Wall Street crisis: Investment banks succumb to collapse in confidence

[Tom Church]

I found this on the Gaurdian.co.uk. The Credit Crisis is fascinating in my opinion, how things spiral downwards, with the blame being passed around like a hot potato. Each small, bad influence has a huge negative multiplier effect. It shows how even with huge positive inputs, only tiny, minuscule gains are made. This is the nature of human life...


The concept of a Wall Street investment bank was in its death throes today as Morgan Stanley and Goldman Sachs succumbed to a collapse in confidence in their financial stability by converting themselves into lower risk, tightly regulated commercial banks.

Beset by plunging share prices and alarmed by the demise of competitors, the two remaining standalone Wall Street banks accepted licences from the Federal Reserve which allow them to take deposits from the public backed by federal government guarantees.

While safeguarding customers' money, the change will radically restrict the firms' activities by imposing strict regulatory limits on the risks their traders can take on the markets and on the amount of money they can borrow.

Morgan Stanley further shored up its financial position by selling a stake of up to 20% in itself to Japan's Mitsubishi Financial Group for an estimated $8bn to $9bn.

Against a backdrop of an ongoing global financial crisis, the hurriedly agreed change in the two US banks' status happened without the usual 30-day waiting period for such applications. It came as Congress began scouring legislation to enact a $700bn government bail-out for banks through the creation of a state-sponsored body to suck up toxic, underperforming mortgage-backed assets.

Goldman Sachs' chief executive, Lloyd Blankfein, said his firm would be viewed as an "even more secure institution" under the new regime while Morgan Stanley's boss John Mack said it offered "certainty about the strength of our financial position and our access to funding".

Only last week, both firms were vigorously defending the viability of their business models in spite of a sell-off which sent their stock plunging by 20% to 30% on consecutive days.

They insist that unlike rivals such as Lehman Brothers and Bear Stearns, they are profitable and suffering few financial problems. But insiders accept that the landscape has changed - once source said: "Given the events of the last few months, particularly the last week, it's become very clear that the market places a premium on safety and certainty."

The conversions end a chapter in US banking history which opened in 1933 when the Glass-Steagall act separated investment banking from high-street banking. Bill Isaac, a former chairman of the Federal Deposit Insurance Corporation, said it was the end of Wall Street banking as we know it.

"They're the only two left and the handwriting was on the wall," said Isaac. "It's a shame because this country was built, in part, on risk-taking by Goldman and Morgan and by a whole bunch of firms before them."

Analysts say the banks' new status will limit their ability to dabble in the types of exotic derivatives and credit instruments which contributed to the credit crunch. Banks' risks are generally judged by a leverage ratio of assets to borrowing. Morgan Stanley's ratio reached 33 last year and Goldman Sachs' touched 28 while high-street banks are typically in the low teens or below.

David Williams, an analyst at Fox-Pitt Kelton in New York, said: "The regulatory tide is moving against the investment banks. There are going to be higher levels of regulation, lower leverage ratios, greater scrutiny on what they do."

Neither Goldman nor Morgan Stanley has immediate plans to open networks of high-street branches. Morgan Stanley already has about 300 branch offices and is expected to offer a broader range of services at the counter.

Goldman intends to bid for deposits on a wholesale basis - for example, by stepping in to become custodian when local banks struggle in the US.

Between them, the banks hold about $56bn of customers' deposits in their wealth management businesses for rich private clients which, as of today, are guaranteed by taxpayers' money.

Bear Stearns' collapse in March was the beginning of the end for Wall Street's "big five" standalone investment banks. Lehman Brothers went bankrupt last week, although its US operation re-opened yesterday under Barclays' ownership. Merrill Lynch is set to be swallowed through a $50bn buyout by Bank of America.

Alarmed by the speed of the industry's unravelling, the Bush administration is pushing for swift legislation on a $700bn bail-out plan. Democrats in Congress are fighting to insert measures in which would give the government a stake in banks benefiting from aid and would cap executive pay.

Critics of the industry say the money ought to be used to help homeowners in danger of losing their houses. Bruce Marks, chief executive of the Neighbourhood Assistance Corporation of America, said: "We are rewarding companies whose only motivation was greed. This is truly moral hazard bearing its ugly head."

During early trading, Wall Street stocks were sharply down with the Dow Jones Industrial Average losing as much as 200 points.