In the midst of a very big day for the Dow Jones Industrial Average, which closed today near its all-time high thanks to shining earnings reports from J.P. Morgan and Johnson & Johnson, brokerage firms Merrill Lynch and Donaldson Lufkin Jenrette (DLJ) finished the day down after reporting second-quarter earnings that didn't live up to Wall Street's elevated expectations. DLJ actually beat analysts' estimates by 3 cents, but its stock had already risen 52 percent this year, so investors were presumably looking for a blowout quarter. Merrill, meanwhile, fell a penny shy of forecasts. Of course, in absolute terms both companies turned in stellar performances, with earnings up sharply and revenues continuing to rise as a result of the bull market. But the investment banking/brokerage sector has been so strong over the past year, recording real growth in earnings where most corporations are struggling just to keep up, that anything less than excellence was bound to be frowned upon.
The dramatic boom in merger-and-acquisition activity, and in the underwriting of bond and equity offerings, has been instrumental in these companies' recent success. Still, there is something curious about the fact that, even as we move toward what is often described as a "disintermediated" economy, investment banks and brokers--the ultimate middle men--are more prosperous than ever. The explosion in Internet stock trading clearly has the potential to eat away at the still lucrative brokerage business, and it's plausible--though not necessarily probable--that soon corporations will take their bonds or equities directly to buyers, rather than letting investment banks take their often sizeable underwriting fees. But for the foreseeable future, being the gatekeeper to the public markets remains an enviable position.
In part that's because investment banks take a so much bigger chunk of the offerings they underwrite, and in part it's because the offerings are so much bigger and so much more common. (Historically, U.S. corporations almost never issued secondary stock offerings--that's when an already-public company sells additional stock to investors--and tended to use retained earnings to fund growth.) In some important respects, we still live in the world created by the Wall Street of the 1980s.
By way of contrast, yesterday I was reading The Seven Fat Years. This is a book about Wall Street in the 1950s, written by John Brooks, who was the New Yorker's first real business writer, and one of the first writers to attempt to make business and the stock market interesting and comprehensible to mainstream readers. One chapter of the book is an account of General Motors' first-ever secondary offering, in January of 1955. Brooks writes of the underwriting process: "Morgan Stanley, as [lead] underwriter, collected $82,439.04 for its share of the risk, and it also received $55,973.30 for managing layoffs, which had totalled 560,200 shares. These fees, together with its fee for management services, presumably made Morgan Stanley happy."
Later, in a chapter about the Ford Motor Co.'s initial public offering (IPO), Brooks writes: "[B]etween five and ten percent of the total [of the available Ford stock] would go to institutional investors--investment trusts, pension funds, insurance companies and the like. A slightly bigger block, amounting to something over ten per cent, was being reserved for the Ford dealers and selected Ford employees. The rest was to go to the public, and all the participating securities dealers were agreeing, in the underwriting contracts they would sign with the management group, not to sell any one customer more than a hundred shares until all orders for a hundred shares or less had been filled."
Imagining people at Morgan Stanley being really excited over making $130,000 (which was less than 1 percent of the whole deal), and Ford limiting institutional investors to 10 percent of an IPO, is like imagining what it was like to go to a penny arcade or to Atlantic City when it was just a resort town. The business world Brooks describes seems so oddly innocent, so unvoracious that he could just as well be talking about children playing Monopoly. There are good reasons why we don't run our economy the way we did in the 1950s. But still.