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With Change, Era Of Investment Banks Ends

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With Change, Era Of Investment Banks Ends


With Change, Era Of Investment Banks Ends

With Change, Era Of Investment Banks Ends

  • Download
  • <iframe src="" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript

Goldman Sachs and Morgan Stanley, the last two big independent investment banks, announced Sunday night they are scrapping the old business model and becoming commercial bank-holding companies. The news came as a shock for those who work on Wall Street.


From NPR News, this is All Things Considered. I'm Melissa Block.


And I'm Michele Norris. First this hour, the changing face of Wall Street. Late last night, the last two big independent investment banks, Goldman Sachs and Morgan Stanley, announced they would rather operate and be regulated as commercial banks. That might not seem like a big change, but on Wall Street it's an earthquake. For most of the last 70 years, investment banks and commercial banks have been kept apart. It was the law. Now that era appears to be ending, as NPR's Jim Zarroli explains.

JIM ZARROLI: For a long time it looked as though Goldman Sachs and Morgan Stanley would survive the carnage on Wall Street. Although they lost money in the mortgage downturn like everyone else, they didn't lose anywhere near as much. Goldman in particular had a reputation for being smart, savvy, and very well-connected. But the drumbeat of bad news about other investment banks like Lehman Brothers and Bear Stearns took its toll on the companies. By last week, investors everywhere were asking would Goldman and Morgan be the next to fail? Christopher Whalen is with the research firm Institutional Risk Analytics.

Mr. CHRISTOPHER WHALEN (Managing Director, Institutional Risk Analytics): So when questions started to come about these securities, about the prices of these securities, which firms like Lehman Brothers and Bear had on their balance sheet, investors began to get afraid to lend these firms money.

ZARROLI: Last night the Federal Reserve said it had allowed Goldman and Morgan to become bank holding companies. It's an arcane change in their legal status that will greatly alter the way they operate. They'll be able to compete with big commercial banks for customer deposits. They'll have permanent access to the Federal Reserve's discount lending window if they need money. That should help reassure investors that the companies can survive the turmoil in the markets. Fred Cannon, an analyst at Keefe, Bruyette & Woods, says the two companies probably felt like they had to make the change.

Mr. FRED CANNON (Associate Director of Research and Chief Equity Strategist, Keefe, Bruyette & Woods): I think that's part of a recognition that the, you know, the go-go days of the last four or five, especially in the mortgage business, have come to an end, that banks and brokers need more capital, and they're going to be more tightly regulated.

ZARROLI: Cannon says Morgan and Goldman will now be monitored by the Federal Reserve, and they'll find their activities much more constrained than they're used to. Investment banks typically use a lot of leverage. They borrow a lot of money to do business, as much as 30 dollars for every dollar of assets on their balance sheets. Now they won't be able to do that, and Chris Whalen says that's likely to cut into their profits.

Mr. WHALEN: They will have to run at lower leverage ratios than they have in the past. The compensation for the masters of the universe that populate Goldman Sachs and Morgan Stanley will probably drop considerably.

ZARROLI: And that will lead to some fundamental changes in the two firms' culture, says Charles Calomiris, professor of financial institutions at Columbia Business School. Calomiris says Goldman and Morgan were innovative, cutting-edge firms that regularly employed some of the smartest people on Wall Street. They came up with new kinds of investment tools and strategies that other firms emulated. Calomiris says, as commercial banks, Morgan and Goldman will be part of a much stodgier and more inhibited world.

Dr. CHARLES CALOMIRIS (Professor of Financial Institutions, Columbia Business School): That kind of process-oriented, bureaucratic regulatory environment is just not conducive to the culture of risk and the culture of innovation.

ZARROLI: But a lot of people would say, isn't that good? Isn't that what's gotten us into all this trouble in the first place?

Dr. CALOMIRIS: Well, they didn't get us into this trouble in the first place. Notice that they're not the ones suffering the large exposures to the subprime and the large losses.

ZARROLI: Calomiris says unlike Bear Stearns and Lehman Brothers, Morgan and Goldman have managed their way through the mortgage downturn pretty well. But ultimately, that wasn't enough to protect them when the crunch arrived. Jim Zarroli, NPR News, New York.

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Death Of The Brokerage: The Future Of Wall Street

In Depth

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The decision by Goldman Sachs and Morgan Stanley to become bank holding companies is nothing short of a historic realignment of the financial services industry. It marks the end of the securities firm model that has dominated Wall Street since the Great Depression.

Here, a look at what the change means to the future of investment banking.

Why did Goldman Sachs and Morgan Stanley decide to become bank holding companies?

The decision enables both firms to gain access to the Federal Reserve's discount window — the same line of credit that is open to other depository institutions. That's in addition to the temporary financial lifeline, called the Primary Dealer Credit Facility, that the Fed established for Wall Street broker-dealers after it bailed out Bear Stearns in March. The transformation into bank holding companies also allows Goldman Sachs and Morgan Stanley to tap into deposits from retail customers.

Goldman Sachs said that over the past several weeks it began discussions with the Fed regarding the possibility of becoming a bank holding company. "We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness," the company said in a statement.

Morgan Stanley CEO and Chairman John Mack said the bank holding structure would place his firm in the "strongest possible position — with the stability and flexibility to seize opportunities in the rapidly changing financial marketplace." On Monday, Morgan Stanley announced that it was pursuing a "strategic alliance" with Mitsubishi UFJ financial group Inc., the second-largest bank holding company in the world, with $1.1 trillion in deposits. If the deal closes, Mitsubishi would gain a 20 percent equity share in Morgan Stanley and a seat on its board. Mack said the alliance would enable Morgan Stanley to grow its business in Asia.

What's the difference between a bank holding company and an investment bank?

A bank holding company is essentially an umbrella organization that runs commercial banks, which accept deposits from retail customers. These institutions are regulated by the Federal Reserve and are also subject to oversight by the Federal Deposit Insurance Corp.

Investment banks help companies and governments raise funds by selling and issuing securities, and they offer advice on transactions, such as mergers and acquisitions. These firms operate with less oversight than commercial banks and are regulated by the Securities and Exchange Commission. Now that Goldman Sachs and Morgan Stanley have switched to bank holding companies, there are no independent investment banks left on Wall Street.

As of June, Citigroup was the largest bank holding company in the U.S., with $2.1 trillion in assets, followed by JPMorgan Chase, with $1.8 trillion in assets, according to the Federal Reserve. Goldman said it would become the fourth-largest bank holding company. Morgan Stanley did not announce where it would stand in U.S. rankings.

Why is this such a big change in the financial services landscape?

It's a huge change in the way Wall Street has done business since the Great Depression. In 1933 — in the aftermath of the stock market crash of 1929 — Congress passed the Glass-Steagall Act. Many people blamed the crash on commercial banks that were too eager to put deposits at risk on the stock market. In response, the act divided the banking universe into two camps: lending institutions and brokerages.

Officially, this wall of separation crumbled in 1999, when Congress passed the Gramm-Leach-Bliley Act, which once again allowed commercial and investment banks to consolidate. However, in practice, this consolidation was slow to take place, because at the time, many investment banking companies did not want to be regulated by the Fed, says financial consultant Bert Ely, the head of Ely & Co.. a financial institutions consulting firm.

So what's changed? Ely says the Bear Stearns bailout followed by Lehman Brothers' collapse and the sale of Merrill Lynch to Bank of America all increased both regulatory and political pressure for Goldman Sachs and Morgan Stanley to adopt the more stable — and more regulated — financial holding company model.

Will there be more regulation of these financial services companies under this model?

Yes. More agencies will have a hand in regulating the two firms.

Goldman already operates two banks — one in the United States and one in Europe — with more than $20 billion in deposits. As part of its reorganization, Goldman said that it would move assets into Goldman Sachs Bank USA. Morgan Stanley said that as of August, it has $36 billion in bank deposits and over 3 million retail accounts.

Ely says the three bank charters that Morgan Stanley owns and the two that Goldman possesses have been operating under special exemptions without FDIC oversight. "The more significant regulatory change is that the Fed becomes their primary regulator," says Ely.

The SEC will still regulate their broker-dealer subsidiaries, and the FDIC will be involved with these firms' banking activities.

Is this the end of investment banking activities on Wall Street?

Not at all. Goldman Sachs and Morgan Stanley and other firms will still be able to engage in investment banking activities. Their function in the marketplace will be very much the same. But now they'll engage in activities under the supervision of the Fed.