“The smiles were frozen on the faces of everyone in the office, and an uneasy silence had set in. A visiting group of bankers from a small regional institution had just slipped up. ‘These guys had extended some credit to us and were expecting to get into a bond-underwriting deal, but we had changed our mind,’ recalls the chief financial officer of the energy company that was hosting the bankers. ‘They said to me, ‘We don’t extend credit to people we don’t get capital markets business from.’ I paused and said, ‘Isn’t that against the law?’ Everyone kind of stopped. Then they quickly backtracked and said, ‘No, what we’re saying is, We don’t call on people for capital markets business unless we’re lending them money.’ Everyone in the room started to laugh,’ says the CFO, who asked to remain anonymous. ‘You know-that uncomfortable sort of laugh,’” writes Julie Creswell in this month’s Fortune

“Banks just keep landing in the headlines these days, and the news never seems to be good. This week’s scandal? Allegations of tying, an illegal practice in which a bank agrees to lend a corporation money only if the client promises to throw the bank some lucrative fee-generating business, such as equity underwriting or advising on an acquisition. Amid growing public concern about the practice, several members of Congress, including Representative John D. Dingell of Michigan, have called for an investigation.”

“Though it’s been illegal for over three decades, tying has become a hot topic in the past few years because of the rise of so-called universal banks. These giants were formed in the late 1990s with the erosion of the Glass-Steagall Act and its eventual repeal, which allowed lending and cash-management services-the purviews of commercial banks-to exist under the same roof as stock and bond underwriting, the realm of investment banks and brokerage houses. A host of quickie weddings anticipated the 1999 revocation of the act. Citibank paired up with brokerage firm Salomon Smith Barney to form Citigroup, the nation’s largest financial institution. Chase Manhattan Bank (already a behemoth after three bank mergers) nabbed tony investment bank J.P. Morgan. Global marriages yielded UBS Warburg, Credit Suisse First Boston, and Deutsche Bank.”

“The commercial banks were eager to go to the altar because their bread-and-butter business-lending money-had become a lousy one. Competition from Japanese and European banks had turned loans into commodities with the slenderest of profit margins. Compounding the pain, the risks had become enormous if the economy headed south-as it eventually did; if a few big customers went bust, a bank could lose billions. Investment banks, on the other hand, earn sky-high margins and don’t put nearly the same amount of capital on the line. Not surprisingly, banks eagerly looked to convert many of their lending customers into high-fee investment-banking clients. In some areas the banks were extremely successful. In a few short years a number of universal banks jumped up several spots in the league tables for underwriting investment-grade bonds, a Wall Street measure of market share (see below).”

“Trouble is, banks have sometimes trodden close to the line of illegal tying in their quest to win new fees from their customers. Banking has always been a relationship business. This used to mean that your banker knew the names of your kids or occasionally treated you to a round of golf. These days banking relationships mean ‘I’ll scratch your back if you scratch mine.’ Corporate officers say their bankers freely talk about how the relationship can be ‘win-win’ or ‘profitable’ for both parties. The implication is that banks won’t lend to companies that don’t buy other services. ‘The banks say it’s tough for them to give loans to people they don’t have ‘relationships’ with or get other business from,’ says Steven McNeal, treasurer at energy firm Entergy. ‘I wouldn’t say it’s a direct tie. But I don’t need to be slammed in the face with a brick to understand what they want.’”

“Are they tying illegally? The banks vehemently deny they are using loans to extort other revenues from their clients. Instead, they say they are cross-selling. They’re offering their lending clients an extensive range of services, including foreign exchange, cash and pension fund management, and high-yield bond underwriting. At the same time, though, the banks complain that the laws are unfair. They are the only ones that can’t legally tie. Investment firms Goldman Sachs and Lehman Brothers can tie all they want.”

@page_break@