Friday, May 18, 2007

Why have investment banks been so profitable? From the Economist

The Economist gives us another great article! This one is on investment banking. Not only does it provide a short history (going back pre-JP Morgan), but also brings us up to date with a look at the current (very profitable) state of investment banking.

The alchemists of finance |
A relatively long look-in:
"Brokerage used to be described as a haulage business, lugging money, as a member of the Rothschild dynasty once put it, “from point A, where it is, to point B, where it is needed”.... But any haulage firm would be flabbergasted by the trading profits and returns on equity seen in investment banking in recent years....earnings from capital-market-related activities at the top ten global investment banks have risen by almost two-thirds in two years....That sort of profit increase is comparable with Apple's rewards for inventing the iPod.... Yet in investment banking there is nothing nearly so tangible to which to ascribe the gains.

Bankers themselves are fuzzy about explaining their trading profits....But it is clear that three powerful forces are at work, all of them overlapping and mutually reinforcing....

The first is the alchemist's trick of turning debt (mostly leaden) into derivatives (mostly liquid); the second is the emergence of a new class of leveraged client (hedge funds and private equity); and the third is seeking out new capital markets, and clients, around the world. Moreover, in all these pursuits the firms are now using not just their clients' money but, to differing degrees, their own too."
Which predictably lead to a discussion of whether this leads to increased risks (probably), whether investment banks have taken enough precautions (maybe), and a warning that these profits have arisen in "an unusually benign economic climate" that will eventually come to an end.

Good stuff! Check it out!

Thanks to FT Alphaville for pointing this one out!

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