On October 14th, the ‘Occupy Wall Street’ protesters were up early in Milan where student demonstrators broke into the local Goldman Sachs building before daybreak until police were eventually able to throw them out.Just down the street, a 36 foot statue of an extended middle finger sits outside the Milan Stock exchange.In these days of heightened social unrest, the Italian scene is just one of a slew of protests that have been launched around the globe in reaction to the ongoing fallout from the global credit collapse and related austerity measures being forced upon citizens worldwide.Protesters in London, Chicago, Frankfurt and New York are raging up against apparent government indifference about taking care of their people while public officials eagerly offer slugs of cash and credit to banks and bankers.Historically, it seems that banks and bankers are always disliked but at times more than others.Right now the real bad boys of the banking world are the investment banking (IB) firms, and most notably Goldman Sachs.Goldman, and in similar measure, the investment banking arms of Morgan Stanley, Bank of America and Citigroup, have been accused of cashing in on others’ misfortunes.During the good times banks gave credit where no credit was due and then made billions on packaging together shaky home mortgages and pushing the dubious securities on other banks and private investors who supposedly did not know what they were getting into.Of course, it all unravelled in 2008 and 2009, finally culminating in a wide swath of financial companies needing to be rescued with taxpayer dollars and recapitalised.The beginning of the end saw the baddest boy of all, Lehman Brothers turning the lights out.No matter that millions of regular people benefited from flipping their homes at a profit, had a good time spending their home equity line monies on flat screen televisions and SUV’s or had the opportunity to retire at 54-years old on a Greek government pension after having paid no taxes.What matters now is that Wall Street seems to be doing okay again and many others aren’t.If banks are disliked and investment banks generally hated, then one must question: why do investment banks exist and should they exist at all?Do IB’s really add value, or are they merely one more phenomenon created by the two decade long OECD ‘credit bubble’ that simply needs to deflate into economic oblivion along with Iceland, Dubai and the mortgage brokers?And perhaps the most important question of all: Are these ‘banks’ just running what amounts to an in-house casino making profits for themselves and having no real social utility? If this is the case then they certainly are undeserving of government bailout money when needed.In the most basic sense, investment banks are financial intermediaries.Theoretically at least, IB’s are designed to be conduits for transferring savings to those sectors of the economy that need capital thereby providing the essential function of efficient allocation of capital.Strategically executed initial public offerings, merger and acquisition activity and issuance of debt securities to raise money are all complex but necessary operations required by most large corporations to grow their companies and navigate global markets.Investment banks line up capital needed to merge or buy out poorly managed companies keeping executives on their toes to ensure they are taking care of shareholders.In addition to capital transactions, the major IB’s also help client to manage their assets through the banks’ extensive wealth management divisions.Besides helping clients directly, the major IB’s act as marketmakers by providing liquidity and stability in the markets to permit the free flow of capital.Finally, however, the most objectionable part of IB business models are their so-called ‘proprietary trading’ divisions where the banks make direct bets in the market for their own account.A look at Goldman Sachs earnings report for the latest quarter might help to answer the question of what a ‘pure’ IB is all about these days.As opposed to the more traditional commercial banks such as Wells Fargo, Goldman in their last quarter reported a Q3 loss of $0.84 per share. Much of the loss was attributed to the company’s proprietary trading division which recorded negative net revenues of $2.48 billion hurt by the tumbling stock and credit markets.Volatile earnings can be expected from the company’s inherent exposure to volatile capital markets. However, in this case it is clear the investment bank’s wager on its own trading landed the firm in the red vastly underperforming its peers.Over the same time period, Wells Fargo reported a 22% gain in third quarter profit with net income rising to over $4 billion.The debate over investment banks’ purpose, profits and viability will likely rage on for years as the industry is faced with the multiple challenges of increased regulation, tricky markets and social backlash.It is safe to say that the ‘glory days’ of investment banking are behind them, but the jury is still out on whether or not the industry can make a reasonable comeback and grow again in some measure.Importantly, US legislators are still hammering out the legal interpretation of the previously enacted ‘Volcker Rule’ designed to limit the scope of what investment banks are allowed to do in there their proprietary trading operations. Industry analyst Glenn Schorr of Nomura Securities estimates that Goldman’s principal trading revenues are about 48% of the total with as much as 20% likely to be impacted by the new legislation.In terms of securities pricing, right now markets have taken a ‘show me’ position on the sector.Five year maturity Goldman Sachs and Morgan Stanley bonds are trading at whopping credit spreads of up to 4.5% above comparable US. Treasury Notes versus only about 2% earlier in the year. If the banks continue to slowly improve their bottom lines and boost capital reserves, these spreads could prove to be excellent value in the years ahead.On the stock side, both Morgan Stanley and Goldman Sachs are trading at discounts to their respective ‘book values’ a valuation metric which rarely lasts for long during normal times.Buying the stocks might be a good play over the long haul, but these companies are almost guaranteed to be more volatile than the overall market due to the high amount of leverage they still employ.A happy medium might exist in the companies’ preferred stock issues where relatively liquid Morgan Stanley and Goldman Sachs issues are yielding between 6% and 7.5% with some upside potential on the price when the credit markets eventually stabilise. LOM Asset Management has selectively participated in some of the credit securities through our proprietary funds.Bryan Dooley, CFA is a portfolio manager at LOM Asset Management in Bermuda specialising in the areas of asset allocation, fixed income portfolio management and quantitative process.He possesses an MBA from the College of William and Mary and has held key positions with progressive financial institutions worldwide throughout a career spanning more than 20 years. Please contact him at 441-505-5675 for further information.