The Death of Wall Street

Since when did weekends become the normal occasion for dumping unprecedented economic news on us? For the … oh, I've lost count … maybe third weekend in a row, financial markets were inundated with news that's bound to shift our economic landscape for ages to come.

Here's the latest:

It's over
That's right. It's done. It's over. Wall Street as it's been known for decades got a dramatic makeover this weekend as the remaining independent investment banks -- Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) -- gained approval from the Federal Reserve to be recognized as bank holding companies.  

What's that mean? For starters, both companies will be permitted to form deposit-taking entities, which will allow them to replenish their balance sheets with a more stable source of capital than the short-term funding they had been relying on.

Good news, right? For most, absolutely. The moves should squelch any remaining fear that the last two independent Wall Street banks are on their death beds, and that ought to (cross your fingers) restore a sliver of confidence in the financial system.

But yes, in many ways, this marks the death of Wall Street as we knew it. Under the new regulations, Goldman and Morgan Stanley will be required to meet strict capital requirements and fierce oversight, and that means the days of being allowed to leverage from here to Timbuktu are over -- and good riddance. In short, that means an end to a good chunk of previous profit streams.

Recently, Goldman was leveraged about 24-to-1, while Morgan Stanley was leveraged nearly 30-to-1. Under their new structures, they'll probably have to scale back to become more in line with the likes of Bank of America (NYSE: BAC  ) and JPMorgan Chase (NYSE: JPM  ) , which were leveraged about 11-to-1 and 13-to-1 last quarter, respectively.

R.I.P., recklessly made profits.

Bailout update
We're getting our first glimpse of how much the mother of all bailouts could cost taxpayers, and it isn't encouraging: $700 billion -- or about $2,300 per person.

First, an important point that hasn't been brought up enough lately. Whatever the final cost to taxpayers will be, it's bound to be less than the amount of credit extended to the bailout program. Once the Treasury starts buying bad assets from banks, it's of course going to make an attempt to resell what it can back to markets, albeit at some unknown price and an unknown time. And yes, these assets still have value. The bad assets clogging the debt market are worth less, not worthless.

The answers to three very important questions regarding the bailout remain unknown: (1) at what price the Treasury will buy assets from banks, (2) how much the Treasury will be able to re-sell those assets for, and (3) what kind of magic trick the Treasury has planned to raise $700 billion without sending the economy into an inflation-driven bender. Until answers to those three questions are hammered out, there's absolutely no telling what the final cost to taxpayers will be.

Perhaps the worst idea I've ever seen
Australia took one of the most excessive market-intruding actions a free-market economy has seen in recent memory after banning all short-selling. No, not just a collection of financial stocks like American markets did last week … the Aussies simply abolished short-selling altogether.

Please, oh, please, regulators, if you can hear me, don't follow our friends down under. Sure, eliminating short-selling on financial companies will be a short-term boon for companies such as Washington Mutual (NYSE: WM  ) , Wachovia (NYSE: WB  ) , and Citigroup (NYSE: C  ) , but ask yourself some questions: How much of that increase is artificial? Once the ban ends, what happens? How much of the recent run-up has been caused by short-sellers covering their positions? Doesn't eliminating short-selling reduce liquidity, and, hence, couldn't it exacerbate some of our current problems?

As a fellow Motley Fool contributor joked last night, what's next … a ban on selling stocks altogether? In a week where the unthinkable has become reality, all options are on the table.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article but would appreciate his weekends back, thank you very much. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (28)

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  • Report this Comment On September 22, 2008, at 11:20 AM, megalon81 wrote:

    The "weekend work" strikes me as a ploy to increase the anxiety of the person on the street ("oh my gosh, they couldn't even wait two days!", and also increase admiration for the powers that be who are addressing the problem ("Gee, these folks are even willing to work on the weekends!") It also seems to be good strategy. THe 24/7 news cycle has never been really 24/7-- weekend events like these simply don't get media coverage, even on the internet. They simply get "news flashes." No analysis, explanation, insights or anything. Hence, folks can make whatever deals they want during these two days, and leave the public with a "f'ait acommplait" (however you spell that).

  • Report this Comment On September 22, 2008, at 11:41 AM, shared03 wrote:

    Short selling should be regulated by the Gaming Control Board, ie.Gambling Control Board. Selling shares is not at all like short selling! When buying and selling shares you are actually exchanging part ownership in a company - something of value. It's was supposed to be a STOCK market. Stock in a company is no different than stock on store shelves, it's physical commodity. You can not practically sell that which you do not own! You have not been authorized by any company to dilute their shares at your will! Short selling is an imaginary concept.

  • Report this Comment On September 22, 2008, at 12:22 PM, nabrum wrote:

    I agree with shared03. Short selling is nothing but counterfeiting stock. What ever happened to the "1 share, 1 vote" concept of stock ownership? Short selling is NOT needed for liquidity, that is just hedge fund BS. If something is too expensive, the price will drop, because no one will buy it at the expensive price. (Look at the housing mkt as an example.) Kinda like supply and demand - what a concept!

    Short selling and Options are nothing more than a ruse for crooks to make money at the expense of Main Street by diluting a product.

    Short selling and the Options Market should be banned. Period.

    Way to go Aussies! Hear that Paulson?

  • Report this Comment On September 22, 2008, at 12:45 PM, ketchupman wrote:

    Ok, I see the wisdom of limiting short selling, especially naked short selling, at least temporarily. But what about these overly complex derivatives that seem to keep popping up in the reports of "What caused this mess in the first place?". There seems to be more than one vehicle described as belonging to this class of "investment" instrument. Is anything being done to weed out this bad paper from the system? If not, why not? It seems to me that some of these things were like some sort of smoke-and-mirrors deal to begin with. Who regulates them and their use in the market? Are they really needed for our economic well being?

  • Report this Comment On September 22, 2008, at 1:40 PM, RRGY2K wrote:

    The Death of Wall Street?

    Hallelujah brother!

    Naked short sales are now illegal. Is this the first sign that the SEC finally gives a damn about protecting the public equity markets? Nah. They just got scared when naked shorts began to attack the only companies they really care about.

    In a free market, price is determined by supply and demand. A fictitious source of additional supply is created when you let people sell something they don't own, destroying the price integrity of the market. Funny that we ban the shorting of Wall Street's favorites, while it's still just great for short attacks to strip capital from countless small companies trying to get traction.

    "Shorting weak companies into oblivion is just culling the herd" goes the argument. This is a more attractive idea to mountain lions than it is to ranchers, and ranchers, unlike mountain lions, produce products, employ people, and pay taxes.

    We have option markets for people who want to leverage their wisdom about the future of a company. Shorting stocks should be illegal, period.

  • Report this Comment On September 22, 2008, at 4:50 PM, nbr3bagshotrow wrote:

    I still don't understand why we allow short selling of stocks. I can't short sell a car, real estate, or anything else. Why does stock have to be different. If you think a stock (or company) isn't going to be any good then sell the stock if you have it and don't buy the stock if you don't. Borrowing stock to sell at a lower price is just gambling.

  • Report this Comment On September 22, 2008, at 5:57 PM, macrophyllum wrote:

    This bailout stinks of the same shenanigans the Bush Administration pulled with the Iraq war: "Quick Congress, act quick or it will jeopardize Main Street". This is the largest spending bill *ever* to pass through Congress, it should not be rushed. In fact, it shouldn't be passed at all because by doing so we have essentially privatized profits and now we will be socializing the loss. This is starting to sound a bit fascism.

    The credit and financial sector grew to fast too quick with no solid foundation and now it needs to contract and the pain of that contraction should not be passed to the American public. And don't start with, "it will be better than the alternative", because that is not true. Do you realize how badly the bailout will send the US deeper into the red. The value of the dollar will tank and inflation alone from this bailout will cost more to the American taxpayer than if there was no bailout. Sell your stocks until the US economy has the necessary "reboot". Buy gold, or eve better platinum, because that is less likely to be confiscated when this economy finally does break. The bailout is just another patch on the balloon trying to pop.

    I liquidated most of my portfolio today and moving to precious metals.

    (p.s. sorry for any typos)

  • Report this Comment On September 23, 2008, at 9:37 AM, sly1948 wrote:

    Who are we "bailing out" is what I would like to know. 95% of all loans are paid on time and minus all the talking head telling us dooms day has arrived, there would have been no massive selloff and no run on the banking system causing the need for a bail out? Are we really just suffering from the age of "to much information" that isn't really anything more that lips flapping filling air time.

  • Report this Comment On September 24, 2008, at 12:28 AM, krazycanuck wrote:

    Nothing wrong with covered short selling (eg borrowing the stock first, then selling it, and buying it back to return to the lender). Naked shorting never should have been allowed for ANY reason. This is what is dilutive and counterfeit. Shorting (borrowed) shares does not increase the float at all.

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