.

  4. IB history in US • In 1933, Glass-Steagall act separate IB and CB • A bank had to be either IB or CB. • IB was perceived risky and CB was safer. • JP Morgan was doing both and chose to be IB • Called “Morgan Stanley”, the 2nd largest IB in US, after Goldman Sachs. • FDIC was created on this act. • FDIC Covers Those Deposits Payable in the U.S. • http://www.fdic.gov/deposit/deposits/insured/basics.html

  5. Glass-Steagall Act • Separated CB and IB in the U.S. • The Glass-Steagall Act of 1933 (Banking Act) restricted the asset powers of commercial banks to low-risk underwriting areas. • In other countries, universal banks were able to combine commercial and investment banking functions.

  6. The Glass-Steagall Act (continued) • CB could not underwrite (buy and resell) risky business securities. • CB were limited as to the risk assumed in their investment portfolio - no risky corporate securities. • IB firms were prohibited from engaging in CB. • Firms became either IB or CB.

  7. U. S. versus Other Developed Nations • Until 1999, investment banks in the U. S. could not do commercial banking activities and vice versa. • Outside of Japan, in most other developed nations, financial institutions are allowed to do both investment and commercial banking. • Engage in deposit taking, making loans, brokerage, securities underwriting, and insurance.

  8. Gramm-Leach-Bliley Act– Before Financial Crisis • Financial Services Modernization Act of 1999 • Repealed Glass-Steagall • So banks can do risky investment because they are IB • But meanwhile, they are insured by FDIC, because they are CB • Seeds of crisis were planted from then. • Permitted CB, IB, and insurance underwriting under a financial holding company • So US banks can compete globally.

  9. Dodd Frank Act 2010 – After Financial Crisis • Section 619: Volcker Rule • Prohibit proprietary from trading by CB • Prohibit CB from owning hedge funds and private equity. • Section 716 • Swap dealers are barred access to Fed discount window • Prevent banks from dealing with swap. • Goldman Sachs shut down prop trading. • After implementing Dodd Frank act, GS is not the old GS anymore.

  10. Other functions of IB - Trading and Brokerage • The brokerage function is to bring a buyer and seller together. • Dealer function - buying (bid) and selling (ask) from an inventory of securities owned by the seller.

  11. Other functions of IB - Mergers and Acquisitions • Specialized IB departments provide the following services. • Arrange mergers which would produce economic synergy or increase total value. • Assist firms in fighting hostile takeovers. • Help establish the value of target firms. • Mergers and acquisitions have been a profitable aspect of the IB business.

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