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Banks' Change Leaves Void On Wall Street

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The Associated Press

Published: September 23, 2008

NEW YORK - The reorganization of Morgan Stanley and Goldman Sachs marks a historic end to a period when investment banks drove Wall Street and leaves open what - if anything - will assume the role of taking big risks that have powered the market's booms and busts.

The move to convert to a commercial bank structure will help the companies avoid the fates of Bear Stearns, Lehman Brothers and Merrill Lynch by giving them broader access to borrow federal money and the ability to build a stable base of deposits.

But it also likely means an end to sky-high profits.

The rules set by the Federal Reserve will limit opportunities for big payoffs from bets on the price of oil and other investments funded with borrowed money.

"The Fed is a much more intrusive regulator," said Brad Hintz, an analyst with Sanford C. Bernstein and a former chief financial officer at Lehman Brothers.
Investment banks provided a wide variety of services from managing initial public offerings, to repackaging and selling various forms of debt, to trading of stocks and bonds.

They profited from deals completed with borrowed money and took risks that commercial banks either opted not to or were unable to because of regulations.

The absence of stand-alone investment banks will leave a void in proprietary trading, which is when a financial company uses its own money or borrowings instead of clients' cash to complete trades. Those units placed big bets on interest rate changes and commodities prices.

The investment banks had been the biggest players in such trading. Experts expect smaller companies - including private equity firms and hedge funds - to take their place.

Boutique investment banks, which are similar to Morgan Stanley and Goldman but on a much smaller scale, could pick up some of the action, said Dave Ellison, the president and fund manager of FBR Funds - a unit of Friedman, Billings, Ramsey Group.

Spreading the risk among smaller players and increasing competition for business could help the financial sector.

But, along with the tighter regulations that will help reshape Wall Street, Goldman and Morgan Stanley will now have access to more federal money to shore up their global operations. Previously they only had temporary access to borrow from the Fed for U.S. operations, Hintz said. Now, as bank holding companies, they can help support their entire global operations with Fed funding.

The pair can also now build up deposit bases, but analysts predict Goldman and Morgan Stanley are unlikely to make a splashy purchase of a large retail banking institution anytime soon.

In a bid to shore up its balance sheet and further restore investor confidence, Morgan Stanley on Monday agreed to sell a 20 percent stake in itself to Japan's biggest bank for about $8 billion.

The investment by Mitsubishi UFJ Financial Group, which has $1.1 trillion in deposits, is the first step in this process of strengthening its balance sheet. Morgan Stanley's profit fell 41 percent during the nine months ended Aug. 31, compared with the year-ago period.

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