What do MSDW et al. actually do?

Factual Questions
1

Having heard about Morgan Stanley Dean Whitter a lot recently due to the World Trade Center tragedy, I’ve started wondering what these huge financial companies actually do. Having not much money myself, I really can’t even imagine all the things that can be done with it that would involve 21 floors of a World Trade Center tower, plus their numerous other locations, or that could possibly require 62,000 employees.

I’m an ardent supporter of capitalism, and love the wealth and power that huge financial companies have. However, I really don’t know what it is that they do, exactly. Also, while I know that whatever it is that Morgan Stanley does, it seems to be somewhat different than what Citigroup, JP Morgan Chase, PriceWaterhouseCoopers, FleetBoston Financial, Merrill Lynch, Salomon Smith Barney each do (although I really don’t know what any of them do either). So, could anyone (manhattan, I’m looking in your direction) help me out here?

I’ve looked at Yahoo’s profile (here), but it doesn’t really seem to be all that clear.

This is really no help to someone as clueless as myself. I don’t even know what securities are exactly.

So, in short, what do the titans of the financial world do?

2

I suppose the answer to that question these days is “all sorts of things,” but it wasn’t always so. After the 1929 stock market crash, the US enacted laws that put limits on what different types of financial firms could do.

In the last decade, those limits were relaxed, so many current financial firms have divisions that handle the different functions that were previously required to be separate.

Oversimplifying, the three primary types of financial firms were:

Commercial Banks/Trust Companies
Investment Banks/Brokers
Insurance Companies

Commercial Banks/Trust Companies

Examples: Chase Manhattan Bank, Citibank, Bankers Trust, J.P. Morgan

Commercial Banks generally have as their primary business the taking of deposits and the making of loans. They also often function as Trust Companies, which can serve as trustees of personal or business trusts.

For instance, if you wanted to create a trust for your children, you could deposit money or securities with the trust department of a commercial bank under a trust agreement, and the trust officers of the bank would manage the funds and pay the beneficiaries under the terms of the trust agreement. Also, an investment bank could create a mutual fund organized as a business trust, and the bank could serve as trustee and custodian of the securities in the fund.

Investment Banks/Brokers

Examples: Merrill Lynch, Morgan Stanley, Goldman Sachs

One primary function of Investment Banks/Brokers is that of Stockbroker. Stockbroker will arrange for the purchase or sale of stocks, bonds and other securities for people. They will also hold securities for people in brokerage accounts.

Another primary function is that of Underwriter. If a company wishes to issue securities to the public, it will arrange with an investment bank to agree to distribute the securities to the market.

A related function is providing securities advice to individuals and businesses. A full-service stockbroker will advise individuals on how they should structure their investments. An investment bank will advise companies on what securities that they should issue.

Yet another function of investment banks/brokers is trading for their own accounts. They buy and sell securities in the hopes of making money for themselves.

Insurance Companies

Examples: The Travellers, Metropolitan Life, Aetna

Insurance Companies take premiums, invest the premiums, and make payments on the occurance of specified events (death, fire, accident, etc.). Insurance companies, particularly life insurance companies, often will sell insurance products that have an investment component, that is to say that the idea is that the insured will get dividends or returns before the payout on death.

The combinations

Each of these companies has the function of taking money from customers and giving them a dividend/interest return. There are a variety of benefits and risks in investing in any of them (tax issues, deposit insurance, growth, etc.). Because they performed similar functions and often had competing financial products, over the last decade the laws separating them have crumbled, resulting in combinations like Travellers/Citigroup.

Even within the prior categories, companies concentrated on different aspects of their businesses. For instance, Merrill Lynch has historically concentrated on retail brokerage to individuals while Goldman Sachs has concentrated on investment banking to companies. Berkshire Hathaway, Warren Buffett’s company, is well known for its prowess in investing in companies, but it is actually organized as an insurance company, while other insurance companies concentrate on the traditional insurance business.

Of the business that you listed, the one that does not fit into one or more of these categories is aricewaterhouseCoopers, an accounting firm. accounting firms have a primary business of reporting, auditing and certifying the financial results of companies, but with other businesses (which often overwhelm the primary auditing businesses) of tax advice, business consulting, computer consulting, and sometimes securities sales.

3

Thank you. I’m starting to understand. So Morgan Stanley and Merrill Lynch are not exactly competitors, but are in the same general field. Anything else that falls under the broad heading of “financial services”? And FleetBoston (I’m in Boston, so I’m somewhat familiar with them) probably counts more or less as a corporate bank, right? But when they describe themselves as “a diversified financial services” company, that means that they probably do some investment banking on the side, I suppose?

Perhaps someone could fill me in on what exactly mutual funds and securities are as well.

4

First, as a followup to Bildo, the restrictions against companies in one field entering into another field weren’t just relaxed, they were obliterated in 1999 when Congress repealed the Glass-Steagall Act, the law in place since 1933 that required division between banks, investment houses, and insurance companies. The repeal of that act removed most of the restrictions on a firm in one industry doing business in another industry.

Now, on to waterj2’s questions.

A “security” is actually pretty difficult to define; broadly speaking, the courts will deem something a security (and thus subject to the securities laws) if it is (1) an investment of money (2) in a common enterprise (3) with an expectation of profits (4) predominantly from the efforts of others. Thus, lots of investment schemes can be considered a “security.” However, when most folks talk about “securities,” they are talking about stocks, bonds, or derivative instruments.

Stocks are shares in a corporation. They represent a direct ownership interest in the company. A shareholder is entitled to vote at shareholders meetings and share in the profits of the company. (This discussion ignores preferred stock, which can have greater or lesser rights, depending on the company; not all companies have preferred stock, but all companies have common stock, which is what is described above and is what people usually mean when they talk about “stock.”

Bonds and other debt instruments, like promissory notes, represent loans made to the company that must be repaid with interest. If I buy a GM bond for $1,000 that is due in 5 years at 7% interest, GM must pay me that sum plus the accrued interest when the bond becomes payable. Alternatively, I can sell the bond on the market, in which case GM will then have to pay the new owner the amount owed.

Derivatives are securities that derive their value from another underlying security. An example is a stock option. A stock option represents the option to buy a share of stock at a fixed price. If I have an option to by a share of XYZ Corp. at $10, and XYZ’s price rises to $15, then the option is valuable because I can realize a profit upon its exercise. There are lots and lots of various types of derivatives – some of them can be mind-bogglingly complicated.

Mutual funds are a way for a small investor to diversify his investment portfolio. “Diversification” means holding lots of different securities from lots of different companies; it is a good idea because it helps maximize the reward while minimizing risk from investing. Put simply, diversification means not putting all your eggs into one basket. The problem is, to diversify by holding individual stocks would be very expensive – most investors cannot afford to buy a significant number of shares in many companies. Thus, the mutual fund: basically, lots of investors pool their money by buying shares of the fund; then the fund manager invests those pooled shares in lots of different stocks. Funds differ in their investment strategies and in the kinds of stocks they hold, but they all have in common the idea of pooling investor resources.

Hope this helps.