Until the early 1970s, investment banking was more an elite fraternity than a competitive business. It lacked risk, it lacked capital, and it lacked imagination. And it was all about to change. Morgan Stanley, though one of the loftiest of the firms, had only 30 partners and less than $20 million in capital. The primary business of the investment banks was mergers and acquisitions (M&A) advice and underwriting. The order of things was that the top-tier investment banks advised their corporate clients and managed their underwriting, and then the bonds or equity shares were farmed out to less prestigious trading houses for distribution. The M&A business was done among friends; old school ties and country club memberships counted for as much as innate talent. On the one hand, the underwriting was clear-cut and highly profitable. It could be run with little capital and overhead. On the other hand, the distribution was closer to a boiler room, with calls to investors, teams of traders and salespeople to manage, and capital at risk if an issue did not sell.

The first challenge to the old order came in the mid-1970s when one of the key distributors, Salomon, decided it wanted in on the underwriting. Salomon figured that if it was going to do the dirty work of distribution, it was also going to co-manage. Forced to invite Solly into their club, the top-tier “white shoe” firms like Morgan Stanley returned the favor by moving into the turf of the distributors. ...

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