What Investment Banks Do

The Blond saw me reading the Wall Street Journal in the coffee shop the other day and sat down next to me.

"Hey," she said, "I didn't know you were a financial expert."

"Well," I said, modestly, "I wouldn't consider myself an ex-. . . ."

"And so," she interrupted, "I'll bet you can answer this question that's been bothering me."

"Which is?"

"Well, everybody's mad because the big investment banks are giving billions of dollars of bonus money to the executives that caused all the trouble on Wall Street.  But what exactly do investment banks do?"

I assumed my Scholarly Mien, cleared my throat, and said:

"Investment banks work for companies and governments by issuing and selling securities, both equity and debt, and. . . ."

"Oh, goody," The Blond interrupted.  "How much do you suppose I could get for my maxed-out Visa card?"

"Doesn't qualify.  If you were General Motors, say, or Fannie Mae. . . .But please permit me to continue.  Investment banks sell credit default swaps; help companies go public, merge or make acquisitions; handle divestitures; package and trade derivatives and all kinds of securities -- fixed income, foreign exchange, commodity and equity securities.  Let us suppose that you were a major target.  The investment bank would work up a pitch book and. . ."

"Sweetie pie, you're losing me.  I'm a blond after all.  If they buy debt but won't buy my Visa card debt, what good are they?"

"That would depend on whether you were a client of the buy side or the sell side.  The front office would decide that.  Then they'd get information from the middle office regarding principal risk, macroeconomics, hedge exposure and otherwise capture accurately the exposure risks.  Then  the back office. . . "

"That must be the one with the escape door for when the front office is full of people who are mad as hell about the bonuses, right?"

"Not exactly.  In the back office they data-check trades, maintain information technology and create the Chinese wall between. . .."

"Enough already," she exclaimed. "I just don't get all this technical stuff, and I certainly don't know from Chinese walls!"

"OK," I said, "try this.  Say you've got a lot of money.  Casino Jack comes around and says, 'You should put that money to work.  Invest it in Las Vegas.'  But, you say, I don't know anything about blackjack or faro or roulette.  'Not to worry,' says Casino Jack, 'just give me all your money and for a modest fee I will invest it for you because it just so happens that I am an expert at faro and roulette and blackjack as well as many other such forms of investment.  If we win, I will of course deduct another modest fee before giving the winnings to you and making you rich beyond your wildest dreams.'  But, you say, what if we lose?  And Casino Jack, he says, 'Honey, "we" don't lose.  "You" lose and I go out and find another sucker.'"

The Blond shouted, "Now I get it.  Investment banks are like Casino Jack.   They gamble with other people's money.  As long as people keep giving them money, and they sometimes win, every thing is fine.  But if they lose, and people don't give them any more money, they go out the back door to the government and get more money and start the game all over again."

"Bingo," I said.  "This time she's got it!  Who said Blonds are dumb?"