Goldman, Morgan Stanley Buy Time for Deals by Becoming Banks

http://www.bloomberg.com/apps/news?pid=20601103&sid=aXdM4uWfeQDY&refer=news

By Christine Harper

Sept. 23 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley have won a respite from investor panic by transforming themselves into bank holding companies.

The change in status allows the last two major independent investment banks on Wall Street to take advantage of different accounting rules, gives them more access to federal funds and buys them time to stabilize their funding base by acquiring deposits, analysts said.

``The move appears aimed at improving market confidence but does not, in our view, signal a major change in the business model,'' Richard Staite, an analyst at Atlantic Equities in London, wrote in a note to investors yesterday. ``The move provides Goldman with time to continue the process of de-risking itself to a level deemed suitable by the market.''

Instead of carrying all of their loans, bonds, stocks and other assets at market value, as investment banks are required to do, the two New York-based firms can now avoid further writedowns by moving some assets into their banking units. They will also gain the ability to borrow from the Federal Reserve indefinitely, an improvement over the primary-dealer credit facility that is scheduled to expire in January.

Now it's up to the banks to raise enough capital and attract enough stable, low-cost deposits to reassure investors that market gyrations won't drive them out of business. Morgan Stanley said yesterday that it plans to sellas much as 20 percent of the firm to Tokyo-based Mitsubishi UFJ Financial Group Inc. for $8.4 billion. Goldman has no immediate plans to raise capital, although it may decide to if it finds attractive investment opportunities, spokesman Lucas van Praag said yesterday.

Deposit Bases

The S&P 500 Financials Index dropped 8.5 percent yesterday as investors lost confidence that a proposed U.S. $700 billion government bailout would solve the industry's bad-debt problem. After dropping 27 percent last week, Morgan Stanley's stock was little changed yesterday. Goldman's shares, which fell 16 percent last week, dropped 7 percent.

The deposit bases of Goldman and Morgan Stanley, at $20 billion and $36 billion respectively, are much smaller than those of their largest bank competitors, according to David Hendler, an analyst at CreditSights Inc. in New York.

Morgan Stanley's deposits amounted to about 4 percent of the firm's liabilities at the end of August, while Goldman's amounted to 2 percent of liabilities, Hendler wrote in a note to investors yesterday. At larger banks, deposits typically account for between 40 percent and 60 percent of liabilities, he wrote.

``We cannot rule out that these companies could pursue bank acquisitions in order to increase their deposit funding more in- line with a typical bank,'' Hendler wrote. Yet their depressed stock prices may make Goldman and Morgan Stanley reluctant to enter deals ``until some premium has been restored.''

`Marketplace Certainty'

Both firms issued statements after the Fed approved their applications that stressed how the change would improve their image with investors. ``We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness,'' Goldman said in a statement on Sept. 21. John Mack, Morgan Stanley's chairman and chief executive officer, said the change ``offers the marketplace certainty about the strength of our financial position and our access to funding.''

Goldman Sachs, now the fourth-largest U.S. bank by market value, is more interested in buying deposits than in buying entire banks, according to a person familiar with the firm's thinking. The firm sees opportunities to buy deposits in the wholesale market and also to buy deposits of failed institutions, such as IndyMac Bancorp Inc., that are under the control of the Federal Deposit Insurance Corp., the person said.

Reducing Leverage

Morgan Stanley said it plans to ``pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits.''

In return for the advantages accorded by their new status, Goldman and Morgan Stanley won't have to change much about the way they operate. Neither firm is being required to dispose of non-financial assets, such as commodities or stakes in companies, that banks normally are prohibited from owning, for at least two years, according to the Federal Reserve orders.

Efforts by the companies to reduce their so-called leverage, or ratio of assets to shareholder equity, are more about trying to reassure markets than to meet any requirements imposed by the Fed. Instead of monitoring gross leverage, the Fed looks at firms' Tier 1 capital ratios, which measure capital requirements based on the riskiness of assets. Both firms exceed the 6 percent Tier 1 capital requirement to be deemed ``well capitalized.''

To contact the reporter on this story: Christine Harper in New York atcharper@bloomberg.net.

Paulson Debt Plan May Benefit Mostly Goldman, Morgan

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By Jody Shenn
Sept. 22 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley may be among the biggest beneficiaries of the $700 billion U.S. plan to buy assets from financial companies while many banks see limited aid, according to Bank of America Corp.
``Its benefits, in its current form, will be largely limited to investment banks and other banks that have aggressively written down the value of their holdings and have already recognized the attendant capital impairment,'' Jeffrey Rosenberg, Bank of America's head of credit strategy research, wrote in a report dated yesterday, without identifying particular banks.
Many banks may not participate in the Troubled Asset Relief Program because they haven't had to write down as much assets under accounting rules, meaning decisions to sell into the program would cause them to lose capital, Rosenberg wrote. Investment banks operate ``under a mark-to-market accounting model while commercial banks hold assets at cost until realizing a loss (or until they reasonably expect one),'' he wrote.
Rosenberg assumed the government will use a reverse auction in which banks submit the lowest prices they are willing to sell certain types of assets for and then the government buys the cheapest ones, with the goal of ``protecting the taxpayers,'' the report said.
Treasury Secretary Henry Paulson's push for the program, now considered by lawmakers, is designed to remove ``illiquid assets'' clogging the financial system, reverse declining asset values and prevent the freezing of lending for U.S. financial firms, companies and consumers.
The intervention into markets would be the broadest since at least the Great Depression. House Financial Services Committee Chairman Barney Frank, a Democrat from Massachusetts, said today lawmakers and Paulson narrowed differences on the plan.
Japan's Failure
In the 1990s, a Japanese government effort to buy troubled assets from banks to free up lending failed because sellers weren't willing to accept the prices offered, said L. William Seidman, a former chairman of the Federal Deposit Insurance Corp. He said that wasn't a problem he had as chairman of the Resolution Trust Corp. in the U.S., which sold off failed lenders' assets after the savings-and-loan crisis of the 1980s.
``If you're talking about institutions that haven't failed, then you have the question of whether they want to sell at a low price, particularly if that price depletes their capital,'' Seidman said in a telephone interview today.
``In Japan, we did all kinds of things, trying to have a mediator who would set a price and other kinds of methods to get around that,'' he added. ``It never really got done, so it was not successful, but here we probably have a more urgent need for more institutions to do something.''
`Hasten the Pace'
While Goldman and Morgan Stanley, both based in New York, were yesterday granted permission to transform themselves into bank holding companies, the companies so far have operated mostly under investment-bank accounting rules, logging almost $21 billion of asset writedowns and credit losses. Paulson is a former chairman and chief executive officer of Goldman.
Charlotte, North Carolina-based Bank of America, which has reported $21 billion of losses, is seeking to buy New York-based Merrill Lynch & Co., which has had $52.2 billion in losses.
Even without sales by commercial banks and savings-and-loans under the program, the companies may be harmed as the disclosure of prices paid in the troubled-debt auctions force them to ``hasten the pace'' of their own losses, Rosenberg wrote in his report. Banks and insurers mark down certain securities and derivatives to market prices in their earnings reports, avoiding losses on others unless they deem the declines to not be temporary and provisioning against loans as they go bad.
Fair Value
Bank lobbying groups today asked Congress and the U.S. Securities and Exchange Commission to suspend a rule that forces companies to put a price on difficult-to-value assets such as subprime mortgages.
``We are suggesting that the SEC issue a temporary order to negate the negative impact'' of the so-called fair-value rule when the economy slumps, Scott Talbott, senior vice president of government affairs at the Washington-based Financial Services Roundtable, said in an e-mail.
Companies including American International Group Inc., the insurer that accepted $85 billion in a U.S. takeover, have said the rule by the Financial Accounting Standards Board requires them to record losses they don't expect to incur. The world's largest banks and brokers have reported more than $520 billion in asset writedowns and credit losses since last year.
To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

History & Now: Commercial Banks & Investment Banks

http://www.nytimes.com/2008/09/18/business/18wall.html?_r=1&ref=business&oref=slogin

Still, many specialists believe that the monumental events of the last four days herald a new period of painful change for the American financial industry — one that speculators are rushing to pounce upon. While Wall Street has gone through tough times before, only to emerge bigger and stronger, some question whether the industry can rebound quickly after using high levels of leverage, or borrowed money, to binge on risky investments. Those investments have proved to be disastrous. Worldwide, financial companies have reported more than $500 billion in charges and losses stemming from the credit crisis — a figure some specialists say could eventually exceed $1 trillion.

Merrill Lynch rushed into the arms of Bank of America this week in a deal that in some ways harked back to the past. During the Depression, Congress separated commercial banks, which take deposits and make loans, from investment banks, which underwrite and trade securities. The investment banks were allowed to do business with less oversight, while commercial banks operated with tighter supervision.

But after Congress repealed those Depression-era laws in 1999, commercial banks began muscling in on Wall Street’s turf. As the new competition whittled down profit margins, investment banks used more of their capital to trade securities and also began developing financial derivatives to fuel profits.