Overview

While huge company mergers, initial public offerings, and other big business transactions may make the headlines, most of them never could have happened with out the hard work and long hours of a solid investment bank behind them. When the law requiring the separation of commercial (what we traditionally call a “bank” from where you deposit and withdraw money) and investment banks (that work with companies and governments to raise and invest money) was repealed in 1999, it caused tremendous upheaval in the industry. Since shortly after the stock market crash of the 1920s, commercial banks and investment banks had needed to be separate companies, but today most financial institutions have their fingers in both pies.

Investment banks are experts at calculating what a business is worth, usually for one of two purposes: to price a securities offering or to set the value of a merger or acquisition. Securities include stocks and bonds, and a stock offering may be an initial public offering (IPO) or any subsequent (or “secondary”) offering. In both cases, I-banks charge hefty fees for providing this valuation service, along with other kinds of financial and business advice.

When banks underwrite stock or bond issues, they ensure that institutional investors, such as mutual funds or pension funds, commit to purchasing the issue of stocks or bonds before it actually hits the market. In this sense, I-banks are intermediaries between the issuers of securities and the investing public. I-banks make markets to facilitate securities trading by buying and selling securities out of their own account and profiting from the spread between the bid and the ask price. In addition, many I-banks offer retail brokerage and asset management services. Retail brokerage services deal directly with the customers, allowing individuals and small organizations to purchase stocks, bonds and other financial service products directly. Asset management services include creating and overseeing a portfolio of products or services, generally for a wealthy individual or organization.

Not surprisingly, the center of this industry rests in the lofty aeries above Wall Street and Midtown in New York City. Other hot spots include London, San Francisco, and Silicon Valley. Firms also compete in Frankfurt, Tokyo, Hong Kong, and other foreign markets 24 hours a day.

Trends

Industry Consolidation
In recent years, investment banking has witnessed a rash of cross-industry mergers and acquisitions in recent times, largely due to the late-1999 repeal of the Depression-era Glass-Steagall Act. The repeal, which marked the deregulation of the financial services industry, now allows commercial banks, investment banks, insurers, and securities brokerages to offer one another’s services. As I-banks add retail brokerage and lending to their offerings and commercial banks try to build up their investment banking services, the industry is undergoing some serious global consolidation, allowing clients to invest, save, and protect their money all under one roof. These mergers have only added to the downward pressure on employment in the industry, as merged institutions make an effort to eliminate redundancy.

Among the M&A activity in recent years: JPMorgan Chase bought Bank One; Bank of America bought Fleet Boston and MBNA; Wachovia swallowed Golden West and SouthTrust; Citizens Financial acquired Charter One; and SunTrust purchased National Commerce.

Meanwhile, foreign firms such as Deutsche Bank and UBS are moving aggressively into U.S. markets. The result: Firms in the United States and abroad are looking for partners or acquisitions to beef up their global presence. These changes are happening overseas as well. In October 2007, a consortium led by Royal Bank of Scotland acquired 183-year-old ABN Amro of the Netherlands in a $101 billion transaction that combined the two, making it the largest banking deal ever made.

Scandals on the Street
The swing in the markets from up, up, up to down, down, down focused a lot of scrutiny on firms on the Street. One of the biggest issues was the fact that banks overrated the investment potential of client companies’ stocks intentionally, deceiving investors in the pursuit of favorable relationships—and ongoing banking revenue opportunities—with those companies. Firms also came under fire for the methods by which they allocated stock offerings (specifically, for whether they charged excessive commissions to clients who wanted to purchase hot offerings), as well as for possible manipulation of accounting rules in the course of presenting clients’ financial info to potential investors.

By now, almost all of the important investment banks have paid fines totaling in the billions of dollars to settle allegations against them, and the scrutiny of regulators remains sharp. And banks are paying millions to purchase independent research to provide to their customers. In addition, former big-time players on the Street, including research analysts like Henry Blodget (Merrill Lynch) and Jack Grubman (Citigroup) and bankers like Frank Quattrone (Credit Suisse), have been accused or convicted of misdeeds and/or fined and fired.

Will the effects of changes that have come out of the banking scandals be lasting? Well, yes and no. Some of the laws that came out of the scandals, such as Sarbanes-Oxley, are complex and their effects are still being felt today. With hefty fines and even jail terms for those involved, there were definite tremors throughout the banking world. However, as markets improve, regulators tend to ease up on doing their jobs, and companies and their employees become more greedy and prone to breaking the rules to make more money. Still, with recent banking losses and the credit crunch—and the possible long-term economic threat from this crisis—coming about as a result of the popularity of subprime mortgage–backed securities, finger-pointing about who was to “blame” has been quick to start again. Much of it was laid at the feet of complex financial products and deals structured by and purchased by I-banks. Those thinking of playing fast and loose with the law are likely to be scared straight again.

How It Breaks Down

The Bulge Bracket
There's no clear and uniformly accepted definition of this group, but it basically includes the biggest of the full-service investment banks. This is the group that matters most in investment banking, and their names confer distinction, whether you're a start-up with an IPO to sell, a Fortune 500 company planning an acquisition, or a job seeker sending out résumés. Merrill Lynch, Morgan Stanley, Goldman Sachs, Citigroup Global Markets, Lehman Brothers, Credit Suisse, and JPMorgan Chase hold top spots in this bracket, at least for the moment.

Boutique and Regional Firms
Boutiques are niche firms that focus on a particular industry, such as technology, or financing vehicle, such as munis. Regionals, as the name implies, focus on financing and investment services in a particular geographic region. The I-banking world extends beyond New York and the bulge bracket, but the list of small firms is getting smaller as the market consolidates. The strongest boutique firms—W.R. Hambrecht + Co., Montgomery Securities, and Alex. Brown—have all been acquired by commercial banks. But that's not to say independent firms are nearing extinction. In New York, Allen & Company still does big business in specialized fields.

Job Prospects

After a series of rate cuts from the Federal Reserve, cheap money flooded the markets in the early 2000s. Investment banks were managing hot IPO and M&A throughout 2005, 2006 and early 2007. Businesses began spending money again. More companies were going public. More companies were spending money to acquire other companies. Emerging markets like China and India promised vast new banking opportunities. And investment banks were enjoying stronger revenues than they’ve had in years. The credit crunch put a damper on that in mid-2007, but that seems to be easing with another Federal Reserve rate cut and positive economic indicators.

One result is that all those banks that laid off employees when the markets tumbled are now hiring. And because it’s cheaper to employ a recent grad than someone with more experience, there are a growing number of jobs to be had for the cream of the crop from the best schools. Remember: Those who do I-banking internships will have the best shot at full-time openings.