Morgan Stanley, Goldman Sachs Turns to Commercial Banking

September 22, 2008 Updated: September 22, 2008

NEW YORK—In a stunning turn of events, on Sunday night the two remaining securities firms, Morgan Stanley and Goldman Sachs, applied to the Federal Reserve to become commercial bank holding companies subject to far greater federal regulations.

According to the Fed, the firms initiated the move, as they acknowledged that the current business model of investment banks—taking big risks, high leveraging, and 7-figure bonuses—may not last in this market turmoil.

The Wall Street landscape now returns to the days before the Great Depression, when Franklin D. Roosevelt signed the Glass-Steagall Act of 1933 into law. The Act created the Federal Deposit Insurance Corporation (FDIC) and separated commercial banks—which are highly-regulated—from investment banks subject to far fewer regulatory measures.

The moves will enable Morgan and Goldman to secure customer deposits, acquire commercial banks, and transition to bank holding companies with commercial and investment banking arms. Their structures are expected to mirror those of Citigroup Inc.., Bank of America Corp., and JPMorgan Chase & Co.

Holding companies are subject to tighter regulation by the Federal Reserve, the Securities and Exchange Commission, the FDIC, and federal bank examiners. Commercial banks must also keep higher capital reserves.

Goldman wrote down $4.9 billion on losses related to mortgage securities, while Morgan’s write downs totaled around $15 billion. The two firms are the only ones still standing from a field of five early this year.

While both firms have ample capital, revenues from investment banking, trading, and advisory have declined this year.

Shifting Approach

An investment bank’s risk-taking business model calls for heaving borrowing, and relies on a liquid financial market to finance its operations. It does not have the stable income and capital commercial banks with depositing customers provide.

“While accelerated by market sentiment, our decision to be regulated by the Federal Reserve is based on the recognition that such regulation provides its members with full prudential supervision and access to permanent liquidity and funding,” said Lloyd C. Blankfein, Chairman and CEO of Goldman Sachs, in a company statement.

Goldman currently has two depository institutions, Goldman Sachs Bank USA and Goldman Sachs Bank Europe Plc. The company will create a new branch called GS Bank USA.

“We are moving assets from a number of strategic businesses, including our lending businesses, into GS Bank USA,” the company said. “With over $150 billion in assets, GS Bank USA will be one of the ten largest banks in the United States. While these assets are fully funded for term, they also are available to be funded by the Federal Reserve. We intend to grow our deposit base through acquisitions and organically.”

On Monday morning, Japanese bank Mitsubishi UFJ Financial Group announced an $8.4 billion investment into Morgan Stanley for up to a 20 percent stake.

“This strategic alliance with Mitsubishi UFJ can put Morgan Stanley in an even stronger position as we look to realize the opportunities we see in the rapidly changing financial marketplace,” Morgan CEO John Mack said in a release. “As one of the largest commercial banks in the world, Mitsubishi UFJ would be a valuable partner as we transition to a bank holding company and build our bank services and deposit base.”

Mack said that the company will “evolve our business model and move quickly to seize these new opportunities.”

Morgan is expected to convert its Utah industrial bank into a new deposit-taking national bank.