Growth and transition
Early merchant banks were centered in various European capitals, eventually settling in London, where they became deeply entrenched as power brokers. Many of the most powerful merchant banks were created and ruled by family dynasties, providing generations of both fortune and reputation to back up their deal-making. In their heyday, European and British merchant banks wielded power equal to and even exceeding that of national governments. They were of fundamental importance to the development of the British economy, and thus to the growing international economy. The banks could thus afford to be selective about their clients, who had to seek them out and request the “honor” of doing business with them.
By the late 19th century, merchant banking was also flourishing in New York, with the powerful House of Morgan at the top. U.S. railroads became big business, spreading rapidly around the country. With no government regulation and a voracious need for capital, railroads provided tremendous opportunities for these institutions to cement the position of American merchant bankers as the top financiers in the world. For example, the influence of the Morgan empire, perhaps unimaginable to us today, spread around the world, into governments, industrial giants, and wealthy families.
Meanwhile, however, public and government concern over this consolidation of power and influence escalated. The Glass-Steagall Act of 1935 set up a regulatory firewall between commercial and investment bank activities, as well as curtailing and controlling them. The Act’s goals were admirable – to rein in overzealous commercial-bank risk-taking with depositors’ money in the stock market, considered at the time a major cause of the 1929 crash and ensuing depression. The Act’s consequences were mixed, however, and it was repealed in 1999. Today, we can trace many current and former obstacles to capital to the Act. More recently, deregulation in London and New York has broken down some of these old regulatory barriers.
The decline of merchant banking was accelerated by Glass-Steagall, but there were many other contributing factors. This history provides valuable insights into what went wrong and how to ensure that our revitalization of the model does not go down the same road. While they were certainly not a homogenous group, many banks suffered from a complacency born of enormous success. They stopped searching out new clients and opportunities and stopped evolving to accommodate client needs. When new opportunities arose, the old firms were often slow to seize them. And since much of the real power of these institutions lay in their networks and connections, their growing isolation was fatal.
