transformation into bank holding companies earlier this week is an attempt to shore up flagging public confidence in the firms, but may have little material impact on the businesses.
Registering with the
as bank holding companies should ease the fears that led to the free fall in the firms' shares last week and allow the firms to avoid a hasty merger with a commercial bank. But despite erasing the line between commercial and investment banks, the changes at Goldman Sachs and Morgan Stanley may not be as dramatic as they sound, industry observers say.
"This is all about perception," says Robert Litan, vice president of research and policy at the Kauffman Foundation. "That's what's driving this, is they want to give the perception they have a more stable source of funding, whether that's true or not. This is all about calming the markets down."
, the last two remaining major, independent investment banks, on late Sunday agreed with the Fed to become bank holding companies, after coming under assault following the bankruptcy of smaller competitor
and the government takeover of
American International Group
While many painted the decision to become bank holding companies as the
as it has existed on Wall Street since the Great Depression, both firms say becoming a bank holding company does not affect their ability to conduct existing business.
The move subjects Goldman and Morgan Stanley to closer regulation and cash requirements, in exchange for easier access to capital. Traditionally, investment banks have operated with significantly more leverage, or borrowed funds, than commercial banks. However, in response to heightened investor and regulatory concern about risk, both investment banks and commercial banks have been reducing leverage.
"For the past several quarters, in light of the difficult market environment, we have been reducing our risk exposures and increasing our capitalization," Goldman Chairman and CEO Lloyd Blankfein said in a press release announcing the move.
Goldman and Morgan Stanley both acknowledge that they will have to reduce leverage further now that they are being regulated by the Fed, but it is not clear how much of an impact that will have.
Jeff Harte, analyst at Sandler O'Neill, told
that Goldman and Morgan will have to reduce leverage, but he doesn't expect a dramatic change.
"It is important to note that Fed auditors have been sitting at the investment banks all year," he said, adding that they are currently comfortable with the levels of leverage and reserve capital held at the investment banks. "This almost seems more symbolic to me," Harte said of the change in status.
Other commentators, such as Sanford Bernstein analyst Brad Hintz, believe the impact of Fed oversight will be significant. In a report published Tuesday, Hintz forecasts lower return on equity for both companies. He believes they will now have to reduce exposure to private equity investments in areas not directly related to banking.
"To gain access to a permanent lender of last resort you're giving away a lot of your flexibility. Goldman owns power plants; Morgan Stanley owns an oil tanker fleet -- the Federal Reserve doesn't look fondly on those kinds of commercial-type investments," Hintz tells
However, an investment banker at a rival firm argues the Fed will simply give waivers to both banks, as it did when
acquired certain energy-related assets as part of its rescue of
On the capital front becoming a bank holding company provides some benefits. While both Goldman and Morgan Stanley already took deposits through bank subsidiaries, the move enables them to rely more heavily on that type of funding.
Goldman said in a press release it plans to grow its deposit base both through acquisitions and "organically," while Morgan Stanley said it "will pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits."
Deposits are attractive because they are more reliable than short-term borrowing from institutions. Bear Stearns, for example, relied heavily on overnight borrowing -- a cheap source of funds, but one that suddenly dried up as the investment bank lost the confidence of the market. The refusal of Bear Stearns' overnight lenders to continue to back the firm once it ran into trouble was one of the major factors that forced it to sell itself to JPMorgan Chase.
Fears that other investment banks funded themselves similarly drove Lehman Brothers to file for Chapter 11 bankruptcy protection and
to sell itself to
Bank of America
, in an effort to stave off the same fate.
Though Morgan Stanley and Goldman relied less on overnight lending than Bear and further reduced that reliance in response to Bear's crisis, equity investors did not appear to care. As the financial crisis drove more and more large institutions into bankruptcy, forced sales, or government bailouts, the perception that large investment banks were unstable became a self-fulfilling prophecy, forcing them to change their official status.
Securities and Exchange Commission
enacted a temporary ban on short-selling in financial stocks last week that halted the plunge in Goldman and Morgan Stanley shares.
The move allowed the firms time to assess the situation and avoid a potentially hasty move. After Goldman and Morgan registered as bank holding companies, Morgan cut off talks with
about a potential merger and has since secured a commitment from
to take up to a 20% stake in the firm. Goldman late Tuesday said
would invest up to $10 billion in the firm.
Those moves, plus their new status as bank holding companies, should help ease the crisis of confidence for Morgan Stanley and Goldman.
"For the brokers, the application to become a bank holding company looks like a safe port in the current credit storm," Hintz said in his report.