REVIEW/PREVIEW: Goldman and Morgan Stanley Ditch Banking Script, So Far

By Landy, Heather | American Banker, December 30, 2009 | Go to article overview

REVIEW/PREVIEW: Goldman and Morgan Stanley Ditch Banking Script, So Far


Landy, Heather, American Banker


Byline: Heather Landy

After their first full year as bank holding companies, the surprising thing about Goldman Sachs Group Inc. and Morgan Stanley is not that they survived this long, but that their traditional business model has.

Many obituaries were written late last year for the concept of the independent investment bank. Conventional wisdom said the firms could not continue without the stability of old-fashioned bank deposits. Popular opinion held that the firms would have to stop putting capital at risk in a market that suddenly revered capital above all else.

But 2009 proved that with a few important tweaks, the investment banking business model could, in fact, continue to function.

The year included a record quarterly profit for Goldman, a blockbuster wealth management deal for Morgan Stanley and a huge resurgence in the shares of both firms. It did not include a combination of either firm with a deposit-taking commercial bank, a pronouncement of crippling capital requirements or a change to the business strategy that Goldman Chief Financial Officer David Viniar succinctly described in the fall of 2008 as "largely to be an adviser, a financier, a co-investor and a financial intermediary for our clients around the world."

Clearly Goldman and Morgan Stanley are carrying on their work with far less leverage to juice their returns. The ratio of assets to equity is below 15-to-1 at both firms, down from 22-to-1 last fall at Goldman and 28-to-1 at Morgan Stanley. Both firms also have been adjusting their mix of investments and funding sources, cutting their exposure to products like leveraged loans and reducing their reliance on short-term debt.

But it is hard to say how much of that change is being driven by the firms' conversions to bank holding companies, and how much is simply attributable to the current realities of the market. And that makes it all the more difficult to predict to what degree the firms will find their bank holdingcompany status too constraining when the environment improves and risk appetite swells.

"The profits in the industry right now are not predicated on taking huge risk," said Barclays Capital analyst Roger Freeman, who notes that a strong flow of client business in bread-and-butter products like currencies and bonds has been a sufficient earnings driver of late. But when the flow slows, or assets appreciate or spreads on investment products compress, the firms "will have to bet more principal" to achieve the same returns, Freeman said.

And that is when the impact of the firms' conversions to bank holding companies will more fully reveal itself.

DEPOSITS NEEDED?

The emergency measures that put two freewheeling Wall Street firms under the formal supervision of the Federal Reserve Board were in some way a natural progression once the credit crisis began to unfold.

After the implosion of Bear Stearns & Co., the Fed dispatched representatives to Goldman and Morgan Stanley, and created a new overnight lending facility for primary dealers.

By September, though, the market was desperate for more permanent forms of assurance. Shortly after the collapse of Lehman Brothers Inc., Goldman and Morgan Stanley applied for bank holding company status, which the Fed swiftly granted, and formal examination teams were quickly dispatched to both firms.

At the time, it was widely presumed that the change in status would drive both firms to make a major push to gather deposits. …

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