The End of an Era

With Goldman Sachs and Morgan Stanley announcing yesterday that they would become Bank Holding Companies, we can say goodbye to the age of the independent Wall Street Investment Bank. The other players are already gone. Bear Stearns and Merrill Lynch were bought out by FDIC-regulated banks while Lehman Brothers kept its date in bankruptcy court.

The purpose of this most recent move is for these firms to adopt a lower risk and lower return business model. They will now be subject to strict risk-based capital requirements and gain two new regulators - the FDIC and the Federal Reserve. In exchange, they will have access to two stable sources of liquidity - bank deposits and permanent access to the Federal Reserve discount window. Rumor has it that Goldman will buy a retail bank soon and that Morgan is planning to sell out to Wachovia.

Neither firm likely needs the new source of funds so much as they need to convince their current lenders that they are not going anywhere. Lender perception is now more important than any tangible asset. A canceled credit line or a margin call is a kiss of death. That said, the shareholders of the new bank holding companies will appreciate having alternative funding sources rather than being held hostage to the whims of their lenders.

Wall Street's reorganization is a triumph of deregulation. Ten years ago, Glass-Steagall was in effect and it was illegal for the same company to conduct deposit-taking and investment banking activities. Since 1999, financial firms are allowed to diversify over several lines of business, making them less likely to fail. Deregulation has also increased the amount of private capital available to the financial industry in times of crisis by expanding the pool of potential buyers for troubled firms. Were the regulation still in effect, Morgan, Merrill, Bear, and likely Goldman would either join Lehman in bankruptcy court or wind up on the balance sheet of the US treasury. That particular piece of deregulation has increased the overall stability of the US financial system.

The only thing that concerns me about the trend of Investment Banks turning into diversified financial companies is that it might be an overreaction to the current crisis. They may be reducing their risk and return below a long-term optimum in response to extraordinary times, and the cost of going back will not be negligible.

Oh well, that's a problem for the shareholders to sort out. Right now they probably value company survival over return on investment.

I plan to get a debit card at the first Goldman Bank to open in my area. It would be pretty cool to have as a symbol of the new era.

Caveat: I'm not an expert, just an interested amateur. My view of the subject is colored by working for a firm that was hired to sell several troubled mortgage companies between 3rd quarter 2006 and 1st quarter 2008. The Wall Street firms currently in trouble are much more complicated than any mono-line mortgage issuer and my experience might be falsely generalized. Also, banking regulation is hopelessly complex and it's possible that I have mispoken somewhere.

Share this

A triumph of deregulation

A triumph of deregulation ?

Loosely regulated investment bank responsible for finding their lenders move into the much more regulated banking sector where they get subsidized loans... how is this a triumph of deregulation ? If anything, it shows that the banking cartel eventually out compete the other companies. It's a sad sad day.