Capital markets: From cottage industry to powerhouse

In 1969 Hans-Joerg Rudloff was a trainee at Kidder Peabody in New York, learning the history of Wall Street from its chairman, the legendary Albert Gordon. Gordon had been put in charge of the firm 40 years earlier, as it struggled to survive after the 1929 crash, by John Pierpont Morgan junior himself.

As well as learning the living history of Wall Street and striving to create a present role for himself, the young Rudloff had an eye to the future.

A stream of unusually strongly worded telexes began to arrive from some trader in London called Stanley Ross, saying that Kidder was missing the birth, or re-birth, of an international financial market in London, called by that time, the Euromarket.

It was going to be huge. Rudloff asked to go home and take part.

What he found, running distribution in Geneva, didn’t quite live up to the billing. A big deal in those days was perhaps $15 million. Rudloff first ran the sales operation in Switzerland, then the most liberal market in Europe. Over the next three or four years he created a retail and institutional clientele, which at a later stage allowed him to add a capital markets business to Ross’s trading operation and bring to the firm corporate and later sovereign issuers.

Initially, the international Euromarket was small compared with its domestic counterparts. But it grew rapidly.

The pioneers of the new business were always missionaries, always salesmen, even the intellectual Michael von Clemm, who joined forces with Rudloff at Credit Suisse White Weld and later built Canary Wharf.

“He was a tall, imposing figure and he was always professor von Clemm,” Rudloff recalls. “But above all else, however deep his understanding of finance, he was first and foremost a brilliant salesman of a new market.”

The collapse of Bretton Woods and fixed exchange rates together with the extraordinary rise in the dollar wealth of oil exporters after the price shocks of the early 1970s – much of that wealth re-invested into the Euromarket through Switzerland – powered the growth of the new international market for capital.

National authorities across Europe that had kept every penny they could at home for rebuilding after the Second World War began to relax their rules and investment in debt and equity began to flow across borders once more in search of return and diversification, just as it had in the years before the First World War. Volatility sprang up in both exchange and interest rates.

“With no one setting out the ambition or a precise plan, the pieces fell into place and slowly but surely this big new Eurobond market began to grow,” Rudloff recalls.

Over the next 25 years, the $50 billion Eurobond market grew to around $2.5 trillion.

Talk to capital markets veterans still running businesses today or who have now stepped away from the markets since the 1970s and that sense of various pieces falling into place and driving the whole thing forward is a recurring feature of their recollections.

Often technology change was a central aspect to any new phase of development; what began as a cottage industry among a handful of UK and Swiss merchant banks in London grew into a vast institutional business.

The capital markets always adapted.

A decade on from the pioneering days of Rudloff, Ross, von Clemm and the rest, a young Guy Hands took a job trading Eurobonds at Goldman Sachs in London. It was 1982, still years before Big Bang. This was not a typical job for an Oxford graduate, pitching Hands in with the Essex boys.

Traders would get into the office at 6.30am and the first task was to calculate yields on the bonds they would be trading, off just two or three points on the three-month to 30-year US Treasury yield curve. Then it was time to hit the phones.

It was primitive. Experienced traders developed an instinct for whether the other party wanted to buy or sell and adjusted prices up or down by 25bp at a time. You could make a fortune or lose one.

“We traded all day every day like that, and the idea was that by the time you went home you should be flat,” says Hands. “You could not sell more than you actually owned because then you would be bought in and, as these were bearer bonds, that would be very expensive. There was a whole list of bonds you simply could not short at all.”

The job involved a lot of dealing against other firms’ traders, rather than buy-side execution desks as today, or interdealer brokers. It was a free for all.

“If they made a price to you, you had to quote a price to them,” says Hands. “Occasionally you would come across some new junior trader trying to be all macho and that would generate a trade as you would lift the poor guy and he would spend the next three months trying to buy in his short.”

Within five years, Hands was running the Eurobond trading desk in London. He was still in his mid 20s.

“It was an extraordinary time,” he recalls. “And the American banks were also handing out extraordinary annual bonuses: maybe £500,000 at a time to people my age when that was enough to buy a couple of houses in Pimlico. And this was to people whose next pay point, if they got laid off, was maybe £60,000 a year.”

The business gradually became more sophisticated. In the primary market, banks managed to develop an infrastructure that enabled large global bonds, beginning with a C$1.25 billion offering for Ontario Hydro and soon followed by the World Bank and sovereign issuers.

John McNiven, who had come up through the derivatives business at Morgan Guaranty and moved into debt capital markets at Merrill Lynch, worked on that Ontario Hydro deal and saw a new era begin.

McNiven recalls a $4 billion multi-currency floating rate note for the Republic of Italy – “nothing of that size had been done” – and the rise of regional lead managers.

“Previously there was only one lead manager on a bond deal,” he says. “It was winner take all. It seemed much better for the client to bring in regional leads, each bringing their separate distribution strength to bear. The global bond concept allowed this to happen.”

As primary deals got much bigger and more liquid, firms soon realized they couldn’t hedge Eurobonds against other Eurobonds but instead had to hedge them with governments. With the arrival of computers and new analytics to gauge these risk spreads, voice dealing declined and the skills and instincts of traders, who could tell from tone of voice if a counterpart wanted to buy or sell before adjusting their prices by a quarter of a percentage point, came under threat.

The good news was that volumes increased enormously and banks were able to hedge and put on more complex trades. The margins for the front book traders declined, but there was real money now in the back book from risk management and principal trading.

The investment banks were on their way to becoming, if not hedge funds, then something quite close to that.

The equities business underwent a similar

transformation in the 1970s and 1980s, again growing from a cottage industry to industrial scale.

In the US, retail wirehouse brokerages dominated distribution in the 1960s and early 1970s. The investment banks that advised companies on strategic decisions like raising capital didn’t do much in the way of trading or sales themselves. They were private partnerships, like law firms. If a company wanted legal advice it would ring its designated lawyer and if it wanted financial advice it would contact its investment bank. Competition between them was hardly cut throat, although they were all wary of new trading firms like Salomon Brothers and later Drexel Burnham Lambert.

Even the so-called bulge-bracket investment banks had tiny balance sheets, with no more than a couple of hundred million of capital, maybe a couple of thousand employees in total, including all support staff. The big commercial banks were the lead providers of debt finance through syndicated loans but were still not allowed to underwrite new issues due to securities laws, particularly the Glass-Steagall Act, brought in in the early 1930s to prevent a repeat of the Great Crash and the ensuing depression.

Eric Dobkin joined Goldman Sachs in 1967 and spent his first 10 years in such glamorous roles as equity distribution in Philadelphia and covering institutional accounts in the mid-West, before being given the task of re-patterning the primary equity market business around the new institutional investors managing mutual funds and pension fund assets.

What emerged was a process of corporations coming to the investment banks to market new share offerings to these portfolio managers, with the aim of winning them over as a stable long-term shareholder base that would regularly meet management, stay close to the company, understand it and hopefully support future issues for investment or maybe M&A deals.

Today, as the average period for public shareholders to own stocks shortens and private capital pools grow bigger and more willing to hold illiquid positions much longer in the hope of higher returns, the primacy of the public stock markets is in question.

It was very different back in 1983 when Vikram Pandit arrived at Morgan Stanley and went to work in the equities division.

“Mutual funds were still nascent, and achieving diversification of physical assets was hard,” recalls Pandit. “Futures and options trading had only recently started and modern finance theory was only just making its way onto Wall Street. Dick [Richard] Fisher [who became president of Morgan Stanley in 1984] talked about a few big trends the firm had to get in front of: the importance of analytics and technology, globalization and deregulation, all of which he was convinced would lead to greater disintermediation.”

Morgan Stanley was an investment bank that covered companies that sometimes needed to do mergers and acquisitions, and sometimes to raise capital.

“Morgan Stanley couldn’t just cover the people who needed capital any more, we also had to cover the owners of capital, and that meant building sales and trading,” says Pandit. “The firm had hired Barton Biggs in 1973 to head research, but we needed to build on that.”

Investing in analytics was part of it.

“There was a Reuters screen in the middle of the trading room, but you had to walk over to it to read market rates,” says Pandit. “I got a Quotron machine on my desk to read stock quotes and we had a couple of Apple IIs on the floor. That was the starting point, and then things moved fast. We built out futures and options in the US and then globally.”

His job, like Dobkin’s, was to build out equity capital markets.

“We had trading and distribution and then equity syndicate, which took responsibility when a company needed to raise equity,” says Pandit. “But we realized we also needed corporate finance bankers who understood capital markets and all the products in depth and who could also talk to companies about their industries and financing needs. Our advantage was that the US had a heritage of equity offerings and rules around underwriting. So we were able to talk to the SEC about stabilization, for example.”

The firm had sought to expand internationally, first opening in Paris before realizing this was a mis-step and putting more people in London. Zurich had also hoped to be the centre of Eurobond trading and new issues, but London had greater heft, partly thanks to sharing a language with the US, the world’s biggest capital market, and partly for the memory of sterling’s role as a world currency, although the dollar had now taken that.

And just as London had become a centre for international bond trading and debt capital markets, there now followed the UK and subsequently other European privatizations, big offerings of shares in state utilities.

“You have to hand it to the UK privatizations,” says Pandit, “as a huge driver of international equity capital markets.”

It is intriguing how often leading figures from the history of capital markets refer back to the days of Margaret Thatcher and Ronald Reagan. Their political ideology of free-market capitalism and deregulation seems somehow to be inextricably linked to the extraordinary growth of secondary and primary securities markets.

“If you think back to the collapse of the Soviet Union in the early 1990s, an event which signalled the non-military victory of one political and economic model over another,” says Rudloff, “the dogmatic approach of [UK prime minister] Margaret Thatcher and [US president] Ronald Reagan, to deregulate, de-nationalize and liberate the forces of competition and innovation changed the world.”

Ken Jacobs, now chief executive of Lazard, arrived at Goldman Sachs in 1984, when it was still a private firm, had about 70 partners and approximately $700 million in capital.

“In the 1980s there was a technology shift on Wall Street, a move from extracting data from annual reports and calculating with pencil, paper and slide rules, toward using for the first time desktop computers, calculators and spread sheets,” Jacobs recalls.

It was almost a primer for the decline of marginal computing costs to close to zero in the 1990s and then the emergence of cloud computing and open source software today.

Back in the 1980s, says Jacobs, “technology made it fundamentally easier to do cash-flow analyses and to predict how companies might fare through economic upturns and downturns.”

And that unleashed a torrent of financial activity.

“At the same time, there was an ideological shift following the elections of Thatcher and Reagan,” recalls Jacobs. “The allocation of the benefits of capitalism had shifted more towards labour in the 1930s but now shifted back to capital. In the 1980s, the concept of companies’ responsibility to maximize shareholder value took primacy. That spurred M&A activity, including hostile takeovers that were often heavily leveraged, as a way to create value for shareholders.”

Most bankers rejoiced that this would be good for the world and pay them wonderfully well too. Warning voices were few.

“I remember Felix Rohatyn, the senior partner of Lazard Frères in New York at the time, expressing the view that this would not be good for the long-term health of capitalism,” says Jacobs.

Not many bankers that Euromoney ever came across shared that concern. It seemed that stridently free-market political ideology and heightened volumes of financial market activity produced good results. A debt super cycle unfolded. Perhaps financial markets really were efficiently allocating capital to its most productive users.

In 1969, world GDP was $2.688 trillion according to the World Bank, as measured in 2017 dollar terms. A decade later, it had more than tripled to $9.919 trillion and it doubled to just over $20.1 trillion in 1989. By 2008 it had tripled again to $63.575 billion and though it dipped to $60.267 billion in 2009, and suffered another fall from 2014 to 2015; it had risen to $80.738 trillion by the end of 2017.

The earth’s population has multiplied too of course and per capita world GDP growth has been slightly less impressive, but it has still grown by 14 times over the 50 years since Euromoney was founded.

Was this cause and effect?

Nobody in banking paused to debate political ideology too much from Big Bang in the mid 1980s onwards, when the industrialization of capital markets took a big step forward as large banks bought up specialist stockbrokers and traders, and devoted more and more capital to trading securities and all their derivatives, as well as to underwriting and distributing new issues.

No one seemed to worry too much that intermediaries, who had once been brokers working in their clients’ interest, were now principal players trading in competition against them. In the US, big banks chipped away at Glass-Steagall, gaining permission to underwrite and distribute bonds and ultimately equity and anything else.

For the 20 years after Big Bang, new financial products – interest rate and currency swaps, futures and options, swaptions, junk bonds, warrants and convertibles, credit default swaps, credit indices, structured credit, securitizations of everything from mortgages and re-mortgages to credit card portfolios to whole company cash flows, collateralized debt obligations, CDOs of CDOs, leveraged buyouts – spilled from bankers’ minds into the pages of Euromoney.

Some of the instruments that took financial markets into crisis 10 years ago and have been damned for excessive complexity, were originally devised for quite legitimate purposes.

“Credit derivatives started as a hedge for banks’ own loan books and operated like that for many years before suddenly accelerating and becoming increasingly sophisticated amid the search for yield enhancement,” says Samir Assaf, chief executive of global banking and markets at HSBC. “They allowed for increasing leverage as banks developed derivatives on the derivatives and also led to far more maturity mismatching.”

Euromoney reported on huge deals for sovereigns, corporations and banks – global bonds, super-liquid bonds, hybrid bonds, high-yield bonds and structured notes – on successes and failures of new technology – e-bonds, the arrival of the internet, single-dealer trading platforms, multi-dealer mutually owned platforms and publicly quoted platforms.

There were ground-breaking privatizations, marketed secondary offerings, block trades and disasters and collapses too. There were intense debates about book building, price discovery, underwriting fees, jump ball and pre-agreed economics.

There were crises and resolutions.

We covered the Latin American debt crisis and the sovereign debt swaps and Brady bonds it spawned; the equity crashes of 1987 and 1989 and subsequent recoveries; the highly leveraged loan bust at the start of the 1990s – and then the fortunes made in distressed debt. We were all over the Asian boom and then the Thai baht devaluation, the subsequent foreign currency debt crisis and the replay of what had happened in Latin America 15 years earlier in Korea and elsewhere.

Free-market ideology and the increasing financialization of developed and emerging economies were taken as a given, especially after the fall of the Berlin Wall in 1989. There was a belief that countries in the former Soviet bloc, including a re-unified Germany, would be transformed by the free flow of capital and the adoption of what came to be called the Washington consensus: privatize everything, lift capital controls and deregulate finance.

Look at Asia.

“The emergence of Asia over the last 20 years as a centre for capital formation, especially when you consider that it has leapt ahead of Europe and emerged as a competitor to the US, is quite extraordinary,” says Mo Assomull, head of global capital markets at Morgan Stanley. “Volumes have tripled since the 1990s. The region’s recent IPOs are the largest to ever be done globally: $18 billion for AIA; $20 billion for Agricultural Bank of China; $25 billion for Alibaba.”

No wonder Morgan Stanley and many other firms have made building up in Asia a priority to get in among these new-issue flows.

The warning signs, especially relating to leverage, flashed periodically but somehow markets always seemed capable of reviving quickly after each crisis.

At the same time as Pandit was building equity trading and capital markets at Morgan Stanley in New York, on a different floor a young Bob Diamond was learning the critical importance of repo and securities finance infrastructure to debt markets.

He went on to build one of the only successful European investment banks ever to achieve global scale, through leadership in foreign exchange, fixed income and risk management. But Barclays Capital was nearly scuppered before it got going.

Barclays had sold the equities business it acquired at Big Bang to Credit Suisse in 1997 and Diamond was trying to build a rump sterling debt firm.

“We had no chance to mimic firms like Morgan Stanley and Goldman Sachs,” Diamond tells Euromoney. “We didn’t have the expertise in the US or the profits in the UK. But we had a triple-A balance sheet and we hired good people in fixed income and FX and DCM and derivatives in the UK, and when we had a base there we expanded in Europe with the advent of the single currency. We hired a big team from Deutsche Bank and over time grew into global leader in financing and risk management.”

In 1998, its results were hit by exposures to Russian bonds, when the country broke all known rules and defaulted on its domestic debts, and then to Long Term Capital Management (LTCM), an over-leveraged hedge fund staffed by financial geniuses.

How did Barclays Capital survive?

“Thankfully the exposures were not outsized and there was strong support on the board for the direction in which we were going,” says Diamond. “We learned a big lesson though. We stopped proprietary trading. You can be good at it, but you’ll always have a bad quarter or two, and that’s very difficult for any public firm.

“For the next 10 years, we didn’t have a single loss-making quarter.”

But problems were hiding in plain view as banks and financial market participants grew accustomed to being protected from the consequences of their miscalculations.

In his play ‘The Lehman Trilogy’, the Italian dramatist, Stefano Massini, starts and finishes with the famous image of the darkened offices where employees learned of the firm’s collapse in 2008.

He doesn’t look forward to Diamond turning up a couple of days later and Barclays giving many of them jobs again, simply changing the colours on the iconic office above New York’s Times Square to blue instead of green. Rather, he takes the story back through the history of a firm that began as a store in Alabama selling to cotton farmers. It expanded into cotton trading and other commodities then finance and Wall Street, surviving all manner of crises from a fire devastating the cotton crop to the American Civil War, the First World War and the 1929 crash, embedding in its founders and their heirs a sense that the firm would always survive.

Did central banks and regulators create the problem that hit in 2008 by excessive accommodation after the stock market crashes of 1987 and 1989 and then the leveraged loan and commercial real estate lending crash at the start of the 1990s, then Asia, Russia and LTCM and finally after the terrorist attacks of September 11, 2001?

There was always an excuse to accommodate. Citibank was to all intents and purposes bust in 1992 until the Fed lowered short-term rates and engineered a steep yield curve to bail it and the other banks out. Of course, that encouraged mal-investment. It always does. Bond traders at Goldman Sachs earned so much in 1993 that every department went long in 1994 and when rates rose it nearly broke the firm.

After Asia in 1997 and Russia and LTCM in 1998, then again after the dot.com bust in 2001 and the attack on the twin towers, central banks always rode to the rescue. Banks thought they would always be bailed out.

“The bursting of the dot.com bubble at the start of the 2000s was like the bursting of a pimple,” says Jeremy Isaacs, who was chief executive of Lehman Brothers outside the US and now heads JRJ Group, a private equity firm. “It actually set the markets up for a period of intense innovation. And after 9/11, when Greenspan kept rates low for so long, a remarkable bull market created so many opportunities – for leveraged loans, for M&A, for equity finance and for IPOs – people ignored the leverage being built up.

“Looking back, the seven years from 2000 to 2007 were extraordinary,” he adds. “The notion that financial services contained an embedded put had certainly taken hold. When governments and central banks failed to provide it in 2008, it cost the world many trillions of dollars.”

Standards of behaviour had deteriorated long before then. In 1991, it emerged that Salomon Brothers had been submitting false bids and seeking to gain advance knowledge of the outcome of US treasury bond auctions. The firm was fined, but it was not subject to criminal proceedings, being later bought by Travelers and folded into what became Citigroup, where many of the firm’s traders and bankers, not implicated in any wrongdoing, thrived. A few of the brightest went on to raise money for a big hedge fund called LTCM. “After that, you saw standards trending down among the gatekeepers to capital, bankers, lawyers and accountants, leading to the corporate and accounting scandals among dot.coms and companies such as Enron and WorldCom,” says Jacobs

Does that explain how the financial markets came to the crisis of 2008?

“You have to ask how did the system get to that point,” says Pandit. “I believe it was because the amount of capital regulators required for banks was far lower than the economic capital the risks they were taking required. That prompted a giant arbitrage and led to an excess of leverage in multiple ways, not just taking on too many illiquid assets funded short term but also acquiring entire businesses.

Much of the wrongdoing took place in the supposedly most sophisticated but also least transparent reaches of the structured credit markets. But something else had been happening.

“If you can run earning assets at lower capital levels than the economic risks warrant, then what starts as an incentive to acquire becomes a compulsion to grow into a conglomerate that serves every customer in every product in every region.”

Having financed the LBOs that broke up corporate conglomerates themselves, the big banks agreed that their own industry had missed out on the supermarket model. They went the other way.

As chief executive of Citigroup from the end of 2006 until 2012, Pandit sought to dismantle the conglomerate his predecessors had built.

Where are capital markets today? Caught between two worlds, it seems.

The crash of 2008 was so severe that a new generation in the west that has not known other inefficient and dictatorial economic systems is turning against capitalism, its credibility now sharply diminished.

All over the world, monetary institutions had to intervene to support the market initially. Now 11 years after the crash central banks are still pursuing a monetary policy that does not remunerate savings, creates massive speculative misallocation of capital and the mis-pricing of credit. The savings of the middle class, the bedrock of democracy, are being destroyed and populist politicians are coming to power across the world and increasing borrowing to make good their promises to fearful electorates.

DCM bankers report huge primary order books for borrowers across the risk spectrum.

But what about risk: 100-year bonds for Argentina anyone? Jim Esposito, global co-head of securities at Goldman, thinks back to the crisis of 2008, when the credit market had become completely unhinged and sees a transformed business that shuns complexity: “The 2008 memory is etched into my generation’s brain. Fortunately, these lessons won’t soon be forgotten. Investors prefer simple and liquid products.”

While the primary markets are open and deep for simple structures now, are they mis-allocating capital? And are they failing to supply it where it is truly needed?

A lot is tied up in so-called risk-free sovereign bonds at negative yields.

“If you look at the deficit in infrastructure financing globally,” says Esposito, “I am surprised that the capital markets have not done a better job matching investors in need of long-dated stable cash flows with governments looking to finance large infra financing needs.”

There is some innovative thinking, however.

Now back in Australia, John McNiven, with ex-Deutsche banker Ian Martin, founded a new business after a chance meeting with Richard Murphy, a veteran of the Australian Stock Exchange. XTBs is pioneering a new market in exchange-traded corporate bonds for retail investors. It plans to introduce this concept to other markets.

“Ordinary investors are searching for yield,” says McNiven. “It used to be that you needed A$500,000 to invest in bonds, otherwise you saved money in bank deposits. But with XTBs, you can put A$500 into names like AGL or Qantas and earn an improved return. The next thing we will do is seek government approval to do primary issues; the vision then is to enable that to flow into infrastructure projects, supported by government.

“Poor infrastructure the world over is a problem. It’s a major impediment to growth in a low-growth world. And the era of low rates is precisely when we should be financing the building and re-building of it. Yet you have institutional money stuck in close to zero or negative return-free risks. If institutions who invest individuals’ money can’t channel it into infrastructure, then maybe it’s time to go direct to the end investor and cut out some of those middlemen’s fees.”

Incumbents rarely feel much incentive to change markets in which they are doing well unless they see an innovation bringing a chance to grab market share.

The leading capital markets firms – JPMorgan, Bank of America, Morgan Stanley, Goldman, Citi – are still big, even after some global banks, like Citi and HSBC have exited retail banking in many countries. Cutting costs isn’t too hard, but revenues tend to fall even faster. Ask Deutsche.

Regulators who had encouraged a massive capital arbitrage by setting regulatory capital standards too low have since insisted on banks holding much higher capital, which has depressed returns. This should have worked out fine because banks are, in theory at least, far less risky. But the premium above the risk-free rate that applies to bank equity has stayed high, due to the volatility of their stocks, partly thanks to huge regulatory settlements and, in Europe at least, fears of the sovereign-bank doom loop. Banks have increasingly bought government bonds, which, in the euro area at least, are no longer deemed free of credit risk. The cost of capital has gone up.

“In fact, regulatory capital is now prohibitively expensive,” says Isaacs. “That’s why the challenger banks are likely to remain relatively small. Policymakers may say they want competition and encourage new entrants, but challengers can’t show attractive returns. When they start to grow beyond a certain scale, they are required to hold much more capital, which is very expensive. Barriers to entry remain high.”

Isaacs concedes that fintech has been the one area where new challengers have appeared.

“But that is just outsourced innovation,” he says. “For every one fintech that succeeds, 100 have failed. Incumbents can partner with and/or buy the winners, and so what if they make the founders of that one rich? They didn’t have to fund the 99 failures.

“That said, the fintech partnership model, where small nimble providers of technology can immediately reap the benefits of scale, has the ability to create real value, economically for the participants and consumers. The other consideration is that post-2008, the enormous level of quantitative easing around the world is likely to have many unintended consequences.”

There are plenty of smart veterans that see a return to the pre-Big Bang model of specialization as the way forward.

“No customer could care less if you can do everything for them,” says Diamond, who was so delighted in 2008 to add a bulge-bracket US broker-dealer with equities and M&A onto the global fixed income, currencies and commodities business he had built at Barclays.

His Atlas Merchant Capital group is now investing in the unbundling of financial services. It has taken a stake in Kepler Cheuvreux.

“To succeed now in the securities and capital markets businesses banks probably do need to offer the equity product to their corporate clients,” says Diamond. “But European banks are beginning to ask themselves: ‘Are we any good at this? Can we compete with Goldman Sachs? Can we make money?’

“And when the answer keeps coming back: ‘No’, then it begins to make sense to hand it to Kepler Cheuvreux, which has scale in European equity research and distribution and is ranked number one or number two in execution. It is a joint venture and each bank may only own 5% to 10%, but instead of making a loss, they own a stake in something that makes a profit, that actually improves their cost-to-income ratios and provides a good service to their clients.”

He adds: “The exciting question here is can it expand by geography and product?”

Atlas Merchant has also invested in one of the old names from British stockbroking and advisory, Panmure Gordon, which was bought by NationsBank in the 1980s then sold to WestLB. Diamond thinks its core activities are better pursued outside a bank today.

“Because of regulatory capital requirements, a lot of flow businesses operate better now inside a broker-dealer model than a bank holding company,” he says. “Banks are still being hit by more and more capital buffers, trying to cut costs and focusing on their biggest clients. That leaves an under-served middle-market segment looking for advisory but also equity capital and debt. Panmure Gordon is a UK business. One of its recent extensions has been into sourcing private equity and private debt from networks of family offices and sovereign wealth funds.

“Ian Axe, its chief executive, calls Panmure Gordon a 21st century merchant bank for small and medium-sized enterprises. And for firms good at serving that segment, the question now becomes: can they do it internationally or even globally?”

But the argument for specialization has now been circulating for a decade since the collapse of Lehman; too-big-to-fail conglomerate banks still endure.

Policymakers haven’t quite learned their lesson either. A verbal onslaught from the US president, perhaps encouraged by the Wall Street money men around him, stopped the Federal Reserve from raising rates this year and from further shrinking its swollen balance sheet after financial markets sold off sharply at the end of 2018.

It seems that preventing an equity bear market is now a political imperative. That doesn’t seem likely to end well.

The debt markets are now vast. Deleveraging has not occurred.

In 2017, McKinsey calculated that in the 10 years since the start of the financial crisis in mid 2007, the total debt of governments, corporations and households (but not banks) has increased by $72 trillion, or 74%, from $97 trillion in 2007 to $169 trillion in the first half of 2017.

Government debt accounted for 43% of this increase and non-financial corporate debt for 41%.

When debt is cost free, you borrow and buy anything that will produce income or promise to grow in capital value.

There has yet to be a day of reckoning for the extraordinarily accommodative monetary policy central banks have rolled out since the crisis through unconventional measures that should have been temporary. It is becoming difficult to see how central banks are eventually going to wean markets off that. As we saw in December 2018, whenever we get to a point where volatility picks up and rates edge higher, the market is given another sedative.

Investors are being trained to think that a little bit of volatility may be allowed, but that the tails have been cut off.

And all this has consequences. By definition, extraordinary liquidity provision drives misallocation of capital. The data shows new debt issuance since the crisis has exploded.

Once again, the problem is hiding in plain view.

“I don’t subscribe to the theory that we are in a debt bubble but would observe that there has been exceptional growth in primary market issuance and shrinking turnover in secondary market volumes,” says Esposito. “If and when investors require more secondary market liquidity, credit markets will be tested. We have experienced some episodic periods of air pockets in secondary liquidity.”

Of course – as he no doubt well knows – it is a question of when, not if. We have already seen it, most recently in December 2018 in both corporate and government bond markets. Traders reported flash crashes even in some of the European government bond markets. If an investor wanted to offload $10 million of a corporate name, it could move the price 50bp to 75bp.

It’s rather like the market Hands was dealing in… 35 years ago.