Reinstating Glass-Steagall: The Harm of Inaction (Part 4)

Is the decline in the number of independent investment banking firms already having an impact on the IPO market? 

The Economist reported on a study by Grant Thornton about a decline in the competitiveness of US securities markets.  The study, A wake-up call for America, looks to the decline in the number of listed companies since the 1990s. From 1991 through 2008, the number of listings fell from 6,943 to 5,401, or a decline of 22%.  The study puts the decline at 52.8% when adjusted for GDP growth.  The statistics mask considerable difference among the exchanges.  While the NYSE fell only 1.3%, Nasdaq dipped by 27.9% and Amex by 43.5%.

What is the culprit?  The decline in the IPO market.  While the US needs 360 new listings a year just to replace departing companies, the number of IPOs has averaged only 166 since 2001, with 54 in 2008.  As the Economist noted:

• For all the talk of a revival in initial public offerings (IPOs), domestic markets are on track to add a mere 50 or so new companies this year, one-seventh of the level needed to offset the average annual loss of listed companies in recent years.

And, in turn, what caused the decline in IPOs?  Not SOX.

• Grant Thornton argues that the root cause of “The Great Depression in Listings” is not Sarbanes-Oxley, as some will suggest. Rather, it is what we call “The Great Delisting Machine,” an array of regulatory changes that were meant to advance low-cost trading, but have had the unintended consequence of stripping economic support for the value components (quality sell-side research, capital commitment and sales) that are needed to support markets, especially for smaller capitalization companies.

In other words, much like the harm flowing from the repeal of Glass Steagall, the decline in listings is a product of deregulation, not the governance reforms contained in SOX.

But, as the Economist notes, there are other explanations for the dearth of IPOs.  US underwriters charge excessive fees, much higher than those imposed by foreign underwriters.  This no doubt reflects at least in part a lack of serious competition for underwriting business.  Yet as bad as things have been, they will now likely get worse.  The class of independent banking firms has largely ceased to exist, a consequence of this ongoing financial crisis. 

This affect has eliminated the one class of financial intermediaries that profited from robust securities markets.  This will, as predicted, harm the securities markets.  Unlike traditional commercial banks, investment banks had every incentive to encourage public offerings.  Moreover, they had the capacity to accept higher levels of risk.  Without these institutions, the number of companies going public may well decline.  In other words, deregulation (particularly the repeal of Glass Steagall) likely resulted in long term structural damage to the US securities markets.  It remains to be seen whether or not they can be fixed.

Putting Glass Steagall back in place will allow for the return of a class of intermediaries committed to robust securities markets.

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets.