My Diary 430 --- The Reversal of Glass-Steagall

My Diary 430 --- The Reversal of Glass-Steagall

I think what’s happening now in the financial industry with banks and investment banks merging is the exact opposite of what happened in the 1933 with the Glass-Steagall Act which at that time prohibit a bank holding company from owning other financial companies (investment bank.)

But this act was repealed in 1999 by the Gramm-Leach-Bliley Act signed by President Clinton which allowed commercial banks and investment banks to consolidate. Citigroup buying Salomon Brothers was the first commercial and investment bank merger after the appeal. I think we should not be surprised if there are no pure investment banks left in future

Below is a good analysis based on what I know so far...

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NYT: Goldman, Morgan to Become Bank Holding Companies

In one of the most sweeping changes on Wall Street in decades, Goldman Sachs and Morgan Stanley, the last two independent investment banks, will become bank holding companies, the Federal Reserve said Sunday night.

The move fundamentally changes one of the mainstay models of modern Wall Street, the independent investment bank. It heralds new regulations and supervisions of previously lightly regulated investment banks. It is also the latest signal by the Federal Reserve that it will not let Goldman or Morgan fail.

The move comes after the bankruptcy of Lehman Brothers and the near-collapses of Bear Stearns and Merrill Lynch.

Now, Goldman and Morgan Stanley, which have been the subject of merger speculation in recent weeks, can become direct competitors to larger firms like Citigroup, JPMorgan Chase and Bank of America. Those firms combine investment-banking operations with the larger capital cushions that come with retail deposits, giving them a stability that pure investment banks lack.

JPMorgan acquired Bear Stearns this spring in a fire sale brokered by the federal government, while Bank of America has agreed to buy Merrill Lynch for $50 billion.

By becoming bank holding companies, Goldman Sachs and Morgan Stanley gained some breathing room in the immediate term. But it likely lays the groundwork for additional deal making. Given the expected bank failures this year, it is possible Goldman and Morgan Stanley could seek to buy them cheaply in a "roll-up" strategy.

Prior to the move, federal regulations prohibited the two investment banks from pursuing such deals. Indeed, Morgan Stanley's recent talks with Wachovia revolved around Wachovia buying Morgan Stanley.

Being a bank holding company would also give the two access to the discount window of the Federal Reserve. While they have had access to Fed lending facilities in recent months, regulators had planned to take away discount window access in January.

The regulation by the Federal Reserve brings a host of accounting rule changes that should benefit the two banks in the current environment.

In return, they will submit themselves to greater regulation, including limits on the amount of leverage they can take on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio, meaning it had borrowed $30 for every dollar in capital it held. Bank of America, on the other hand, currently has about an 11.7:1 leverage ratio.

Morgan Stanley had sought other ways to bolster its capital, and had been in advanced talks with China's sovereign wealth fund and others about raising as much as $30 billion, people briefed on the matter said Sunday night.