In defence of investment bankers

Ignacio de la Torre. Professor. IE Business School

13 April 2012

Holding investment bankers responsible for the crisis is a mistake. And not because they are not entirely blameless, but rather because they were led into temptation by others.

“Lately, when in dinner parties I prefer to hide the fact that I am an investment banker by profession. If I happen to reveal it, people give me worse looks than they would a paedophile”, claimed a banker and Financial Times columnist some three months ago.

The discredited status of investment bank industry has plumbed unprecedented depths, occasionally equalled by other financial sectors, such as the savings banks in Spain or commercial banks in the UK.

The underlying reasons currently being bandied around for this state of affairs include the following:

First, investment banking is seen as being responsible for the credit crunch, having handed out cheap money for mortgages, junk bonds, mergers and acquisitions, which now lie at the epicenter of the debt crisis.

Second, investment banking has become little more than a casino, where heavy bets are placed on the market using its proprietary trading mechanisms in such a way that when the price of assets go up, enormous sums of money are made, but during a slump, many banks go bankrupt and have to be bailed out by taxpayers to avoid the entire system from crashing, as in the case of Lehman Brothers.

Third, the remuneration system in investment banking has the wrong approach, entailing massive moral risks, whereby in practice its employees have made enormous sums of money at the cost of the taxpayer, basically.

If you add to these the unpleasant image of the financial shark, brash, devoid of empathy and with no principles, as portrayed in literature (e.g. the excellent, but highly exaggerated Pokers’ Liars ), cinema (Wall Street), and the press (the graphic image par excellence is that of Dick Fould, former President of Lehman Brothers), it is hardly surprising that investment banking is the perfect target for the ire of both media and general population. My opinion is, however, that it is unfair to seek out just one target when there are a whole series of causes. The situation is more the result of bad central bankers, worse regulators, and a useless political class, which make up the trinity responsible for having provided the perverse incentives that lie behind the behaviour of the different agents involved.

It’s probably easy in a damaged society to seek the people who are guilty for the current wretched situation to provide some kind of moral buffer with specific escape valves. Past examples of this include blaming the Jews for the black death in the mid fifteenth century (in spite of the fact that it originated from the Tartars) and massacring them in the terrible mob attacks that followed, accusing the Jesuits of putting poison in wells at the end of the eighteenth century, drip feeding said accusation to the general population to expedite their expulsion and subsequent suppression, and the systematic blaming of the successful Chinese trading minority of Southeast Asia for the backwardness of other segments of the population, something that they paid for in the form of legal discrimination and in many cases mass lynchings.

In the current scenario the “blame” has been shared out among a) the political class (I was the first to contribute with several articles, defending prison sentences for certain types of political conduct, and I do believe that behaviour like that of Elena Salgado in Endesa or Pedro Solbes in Enel are reprehensible), b) Spain’s savings banks (in my article headed “The Big Lie” I set out my vision in this respect, attempting to differentiate the good from the bad), c) trading banks (I also defended the classification in the penal code of certain bad banking practices being labelled as treason and being subject to prison sentences) and d) investment banking (I criticized some time ago the excesses and lack of control of banking heads and CEOs in an article headed “The Misgovernment of Banks”).

But in this instance I have adopted a stance that goes against current thinking, and today I want to throw a lifeline to the professionals in the banking industry, a sector in which I have spent ten years of my life.

First, the immense majority of the numerous professionals I have known in this industry, and I am speaking here in a broader context than merely the corporate finance arm of the sector, including those employed in stock market and fixed income markets, are extraordinarily valuable workers due to their enormous capacity to work hard, their extremely high level of productivity, their great honesty, the way they place the client’s needs first when assigning resources and processes, and the sheer talent of many of them, talent which translates into a dynamic learning process for all.

Second, the “guilt” of the investment banking sector which hinges on the factors described above, applies to only a handful of employees, specifically a small number of useless heads (I wouldn’t actually call them dishonest - Dick Fould for example, had the vast majority of his fortune invested in Lehman, if he had meant to jeopardize the bank on purpose I think he would have withdrawn his investment beforehand - they were obviously useless and therefore I believe that their decisions were as a result of blindness rather than malice). A very small group of mortgage traders, who clearly exploited the implicit support of the taxpayer in their favour, and management boards who were obviously useless and ignorant when they permitted the massive leverage of their organizations, which is what made them so vulnerable.

The problem with the banking industry does not lie with its professionals, but rather in the terrible level of management, which is a consequence of the idiotic idea that a good analyst or a good trader would make a great boss, when in practice their promotion means losing a good trader and gaining a bad boss. The investment banking sector makes a terrible business school.

Third, if the original role of the investment banking sector was to provide advice on financial asset transactions based on talent, hard work and long-term relations, cheap money led to a sudden growth in the number of firms that associated assessment with funding. These firms, courtesy of the central banks with their low interest rates, changed the industry radically, relying on short-term relations, less dependence on talent if they got funding in return, and astronomical balances that placed the whole system at risk. Fortunately, this banking model has now either been declared illegal (US) or is moribund (Europe).

Going back again to the origins of the industry, there are more than 100 billion financial assets in the world, savings levels are the highest in history, and everyone needs advice to invest all that money. You could argue, somewhat sarcastically, that a blindfolded monkey is probably as good a stock exchange analyst as any, but I don’t know many people who have placed their money with an adviser who appears to have the same level of intelligence as a monkey.

The more money is channeled toward passive tools like the ETF, the more opportunities there are for active investment, which in turn brings about a resurgence of stock exchange intermediation. With interest rates being so low for so long, high yield and convertible issues will continue, reviving fixed-income bonds. With the highest levels of cash-flow to assets in recent history, companies will use these balance sheet conditions to carry out mergers and acquisitions, thereby making corporate finance assessment services ever more popular.

The banking industry will not go back to how it has been since 1997, and I think that will be a healthy thing. It will recoup its relative importance and the capacity to change history will lie in the hands of a new class of rulers who will either manage to rebuild the iconic image of an old Warburg, or go back to their old ways with another Bear Stearns.

History will be the judge, and will decide what the cost will be.


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