How Wall Street Turned a Crisis Into a Cartel

By William D. Cohan, Bloomberg View

12 January 12

lmost 65 years ago, in 1947, the U.S. government sued 17 leading Wall Street investment banks, charging them with effectively colluding in violation of antitrust laws.

In its complaint - which was front-page news at the time - the Justice Department alleged that these firms had created "an integrated, overall conspiracy and combination" starting in 1915 "and in continuous operation thereafter, by which" they developed a system "to eliminate competition and monopolize ‘the cream of the business’ of investment banking."

The U.S. argued that the top Wall Street investment banks - including Morgan Stanley (MS) (the lead defendant) and Goldman Sachs - had created a cartel by which, among other things, it set the prices charged for underwriting securities and for providing mergers-and-acquisitions advice, while boxing out weaker competitors from breaking into the top tier of the business and getting their fair share of the fees.

The government argued that the big firms placed their partners on their clients’ boards of directors, putting them in the best possible position to know when a piece of business was coming down the pike and to make sure that any competitors were given a very hard time should they dare to try to win it.

The government was spot on: The investment-banking business was then a cartel where the biggest and most powerful firms controlled the market and then set the prices for their services, leaving customers with few viable choices for much needed capital, advice or trading counterparties.

The same argument can be made today.

Even More Powerful

Indeed, following the destruction of Bear Stearns Cos., Lehman Brothers Holdings Inc., Merrill Lynch and countless smaller and foreign competitors during the financial crisis that began in 2007, the investment-banking business is an even more powerful and threatening cartel than it was in 1947.

Today, there are far fewer than 17 firms in control of the investment-banking business. After Goldman Sachs Group Inc. (GS), Morgan Stanley, JPMorganChase & Co. (JPM), Citigroup Inc. (C), Bank of America Corp. (BAC) and Deutsche Bank AG (DBK), one is pretty much at a dead end. The investment-banking business is now both much, much bigger - in terms of revenue and profits - and much, much more concentrated than it ever was close to being in 1947.

How could that have happened? Unfortunately, in October 1953, Harold Medina, the presiding federal judge in the case, threw the antitrust lawsuit out of court. In an extraordinary 417-page ruling - a must-read for anyone interested in the history of Wall Street - Medina decided that the government’s case rested solely on "circumstantial evidence" and that the banks didn’t violate antitrust laws. Yet Medina’s ruling also laid bare the extent to which the 17 Wall Street firms would go to defend their turf and prevent other banks from getting access to lucrative, fee-paying clients. It wasn’t a pretty picture.

Today, while there is no inkling of an antitrust lawsuit against Wall Street, its cartel-like behavior is very much in evidence. The remaining banks have increased their hold over the marketplace and continue to collude when it comes to pricing their services.

Although banks will argue that all fees are negotiable, every corporate issuer knows the rules: Initial public offerings are priced at a 7 percent fee; high-yield-debt underwriting is priced at 3 percent; loan syndications are priced at about 1 percent. M&A deals are still priced off the "Lehman formula," even though there is no more Lehman Brothers.

A Fateful Offering

There was a moment, in August 2004, when things might have changed, during the high-profile IPO of Google Inc. (GOOG) The old guard on Wall Street was worried that WR Hambrecht & Co., the architect of the so-called auction IPO, might upset the pricing cartel after it successfully arranged - along with Goldman Sachs and Morgan Stanley (brought in for ballast) - for the IPO of Google to operate in a way that benefited both Google and its investors. (The stock was priced at $85 per share before trading up significantly; it ended last week at about $650 per share (GOOG)).

But after the initial hoopla, the promise of what Hambrecht was trying to do - give the market, rather than the underwriters, the chance to set the price - largely faded. None of the recent high-profile, high-tech IPOs either completed (Zynga Inc (ZNGA). and Groupon Inc (GRPN).) or being contemplated in the coming months (Facebook Inc.) seriously considered the Hambrecht alternative. The cartel, now with even fewer members, continues to rule the IPO market. The renewed power of the Wall Street cartel may be the worst consequence of the 2008 decision to rescue Wall Street rather than let it collapse under the weight of its broken business model. Sure, the corporations are struggling a bit now - profits are down, bankers and traders are being fired in droves and new regulations are being crafted every day - but when the economy returns to full strength the iron grip of the remaining Wall Street powerhouses will be readily apparent.

In a rare show of backbone toward Wall Street, President Barack Obama’s Justice Department flexed its muscles last year when it sued to block the merger of AT&T Inc. (T) and Deutsche Telekom AG (DT), causing it to be scuttled and hundreds of millions of dollars in fees to be lost. The administration should build on that success. Sixty-five years late, let’s break up the Wall Street cartel and re-establish the integrity of the capital markets.

(William D. Cohan, a former investment banker and the author of "Money and Power: How Goldman Sachs Came to Rule the World," is a Bloomberg View columnist. The opinions expressed are his own.)