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Our Tarnished Titans

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics
June 16, 2008
Washington Post


Ever since J. Pierpont Morgan was simultaneously reviled and celebrated a century ago, the titans of banking have enjoyed a special place in the popular imagination. Their economic clout, political influence and sheer wealth have inspired justified awe; the alumni of a single firm, Goldman Sachs, include the current Treasury secretary, the White House chief of staff, New Jersey’s governor, the World Bank boss, the head of Italy’s central bank and the Nature Conservancy’s incoming president. Yet there are questions about what modern investment banks do—and last week’s ructions at Lehman Brothers only make these questions trickier.

Until about a year ago, the main complaints about investment banks concerned conflicts of interest. By collecting all kinds of financial business under one roof, they created all kinds of opportunities to take advantage of customers.

Investment-bank brokerage departments execute buy and sell orders on behalf of outside clients, supposedly at the best price possible. But the proprietary trading desks make money by trading the banks’ own capital; the temptation to use knowledge of outside clients’ strategies to boost prop-desk profits is, shall we say, considerable. Long-Term Capital Management, the hedge fund that blew up in 1998, was partly a victim of brokers who were copying its trades, making them impossible to exit in a crisis.

In 2000, the tech and telecom bubble burst, revealing further conflicts of interest. Investment-bank research departments, which advise fund managers on what to buy, were caught pushing stocks that they knew to be worthless—because the banks collected fees from those worthless companies.

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