Death Of The Brokerage: The Future Of Wall Street The decision by Goldman Sachs and Morgan Stanley to become bank holding companies marks the end of the brokerage model that has dominated Wall Street since the Great Depression. Here, a look at what the move means and the future of investment banking.

Death Of The Brokerage: The Future Of Wall Street

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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.