Let's pause and shed a tear for a class of American workers who are suffering unduly thanks to big, uncontrollable trends in the global economy. The rise of China and heightened government involvement in the U.S. economy are placing sharp downward pressure on their wages. The slowdown and uncertainty in the markets is reducing demand for their services. They've become political punching bags.
Unionized blue-collar employees? No, I'm talking about America's investment bankers—especially those who specialize in the art of underwriting new stock and bond offerings. The recently concluded second quarter was a stinker for them—issuance was way down from the frenzied pace of capital- and debt-raising in the first half of 2009. On Monday, embattled Goldman Sachs reported that the firm's underwriting business produced revenues of $445 million in the second quarter, down 58 percent from the second quarter of 2009. Revenues from underwriting stock sales were off 70 percent. In JPMorgan Chase's second quarter, equity underwriting fees were down 68 percent. Citi reported that debt and stock underwriting revenues were off 32 percent and 30 percent, respectively, from the year-ago quarter.
What gives? Volume is down in these banks' core market. Thomson Reuters provided me with data showing that equity issuance in the United States was off about one-third in the first half of 2010 from 2009, and debt issuance was off about 22 percent. Since underwriting is a commission-based business, fewer, smaller deals produce fewer and smaller commissions.
But other shifts in the global economy are hurting their business. Underwriting new issues of stocks and bonds has been a great racket, particularly for initial public offerings. It's an extremely competitive business, we are assured; and yet it's one in which the largest firms frequently collaborate as co-underwriters and in which fees always seem to come out to be between 6.5 percent and 7 percent of the value of the IPO, with little or no discount for volume. A $100 million IPO generates $6.5 million in fees and a $1 billion IPO generates $65 million in fees. In the recent IPO of electric car maker Tesla, according to the prospectus, underwriters took home a commission of $1.105 per share on the $17-per-share offering—or about 6.5 percent.
The changing shape of the global economy is altering the mix of business for investment bankers. I noted four years ago that companies staging IPOs in Europe pay significantly lower underwriting fees than firms going public in the United States. In Asia, rates are lower. In the recent $19 billion IPO of China's Agricultural Bank, which was staged simultaneously in Hong Kong and Shanghai, a consortium of investment banks including Goldman and Morgan Stanley, "agreed to reduce the total gross fee pool from about $206 million to about $142 million," the Financial Times reported. (BloombergBusinessweek has more details on the fees and suggests they amount to less than 2 percent of the offering. Yet another sign of how China is squeezing margins.)
Of course, China is an increasingly important source of new equity offering business. Renaissance Capital has a lot of excellent data on global IPOs. So far this year, 222 IPOs around the world have raised $106 billion—an average of $474 million per IPO. But America's 68 IPOs raised just $10.4 billion—about $150 million each and just 10 percent of the total. By contrast, the Asia-Pacific region accounts for 68 percent of the total dollars raised in IPOs so far this year. Here's a chart on the global market for IPOs, a list of recent pricings, and a list of top underwriters for U.S. IPOs. In 2009, the largest IPO in the United States was a $371 million offering of battery maker A123 Systems, a midget compared with many of the deals coming out of China. With each passing month, the high-margin U.S. IPOs that used to be investment banks' bread and butter are becoming a smaller part of the global business.
In addition, in the wake of the bailouts, the U.S. government is proving to be a substantial consumer of investment banking services. Firms that want the taxpayers' business are finding they must reduce their commissions. For example, Morgan Stanley is handling the slow-motion sale of the government's huge stake in Citi. But as this prospectus shows, the government is paying Morgan Stanley "a commission of $0.003 per share sold by Morgan Stanley using electronic trading systems and $0.0175 per share sold by Morgan Stanley using other means." Given that the sales of Citi's stock have been conducted at about $4 per share, Morgan Stanley is receiving infinitesimal commissions. Morgan Stanley is also likely to handle the initial public offering of government-controlled General Motors—but at a sharp discount to the fees it would charge, say, Ford for similar services. Other investment banks have become involved in TARP-related business by, for example, underwriting the sale of stock warrants Treasury received in exchange for injecting capital. Here, again, they're getting paid more like civil servants than masters of the universe. The prospectus for the recent sale of warrants in Valley National says Deutsche Bank received $155,000 in commissions, about 2.7 percent of the total sale.
Of course, even these discounted rates might strike many of us as high. Given the extraordinary aid taxpayers have extended to the financial system—and especially to the big investment banks—they should probably be providing some of these services to the government for free.