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November 15, 2006

A Return to the Banker's Honor Code

Jonathan Knee wants to bring back the traditional values of investment banking's early days -- before junk bonds, LBO funds and the Internet bubble changed everything.


In your new book, The Accidental Investment Banker: Inside the Decade That Transformed Wall Street, you talk about how the Internet boom in the 1990s transformed the world of investment banking.

For most of the last century, investment-banking firms all bought into what Ron Chernow has described as the gentleman banker’s code. This referred not only to how they dealt with each other, but how they dealt with clients. Clients were for life — and actually, longer than life, since clients were handed down from one generation of bankers to the next. Indeed, the entire idea of calling on a new client or trying to steal a client was total anathema.

In my book, the diminutive former chimney sweep Sidney Weinberg, who ran Goldman Sachs for 40 years, is cast as the unlikely hero of the story. Weinberg was an iconic figure in early investment banking, and he believed that the role of the banker was to serve the client, the firm and the public. He was so devoted to clients that he would get off of a train if it served food produced by a competitor to one of his clients. In the current world, that kind of loyalty is seen as completely anachronistic.

Weinberg died in 1969, after having run Goldman Sachs for four decades. His son, John Weinberg, died in August. The heart of this book is really about how the investment banking world changed between the death of Sidney and the death of John.

How did the culture start to change?

In the 1970s, several things happened that shifted the kind of business these firms conducted. This was the decade when the first M&A departments sprung up. Before, mergers and acquisitions were something that you frequently did for free for a long-standing client. Similarly, junk bonds as a business didn’t exist before the early 1970s in a big way. These firms also started establishing their own LBO funds and investing their own money in deals. There’s nothing evil about any of these changes, but each had, in its own way, an incremental impact on the culture.

In the context of junk bonds and M&A, the point is that firms used to do business only with companies that met very rigorous criteria. Unless you were the quality of company that the firm wanted to be associated with, they wouldn’t deal with you. Well, once you agree to be in the business of selling companies — which is what M&A is — you’d be happy to sell many companies that are much smaller and less established, even if you wouldn’t be happy to underwrite them in the public markets.

I interviewed a number of bankers who were in the early M&A group at one firm, and they talked about how their colleagues looked down on them for associating with these less highfalutin clients. And junk bonds, by definition, are for more speculative credits. So with M&A departments and junk bonds, the standard of whom these institutions would do business with started to go down.

A subtler distinction is in establishing M&A as a separate business. Making it a separate business rather than part of the overall client relationship suddenly moved the focus of these institutions from relationships toward transactions. And with the establishment of LBO funds, these firms crossed an even more significant line. For the first time, these institutions were putting themselves at cross-purposes to their established clients. They could be in the position of competing to buy an asset for their own account that a long-standing firm client wanted to buy. All of these tensions were managed reasonably well for many years, but the Internet boom changed the balance fundamentally.

How did the boom upset the equilibrium?

With the arrival of Internet companies, the volume of business and the potential for profit exploded to such a dramatic degree that the firms were faced with a very stark choice: they could let their market share decline, or they could let their standards decline. To a greater or lesser degree, everybody chose the latter.

The standards decline affected how they managed conflicts, the quality of the firms they were willing to underwrite and the extent to which they were focused on the short term rather than the long term. It became overwhelmingly about the transaction rather than the long-term relationship. Everything went out of whack, and it profoundly undermined the perceptions of these institutions by both clients and employees.

You refer to the attitude of bankers during this period by an acronym — IBG YBG.

That meant, “I’ll be gone, you’ll be gone.” It was something that people said on the high-yield floor, reflecting the sentiment that the ultimate fortunes of the companies being sponsored were someone else’s problem. This exemplified the basic failure of investment banks during the boom era. Firms once seriously asked whether they should underwrite a company, not just whether they could.

Has the atmosphere improved, now that the good times have passed?

Most investment bankers want to do good by their clients, but different institutions have done a better or worse job at fixing the problems. Broadly, when the bust happened in the early 2000s, these institutions as a group did not take that as an opportunity to redress the excesses. Instead what you saw at most firms was incredible infighting over the few remaining scraps.

Some reviewers have described your book as a tell-all. What sort of reaction have you received from colleagues?

A number of commentators have suggested that I’d never eat lunch in this town again. But the interesting thing is that many investment bankers who have been around for a while are equally sentimental about what things used to be like and are equally frustrated about how things have become. So I’ve actually gotten a fair amount of positive feedback.

Also, I wanted to reach current investment bankers. Most investment bankers today have been in the business for five years or less. They have no historic context for what they do and why things are the way they are. Without historic context, it makes it much more difficult to make the right choices.

There are a lot of really good people in the industry. Some of these issues are structural, but many of the worst excesses are really the result of individual decisions by individual people. It’s really a question of what choices you take. I wouldn’t have written the book if I didn’t think people could make better choices in the future.

Jonathan Knee is director of the Media Program and an adjunct professor of Finance and Economics at Columbia Business School and a senior managing director at Evercore Partners.

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