Ahhh! WTF Happens Inside an Investment Bank!?!

So they had a huge hand in the financial crisis, they have most of Washington in their pockets, they are really confusing and everyone that works at one seems to be a millionaire.  They have names like Morgan Stanley, Goldman Sachs, Lazard and in the recent past Lehman Brothers, Merrill Lynch and Bear Stearns.  It takes about '100' years to make a good one and they are the envy of ivy league business majors and MBA's all over the world.  They are investment banks, not to be confused with your mom and pop banks and below is what they look like inside.

So lets talk about what we are looking at, hopefully in a way that won't make you cringe.  At first glance we have four main sections in our picture:

1) Investment Banking
2) Sales and Trading
3) Operations
4) Capital Markets

*In reality you will see many other functions such a prime brokerage, asset management etc. but the big players are above.

Lets discuss what they do and to make it more interesting we can also discuss their personalities and how much money they make!

Our first stop will be the investment banker, the investment banker usually specializes in an industry and may specialize or fall into another group such as Mergers & Acquisitions.  These are like financial advisors for companies.  They help companies raise capital (through debt/equity offerings), tell companies to buy other companies and bring private companies public; and they do not do this for free, they charge hefty fees.  The general character of an investment banker is calm and reserved.  Unlike traders (who we will discuss later) they don't use brash words and never unbutton a shirt collar. 

Because the investment bankers only make money when a business moves money around, either to purchase a company or raise money - they constantly want corporations to move money.  To do this they have to give the companies ideas of what they should do at all times in the form of neat little presentations called pitch-books (in industry terms PIBS).  Many of these ideas never see the light of day but because the bankers have to think up 100's of pitches for every one that comes to fruition they never sleep and are at the beck and call of a company that is processing a deal - the lower you are on the totem pole the less you sleep.  You start as an analyst, then become an associate, if you are good the following step is vice president and if you can make it rain a Director or even Managing Director. 

In 2010 as a starting analyst you can expect to get a $70,000 salary and get a bonus of about 80% and up of that, you can also expect to work 90-120 hour weeks during deals.  After two years of being an analyst you go back to get your MBA and become an Associate.  Now you have a salary of about $100,000 and your bonus structure remains the same.  If you are good you make VP and are crushing half a million bucks a year and a good Managing Director that can really make it rain could be making eight, nine or ten million a year (there are those poor suckers who only make a couple million).  Ohh and what about that little red line in the picture,  that is called "The Chinese Wall."  Because bankers have access to private client information (they need it for their pitches) they aren't allowed to be around other people in the bank who could profit from that information.  Hence all banks have two big escalators and two big elevator banks that never mix.

Traders are a whole other entity not to be confused with bankers or salesman.  Traders and salesman work together on a trading floor but that is the only thing they have in common.  Traders for the most part specialize in a certain product or region and trade for either clients (flow trading/market making) or for the bank itself (proprietary traders) although these are a dying breed thanks to the Dodd-Frank bill and the Volcker Rule.


Because Frank Partnoy already described the difference between a trader and a salesman in his book "FIASCO," I can just steal his work!

"The traders are the men with rolled up sleeves and loosened ties who hold several phones each and periodically smash one phone against a desk, a computer or a trading assistant, and then grab another donut out of a monstrous box."

"In contrast the salesman calmly adjust their cuff links while they hold one phone to each ear and, by alternatively squeezing hidden mute buttons in their handsets, carry on several composed conversations at once.  A good salesman can simultaneously schmooze a client, discuss tonight's Knicks game with his bookie, order his assistant to steal a donut from the traders, and explain to his wife where he had been last night until 4:00am - and none will be aware of the other conversations or the nearby pandemonium." (of the trading floor).

Folks in sales and trading get similar salaries to their counterparts in banking but their bonuses are based on the number of clients and how much they trade or how their trades fair in the market.  This allows them to be ridiculously profitable.  A good proprietary trader can make more than the CEO of a large bank in a good year and the guy that controls the money is the one that really runs the bank.  Think Michael Milken of Soloman Brothers in the 1980's.  Best of all for proprietary traders (the high-flying jocks of the traders), you are gambling with the firms money!

Capital markets guys are there to help feel out the markets when the bankers need to raise debt.  An investment banker will say something like "Johnson & Johnson wants to raise $10 billion in debt, they want something that has a pretty short maturity.  How much will it cost them?"  Capital markets will work with a group called "Syndicate" to price the security in the market for the bankers.  Of course this is after the investment banker has pitched to '100' different companies that they need to raise debt and one has finally listened.  A good capital markets guy keeps his pulse on the market and knows how much everything costs at the time.  A capital market workers salary is slightly below a bankers mainly because they lie further from the clients.

Then there are the Operations guys.  This is everything that the bank has that slightly resembles a normal company.  This is management, legal and administration.  Most banks have huge seperate buildings to house the real gritty operations people that actually work out their trades as well as clear their accounts and make sure everything goes through.  These buildings aren't nearly as glamorous as to the buildings for the bankers and traders (ie. Goldman Sachs shuffles all of its operations people off to a large building in New Jersey) and the pay is a fraction of every other position.

So those are the basics of an investment bank, it can be as complicated as you make it but the knowledge above will put you leagues ahead of the average person!