Investment Banks, RIP

The meme of the day is the end of the investment bank. Here's John Gapper:

Morgan Stanley opened on Wall Street on Monday September 16 1935 and, 73 years later, almost to the day, the institution of the broker-dealer died...
There will, of course, be investment banks in future. But they will be smaller, specialist institutions, like the merchant banks of old. There are plenty of advisory firms, hedge funds and private equity funds and this Wall Street crash will create more. All of those unemployed financiers will need something to do.
The full-service investment bank, buying and selling shares and bonds for customers as well as advising companies and trading with its own capital, is doomed.

Roger Ehrenberg has a slightly different take:

What I see happening is a new wave of boutique investment banks opening for business - the next generation of Evercores, Gleachers, Beacon Groups and Greenhills. Top talent will not stay inside these monolithic mega-firms; if Citigroup is any example, these firms are not good places to work as integration disruption continues for many, many years. Value accretion? I'd say not. So once these boutiques are created what will happen? Some will merge to achieve the benefits of scale. And soon enough, we'll once again have multi-product, multi-geography investment banks as we've had for generations.

I'm more with Gapper than with Ehrenberg. They both see a proliferation of boutiques, but Ehrenberg thinks that once boutiques start merging we'll soon enough be back where we started.

I don't see it, because no matter how many boutiques you merge together, you're never going to amass a trillion-dollar balance sheet like that of Goldman Sachs. Here's John Hempton:

Goldman Sachs has a balance sheet the same size as a smaller Japanese megabank.
One thing is for sure - you don't hold all these assets because you are facilitating trades on behalf of your customers.

It's kinda crazy, I think, that the Treasury is turning to Goldman Sachs -- the supposedly lean-and-mean investment bank -- to orchestrate a $75 billion loan for AIG. Investment banks don't do loans, commercial banks do loans. Goldman's not a commercial bank, but you can't deny that Hank Paulson knows how Goldman is put together better than just about anybody. What that means is that Goldman is at this point some kind of weird hybrid -- and if investors have reached the point at which they stop investing in things they don't understand, they're likely to continue to shun Goldman stock.

A year ago, Jesse Eisinger asked the big question which is now being answered:

Could the business models of the big independent investment banks be fundamentally flawed?

The answer, of course, is yes. It turns out that big investment banks do very well in good times, when no one feels any need to worry about their solvency. But in bad times, their black-box nature and bloated balance sheets mean that even other banks shy away from taking on the huge amount of unknowable risk that lurks within their walls.

Gapper's feeling is that Morgan Stanley will end up selling itself to a large commercial bank, while Goldman Sachs will downsize into an elite buy-side institution, giving up most of its broker-dealer operations. He might well be right. But with only two independent investment banks left, even if they stay in their present form, the business model has clearly been discredited. "Trust us, we know what we're doing" works in bull markets. It doesn't work in a credit crunch.