I have seen a recent article in the news about the demise of the investment bank. That sounds bad. What are they talking about?
The article was referring to the large losses that many investment banks have suffered because of the practice of buying securities that were collateralized (backed up) by sub-prime mortgages . Investment banks help raise money in capital markets by buying issued securities and trying to sell them later to investors. The issuer gets the money from the sale of the issue and the investment bank picks up the risk of owning the security. The trouble is that the sub-prime mortgages on which these securities value was based were not high quality and were very risky (people were not paying the mortgage or able to meet the minimum payments) and the securities lost value rapidly after the investment bank bought the securities. The investment bank had to hold them because the securities are worth much less (or some times worthless!) then originally thought and no investors would buy them, and massive losses were generated. Several investment banks suffered enough to go bankrupt or fail, many of these very old and well established investment banking firms such as Bear Stearns and Lehman Brothers. Their failure or bankruptcy dealt a serious shock to the financial system and investor confidence in the securities markets. The Federal Government selectively stepped in and in some cases helped the investment banks that had suffered from the sub-prime market fiasco but it is unlikely that the government will now, in this political climate, continue with these 'bailouts'.
The article misses an important point though; while many large investment banks did in fact fail, the need for the essential marketing services investment banks provide insures that other entities will step up in a free market to supply that demand. Many other investment banks exist besides just the marquee names that failed on Wall Street, and while the large players may be gone smaller regional or smaller national investment banks will take on those accounts and clients, and continue to provide the necessary services as market facilitator. So, it is unlikely that investment banks will go away altogether, but the major players in the market may no longer be around.
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The article was referring to the large losses that many investment banks have suffered because of the practice of buying securities that were collateralized (backed up) by sub-prime mortgages . Investment banks help raise money in capital markets by buying issued securities and trying to sell them later to investors. The issuer gets the money from the sale of the issue and the investment bank picks up the risk of owning the security. The trouble is that the sub-prime mortgages on which these securities value was based were not high quality and were very risky (people were not paying the mortgage or able to meet the minimum payments) and the securities lost value rapidly after the investment bank bought the securities. The investment bank had to hold them because the securities are worth much less (or some times worthless!) then originally thought and no investors would buy them, and massive losses were generated. Several investment banks suffered enough to go bankrupt or fail, many of these very old and well established investment banking firms such as Bear Stearns and Lehman Brothers. Their failure or bankruptcy dealt a serious shock to the financial system and investor confidence in the securities markets. The Federal Government selectively stepped in and in some cases helped the investment banks that had suffered from the sub-prime market fiasco but it is unlikely that the government will now, in this political climate, continue with these 'bailouts'.