An era on Wall Street ended Sunday night as Goldman Sachs Group Inc. and Morgan Stanley - the last two large independent investment banks remaining - announced they would become bank holding companies, subjecting themselves to greater regulation and effectively agreeing to take on fewer risks.
The moves capped an end to a tumultuous week on Wall Street, in which two other investment banks lost their independence. Last Monday, Merrill Lynch & Co. agreed to be bought by Bank of America Corp., and Lehman Brothers Holdings Inc. declared bankruptcy.
"It's almost as if the entire last 75 years has been stood on its head," said Charles Geisst, a professor of finance at Manhattan College and author of Wall Street: A History. "We're back to the Wall Street, at least in function, which was predominant in the 1920s."
Following the action, Wall Street reverts to its pre-Great Depression business model, before the Glass-Steagall Act required the separation of commercial and investment banks. Deregulation has led to the creation of conglomerates that provide both services, but until Sunday, the large, independent investment banks held out.
The Federal Reserve has already approved Goldman and Morgan Stanley's conversions, bypassing the normal five-day antitrust waiting period. In addition, it agreed to provide added liquidity support to the broker-dealer units of Goldman, Morgan Stanley, and Merrill as they make their transitions.
"We believe that Goldman Sachs, under Federal Reserve supervision, will be regarded as an even more secure institution with an exceptionally clean balance sheet and a greater diversity of funding sources," Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs, said in a statement.
"This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position, with the stability and flexibility to seize opportunities in the rapidly changing financial marketplace," John J. Mack, chairman and chief executive officer of Morgan Stanley, said in a statement. Morgan also announced yesterday that Mitsubishi UFJ Financial Group Inc., Japan's largest banking group, had agreed to buy a 20% stake in the firm.
By converting to bank holding companies, Goldman and Morgan can build deposit bases that could provide a stable capital source, allowing them to better weather future liquidity crises. Morgan Stanley had three million retail accounts and $36 billion in bank deposits as of Aug. 31, according to the company. Goldman Sachs Bank USA and Goldman Sachs Bank Europe PLC hold $20 billion in customer deposits, the bank said.
Both banks said they plan to grow their deposit bases, although experts said it remains to be seen how. Setting up a traditional bank could be expensive and difficult, so Goldman, for instance, might seek to acquire a commercial bank rather than growing on its own.
"It's still early to really imagine that Goldman is going to be a bank in the traditional sense," Geisst said.
But along with the ability to hold deposits comes greater regulatory oversight from a number of institutions, including the Federal Reserve. The Fed had already moved "75%" of the way in this direction when it began extending credit to the banks following the collapse of Bear Stearns earlier this year, according to Philip Strahan, a finance professor at Boston College's Carroll School of Management.
Higher capital requirements will force banks to reduce the leverage they have used to book high returns on equities in the past. The investment banks will either have to take on fewer risks or hold more capital for risks they take.
"On the one hand, they're receiving a government subsidy in the form of deposit insurance, so on the other they're not going to be able to take free reign as they please," said William J. Wilhelm Jr., finance area coordinator at the University of Virginia's McIntire School of Commerce.
The move could also lead to the end of the lavish compensation paid to Wall Street bankers. Although banks will still try to pay employees top dollar, lower leveraging could lead to a lower return on equity and a reduced ability to doll out fat paychecks in the future.
"I think there's going to be a lot of Wall Street people who are now going to have to learn how to live on a salary," Geisst said. "I just don't think they're going to be generating the money any more to justify it."
Also yesterday, Lehman Brothers U.S. broker-dealer unit reopened under new owner Barclays Capital following the approval of the transaction in bankruptcy court on Sunday. The firms reiterated their commitment to the public finance market and said the municipal securities business will be "operational as soon as possible."
"Barclays Capital is tremendously excited about the opportunities that exist within the Municipal Securities business," according to a joint statement from Eric Bommensath, head of global fixed-income trading at Barclays Capital, and Jerry Rizzieri, head of municipal and public finance for Lehman Brothers. "The integration of Lehman Brothers' municipal finance franchise into Barclays Capital's global platform will produce unparalleled commitment to underwriting, trading, distribution, and derivative solutions for our clients."
Patrick Temple-West contributed to this story.