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On Sunday, the US Federal Reserve moved quickly to grant a request by the country's last two major investment banks - Goldman Sachs and Morgan Stanley - to change their status to bank holding companies. The change in status will allow Goldman Sachs and Morgan Stanley to take deposits, bolstering the resources of both institutions. Apparently, Goldman and Morgan Stanley do not want to walk the same catastrophic path as their peers, who have faced mergers and bankruptcy.

This change represents the biggest restructuring on Wall Street since the Great Depression. The two big names will be leaving behind the legend of the past as they now are no longer certain about their future or whether they can continue to maintain their independence. By converting their status from investment banking, both institutions have admitted, with Federal Reserve and Treasury support, that the old investment-banking model no longer works. Before, Morgan Stanley and Goldman Sachs were regulated by the Securities and Exchange Commission. Now they will come under the supervision of the Federal Reserve, the central bank.

Under the investment-banking model, investment banks rely on short-term funding to finance investment in risky or longer-term assets. They make money from advisory fees, from underwriting bonds and equities and from their own portfolio trading. When financial turmoil hits, investment banks can't withstand the crisis because their capital base and funding sources are not big enough. They end up facing a mismatching of funding. This is why most investment banks have gone under. Many also fear that Goldman Sachs and Morgan Stanley might be acquired by bigger banks.

Goldman Sachs had total assets of US$1.08 trillion as of the end of the second quarter of 2008. It had $397 billion in short-term debt due within one year. But it only had only $230 billion in cash on hand. The ratio of short-term debt to cash is 1.7 times. With the financial meltdown going on, it would be difficult for Goldman Sachs to roll over its debt. Once the debt obligations are met, the creditors are likely to play it safe by demanding their cash back. Goldman Sachs won't be in a position to meet the debt obligations. Goldman Sachs is going to face a classic mismatching of funding, similar to what Asian countries faced during the financial crisis of 1997.

The situation is the same with Morgan Stanley. As of the end of the second quarter of 2008, it had total assets of $1.03 trillion. It had $358 billion in debt due within one year. But it had only $243 billion in cash. The ratio of the short-term debt to cash is 1.5 times. Once the creditors demand their money back, Morgan Stanley won't be able to fulfil the obligations because it has more debt than cash.

It is no surprise to learn that Goldman Sachs and Morgan Stanley are borrowing from the Federal Reserve Bank of New York to meet short-term debt obligations. The US Fed is now acting as a safety net for the entire US financial system. The two investment banking giants are using all kinds of collateral to get the cash from Uncle Sam. The US government is now trying to bring in legislation to form a Resolution Trust Corp to buy out he bad debts from financial institutions to the tune of US$700 billion.

The situation is similar to the run on Thai finance companies in early 1997, when they were forced to borrow short-term funding from the Financial Institution Development Fund to cope with panic withdrawals of deposits. The finance companies used all kinds of collateral to get the funding from the FIDF, which ended up owning land, buildings, golf courses and expensive paintings.

Bear Stearns and Lehman Brothers, which have already failed, were fine institutions. They had strong operations but their nature of borrowing in the short-term market for investing in the longer-term market could not be sustained in the financial meltdown.

On the contrary, big banks such as Bank of America and CitiGroup are in a better position to weather the meltdown due to their large deposit base. Bank of America posted total assets of $1.7 trillion in the second quarter of this year. It had $416 billion in short-term debt and $154 billion in cash on hand.

But unlike the investment banks, Bank of America has a large deposit base in which savers are not likely to rush to withdraw their money. The investment-banking firms mostly raise funding from institutions. That is why Bank of America is in a position to acquire Merrill Lynch for $50 billion. Merrill Lynch had total assets of $966 billion, with short-term debt of $402 billion against $282 billion cash. Merrill Lynch moved quickly to seek a merger with Bank of America to avoid bankruptcy like Lehman Brothers.