14 Dec The 1980s: The Decade of Innovation in Investment Banking & Finance
We’ve heard a great deal about the rise of venture capital and investment banking in the recent Presidential cycle thanks to Gov. Mitt Romney. During the time in which Romney ran Bain Capital, some of the most innovative products hit the market, making the 1980s a literal hot-bed for innovation in the array of products produced by the investment banking industry at large. Here is an interesting list of some of the products which grew of the evolution of iBanking and finance in the 80’s.
Debt Warrants (1980)
Bonds sold with warrants or rights to purchase additional bonds in the future. The future date and price is explicitly outlined in the debt warrant.
Original Issue Discount or OID (1981)
OIDs offer investors lower risk in reinvestment and call on bonds than other current-coupon securities by giving a discount on the par value (or a low coupon) at the time the bonds are issued.
Floating-Rate Preferred Stock (1982)
At the outset, many differing floating-rate structures were created with differing formulas. Within two years, the Dutch Auction became the most widely-used and it sets rates on Floating-Rate Preferred Stock every 49 days.
Zero-Coupon Bonds (1982)
These are very similar to Original Issue Discounts, but have a complete lack of coupon. The need for higher quality led to the trading and stripping of bonds.
Futures Options (1982)
The Chicago Board of Trade allowed puts and calls on U.S. Treasury bond futures contracts. Shortly thereafter, daily trading volume exceeded the cash market for U.S. Treasury bonds.
Interest-Rate Swaps (1982)
Interest-rate swaps is a swap of specified cash flows typically based on a fixed interest rate (in most cases on LIBOR). Swaps are typically treated like futures contracts with longer maturity horizons (generally >10 years).
Collateralized Mortgage Obligations or CMOs (1983)
One pool of mortgage securities is used to guarantee multiple-class (short and long term) issue securities. Within three years CMOs were using short-maturity and floating-rate asset classes with capped interest.
Asset-Backed Securities (1985)
Asset-backed securities WERE a collection of non-mortgage securities used to guarantee multiple classes of securities. Things changed over time and both CMOs and asset-backed notes with mortgage securities have been tied to much of the mortgage loan crisis which caused the 2008 Great Recession. Collateralized debt obligation removed the risk from the loan originator and passed it into the general market, which effectively provided a way to skirt responsibility for banks who were underwriting bad mortgage loans, but that’s ultimately a entirely different discussion.
Capped Floating-Rate Securities and Interest-Rate Caps (1985)
Floating-rate securities are tied to LIBOR and capped a particular interest rate. Caps are often sold to third parties. Within a year, interest-rate caps grew to a completely separate market entirely, no longer tying itself to the floating rate at all.
Both creativity and necessity brought about the growth in various financial instruments of the 1980s. And while many of these instruments have built bad names for themselves over the last decade, they have also helped to build wealth for many individuals by creating new markets and frontiers where trading and asset exchange occurs. In addition, they’ve increased the sophistication required by investment bankers, helping to eliminate what Warren Buffett calls the “riffraff.”