INVESTMENT BANKING
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t 21:30 hours on 21 September 2008, at the end of the most tumultuous week in the financial markets since the Wall Street Crash of 1929, the US Federal Reserve Board announced that it had approved the applications of Goldman Sachs and Morgan Stanley to become bank holding companies.
In this bland statement, rushed out on a Sunday night before the start of trading in Asia, the Fed had, in effect, called time on the last two major bulge bracket broker-dealers on Wall Street. The full-service investment bank model – buying and selling shares and bonds for customers, as well as advising companies and trading with their own capital – was declared extinct. Whereas universal banks raise their money by taking deposits from investors, the US investment banks relied on short-term funding through the money markets and on leverage to grow their return on equity. Their growth was fuelled by the low cost of capital in recent years, as Wall Street engaged in one of the largest carry trades in history, borrowing more cheaply than they could lend. When this funding dried up they were left ruthlessly exposed. By waiving the normal five-day waiting period for approval, the Fed was attempting to shield Goldman Sachs and Morgan Stanley from the financial storm that had already engulfed their former peers – Lehman Brothers, Bear Stearns and Merrill Lynch – and, at the same time, to assist them to transition to another business structure following the sudden collapse of confidence in their stand-alone broker-dealer model. In the short term, relinquishing their cherished status will afford them greater access to emergency funding from the US Federal Reserve’s lending facility. In March, the Fed opened its discount window to invest-
ment banks for the first time since the Great Depression – but this was only ever designed to be a temporary measure. In the longer term it will also make them subject to far tighter regulation by the US central bank, which will mean yet more capital, lower leverage and more disclosure. “When Goldman Sachs was a private partnership, we made the decision to become a public company, recognising the need for permanent capital to meet the demands of scale,” said Lloyd Blankfein, its chairman and chief executive. “While accelerated by market sentiment, our decision to be regulated by the Federal Reserve is based on the recognition
THE GLOBAL FINANCIAL SYSTEM STARTED TEARING ITSELF APART that such regulation provides its members with full prudential supervision and access to permanent liquidity and funding.” John Mack, his Morgan Stanley counterpart, stuck to the same script. “This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position – with the stability and flexibility to seize opportunities in the rapidly changing financial marketplace. It also offers the marketplace certainty about the strength NOVEMBER 2008 I CNBC EUROPEAN BUSINESS 23
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