While the macro, long-term picture is sound, the industry is certainly in flux. Within the past six months, five of the largest investment banks have either folded, been sold to commercial banks, or have become commercial banks themselves; and two of the top ten commercial banks have had forced transitions. In addition, American International Group (AIG)—one of the largest insurers—has been bailed out by the federal government, and Freddie Mac and Fannie Mae have been nationalized. At least ten European banks have been nationalized or bailed out and there are also rumors that additional financial services firms both in the US and Europe may not survive to year end.

The current condition in the US is mostly a result of greed and poor governance, and there is certainly enough of that to go around. We can blame the speculator who thought real estate only went up; borrowers who took on too much debt; banks that gave loans to virtually anyone who applied; investors who wanted higher interest rates; investment banks that took on too much leverage; or auditors and legislators who applied pressure to banks to make loans to the less financially capable, and regulators who turned a blind eye and should have known better. There is certainly at least $840 billion of blame to go around.

While blame may be cathartic, the real question is what is next? Is the independent investment bank really dead? Well for now it is, but what does this mean for banks, investors, the general economy and for the market?

Hopefully we can assume once the markets stabilize, commercial banks—including Morgan Stanley and Goldman Sachs—will be forced (by regulators, legislators, and boards) to become more conservative. As banks become more conservative, their risk and compensation levels will go down and the more highly compensated and risk tolerant will leave to set up or join new institutions. These new organizations will become the investment banks of the future.

These newly minted investment banks will be structured as partnerships, they will be more adroit and nimble, and take on much of the risky aspects of the traditional investment banks of the past. The major difference will be that these new organizations will be much smaller and less capable of instigating financial Armageddon; and because these firms will be partnerships, they will be more cognizant of their risk level and more hesitant to take risks that will jeopardize their well being.

The TABB Group Note on The Future of Investment Banking:
Subprime and Its Impact on the Industry

This Vision Note takes an in-depth look at current industry issues: Much of this Note is based upon conversations with senior industry management as well as my readings and thoughts. Although this Note reflects the events that occurred August through early October 2008, the market is still in too much flux for this to be the definitive treatise on the subprime and investment banking crisis of 2008. It will take experts and historians years if not decades to thoroughly understand, articulate, and prescribe fixes for our financial markets.

Although it may take years to determine the cause and impact, the subprime crisis needs to be put into more immediate perspective so banks, brokers, industry professionals, and the entire financial services ecosystem can begin adjusting their business models, support systems, and strategies to react to the massive change affecting our industry. In addition, regulators and legislators must quickly begin to put these issues into perspective as they implement changes that may inadvertently cause more harm than good.

In this Note, we will try to put this crisis into context, examining some of the causes, and investigating some of the possible outcomes, challenges, and opportunities that the industry will face in the coming years.