Investment Banks: Manipulating Government For Their Gain

Investment banks have a long and complex history of working with governments. In the US, investment banks are continuously reviewed and regulated by the Securities and Exchange Commission (SEC) and occasionally by Congress. They were first distinguished from commercial banks by the 1933 Banking Act (Glass-Steagall), which was passed in response to the Great Depression. Since then, various acts of Congress have impacted the way investment banks operate, including the Financial Services Modernization Act (1999) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010).

Investment banks advise governments on high-value financial transactions, including raising financial capital, mergers and acquisitions, and issuing debt or equity securities. They also play a role in policy-making, providing rules and regulations for operating and investing within a sector.

During the 2007-2008 financial crisis, several investment banks collapsed, and the industry was bailed out by taxpayer-funded loans through the Troubled Asset Relief Program (TARP). This led to further questioning of the investment banking business model and its regulation.

Public investment banks, in particular, can be powerful catalysts for investment-led growth if they are well-structured and governed. They can provide patient, long-term finance for innovative areas that the private sector might consider too risky, such as environmental challenges and technological breakthroughs.

Investment banks advise governments on policy-making

One of the primary ways in which investment banks advise governments is through disinvestment services. After World War II, many governments worldwide owned a large number of public sector companies, including those providing essential services like water, electricity, and telecommunications. However, over time, these governments realised that managing these businesses was not their forte. Consequently, they initiated the process of disinvestment, selling these government-owned assets to private companies. Investment banks play a crucial role in this process, not only by acting as intermediaries but also by helping governments identify which assets to sell and determining the value of these assets.

Another area in which investment banks provide advisory services to governments is in policy-making. Governments often face the dilemma of choosing between protectionism and a liberalised free market. Investment banks offer guidance on formulating rules and regulations that govern the operations and investments within a particular sector. However, it is argued that the advice of investment banks may be biased as they stand to gain more financially from a liberal policy that enables more deals. Thus, there is an inherent conflict of interest.

Furthermore, investment banks assist governments in finding partners for public-private partnership (PPP) initiatives. When public-private partnership projects are announced, investment banks help collect and evaluate potential bids, advising the government on selecting the best partner based on the given constraints.

In summary, investment banks have a deep partnership with government agencies, providing them with advice and acting as intermediaries in various matters, including disinvestment, policy-making, and PPP initiatives.

They help governments identify assets to sell

Investment banks have a lot of experience mediating high-value transactions and are often appointed by governments as their advisors. After the Second World War, many governments ended up owning public sector companies, such as water, electricity, and telecommunications services. However, as time went on, governments realised that they were not best suited to running these businesses and began the process of disinvestment, selling these assets to private companies. This is where investment banks come in.

The process of identifying assets to sell is a complex one. Governments often do not know which assets they want to sell and which to hold on to. Investment bankers start by identifying the assets, based on broad strategic guidelines issued by the government. For example, some governments are more interested in selling their most profitable units as they believe these will fetch the best price, while others want to sell their loss-making units, thinking that private industries can run them better.

Once the assets have been identified, investment banks are also responsible for valuing them. This can be a tricky exercise as the running of a government firm is very different from a private firm. The valuation may be done based on positive cash flows or, if there are no cash flows, on the book value of the assets held by the firm being sold.

The services of investment bankers are also used to manage the bidding process. They organise and collect bids from private sector buyers and then evaluate them based on predetermined criteria. The government relies on investment banks to conduct thorough background checks and due diligence, comparable to what is done in the private sector.

In many cases, the government does not want to sell the underlying asset but instead wants to improve the functioning of these private sector entities. In these cases, the services of investment banks are also enlisted.

They advise on public-private partnerships

Public-private partnerships (PPPs) are a tool that governments use to leverage the expertise and efficiency of the private sector, raise capital, and spur development. They are a way for governments to collaborate with private-sector companies to finance, build, and operate projects. PPPs are typically found in transport and municipal or environmental infrastructure and public service accommodations.

PPPs involve a city government, for example, partnering with a private enterprise to fund the construction of a building project in exchange for receiving the operating profits once the project is complete. The private partner participates in designing, completing, implementing, and funding the project, while the public partner focuses on defining and monitoring compliance with the objectives.

PPPs can be used to deliver public services in line with strict service criteria. The government establishes the project objectives, while the private sector takes responsibility for meeting them. Payment on delivery and risk-sharing help keep the private partner focused on delivering quality public services that help meet national development goals.

PPPs can be used to improve access to education, energy, transport, healthcare, and sanitation. They can also play a key role in giving local populations access to the latest technologies, increasing the efficiency of communications, and reducing the cost of services.

PPPs can also help address global water issues, such as providing access to safe drinking water and improving sanitation services. In addition, PPPs can be used to improve the agriculture sector, such as through improved grain transport and storage and irrigation technology.

Overall, PPPs are a tool that investment banks use to advise governments on how to leverage the expertise and efficiency of the private sector to deliver public services and infrastructure projects.

They help governments issue debt

Governments around the world often issue debt, and investment banks play a crucial role in this process. As experts in mediating high-value transactions, investment banks are well-equipped to act as intermediaries between governments and investors. This function of investment banks is particularly important given the significant financial liabilities involved in government debt issuance.

The process of issuing debt involves governments selling debt instruments, such as bonds, bills, or notes, to investors. These debt instruments are financial claims that require the government, as the debtor, to make payments of interest and/or principal to creditors in the future. Investment banks facilitate this process by connecting governments with investors and helping to determine the pricing of these debt instruments.

The role of investment banks in government debt issuance is particularly notable in cases where governments need to roll over debt. This occurs when a government issues new debt to repay its existing debt. Investment banks continuously engage with governments in this process, managing one issue of debt after another.

By assisting governments in issuing debt, investment banks contribute to the broader economic landscape. They help coordinate present and future consumption by influencing interest rates, which in turn affects saving and borrowing behaviour. Additionally, investment banks enable governments to raise funds to finance various projects and initiatives, which can have a positive impact on economic growth and development.

Overall, the involvement of investment banks in government debt issuance is a critical aspect of the relationship between these two entities. By leveraging their expertise and connections, investment banks facilitate the process of governments obtaining the necessary funds for their operations and initiatives.

They provide underwriting services

Investment banks play a key role in the issuance of new corporate and state and local government securities. They provide underwriting services, which is the process by which an individual or institution takes on financial risk for a fee. Underwriting involves conducting research and assessing the degree of risk that each applicant or entity brings to the table before assuming that risk. This helps to set fair borrowing rates for loans, establish appropriate insurance premiums, and create a market for securities by accurately pricing investment risk.

Underwriting services are critical to the smooth functioning of the financial system. In the context of investment banks and governments, underwriting services are often utilised when governments engage in disinvestment, which involves selling government-owned assets to private companies. Investment banks act as intermediaries in these transactions, helping governments identify which assets to sell, valuing these assets, and managing the bidding process.

The process of underwriting can be broken down into several key steps. Firstly, underwriters assess the level of risk involved in a transaction. They evaluate the financial health of the entity seeking underwriting, analysing factors such as credit history, financial records, and the value of any collateral. Secondly, underwriters determine the appropriate pricing for the securities being issued. This involves considering the current market conditions, investor appetite, and the specific characteristics of the securities. Thirdly, underwriters facilitate the sale of these securities to investors, either directly or through dealers.

It is important to note that underwriting carries substantial risks for investment banks. If they are unable to resell the securities at a profit, they may incur losses. To mitigate this risk, investment banks often form syndicates with other banks, spreading the risk across multiple institutions.

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