Fed OKs Changes At Goldman, Morgan Stanley

The Federal Reserve says the last two big, independent investment banks, Goldman Sachs and Morgan Stanley, are scrapping the business model that made them so profitable for so long. They are now bank holding companies and are regulated by the Fed.

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STEVE INSKEEP, host:

It's Morning Edition from NPR News. Good morning. I'm Steve Inskeep in New York where financial markets reopened today.

LINDA WERTHEIMER, host:

And I'm Linda Wertheimer in Washington where Wall Street's future will be decided. Lawmakers are working on a rescue plan estimated to cost $700 billion.

INSKEEP: Today's trading comes after a week of dramatic changes and a weekend of negotiations. One big question is whether the bailout will work.

WERTHEIMER: Another is how much the financial world will change. The Federal Reserve says the last two big independent investment banks, Goldman Sachs and Morgan Stanley, are scrapping the business model that made them so profitable for so long. They'll now become bank holding companies regulated by the Fed. NPR's Jim Zarroli joins us now. Jim, how will this move change the way these two companies do business?

JIM ZARROLI: Well, it means several things. First, in the long run they can compete with big commercial banks like Wachovia. It will give them new sources of capital. Down the road they can take deposits. But more important is this. They will now be able to go to the discount lending window which is operated by the Federal Reserve. They can do this now, but it's not permanent. But what it means is that if they need a loan because of some emergency, there's a place they can go to get it. It's like getting a new credit line from your bank. And that's important because even if they don't need it and never use this right, the market now knows that they have this lender of last resort, which will make people feel more confident about them. People feel like, you know - people will feel like it's safer to buy their stock or invest in them. And that's really the game right now, finding a way to regain people's confidence.

WERTHEIMER: So is that why they've decided to become bank holding companies now?

ZARROLI: I think they saw the handwriting on the wall. In the past half a year we have seen, you know, the demise of Bear Stearns and Lehman Brothers. We've seen Merrill Lynch get bought by Bank of America. Investment banking is just a really rough business right now. And even though Morgan and Goldman were seen as, you know, relatively speaking, the healthiest of the investment banks, there were questions about how long they could survive. These are companies that borrow a lot of money to operate. The credit market is very bad right now. It's become harder to do this. Last week you really saw this beginning to hit home. The stock price of both Goldman and Morgan fell. So I think they just felt like they had to do something, and this is what they did.

WERTHEIMER: What about regulation? They now come under bank regulation.

ZARROLI: Oh, yes. Yes. The government exacts a big price for the right to borrow from the discount lending window. Big bank holding companies are much more tightly regulated than investment banks. The government is going to be in there watching what they do in a much more intrusive way. Here is an example. These big investment banks, as I've said, have always done a lot of borrowing. They're really highly leveraged, which means, you know, they have a dollar of assets on their books and they can go into the credit markets and borrow many times its value. Until recently, Morgan was borrowing, I think, at levels of, you know, more than 30 to one. You know, now, when times are good this is good. This makes them much more profitable. But it is a risky strategy, because they can also lose a lot of money in bad times. Well, they won't be able to do this kind of borrowing anymore. So they're going to be potentially a lot less profitable, but the hope is that they will also be much more stable.

WERTHEIMER: Jim, could you tell us very quickly, the Bush administration and Congress have been negotiating all weekend on this $700 billion financial rescue plan. What do you know about the shape of the plan right now?

ZARROLI: Well, we don't know a lot. You know, the underlying problem is that a lot of banks and financial firms have these mortgage-backed securities. Some of them are not worth very much. So everyone is scared to lend. You know, they say I don't know, you know, whether the other company will ever be able to pay me back. So, the government is saying, you know, we will buy these debts. You can come to us. We'll pay you for them, maybe at, you know, pennies on the dollar, but the idea is that this will sort of draw a boundary around the crisis. People will feel more confident about lending because they can see an end to the problem.

WERTHEIMER: The thing that concerns Congress, of course, and many of the members of Congress' constituents is who benefits? Do we know yet who benefits from this bailout plan?

ZARROLI: Well, that's really the subject of a lot of intense lobbying in Congress right now. A lot of financial institutions are trying to get a piece of the bailout. One of the questions right now is whether foreign banks should be able to take part. Now, it might seem crazy that U.S. taxpayers would be called upon to bail out, you know, the Royal Bank of Scotland, or UBS. But Secretary Paulson says, you know, these banks do a lot of business in the U.S., they employ a lot of people here, but you can expect that that will be a hard pill for a lot of Americans to swallow.

WERTHEIMER: NPR's Jim Zarroli. Jim, thanks.

ZARROLI: You're welcome.

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