Goldman Sachs and Morgan Stanley have ripped up the traditional business model of investment banking and — in a desperate bid to survive — submitted themselves to new regulations and restrictions that end the excesses of swashbuckling trading on Wall Street.
Their decision to convert into traditional bank holding companies, under the supervision of myriad US regulators, sparked a furious debate yesterday about the future of the finance industry when it emerges from its worst crisis since the Great Depression.
And in the short term it frees up the two firms, until Sunday night the last independent major investment banks left standing, to acquire retail banks and the stable deposit base that has enabled them better to weather the storm.
Morgan Stanley's chief executive John Mack mothballed emergency talks about being taken over by Wachovia, one of the biggest high-street banks in the country, and instead began a search for an acquisition. The company also, yesterday morning, announced that the Japanese bank Mitsubishi UFJ would provide around $8.5bn in new financing in return for a stake of up to 20 per cent in Morgan Stanley.
The panic of last week had threatened to destroy both Goldman Sachs and Morgan Stanley, as their shares plunged, the cost of financing their operations in the credit markets ballooned, and their most nervous clients began to pull business from the firms.
At the root of their problems has been the enormous leverage put on the businesses as they expanded their highly-profitable proprietary trading desks in the years before the credit crisis broke. Through leverage, Goldman Sachs has been trading assets with a value some 22 times that of its underlying capital; Morgan Stanley's leverage reached 30 times. These allowed them to juice profits on their investments during the boom, recording record earnings for shareholders and handing giant bonuses to their most aggressive traders, but it also made the companies inherently unstable. Lehman Brothers and Bear Stearns, two of the other big five investment banks, collapsed when their riskiest mortgage investments went sour; Merrill Lynch sold itself to Bank of America a week ago to avoid the same fate.
“This is a major realignment on Wall Street and we are going back to the days of merchant banking of the 1800s,” said Bob Ellis, senior vice president of the wealth management group at Celent, a Boston-based financial research and consulting firm.
“The universal bank model that has proved so successful in Europe and Asia and was not even permissible in the US until recently, had become the winning business model in the US, too. These copanies will have a strong retail bank, a strong retail brokerage and a reasonably strong investment bank and each of these companies supports the other.”
The existence of a strong deposit base should reduce the cost of funding the overall business, according to proponents of the universal banking model, since the whole is less risky. It also provides firms with greater access to lending facilities from the Federal Reserve.