Goldman, Morgan Become Bank Holding Companies

The current financial crisis has effectively wiped out the main investment banks on Wall Street. Bear Stearns and Merrill Lynch are no longer independent. Lehman Brothers is broke. Over the week-end, Goldman Sachs and Morgan Stanley were rechristened as bank holding companies, meaning they can now accept deposits, have accepted greater regulation, and have brought an end to an era.

The change leaves America without an independent investment bank of any importance. The reason is the model on which they worked failed. Liz Moyer at Forbes put it succinctly, “That model included using a combination of unsecured and secured debt financing to fund activities like trading and corporate lending, rather than relying on stable bank deposits to fund some of those activities.” Most of their activities were focused on trading on their own accounts and less than half on providing investment banking services (IPOs, mergers and acquisition advice and financing).

On Monday, Morgan sold a 20% stake in its operations to Mitsubishi UFJ Financial Group, the largest bank in Japan. The price is about $8.4 billion. This helps Morgan reduce its leverage, 24-to-1 for most broker-dealers, to 10-1 for commercial banks. With the Fed waiving the 30-day comment and review period, Morgan can get on with taking deposits and becoming just like any retail bank.

Goldman has yet to team up with anyone. It was the strongest of the independent investment banks, having sold all that mortgage paper rather than buying it. JPMorgan Chase & Co. analyst Kenneth Worthington wrote in a research note that Goldman will probably just reduce its operating leverage during the next peak cycle, keep more capital, and therefore, reduce its return on equity. Goldman already has two deposit-taking institutions, Goldman Sachs Bank USA and Goldman Sachs Europe PLC, which hold more than $20 billion of customer deposits.

The change in status means that the SEC will no longer regulate them; the Fed will. The regulations with which they must comply will make them much safer for their customers. And as Mr. Worthington noted, reduced leverage will make them less profitable. He anticipated Goldman’s profits to be on the 20% level in future rather than the 40% it has previously made. Reality time – 20% is a damn fine rate of return.

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