The Death of the Investment Bank - TheStreet

Updated from 8:38 a.m. EDT.

The modern, standalone investment bank died Sunday, the culmination of a stunning seven days that transformed Wall Street.

Goldman Sachs and Morgan Stanley

, the last two remaining major, independent investment banks, on late Sunday agreed with the

Federal Reserve

to become bank holding companies that subject them to closer regulation and cash requirements, in exchange for easier access to capital.

Once vital cogs in global finance, investment banks like Goldman, Morgan Stanley -- and recently defunct firms like Bear Stearns and Lehman Brothers -- were brokers in prestige and capital. Most companies could not finance their business without them.

That isn't the case anymore. Corporate powerhouses like

Microsoft

(MSFT) - Get Report

and

Google

(GOOG) - Get Report

command enough capital and clout to leave investment banks struggling for relevancy.

"What are investment banks doing for the economy?" asks author and historian Ron Chernow, who wrote

House of Morgan

, the definitive history of J.P. Morgan banking dynasty. "In recent years investment banks have become more like corporate versions of hedge funds. Instead of being providers of capital they are managers of capital or even users of capital. When an investment bank is leveraged 35 times, it's more a debtor than a creditor. The history of Wall Street has been stood on its head in recent years."

Cramer: Goldman, Morgan Better Off

var config = new Array(); config<BRACKET>"videoId"</BRACKET> = 1811349290; config<BRACKET>"playerTag"</BRACKET> = "TSCM Embedded Video Player"; config<BRACKET>"autoStart"</BRACKET> = false; config<BRACKET>"preloadBackColor"</BRACKET> = "#FFFFFF"; config<BRACKET>"useOverlayMenu"</BRACKET> = "false"; config<BRACKET>"width"</BRACKET> = 265; config<BRACKET>"height"</BRACKET> = 255; config<BRACKET>"playerId"</BRACKET> = 1243645856; createExperience(config, 8);

On Sunday evening, Sept. 14, four major investment banks remained following the forced sale of

Bear Stearns

in March. A week later, only two,

Morgan Stanley

(MS) - Get Report

and

Goldman Sachs

(GS) - Get Report

, were left.

The events of the week -- which included

Lehman Brothers'

bankruptcy filing,

Merrill Lynch's

(MER)

resulting flight into the arms of

Bank of America

(BAC) - Get Report

and the near collapse and eventual government takeover of giant insurer

AIG

(AIG) - Get Report

-- led to a crisis of confidence in the very business model of century-old institutions like

Goldman Sachs and Morgan Stanley

.

Chernow argues that while firms like Morgan Stanley and Goldman once played an important role in bringing together industry and capital, that function is no longer as necessary.

"Fortune 500 companies have outgrown their Wall Street investment banks," he says. "They no longer need to piggyback on to the superior capital or higher credit ratings of their banks. Very often they have better credit ratings and more cash on hand than the investment banks -- and there are so many sources of capital in the world."

Investors relentlessly fled Goldman and Morgan after the failure of Lehman and the bailout for AIG. Morgan, in a surprise move, had moved up its earnings call from Wednesday morning to after Tuesday's closing bell to try and stop the bleeding, but it didn't work. Its shares fell 24% the next day. Both firms, each of which beat third-quarter earnings expectations on Tuesday, sank to hit 52-week lows by Thursday.

Morgan Stanley

then set off on a frenetic search for a merger partner. But talks between Morgan Stanley and

Wachovia

have cooled since the announcement of the plan to make Goldman, Morgan Stanley and Merrill bank holding companies.

Goldman and Morgan Stanley had recovered Friday, amid the stock market surge following the federal government's announcement of several extraordinary measures to stem equities' slide. The plan includes the creation of

Resolution Trust Corp.

-like vehicle, of hundreds of billions of dollars, to buy up illiquid debt and a temporary ban on all

short selling

of financial stocks.

These measures are temporary solutions, however, and as Goldman and Morgan Stanley embark as newly minted banks, they confront a changed landscape.

The move is not entirely unanticipated. With Bear Stearns ending up as part of JPMorgan Chase and Merrill linking up with BofA, it has become clearer to many on Wall Street that investment banks would have to acquire a deposit base to survive. Bill Cohan, a writer and former investment banker who is currently working on a book about the fall of Bear Stearns, said companies will still need to raise debt and equity, but those activities will be restricted to better capitalized and better regulated commercial banks.

"There will be a new world order as there has been on Wall Street any number of times," Cohan says. "Because Wall Street is in the business of chewing up and spitting out anybody who has a shred of memory, this seems like a revelation -- an extraordinarily new phenomenon, but it's not. If Wall Street would celebrate the collective wisdom of its older people instead of shooting them out the door, maybe stuff like this wouldn't happen."

One older person who has stuck it out is Alan "Ace" Greenberg. The octogenarian former Bear Stearns chairman and CEO still mans a trading post at

JPMorgan Chase

(JPM) - Get Report

, which acquired Bear in a federally orchestrated fire sale in March. Reached at his desk Thursday morning, he was not ready to write the obituary of Goldman or Morgan Stanley.

"I think those two are terrific. I think they'll survive," he said. "A lot of things are threatened and sometimes they come back. They're putting it on the endangered list and then they come back beautifully. "

Small, less capital-intensive investment banks look to have a future. While shares of Morgan Stanley and Goldman have plummeted last week,

Lazard

(LAZ) - Get Report

and

Evercore Partners

(EVR) - Get Report

have actually seen their shares rise. On Sept. 3, Lazard announced it would sell $260 million worth of shares in a secondary offering. Not because the firm needed capital, but apparently because some of the firm's top executives wanted to take some money -- more than $10 million each, in fact -- off the table.

These smaller firms, along with a few others, offer merger advice and asset management, but for the most part they do not help companies raise capital or trade securities and they do not lend. Big banks, on the other hand, must unwind their hedge fund-type ways.

"As long as we were seeing the high reward part of it we forgot about the high risk," Chernow says.

Cohan expects that model could return in 10 years, but in the meantime, he sees at least one reason for optimism in the crisis.

"Maybe some of our best and brightest people will go into other things than pushing paper around on Wall Street," he says. "Maybe they'll get involved in innovating solar power and fuel cells, and -- where we really need them -- in politics."