Investment Banking

Investment Banking in 2008 Group Report 1. tribulation Analysis Identify the major(ip) factors that contri thated to back Stearnss failure? Who stood to confide one over from its implosion? How did own Stearnss turn over disagree from the Long Term smashing Management failure a cristal earlier? What could succumb Stearns select through differently to avoid this helping? In the early 2000s? And during the summer of 2007? And during the week of March 10, 2008? (1) Identify the major factors that contri besidesed to harbour Stearnss failure? rescues some(a)what cutthroat and renegade refinement of maverick may learn contri provideded a lot to their failure.This culture in some manner made it killed by the recognize crisis, while other investiture imprecates survived. hardly the direct factors resulted in Bears implosion were the failure of Ralph Cioffis best merged Credit Strategies Fund and Enhanced Leverage High-Grade Structured Credit Strategies Fund, which invested in sophisticated quote derivatives backed by mortgage securities. And these failures cost Bear more than 1. 6 billion dollars to prop up two hedge strains. And the failures of two hedge property led to a continuous questioning ab away(a) Bears pecuniary st talent.At the very(prenominal) time, Bear concentrated its technical enterprise on CDOs, which operator it had high flick to this item. Thus when credit crisis happened, it is signifi corporationtly tinted. And in early 2008, Moodys downgraded 163 tranches of mortgage backed bonds issued by Bear. Al virtually everyone pissd that Bear leave face liquidity line. But meanwhile, Bear highly relied on repo to pay itself. When lender muddled authority in Bear, it failed in finding another(prenominal) effective route to find immediate payment. In sum, the reasons above contri justed to the failure of Bear in 2008 crisis. (2) Who stood to benefit from its implosion?JP Morgan is the beneficiary from Bears desir eruptcy. It prepareed a beau monde which had $172. 61 worth less than 8 months ago with an incredible slump price of $10 a treat. (3) How did Bear Stearnss buckle differ from the Long Term Capital Management failure a decade earlier? The origin in LTCMs failure was the high-leveraged organise. It obtained excessive debt for the enthronization of the bonds. Simultaneously, the market place manoeuvreplace capacity was not sufficient to support LTCMs boastfully bloated size. As time had gone, market competition and capacity diminished its profitability.But with such(prenominal)(prenominal)(prenominal)(prenominal) a high leverage, LTCM had no other choice but to gain enough profit to move on. Therefore, they got a foot into some unacquainted with(predicate) area. Meanwhile, as to the trading strategy, LTCM held a large quantity of summation with wretched liquidity. However, situation was different from what they had predicted. Big loss happened eventually, but LTCM could not trade asset for enough cash. It inevitably had to go bevelruptcy. High leverage structure of Bears hedge fund as well as had great impact on its collapse. But the awful strategy of Bears direction should blame most for its positruptcy.If it was in a less turbulent environment, things susceptibility be different. Continual bad news about Bear from executives bad-mannered behavior to its first quarterly loss since foundation ruined the agency of investors. And another difference in the failure of both was that Bear generally died of market failure. When the whole market was fear of the loss of subprime asset, the large subprime assets keeping companies such as Bear Stearns, could not avoid a fate of great loss and liquidity problem. (4) What could Bear Stearns suck done differently to avoid this fate?In the early 2000s? As an enthronement funds desire, Bear was just in pursuit of the glide by while underestimated the capability aftermath of being too risky. Most o f its profit was composed of dictated in jazz securities. Meanwhile, Bear should not let each hedge fund motorcoach just specialize in a firearmicular security measures to constitute volatility. It is obvious that Bears risk management had signifi buttt flaw. Furthermore, since the over-confident Bear was desperate for the incredible return, it was not attentive to such supernormal development of the housing price.They should not just concentrate on CDOs without also devoting their asset in other business, as diversification is so most-valuable for a unwavering. But it may not happen, since Bear was not less covetousness than the surrounding. And during the summer of 2007? If Bear realized the market could not be defeated, they should flip manoeuverled Cioffis risky attain of raising new hedge fund with a higher leverage. Conversely, they should liquidate the fund. If the liquidation was performed, they should not have lost such great measuring in this worthless fund.An d meanwhile it began to puree to search for cash to finance itself. Except those worthless toxic assets, Bear still had some assets, which could provide it some cash flow. If Bear change these assets earlier with determination, they might not sink in liquidity problem so deeply. And during the week of March 10, 2008? After Bear was downgraded by Moody, market had lost confidence in it. Almost everyone realized bears liquidity problem. When pointed out to have liquidity problems, Bears executives should realize the severity of the crisis rather than believing the worst was once again idler them.Even though they could not re chase after from the difficulty, prime actions could be taken, including exposing the reality to the market, reassure the investors, make urgent strategies, applying for emergent aids from the supply, and applying for temporary held in stock up trading. 2. fluidness Crisis and Business Model of Investment Banks What is the theatrical role of Liquidity for banking and enthronization funds banking firms? Is perception of Liquidity more important for a banking/investment banking firm than manufacturing firms (such as crossroad or Boeing)? wherefore?What could Bear Stearns have done to spoken communication its Liquidity concerns, which initiated the run on the bank? Looking back, what lessons can we infer from Bear Stearnss failure regarding the business model of investment banks? Looking fore is the concept of pure-play investment banks sustainable? (1) Whats the role of liquidity for banking and investing banking firms? Liquidity can reveal the untrue universe of cash (and cash equivalents), short investments, accounts receivable and accounts payable, etc. To which extent it lives up to the real condition.It measures whether the banks business is legal, reasonable and whether the financial office is promptly and properly reflected on the financial reports. Liquidity risk is also important. It values the repayment of debt and r eminds the board of the corporations risk at whatsoever time. Managing liquidity is a daily process requiring bankers to monitor and purport cash flows to ensure that adequate liquidity is maintained. The investment portfolio serves as the elementary source of liquidity and represents a smaller portion of assets. Investment securities can be liquidated to satisfy alluviation withdrawals and increase loan demand. 2) Is perception of Liquidity more important for a banking/investment banking firm than manufacturing firms (such as Ford or Boeing)? Why? Yes. The main sources of accompaniment for technical banks are deposit, interbank borrowings, commercial-grade banks deposits, the international money market borrowings and the issuance of financial bonds, among which the short deposit accounts for the vast majority of the correspondence. However, these funds are primarily employ for commercial loans, discounting business, securities investment, etc. These higher profitability and long-term loans account for the absolute proportion in the composition of assets.This mismatch among assets and liabilities makes the liquidity of assets very important in banks operation. Since when sudden changes occurred in the market, a large number of customers pull up stakes be forced to perform withdrawal, in that respectfore the bank bequeath be very difficult to realize its assets and to meet its liquidity regards. In some sense, it is similar for the investment banks. The difference is just that they do not gain money from retail depositors most of the money is funded in the interbank market and is used to hold illiquid mortgage backed securities.Once banks were not able to provide funding for business, a banking contagion will occur and cattle farm. A traditional manufacturing business is generally funded by right or long-term debt and has steady cash flows from business operations. Even in the eggshell of a collapse of such businesses, it would not have the same contagion effect as banks. (3) What could Bear Stearns have done to address its Liquidity concerns, which initiated the run on the bank? 1. The basis of the modern financial system is not physical assets, but peoples confidence in this system. dallyually when the rumor of BSC running out of cash was widely spread, BSC was forced to make a overt declaration to ensure the human beings that their financial situation was solid and their liquidity was sufficient. Unfortunately, BSC did not take valid action or provide strong depict such as strengthen its financial sheets or reducing leverage to convince investors. The board should pay more attention to the operation of the integrated rather than participate in a bridge tournament. 2. BSC could reduce leverage by alloting their risky assets to generate cash during a layover of financial stress.They should maintain enough reserves in the form of short-term instruments of the highest credit quality to meet the obligation. So an amount of funds should be invested only in instruments that have guaranteed liquidity, like treasury instruments. 3. Bear Stearns, three-quarters of whose tax was still dependent on the market (see the source below), should adopt diversification strategy to find a real alternative to business and amend its finance. The plans could be accelerate the development in other countries and diversified business, including equities, investment banking and asset management businesses.Source http//finance. sina. com. cn/money/future/20080403/09024705325. shtml (4) What lessons can we infer from Bear Stearnss failure regarding the business model of investment banks? Diversification of the investment is the foremost thing to consider for any matured investor. Investing severely into one family, one persistence, or having only one investment strategy is unadoptable. You are banking for speculation that one club or industry will always do well. But in fact, it is hardly possible to be in per fect condition at any time.You must make your investment portfolio diversified. Maybe an element of international stocks can be added into the portfolio. When the U. S. market is unprofitable, it still has the chance to drag profits from Asia and Europe so as to keep the portfolio solid. Sometimes high leverage can kill a firm. In March 2008, Bear owned tangible equity jacket of about $11 billions versus total assets of $395 billionsa leverage ratio of 36. For some(prenominal) years, this reckless financing bring the company a profit coast of about one third and a return on equity of twenty percent.However, when the market endured a sharp downturn, Bear lose a lot of capital and willing creditors. During the ensuing months, the same story was to be played out at scores of other banks and non-banks. (5) Looking forward is the concept of pure-play investment banks sustainable? The achievement of a pure-play investment bank can be highly influenced by the type of investing course which tar abides at it. For instance, if a pure-play banks business is favored by growth investing, the company will do well during a bull market, where growth stocks go to outperform the market.Conversely, a pure-play bank associated with growth investing will do poorly during bear market, when a value investing strategy is historically more profitable. Whats more, the pure-play investment banks have relied heavily on short-term capital, especially repo transactions in which counterparties take positive as security against the cash they lend. As public companies, pure-play banks faced pressure to deliver return on equity comparable to that of universal banks, even as those banks put competitive pressure on traditional advisory businesses such as MA, underwriting, and sales and trading.In rejoinder, pure-play banks resorted to the two advantages they had over non-depository organizations un reverberateed, unregulated leverage capacity, and increase reliance on proprietary tradi ng to deliver earnings. 3. systemic Banking Crisis and formula What is a systemic banking crisis? What is banking contagion? What was the rationale for the creation of fire-wall of separation between investment banking and commercial banking in USA that was institutionalized by the Banking Act of 1933? Why did the regulators weaken and leg out that fire-wall of separation in mid-nineties?Identify the major Deregulatory Acts and its role in the meltdown of the investment banking industry? In your opinion, ground on lessons from past worldwide banking crisis, what stairs should regulators make up now to address similar future problems? (1) What is a systemic banking crisis? Systemic banking crisis refers to the crisis detrimental to the whole financial system. It is the fatal chaos that several foreboding(a) crises occur simultaneously, such as monetary crisis, banking system crisis, foreign-debt crisis, etc.The crisis expands from one financial market to another. For example, from the stock market to the real estate market or foreign-trade market, etc. (2) What is banking contagion? Banking contagion refers to a scenario where the banks, which initially affected by some crisis spread to the other banks even the other countries whose economy is antecedently healthy. In this scenario, the expansion could be very quick and disastrous. The international spread might cause the whole banking system to be paralyzed and need another several more years for recovery. 3) What was the rationale for the creation of fire-wall of separation between investment banking and commercial banking in USA that was institutionalized by the Banking Act of 1933? There are 3 major factors. 1. Risk of losings (safety and soundness). Banks that engaged in underwriting and holding corporate securities and municipal revenue bonds presented prodigious risk of loss to depositors and the national organization that had to come to their rescue they were also more relegate to failure wit h a resulting loss of public confidence in the banking system and greater risk of financial system collapse. . Conflicts of saki and other abuses. Banks that offer investment banking serve and mutual funds were subject to conflicts of interest and other abuses, thereby resulting in the harm to their customers, including borrowers, depositors, and correspondent banks. 3. out-of-the-way banking activities. Even if there were no actual abuses, securities-related activities are contrary to the way banking ought to be conducted.The Act prohibited the combination of a depository institution, such as that, commercial banks (those that accept deposits) were prohibited from engaging in most investment banking activities, including underwriting and selling securities, and from affiliating with investment banks and other companies engaged principally in the trading of securities. Likewise, investment banks were barred from accepting deposits. (4) Why did the regulators weaken and phase out that fire-wall of separation in 1990s? Inspired by a desire to make U. S. nvestment banks competitive with foreign deposit-taking investment banks such as UBS, Deutsche Bank, and Credit Suisse First Boston, a Republican Congress and President Clinton passed the Gramm-Leach-Bliley pecuniary service Modernization Act in 1999, permitting insurance companies, investment banks, and commercial banks to compete on equal footing across products and markets. (5) Identify the major Deregulatory Acts and its role in the meltdown of the investment banking industry? 1999Glass-Steagall Act shed The repeal of the Glass-Steagall Act in 1999 had larger ramifications than any other steps in deregulation.Repealing this act made it possible for investment banks to be savings and loan banks and to receive to the same government protections as savings and loan banks. An investment bank could make investments with peoples savings, sometimes irresponsibly, and those investments now were guaranteed by the federal government. 1988Securitization In 1988, securitization, or repackaging assets as a financial instrument to sell to investors, became legal. Banks were allowed to sell their mortgages to SPVs. Mortgages were no longer being made to hold but to sell, and lending requirements became substantially more lenient.This created a combination of bad loans and banks without the funds to back them up. 2004SEC In 2004, the SEC abolished the net capital rule, which limit the amount of debt their brokerage units could take on-demonstrated this growing appetite for leverage. This led investment banks to leverage themselves at a financially irresponsible 30 to 1 percent, meaning that for every $1 they had on hand they had $30 in debt. When some of these investments collapsed, the banks did not have the ready capital to maintain their companies. Ultimately, increased leverage and proprietary trading ravaged the nvestment banking industry, leading to the collapse, merge, or structure of all 5 major pure-play banks on fence in Street. This time, the SEC took the odd step of temporarily banning short sales of financial institution stocks. The ban caused massive losings in hedge fund portfolios and dissuaded them from making additional investments, denying would-be issuers access to needed capital. Moreover, the SEC placed a ban on so-called naked shorting, which reduced the total amount of short interest that could accumulate in a stock. 6) In your opinion, based on lessons from past global banking crisis, what steps should regulators institute now to address similar future problems? 1. The regulations should be placed on the fundamental part of economy. For example, when there seems to have bubbles in one field, the federal official should not ignore. It should right the form _or_ system of government towards the industry to change the unbalanced situation. 2. To fortify the risk ken continuously in traders mind, especially those who control the wealth of millions of people. Their behaviors might have huge influence to the market and the profitability of the firms. 3.The provide should research for qualifying for investors from the market of different systems to ensure that obstacles will not exist in multinational trades. Meanwhile, policies of staying resistant to exterior crisis should be prepared in case of the explosion of crisis. 4. Federal Bailout and Public Policy Why did the Federal keep back bail-out Bear Stearns? Why was Lehman Brothers allowed to collapse while Bear Stearns was not? Is the Fed orchestrated sale of Merrill Lynch to Bank of America the optimal declaration for addressing the crisis? Could Morgan Stanley and Goldman Sachs have survived with out becoming bank holding companies?In your view, what public policy role should the Federal Reserve play in maintaining sustainability in global banking and stability securities markets? Why was there such a public out-cry against the bailout of Wall Street investment banks? Based on this recent performance how would you rate the Federal Reserves response to the financial crisis? (1) Why did the Federal Reserve bail-out Bear Stearns? If Bear went bankruptcy, it would affect other firms in Wall Street as well, since Bear was a market attractor in prime brokerage and clearing who provided trading and back-end run to legion(predicate) other Wall Street financial institutions.Most customer asset would get frozen in the event of bankruptcy, and many hedge funds had collateral in the firm. Because of Bears holding of 13 trillion credit default swaps, the collapse of Bear would influence many other companies, which means too big to fail at that time. However, the Fed didnt judge that this kind of matter will happen again. The Fed Reserve bailed out Bear Sterns just to avert crisis and dissuade further irresponsible risk-seeking. The bailout benefited Wall Street at the expense of Main Street and the low share price was to discourage banks from taking on si milar risk. 2) Why was Lehman Brothers allowed to collapse while Bear Stearns was not? The decision to let Lehman Brothers fail was more often than not made by then-Treasury Secretary Henry Paulson and the British Financial Services Authority. The public outcry over the taxpayer assumption of $29 billion in potential Bear losses made repeating such a move politically untenable. Therefore, the Fed refused to back Lehmans liabilities and backstop losses from Lehmans toxic mortgage holdings. Moreover, Barclays quitted the acquisition, worrying that it could not be satisfied with the timely shareholder approval, which directly led to the collapse of Lehman.The Fed also wanted to set it as an example, to let other company to know that not every time the government will come out to bail out the company, so they will have moot consideration repeatedly before making all kinds of risky investments. (3) Is the Fed orchestrated sale of Merrill Lynch to Bank of America the optimal firmness o f purpose for addressing the crisis? No. This transaction doubled the investment banking size of Bank of America. Furthermore, it open Bank of America to mortgage-backed securities, which had negative impact on the long-term credit rating of the bank.This transaction could not prevent the occurrence of another such case like Merrill Lynchs, and this behavior could not bring red-letter lesson to other banks. (4) Could Morgan Stanley and Goldman Sachs have survived without becoming bank holding companies? No. accord to the research, Goldman Sachs was a major beneficiary of the governments bailout of the financial services industry, not only through AIG but also through its ability to fall under the regulatory umbrella as a bank holding company, which made it eligible for debt guarantees and other government backstops.Every financial services company on the earth wanted to acquire a bank and line up for the handouts coming from Washington such as American Express, GE Capital, and G MAC. Even Willem Buiter, a former central banker, wanted to become a bank. Goldman was in a more precarious position than bank holding companies because of the vulnerabilities of being a broker-dealer. Nouriel Roubini warned repeatedly before Lehmans collapse that the large full services broker-dealer model was broken. (5) In your view, what public policy role should the Federal Reserve play in maintaining sustainability in global banking and stability securities markets?From the lesson of subprime housing crisis, we think the Federal Reserve should control the capital, but without influencing the supply and demand. Since this crisis was created by those bad loans, the governments control would limit people to invest on housing market, and somehow be soften for people who are really in need of a place to stay. Furthermore, we have several pieces of advice to the Fed, besides in housing matters a) Regulate the utter(a) domestic and international banking environment. b) Reinforce th e supervision over the risk control of investment banks. ) Restrict the expansion of any potential crisis once any symbol occurs. d) Do best to avoid the asymmetric information in the market. e) Ensure a fair and open environment for trading. (6) Why was there such a public out-cry against the bailout of Wall Street investment banks? masss being against to governments bailout the Wall Street had 2 main reasons. First, people believed Wall Street got this mess by themselves and they should be the one to clean it up, rather than that the government used tax payer money to save the Wall Street.They thought this was not fair, because this kind of action would increase the US governments debt, and tax payer would have to pay more tax in the future to cover this debt. This debt may take a long time to be recovered. Second, when the government did get involved in the Wall Street crisis, the free market would not exist anymore, and next time if any firm had problem, they would ask the gove rnment to save them, which would totally be against the American economic policy, and belief. 7) Based on this recent performance how would you rate the Federal Reserves response to the financial crisis? Based on the recent performance, we think they had done what they had to do, but we think they should let the economic fail, based on the free market of American. They should let the invisible hand control the market, and the market should flow freely by itself. It will come back up, however long it takes. straightaway the government is using the tax payers money to cover Wall Street crisis, which actually is not fair.