Investment banking isn’t risky. What’s dangerous is creating stand-alone firms that can’t diversify.
The 1999 repeal of Glass-Steagall was unfairly blamed in the aftermath of the 2008 financial crisis. Some people—apparently Mr. Cohn among them—mistakenly believe that investment banking is so risky that it should be once again kept separate from commercial banking. The truth is exactly the opposite: Traditional investment banking entails very little risk. The danger is stand-alone investment banks that are not diversified enough to survive a shock.
..Banks are at risk of failure when they become too concentrated by geography, industry or product line. Risk needs to be diversified so that no one mistake can bring down the entire institution. Even firms like Citigroup
and Bank of America
that made a series of mistakes in the 2008 crisis survived because they were diversified. Investment banks that were not properly diversified did not survive: Bear Stearns, Lehman Brothers, Merrill Lynch.
..The major perpetrators of the 2008 financial crisis were 20 or so institutions
that had originated, securitized and distributed exotic subprime mortgages with toxic features. About 10 investment banks packaged mortgages made by savings-and-loan associations
such as Countrywide
, Washington Mutual
and Indy Mac
, and by state-chartered mortgage brokers—many of which committed outright fraud. These S&Ls were the remnants of an industry that had cost taxpayers some $150 billion during the 1980s and early 1990s. Notably absent from this array of culprits were large commercial banks, with an exception or two.