One of the things that really annoys me about the media coverage of the credit crisis is the media paints all “financial institutions” with the same brush stroke and does not attempt to differentiate between the different players and their functions in this industry. Thus, when an investment house files for bankruptcy, everyone gets worried about their savings account at a bank when they are two different structure with different purposes.

In an attempt to separate out the different players in the financial institution, here is a quick and dirty primer of who is who and who does what. I admit this is very difficult because banks own trust companies now and investment banks own traditional deposit taking banks so there is significant over-lap. But here’s my best attempt:

Banks (in the traditional sense of the term) is a government licensed body that takes deposits (a bank is a borrower of your money) or issues bonds or stock and lends out the money raised to other parties or invests in securities. A bank’s profit on the most simple of basis is (interest earned on loans made) – (interest paid to deposit holders).

Credit union is a co-operative for its members (a co-op is a type of legal structure where the owners are also the customers of a business set up for a specific purposes- typically for charitable or not-for-profit purposes but also for profit). In other words, you can only deposit money into a credit union if you are a member. Thus, as an account holder, you are also an owner of the financial institution and there are no shareholders but members.

Savings and loan (S & L’s) is somewhere between a bank and credit union BUT with one huge structural advantage or disadvantage. Like a bank, it takes deposits. Like a credit union, some S & L’s require that account holders are members as well. But S & L are mandated in many jurisdictions to use the deposits to lend out in the form of mortgages. It is bascially a government endorsed vehicle to put out as many mortgages as possible and support home-ownership. Thus, the fate of S & L’s and the real estate market are closely tied together.

Merchant Banks has a much more amorphous definition than banks but it is basically an institution (not necessarily holding a banking license) that advises wealthy clients and corporations on how to manage their money from sourcing lending opportunities, acquisition opportunities or sourcing out money. Most wealth management arms of big banks now carry out a lot of functions of merchant banks. They are really private bankers for the rich (private equity and merchant banking are used in certain circles inter-changeably).

Trust companies are organization who act as fiduciaries, agents or trustees (hence, the name) in the administration of monies, trusts and estates. A trust company is like a faceless lawyer for a trust fund kid- they manage funds, hold onto property, pay bills and distribute income. Trust companies have now evolved into deposit taking institutions as well (which muddies the waters between banks) but with different types of restrictions than banks (they typically are limited in how they can invest deposits).

Investment banks act as advisors, agents and underwriter (in banking, an underwriter is the intermediary between the issuer of product and the general public) for the issuance of product (stock or equity). Maintain the liquidity of issued product by acting as brokers and dealers and offer advice on M & A and analogous fee generating activities. Unlike a traditional bank, it is not deposit taking (but that has changed as well recently to ensure their survival). It gets its money through issuing stock and outrageous fees.

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The image of financial institutions as one big mush of pin-striped bankers and cowboy traders most likely originates from the fact that large banks bought investment bank arms, trust company arms, merchant bank arms and then the investment bankers took over the banks and made stupid bets using our money.

Most of the credit crisis started in the investment banking sector where they started buying their own toxic products they were putting out (in some sense poetic justice but, on another level, an exercise is sheer stupidity and arrogance). The linkage is that the banks and S & L’s were lending out the bad mortgages which got packaged into the product the investment banks sold and bought themselves (this is a very broad narrative).

What goes around comes around and an era seems to have ended for investment banks as the last two great investment banks, Morgan Stanley and Goldman Sachs, have been approved to become “mere” banks and will start taking deposits from Ma and Pa in an effort to survive.  The question becomes would you deposit your money with one of the culprits of the mess we are in?