IN A SPACE of just one week, the landscape of the U.S. financial sector has changed quite dramatically.
Days after the collapse of Lehman Bothers and the takeover of Merrill Lynch by Bank of America, the two remaining independent investments banks, Morgan Stanley and Goldman Sachs, have sought to convert themselves into bank holding companies.
As bank holding companies, they will resemble the commercial banks in the matter of rules of governance: more disclosures, higher capital reserves and tighter regulation. In return, they will have access to emergency funds from the Federal Reserve.
There are significant messages for regulators everywhere. In the United States, commercial banking and investment banking services were segregated under a 1933 Depression-era Glass-Steagall Act. Even after its repeal in 1999, when financial conglomerates were allowed to undertake a range of activities, they retained the walls between commercial banking and investment banking. As recent events demonstrate, that strategy has cushioned their losses from exposure to the sub-prime crisis.
For the two big investment banks, regulatory approval for their transformation can only be the starting point. Evidently both will require hefty doses of capital infusion. Recent reports suggest that they are turning to Japanese investors. Goldman Sachs leveraged every $1 of capital into $22 of assets and Morgan Stanley, $1 into $30. Clearly such high leveraging, besides being unacceptable to more prudent conventional banking, might continue to cause problems to the transformed entities irrespective of the other, diversified, financial services they might undertake.