The end of Wall Street

Stopping at a news stand today, I saw this article on the front page of The Wall Street Journal:

Goldman, Morgan Scrap Wall Street Model,
Become Banks in Bid to Ride Out Crisis

The Federal Reserve, in an attempt to prevent the crisis on Wall Street from infecting its two premier institutions, took the extraordinary measure on Sunday night of agreeing to convert investment banks Morgan Stanley and Goldman Sachs Group Inc. into traditional bank holding companies.

With the move, Wall Street as it has long been known—a coterie of independent brokerage firms that buy and sell securities, advise clients and are less regulated than old-fashioned banks—will cease to exist.

Here is an excerpt from the New York Times’ coverage of the same story:

Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater regulation, the Federal Reserve said Sunday night, a move that fundamentally reshapes an era of high finance that defined the modern Gilded Age.

The firms requested the change themselves, even as Congress and the Bush administration rushed to pass a $700 billion rescue of financial firms. It was a blunt acknowledgment that their model of finance and investing had become too risky and that they needed the cushion of bank deposits that had kept big commercial banks like Bank of America and JPMorgan Chase relatively safe amid the recent turmoil.

It also is a turning point for the high-rolling culture of Wall Street, with its seven-figure bonuses and lavish perks for even midlevel executives. It effectively returns Wall Street to the way it was structured before Congress passed a law during the Great Depression separating investment banking from commercial banking, known as the Glass-Steagall Act.

By becoming bank holding companies, the firms are agreeing to significantly tighter regulations and much closer supervision by bank examiners from several government agencies rather than only the Securities and Exchange Commission. Now, the firms will look more like commercial banks, with more disclosure, higher capital reserves and less risk-taking.

For decades, firms like Morgan Stanley and Goldman Sachs thrived by taking bold bets with their own money, often using enormous amounts of debt to increase their profits, with little outside oversight.

They were the envy of Wall Street, dominating the industry’s most lucrative businesses, landing headline-grabbing deals and advising companies and governments around the world on mergers, stock offerings and restructurings.

But that brash model was torn apart over the last several weeks as investors lost confidence in the way they made those bets during the recent credit boom, when investment banks expanded with aplomb into esoteric securities, the risks of which were not easily understood.

Over several harrowing days, clients started pulling their money, share prices plunged and these banks’ entire enterprises were brought to the brink.

In exchange for subjecting themselves to more regulation, the companies will have access to the full array of the Federal Reserve’s lending facilities. It should help them avoid the fate of Lehman Brothers, which filed for bankruptcy last week, and Bear Stearns and Merrill Lynch—both of which agreed to be acquired by big bank holding companies.

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A. Zarkov writes:

Investment banks like Morgan Stanley will now have capital requirements and other regulations that should significantly reduce their return on investments. Regulation of the derivative market is also coming. Congress took that function away from the SEC years ago, and the use of derivatives ran wild contributing to the current mess.

All this means lower profits, and lower salaries for Morgan Stanley and the rest of Wall Street. As a result, real estate prices will drop in New York City. All this means smaller government revenues. Now let’s see what happens to the liberal welfare state. Will it get cut back? In California there will be less construction and fewer jobs for Mexicans. Will the taxpayers allow the CA government to support out-of-work illegal Mexican migrants and their families at their expense? Perhaps we will see if immigration and a reduced welfare state can co-exist or does something have to give?

Posted by Lawrence Auster at September 22, 2008 03:59 PM | Send