Investment Banks and Capital Markets

Over the weekend of 12–14 September 2008, the heads of Wall Street's largest firms met at the New York Fed to find a buyer for Lehman Brothers. There was no public money on offer. Bank of America, the most likely buyer, agreed instead to buy Merrill Lynch for about $50 billion. Barclays was willing, but the UK's Financial Services Authority would not waive the shareholder vote it needed, and the British government was unwilling to take on the risk. On Monday 15 September Lehman filed for bankruptcy with about $639 billion of assets and about $613 billion of debts, the largest bankruptcy in US history. The next day the Reserve Primary Fund, a money-market fund holding about $785 million of Lehman paper, "broke the buck", and investors began pulling money from money funds across the country.

Six days after Lehman's filing, on 21 September, Goldman Sachs and Morgan Stanley became bank holding companies, accepting Fed supervision in exchange for permanent access to its lending. On 23 September Berkshire Hathaway bought $5 billion of Goldman preferred stock paying 10%, with warrants to buy $5 billion of common shares at $115. Goldman sold about $5 billion of common stock the same week and took $10 billion of TARP capital in October. One firm survived the weekend and one did not, and the difference had less to do with the quality of their bankers than with whether their lenders kept lending. This chapter explains how investment banks earn, why they are fragile, and how trust in their conduct became as important as trust in their balance sheets.