A Snapshot History of Investment Banking

Investment banking practices such as extending credit to merchants date back to ancient times. In the 1600s, early investment institutions such as acceptance houses and merchant banks helped finance foreign trade and accumulated funds for long-term investments overseas.

The nineteenth century saw the rise of several prominent banking partnerships such as those created by Rothschilds, the Barings and the Browns. These firms had their origins in the Atlantic trade, financing the importation of commodities for European manufacturers and helping them export their finished products around the world.

In the United States, investment banking received a boost during the American Civil War. Syndicate banking houses sold millions of dollars worth of government bonds to large numbers of individual investors to help finance the war. This marked the first mass-market securities sales operation, a practice that continued later in the 1800s to finance the expansion of the transcontinental railroads.

The 1800s also saw the birth of some of the most famous firms in investment banking, many of which are still with us, in one form or another, 150 years later. The firm of J. P. Morgan played a major role in the corporate mergers of the era, such as the merger of U.S. Steel Corp and the Northern Pacific and Great Northern railroads. The firm grew to such size and prominence at the turn of the century that J.P. Morgan, the founder, is credited for “saving” Wall Street during the banking crisis of 1907 by allegedly locking top executives from major banks in his office until they hammered out a solution.

Goldman Sachs was founded in 1869 by German Jewish immigrants Marcus Goldman who later partnered with his son-in-law, Samuel Sachs. Goldman Sachs was among the pioneers of the initial public offering (IPO), and managed one of the largest IPOs at that time, for Sears, Roebuck and Company in 1906.

In the early twentieth century, investment banking expanded dramatically. One reason was an increase in the number of individuals who owned stock, something that resulted from the prosperous years after the First World War. However, the ensuing run-up in stock prices created an unsustainable bubble that finally collapsed with the Great Depression in 1929. The U.S. plunged into one of the worst depressions in history. More than 11,000 banks failed or merged, and a quarter of the population was out of work.

The excesses of that period and the many bank failures led to a flood of new regulations to protect investors from fraudulent stock promoters and stabilize the banking system. It led to the passing of the Federal Securities Act of 1933, which required “full disclosure” of accurate information for publicly offered securities and a prospectus filed with the Securities and Exchange Commission.

More importantly for investment banks, the government passed the Glass-Steagall Act in 1933, which compelled commercial banks to separate themselves from their securities distribution arms. Large universal banks such as JP Morgan, for instance, split into separate entities. In JP Morgan’s case, it created JP Morgan as a commercial bank, Morgan Stanley as an investment bank, and Morgan Grenfell, as a British merchant bank. The Glass-Steagall Act remained in force until it was repealed during the Clinton administration in 1999.

Next time, we’ll look at Golden Era of Investment banking in the 20th century, as well as current  trends.

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