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You’d think the last thing Goldman Sachs and Morgan Stanley would choose to become is a bank. Such is the fury at financials these days they should have re-classified themselves as cuddly toymakers. But this simple change is tactically smart. Confidence in broker-dealers is shot; by becoming regulated banks Goldman and Morgan Stanley have made sure they will survive. They now have long-term access to the Federal Reserve primary credit facility and can tap alternative sources of funding such as deposits. Certainly Mitsubishi UFJ – which agreed to buy a stake in Morgan Stanley on Monday – must think the US bank will exist a while longer yet.
This new status also reflects a new reality. Investors have lost faith in wholesale funding models. Politicians want banks to be less geared. Even if Goldman and Morgan Stanley could have convinced the market of their future as pure investment banks, investors and regulators would still have insisted on less leverage. Eventually, returns would probably have fallen to a level in line with the stodgier universal banks anyway.
So if you cannot beat them, join them? Not quite. Goldman and Morgan Stanley are class acts and will continue to allocate capital to business lines with the highest returns. Their new regulatory master, the Fed, considers an “adequately” capitalised bank to be 20 times geared. For now anyway, that lets them operate as is. That is lucky because Bernstein research shows for the three years before the credit crunch, half of the increase in US broker earnings came from leverage.
If markets regain some composure, Goldman and Morgan Stanley should benefit from reduced competition in investment banking. But they will probably have to buy retail deposits or themselves be acquired by a deposit-taking institution, if for no other reason than to please regulators and baying shareholders. Whether they then put their hearts and souls into it is another matter. Nor is there any guarantee they would be successful. Retail banking requires scale and a trustworthy brand – broker-dealers are a little short of both at the moment.
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