The End of Pure Investment Banking

Two investment banks, Morgan Stanley and Goldman Sachs, are losing the adjective ‘pure’ in the phrase ‘investment banking’ and are becoming just banks that combine investments and deposits. This allows them access to a freshly approved amount of $700 billion in FED loans.

Written by: Vanja Figenwald
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The current story of Wall Street in collapse symbolically, but also ‘de facto’, marks the end of an era in recent weeks – the era of investment banking, which enabled the United States to rise to the financial pinnacle of the world about a hundred years ago. After the departure of three of the five largest banks from the financial scene in one way or another, the remaining two, Morgan Stanley and Goldman Sachs, will close the story of the legendary five without a helmsman. Namely, the two investment banks will lose that adjective and become just banks. Allegedly, these frightened banks came to such a decision on their own, although the reason is perfectly prosaic. This allows them access to the freshly approved $700 billion in FED loans, with which they hope to save themselves from the flood that their colleagues have experienced in recent weeks, unaware of the storm that is coming.
High financial circles that have lost themselves in their virtual dealings have now realized that a bank can hardly exist without a solid cash-deposit foundation.

Bank of America and JP Morgan Chase relied on those deposits, thus surviving the shipwreck to some extent. More precisely, they currently have the worst results. The state will now inject the huge money needed to surface, but it will also increase regulation of these ‘bad guys’, which includes the end of seven-figure rewards and privileges for various talented managers. Goldman paid its CEO and two vice presidents more than $67 million each last year. Wall Street is thus returning to the hated, classical banking, or universal banking, which combines investment with deposits. Paradoxically, the division was introduced during the Great Depression precisely to prevent the spillover of the investment circus directly into the traditional segment, that is, to reduce the volume of speculation, which was abolished in 1999. Now all cards are thrown on combined banks.

Greater Oversight of Operations

In practice, the transition from investment banks to bank holdings means significantly more careful oversight from several different state institutions (instead of the previous one – the Securities and Exchange Agency), transparent operations, higher capital reserves, and, most importantly, less risky behavior. Investment banks built their anthology status by betting their own money, and in a later phase, others’ money, on securities that, as everyone forgot somewhere in this game, are still just that – papers. Then investors suddenly lost confidence and began to pull their money out, revealing a very unpleasant truth. The banks simply did not have that money. No one did. Why did they suddenly become so contrite? Because they can only access the mentioned credit line if they make that concession, more precisely, if they agree to stronger control.

The best part of the whole story is that yesterday’s heavyweights invested significant money to reject greater regulation of their operations, only to today beg for water and a crust of bread from that same wicked state that constantly wants to meddle in their business. Now they would very much like to be meddled with a little. How shaky things were is shown by some numbers: today Goldman Sachs has one dollar of capital for every $22 of assets it manages, Morgan Stanley one dollar for every $30, while on the other hand, the surviving, at least for now, Bank of America has one dollar of capital for every $11. Even though both banks recorded losses of $15 billion (Morgan) and $5 billion (Goldman), they have managed to remain profitable so far, which means that these are preventive measures to anticipate possible consequences similar to Bear Stearns, Merrill Lynch, and Lehman Brothers.

In addition, Goldman Sachs will become the fourth largest bank in the U.S. with this move, thus retaining a high position in the market. The use of now available credit funds from the FED will likely be supplemented by acquisitions of other banks, with which they hope to increase their deposits of real money, the only remaining game in town. Besides the unfortunate fate of the largest banks, interestingly, the regulatory body, the infamous SEC (Securities and Exchange Commission), will have an uncertain future due to these changes, considering that the house it ‘supervised’ is almost empty. On the other hand, Morgan, like its colleagues, has begun to seek hard currency around the world to increase real capital, and the courting mainly refers, symbolically, to what Americans until recently liked to call the Third World, Chinese, South Korean, and other sovereign funds.

No Safe Model

Discussions about the future of the concept of investment banking have already begun, but the bigger question is whether returning to the universal model is a true solution to today’s problems. Because, as long as the investment element participates in the operations of the bank, there is a risk of spreading problems to the commercial, retail segment. This risk has been reduced by the existence of the deposit model of business, but it has not completely disappeared. Moreover, many overlook a somewhat superficial, but by no means unimportant, fact that directly relates to the ‘safe’ model – the trust of the wider population in banks has been shaken, which directly calls into question the inflow and amount of money available to banks in the near future. No one will easily leave money in Goldman Sachs just because it has overnight transitioned from investment, failed banking to commercial, and this applies to other banks as well.

And so ends yet another repeated cycle that the world has more or less already experienced. It is sad, in the end, that all those who were at the center of that crisis and thought that if everything collapsed, the state would take over and save them, were right. The FED actually bought AIG for $85 billion, thus acquiring about 80 percent of the shares in that insurance company. Neither America nor any other state can simply afford the collapse of the financial system at any cost, so there is no choice but to loosen the purse filled with taxpayers’ money to patch up the uncontrolled enrichment of a few. It is not hard to believe that this grotesque model will likely resurface after enough time has passed, and all those brokers will bring their boxes back into some new Lehman Brothers.