Management

This rather glosses over the fact that investment banking has become a toxic industry, injurious or fatal when swallowed, writes Tony Jackson

FOR A lay public baffled by the self-immolation of the western banking system, perhaps the most bizarre single instance is the scramble to hire employees of Lehman Brothers. Barclays is shelling out $2.5 billion (€1.77 billion) in bonuses to Lehmanites in New York, and Nomura up to $1 billion (€707 million) in London.

Yet those are the same people who drove their former employer into bankruptcy. Surely this is bonkers?

Not at all, the experts will explain.

This is a unique opportunity. Some investment banks have gone under, so their market share is going begging. The survivors can snap up all that unemployed talent and get a jump on the opposition.

This rather glosses over the fact that investment banking has become a toxic industry, injurious or fatal when swallowed. Consider three sufferers - Merrill Lynch, AIG and UBS.

Merrill was, at its roots, a network of retail broking branches in every main street in America. This was low-risk business, but correspondingly unexciting.

Hence the push into investment banking, culminating in mortgage-backed derivatives. Goodbye Merrill.

AIG had a global spread of solid insurance businesses. But it ended up writing $400 billion (€283 billion) of credit default swaps to European banks, as a means of helping them expand their loan books without also expanding their capital base. Goodbye AIG.

UBS had a similarly enviable position as the world's leading wealth manager. Its expansion in investment banking has caused crippling write-offs.

So its wealth business is now under pressure, on the grounds that the world's rich are less keen on entrusting money to a business so singularly inept at handling its own.

As for Lehman, Barclays is already heavily involved in investment banking, so presumably knows what it is in for.

Nomura, though, is still pretty much what Merrill used to be - the dominant retail broker in its home market. Over $4 billion (€283 billion) of its revenues - more than half the group total - come from commissions.

Again, safe but dull. So Nomura is now the proud owner of Lehman's business in both Europe and Asia, the latter being described by Nomura's chief executive as "a once-in-a-generation opportunity".

The bonus guarantees, meanwhile, stretch belief.

Lehman always had a reputation for paying aggressively, and kept it to the end. Five days before bankruptcy, the firm rushed out third-quarter figures showing that whereas revenues had gone from $4.3 billion (€3.03 billion) the year before, to minus $2.9 billion (€2.04 billion), total compensation had gone from $2.1 billion (€1.48 billion) to $2.0 billion (€1.41 billion).

Both Barclays and Nomura are plainly bent on maintaining that tradition, hopefully with different results.

Indeed, Lehman's London bankers have persuaded Nomura not just to repeat last year's bonuses this year and next, but to pay this year's wholly in cash. The rest of the world's investment bankers, faced with shrunken bonuses paid in risky stock, must be dumb with admiration.

The reason for this generosity can only be that Lehman's bankers have shown their new owners similarly generous offers from elsewhere. This is a classic instance of behaviour that may make sense for an individual firm, but none at all collectively.

In the next-door world of interdealer broking, similar behaviour recently moved the head of one London firm to compare his industry to a circular firing squad. In investment banking, they use howitzers.

What has caused this? Essentially, the extreme profitability of investment banking in the past. In the US, this was perversely due in part to the Glass-Steagall Act of 1933.

The Act's original, very sensible intent was to make sure the risks inherent in investment banking would not contaminate the guaranteed world of retail banking. But that also allowed investment banking to become a super-profitable oligopoly, safe from competition by the big commercial banks.

Unsurprisingly, then, the scrapping of the Act in 1999 was primarily due to lobbying from commercial banks keen to get in on the action.

This was immediately followed, as luck would have it, by investment banking's golden years - a period of fabulous and unsustainable growth.

The fact that this is now over, perhaps for good, is plainly lost on those still clamouring to get into it.

Some will argue that Warren Buffett has endorsed the industry's future with his $5 billion (€3.53 billion) stake in Goldman Sachs. He has done nothing of the kind - merely identified a business desperate enough to pay him 10 per cent interest in perpetuity, with free equity options thrown in.

Last week, a retired investment banker told me the most striking difference in the industry over the past 20 years had been the personality of new recruits. Latterly, they had all been hyper-aggressive alpha-male types. The best hope for the industry, he said, was probably to fire the lot and start again.

Instead, employers are fighting over them. The lay public is right. This is bonkers.

- FT Service