(Recasts throughout, adds analyst comments, details)
By Mark Felsenthal and Jessica Hall
WASHINGTON/PHILADELPHIA, Sept 21 Goldman Sachs
and Morgan Stanley were granted approval on Sunday to become
bank holding companies regulated by the U.S. Federal Reserve,
effectively killing off the investment banking model that has
dominated Wall Street for more than 20 years.
The move enables Goldman (GS.N) and Morgan Stanley (MS.N)
to take deposits, gain easier access to financing and gives
them more flexibility to buy retail banks. It was initiated by
the only two big and independent U.S. investment banks left
after the failure of Lehman Brothers LEHMQ.PK and the agreed
takeover of Merrill Lynch MER.N last week.
The change, part of a wrenching transformation of the Wall
Street landscape amid financial markets turmoil in the past two
weeks, means that previously freewheeling firms will be subject
to much tighter regulation by the Fed, including tough capital
That could curb their ability to leverage up their
proprietary trading and other activity with mountains of
borrowed money. This will reduce their chances of producing the
kind of mega profits they had been making until the credit
crisis started to hit home this year.
"The timing of this move, in conjunction with all of the
other unprecedented steps taken in the past week, shows the
seriousness with which the government and the banks themselves
are still taking the short-term risks to systemic stability in
the financial markets," said Kirby Daley, senior strategist at
Newedge Group in Hong Kong. "The implications of all these
measures taken together are mind-boggling."
Under the new set-up, the primary regulator of the parent
companies switches to the Federal Reserve from the Securities
and Exchange Commission but the SEC continues to regulate their
U.S. securities businesses.
In exchange for the increased scrutiny, Goldman and Morgan
gain long-term access to the Fed's discount window and access
to bank deposits insured by the Federal Deposit Insurance Corp.
MORGAN, WACHOVIA MARRIAGE LESS LIKELY
Morgan Stanley is also now less interested in a merger with
the banking group Wachovia Corp WB.N. That is no longer
Morgan's first priority, though talks with other parties
continue, a person familiar with negotiations said.
It held a board meeting over the weekend to discuss
Wachovia and the possibility that China's sovereign wealth fund
China Investment Corp could increase its stake in Morgan
Stanley, according to sources familiar with the situation.
Morgan Stanley declined comment on the talks but it did say
in a statement that the new status would give it "flexibility
and stability to pursue new business opportunities."
"In some ways this makes it easier for them to buy a retail
bank, but they may argue that this makes them self-sufficient
and they don't need to buy a bank now," said the head of global
mergers at a U.S. investment bank.
"But they can't raise deposits fast enough organically to
stabilize their problems, it has to come through M&A," said the
banker, who declined to be identified because he was not
authorized to speak with the media.
Goldman intends expanding its deposit base by acquiring
deposits wholesale from other banks, particularly those in
distress, said the firm's spokesman Lucas van Praag.
It began to feel that it needed to consider something like
Sunday's move after the government-financed fire sale of
another investment bank, Bear Stearns, to JPMorgan Chase & Co
(JPM.N) in March, and the events of the past week accelerated
this thinking, he said.
"Last week the markets were looking for a 'belt and braces'
approach to safety and soundness -- now we have the central
bank as our regulator and permanent access to the lender of
last resort," he said.
Goldman saw its shares plunging as much as 45 percent in
the first four days of last week as even once seemingly
untouchable Wall Street firms appeared vulnerable to the
Its stock partially recovered amid news of a planned $700
billion bailout of the U.S. financial system by the government
and a ban on short selling of financial stocks.
To provide increased liquidity to the companies while they
go through the transition, the Fed agreed to lend to the firms'
broker-dealer subsidiaries on the the same terms as the Fed
discount window for banks.
The Fed said it was making the same collateral deals
available to the broker-dealer subsidiary of Merrill, which is
being acquired by Bank of America (BAC.N).
"It creates a perception of greater safety and supervision.
It really rationalizes the regulatory system. It should be good
for both Goldman Sachs and Morgan Stanley," said Chip
MacDonald, mergers partner at law firm Jones Day. "It gives
them better sources of funds through a commercial bank
The approval by the Fed came at the request of Goldman and
Morgan, according to a source familiar with the application.
RETAIL BANK ACQUISITIONS EASIER
Goldman Sachs said it would move assets from a number of
businesses into an entity called GS Bank USA that would have
more than $150 billion in assets, making it one of the ten
largest banks in the United States.
Under a commercial banking model Goldman and Morgan will be
able to take deposits which during this shaky financial
environment are considered a stable source of funding.
Their ability to take risks will not only be more
thoroughly questioned but also be more measured because
regulators will require stringent capital levels relative to
the risks they take. They will also be required to maintain
managerial and operational soundness and be subject to a strict
regulatory ratings system.
(Additional reporting by Paritosh Bansal and Joseph Giannone
in NEW YORK, John Poirier in WASHINGTON and Tony Munroe in HONG
KONG; Editing by Lincoln Feast)