When the Federal Reserve agreed to allow Goldman Sachs (NYSE: GS ) and Morgan Stanley (NYSE: MS ) to become bank holding companies, it signaled the final curtain call for the last major independent investment banks.
The year began with five investment-bank Goliaths ruling Wall Street with seemingly valuable franchises, and now none remain in their previous form. The practice of borrowing short-term to lend and invest long-term is essentially being abandoned in favor of the safety of deposit insurance and full access to central bank liquidity.
The full implications of these developments are not yet completely clear, but it doesn't stop us from recognizing it as a watershed moment and speculating about the future implications.
First, let's make it clear that Goldman and Morgan's primary focus is survival, even if it means drastically lowering their current leverage ratios and facing much more stringent capital requirements as banks. Both companies share similarly difficult journeys, but I believe their yellow brick roads diverge into two different paths of intention.
Morgan Stanley is more likely to go the retail-banking route as it grows its core base of deposits. As of August, Morgan had $36 billion of deposits, 3 million retail accounts, and 600 offices in 35 countries. In addition, Morgan's plan to sell up to 20% of the company to Japan's Mitsubishi UFJ Financial serves as a clear indication of its desire to partner with a large bank on its way to becoming a deposit-based institution.
Goldman's story is a bit more interesting. As for Goldman becoming a traditional retail bank, you shouldn't be expecting your complimentary toaster anytime soon. At heart, they are investment bankers committed to retaining their fiercely independent culture, even if it means allowing Warren Buffett to swoop in and score a sweetheart deal.
And don't be surprised if Goldman has simply taken temporary shelter in both the liquidity of the Federal Reserve and the aura of the Oracle. Becoming a commercial bank allows it to have continued access to the Federal Reserve Bank Discount Window and expanding opportunities for funding. Buffett's investment provides the company with not only $5 billion up front but also enough market credibility to raise additional capital simply off his implicit seal of approval.
Despite recent actions, it is reasonable to believe that Goldman is reserving the luxury to jettison both the banking structure and the accompanying regulation when bluer skies appear.
Regardless of intentions, I anticipate that the boutique investment firms such as Greenhill (NYSE: GHL ) , EvercorePartners (NYSE: EVR ) , Lazard (NYSE: LAZ ) , and Thomas Weisel Partners will be spotted a three- to five-year window to grow, while their larger competitors will be playing with one arm tied behind their backs.
While these midsize investment banks are driven by the cyclical nature of the mergers-and-acquisitions market, they do not have the liquidity issues that are plaguing their larger rivals. Even the publicly traded private-equity funds such as Blackstone (NYSE: BX ) , Fortress Investment Group (NYSE: FIG ) , and Och-Ziff Capital Management have the unique opportunity to use both the market turmoil and talent turnover to stitch together global investment-banking operations.
Either way, it will be the players who can think three to five to 10 years down the road who will dominate the future of American, if not global, finance. Tomorrow's investment franchises are being formed now, during these turbulent times.
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