USA: Bear Stearns, Merrill Lynch and Lehman Brothers

Abstract

Different rules of the game The three investment banks mentioned in the headline all disappeared in the financial crisis. Bear Stearns was bought by JPMorgan Chase and Merrill Lynch by Bank of America, while Lehman Brothers was allowed to fail. We will provide more detailed descriptions of their demise later in this chapter. The other two major investment banks, Goldman Sachs and Morgan Stanley, were accepted by the Federal Reserve as commercial bank holding companies. A whole industry, created by the Glass–Steagall Act of 1933, had basically ceased to exist almost overnight. Some would say it was inevitable because their business model was no longer viable. Others would say that the lure of the TARP money on attractive conditions offered to banks (but not investment banks) was the main incentive for the shift. Table 21 tries to spell out the different degrees of risk taken by the investment-bank sector in comparison with US commercial banks and European universal/investment banks. A first observation is that the American investment banks had substantially more risk (higher leverage ratio) when the crisis struck than the major US commercial banks. When the two remaining major investment banks converted to bank holding companies on 21 September 2008, their risk level had to be substantially reduced. There were two reasons for this forced change in behavior. Firstly, the investment banks were regulated by the SEC, not the OCC or the Fed, in what used to be characterized as “light touch” regulation. Regulation could, it had been concluded, be lighter since they did not take insured deposits from the public. Hence they had not the same need to be supervised and restricted in their activities since they did not pose the same degree of risk to overall financial stability, namely the risk of a “run” on their deposits. The fallacy of this argumentation will become apparent in the following. A run can ensue on wholesale funding through commercial paper and/or repos just as well as on deposits. Secondly, the capital requirements of banks vs. investment banks were vastly different. Investment banks in the US were permitted to shift to the Basel II framework, allowing them to calculate risks by their own internal models.