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With Change, Era Of Investment Banks Ends

MELISSA BLOCK, host:

From NPR News, this is All Things Considered. I'm Melissa Block.

MICHELE NORRIS, host:

And I'm Michele Norris. First this hour, the changing face of Wall Street. Late last night, the last two big independent investment banks, Goldman Sachs and Morgan Stanley, announced they would rather operate and be regulated as commercial banks. That might not seem like a big change, but on Wall Street it's an earthquake. For most of the last 70 years, investment banks and commercial banks have been kept apart. It was the law. Now that era appears to be ending, as NPR's Jim Zarroli explains.

JIM ZARROLI: For a long time it looked as though Goldman Sachs and Morgan Stanley would survive the carnage on Wall Street. Although they lost money in the mortgage downturn like everyone else, they didn't lose anywhere near as much. Goldman in particular had a reputation for being smart, savvy, and very well-connected. But the drumbeat of bad news about other investment banks like Lehman Brothers and Bear Stearns took its toll on the companies. By last week, investors everywhere were asking would Goldman and Morgan be the next to fail? Christopher Whalen is with the research firm Institutional Risk Analytics.

Mr. CHRISTOPHER WHALEN (Managing Director, Institutional Risk Analytics): So when questions started to come about these securities, about the prices of these securities, which firms like Lehman Brothers and Bear had on their balance sheet, investors began to get afraid to lend these firms money.

ZARROLI: Last night the Federal Reserve said it had allowed Goldman and Morgan to become bank holding companies. It's an arcane change in their legal status that will greatly alter the way they operate. They'll be able to compete with big commercial banks for customer deposits. They'll have permanent access to the Federal Reserve's discount lending window if they need money. That should help reassure investors that the companies can survive the turmoil in the markets. Fred Cannon, an analyst at Keefe, Bruyette & Woods, says the two companies probably felt like they had to make the change.

Mr. FRED CANNON (Associate Director of Research and Chief Equity Strategist, Keefe, Bruyette & Woods): I think that's part of a recognition that the, you know, the go-go days of the last four or five, especially in the mortgage business, have come to an end, that banks and brokers need more capital, and they're going to be more tightly regulated.

ZARROLI: Cannon says Morgan and Goldman will now be monitored by the Federal Reserve, and they'll find their activities much more constrained than they're used to. Investment banks typically use a lot of leverage. They borrow a lot of money to do business, as much as 30 dollars for every dollar of assets on their balance sheets. Now they won't be able to do that, and Chris Whalen says that's likely to cut into their profits.

Mr. WHALEN: They will have to run at lower leverage ratios than they have in the past. The compensation for the masters of the universe that populate Goldman Sachs and Morgan Stanley will probably drop considerably.

ZARROLI: And that will lead to some fundamental changes in the two firms' culture, says Charles Calomiris, professor of financial institutions at Columbia Business School. Calomiris says Goldman and Morgan were innovative, cutting-edge firms that regularly employed some of the smartest people on Wall Street. They came up with new kinds of investment tools and strategies that other firms emulated. Calomiris says, as commercial banks, Morgan and Goldman will be part of a much stodgier and more inhibited world.

Dr. CHARLES CALOMIRIS (Professor of Financial Institutions, Columbia Business School): That kind of process-oriented, bureaucratic regulatory environment is just not conducive to the culture of risk and the culture of innovation.

ZARROLI: But a lot of people would say, isn't that good? Isn't that what's gotten us into all this trouble in the first place?

Dr. CALOMIRIS: Well, they didn't get us into this trouble in the first place. Notice that they're not the ones suffering the large exposures to the subprime and the large losses.

ZARROLI: Calomiris says unlike Bear Stearns and Lehman Brothers, Morgan and Goldman have managed their way through the mortgage downturn pretty well. But ultimately, that wasn't enough to protect them when the crunch arrived. Jim Zarroli, NPR News, New York. Transcript provided by NPR, Copyright NPR.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.

Jim Zarroli is an NPR correspondent based in New York. He covers economics and business news.