From the Board of Governors of the Federal Reserve: Goldman Sachs and Morgan Stanley to become bank holding companies.

To provide increased liquidity support to these firms as they transition to managing their funding within a bank holding company structure, the Federal Reserve Board authorized the Federal Reserve Bank of New York to extend credit to the U.S. broker-dealer subsidiaries of Goldman Sachs and Morgan Stanley against all types of collateral that may be pledged at the Federal Reserve’s primary credit facility for depository institutions or at the existing Primary Dealer Credit Facility (PDCF); the Federal Reserve has also made these collateral arrangements available to the broker-dealer subsidiary of Merrill Lynch.

In addition, the Board also authorized the Federal Reserve Bank of New York to extend credit to the London-based broker-dealer subsidiaries of Goldman Sachs, Morgan Stanley, and Merrill Lynch against collateral that would be eligible to be pledged at the PDCF.

The New York Times has this take on 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.

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.

Kiss the last independent investment banks goodbye. And with this change, it is going to become much harder for Goldman and Morgan Stanley to make (or lose) money given leverage will be reduced to 12 instead of 30-40.

Mike “Mish” Shedlock
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