You'd think the last thing Goldman Sachs and Morgan Stanley would choose to be called is a bank. Such is the fury towards financials these days they should have re-classified themselves as cuddly toy makers. But this simple change is tactically smart. Confidence in broker-dealers is shot; by becoming regulated banks Goldman and Morgan Stanley have at least made sure they will not suffer the same fate as their Wall Street rivals. They now have long term access to the Federal Reserve primary credit facility, and, further down the road, alternative sources of funding such as retail deposits.
Their new status 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 standalone 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, still considers an “adequately” capitalised bank to be 20 times geared on a tangible equity to tangible asset basis. For now anyway, that lets them operate as is. Which is just as well because as BernsteinResearch shows, for the three years before the credit crunch, half of the increase in US investment banking earnings came from leverage.