• 
• 

The Wall Street that shaped the financial world for two decades ended last night, when Goldman Sachs Group and Morgan Stanley concluded that there was no future in remaining investment banks now that investors have determined the model is broken.

The US Federal Reserve's approval of their bid to become banks ends the ascendancy of securities firms, 75 years after Congress separated them from deposit-taking lenders, and caps weeks of chaos that sent Lehman Brothers into bankruptcy and led to the rushed sale of Merrill Lynch to Bank of America.

"The decision marks the end of Wall Street as we have known it," said William Isaac, a former chairman of the Federal Deposit Insurance. "It's too bad."

Goldman Sachs, whose alumni include Henry Paulson, the treasury secretary presiding over a US$700-billion (Bt23.7 trillion) banking bail-out, and Morgan Stanley, a product of the 1933 Glass-Steagall Act that cleaved investment and commercial banks, insisted they did not need to change course, even as their shares plunged and their borrowing costs soared last week.

By then, it was too late. As financial markets gyrated - the Dow Jones Industrial Average whipsawed 1,000 points in the week's last two days - and clients defected, executives at the two firms concluded they had no choice. The Federal Reserve Board met at 9pm (New York time) yesterday and considered applications delivered that day, said Michelle Smith, a spokeswoman for the central bank. The decision was unanimous, she said.

"There's blood in the water in the industry and the sharks are circling," Peter Kovalski, who helps oversee about $10 billion at Alpine Woods Capital Investors, said at the end of last week. "It all comes down to perception and the current trust within the community."

Wall Street has not had such a shake-up since the 1980s, when firms including Morgan Stanley and Bear Stearns went public and London's financial markets were altered forever with the so-called Big Bang reforms implemented in 1986. Bear Stearns disappeared in March this year, when it was bought by JPMorgan Chase.

The announcement paves the way for the two New York-based firms, both of which will now be regulated by the Fed, to build their deposit base potentially through acquisitions. That will allow them to rely more heavily on deposits from retail customers instead of using borrowed money - the leverage that led to the undoing of Bear Stearns and Lehman.

Morgan Stanley has taken $15.7 billion of write-downs and losses on mortgage-related securities and various loans since the credit crunch started last year. Goldman Sachs's tally stands at $4.9 billion.

"Deposit-banking is king right now," said David Hendler, an analyst at CreditSights in New York. "It's the only meaningful critical-mass way to make money."

Morgan Stanley may feel it has more time to contemplate alternatives to the deal that it began to shape last week with Wachovia, said Tony Plath, a finance professor at the University of North Carolina.

"This means Morgan Stanley is reassessing its plan for a merger with Wachovia," Plath said. "Morgan Stanley is going to try to go it alone, and I expect it will try to buy a bank with a market-to-book ratio that is next to nothing. It means they are walking away from Wachovia."

Morgan Stanley, the second-biggest securities firm until this week, had $36 billion in deposits and 3 million retail accounts at the end of August. The company plans to convert its Utah-based industrial bank into a national bank.

"This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position," chairman and CEO John Mack said last night.

"It also offers the marketplace certainty about the strength of our financial position and our access to funding."

Goldman Sachs, the largest and most profitable of the US securities firms, will become the fourth-largest bank holding company. The firm already has more than $20 billion in customer deposits in two subsidiaries and is creating a new one, GS Bank USA, that will have more than $150 billion of assets.

The Washington-based Fed is the primary regulator of bank-holding companies, which are firms that own or control banks. Citigroup, Bank of America and JPMorgan are bank-holding companies regulated by the Fed.

Securities firms, by contrast, had been regulated by the Securities and Exchange Commission, which started facing a dim future after the structures of Goldman Sachs and Morgan Stanley changed.

"You can't kiss goodbye to the last two important investment banks without noting that the house is empty," said David Becker, a former SEC general counsel who is now a partner at Clear Gottlieb Steen and Hamilton in Washington. "It's a downward spiral where the less significant the population you regulate, the less your available resources."

The change is also likely to lead to less risk-taking by the companies and possibly lower pay for their employees.