Obviously the big news lately revolves around the credit crunch. AIG’s problems stem from it as well. But the most shocking news has been the fallout of the largest investment firms history has ever known. Bear Stearns, Merrill Lynch, and Lehman Brothers are all but dead. Merrill will live on only as a brand of Bank of America. Only two remain, Morgan Stanley and Goldman Sachs. But rumblings of mergers with other brick and mortar banks like Wachovia have left their future very uncertain. We all knew (because I called it even before CNBC) that there would be a consolidation of the finance industry. What we didn’t know was who would do what to whom and when and why. Now we do.
What’s the Problem?
The investment banks from my first paragraph are falling apart. They don’t have enough money to back up their loans. Like anyone, if you don’t have the cash to pay for your house and car, you must either sell your house and car or declare bankruptcy. Some of them chose the former, the other the latter. Morgan and Goldman are still independent, but that could change any day.
Why Just Investment Banks?
Investment banks are not like deposit banks. Investment banks are regulated by the Securities and Exchange Commission (SEC). Deposit banks are known as bank holding companies and are regulated by The Federal Reserve. Each has its advantages. Under the SEC, you are free to do almost whatever you want. In essence, this means you can borrow tons of money with little collateral. The simplified version is: investment banks can take a bunch more risk. Under Federal Reserve regulation as a bank holding company you are limited on the types of transactions you can be in. In other words the Fed keeps depository banks from taking too much risk. The investment banks fell much harder because they took more risk.
Will Morgan and Goldman Stay Independent?
That remains to be seen. They petitioned The Fed to be given holding company status. 18 months ago this would have been a nightmare for any investment bank. Lobbyists have been in Washington for decades protecting the investment banks from being forced under Fed regulation. Becoming a holding company would require much more regulation, and limit their activities. In the end profits would suffer. But being a holding company has its advantages. The biggest one is being able to borrow from The Fed. Bank of America, JP Morgan, Citi, Wells Fargo, Wachovia and others are able to borrow money from The Fed to stay afloat. Now that Morgan and Goldman have been given this status they can too. Chances of survival are increased, but not guaranteed. One of two things will happen: 1) the investment banks sell part of all of themselves to the likes of Wachovia and other finance institutions (China Investment Corporation is also a rumored buy) to be backed by deposits or 2) they remain alone but slowly morph into the depository banks they fought so hard to not become.
In the end, their own greed for profits caused their downfall, forcing them to become what they didn’t want to be. Sound familiar Star Wars fans? Anakin Skywalker didn’t want to be a Sith Lord. He fought hard to differentiate himself and remain a true
investment bank Jedi. In the end his own thirst for power lead him down the dark path as a means for survival.
Investment banking, as an independent industry, is officially dead.