2008 Financial Crisis
The importance of investment banking grew during the late 20th century, because of the growing demand for investment services, technological changes, deregulation, and globalization. Investment banks were at the heart of the shadow banking system. They invented many of the financial products used, often disguising its operation. Investment banking played a major role in the outbreak of the global financial crisis of 2007-9. In the aftermath, leading American investment banks were converted into bank holding companies, and brought under new regulations. One result is the recent rapid growth of alternative financial institutions, especially long-time-horizon institutional investors, sovereign wealth funds, pension funds, and other beneficiary institutions not located in New York or London.
The 2007 credit crisis proved that the business model of the investment bank no longer worked without the regulation imposed on it by Glass-Steagall. Once Robert Rubin, a former co-chairman of Goldman Sachs became part of the Clinton administration and deregulated banks, the previous conservatism of underwriting established companies and seeking long-term gains was replaced by lower standards and short-term profit. Formerly, the guidelines said that in order to take a company public, it had to be in business for a minimum of five years and it had to show profitability for three consecutive years. After deregulation, those standards were gone, but small investors did not grasp the full impact of the change.
Investment banks Bear Stearns, founded in 1923 and Lehman Brothers, over 100 years old, collapsed; Merrill Lynch was acquired by Bank of America, which remained in trouble, as did Goldman Sachs and Morgan Stanley. The ensuing financial crisis of 2008 saw Goldman Sachs and Morgan Stanley "abandon their status as investment banks" by converting themselves into "traditional bank holding companies", thereby making themselves eligible to receive billions of dollars each in emergency taxpayer-funded assistance. By making this change, referred to as a technicality, banks would be more tightly regulated. Initially, banks received part of a $700 billion Troubled Asset Relief Program (TARP) intended to stabilize the economy and thaw the frozen credit markets. Eventually, taxpayer assistance to banks reached nearly $13 trillion, most without much scrutiny, lending did not increase and credit markets remained frozen.
A number of former Goldman-Sachs top executives, such as Henry Paulson and Ed Liddy moved to high-level positions in government and oversaw the controversial taxpayer-funded bank bailout. The TARP Oversight Report released by the Congressional Oversight Panel found, however, that the bailout tended to encourage risky behavior and "corrupt[ed] the fundamental tenets of a market economy".
|“||The TARP has all but created an expectation, if not an emerging sense of entitlement, that certain financial and non-financial institutions are simply “too-big-or-too-interconnected-to-fail” and that the government will promptly honor the implicit guarantee issued for the benefit of any such institution that suffers a reversal of fortune. This is the enduring legacy of the TARP. Unfortunately, by offering a strong safety net funded with unlimited taxpayer resources, the government has encouraged potential recipients of such largess to undertake inappropriately risky behavior secure in the conviction that all profits from their endeavors will inure to their benefit and that large losses will fall to the taxpayers. The placement of a government sanctioned thumb-on-the-scales corrupts the fundamental tenets of a market economy – the ability to prosper and the ability to fail.||”|
|— Congressional Oversight Panel, TARP Oversight Report|
Under threat of a subpoena by Senator Chuck Grassley, Goldman Sachs revealed that through TARP bailout of AIG, Goldman received $12.9 billion in taxpayer aid (some through AIG), $4.3 billion of which was then paid out to 32 entities, including many overseas banks, hedge funds and pensions. The same year it received $10 billion in aid from the government, it also paid out multimillion-dollar bonuses to 603 employees and hundreds more received million-dollar bonuses. The total paid in bonuses was $4.82 billion.
Morgan Stanley received $10 billion in TARP funds and paid out $4.475 billion in bonuses. Of those, 428 people received more than a million dollars and of those, 189 received more than $2 million.
Source: Wikipedia February 13, 2020 https://en.wikipedia.org/wiki/History_of_investment_banking_in_the_United_States