The latest “Let’s do something, anything” move to rescue the financial system is yet another example of expediency trumping sound long-term measures. The motivation for making Goldman and Morgan Stanley banks seems obvious: the powers that be seem determined to prevent either firm from going under. Being banks gives the firms access to a expanded menu of rescue facilities and tools. The other reason for the move is to subject the firms to increased oversight, but given the lack of enthusiasm of the Fed for regulating banks going into this crisis, and its lack of expertise in complex debt products, bringing the firms under the Fed’s purview at this juncture is more a political talking point than a risk-reduction measure.
However, as we have mentioned, one of the characteristics of this crisis, as Richard Bookstaber pointed out in his book Demon of Our Own Design, is that processes in financial markers are tightly coupled, which means that they proceed through a series of steps with no possibility of intervention. One way to reduce tight coupling is to introduce interruptions in the sequence, such as the trading halts instituted in the wake of the 1987 crash. Another is to fragment the system by isolating various types of participants from each other by restricting how they interact or what kind of business they can conduct. Thus Glass-Steagall, the separation of commercial banking from investment banking, helped promote systemic stability by creating separate types of institutions that competed with each other only in limited ways.
Thus making Goldman and Morgan Stanley is an embodiment of the philosophy that helped create this mess.
The Federal Reserve Board approved the applications of Morgan Stanley and Goldman Sachs Group Inc. to become bank holding companies, the Fed said.
“The Federal Reserve Board on Sunday approved, pending a statutory five-day antitrust waiting period, the applications of Goldman Sachs and Morgan Stanley to become bank holding companies,” the central bank said in an e-mailed press release in Washington.
Fed officials also increased the two securities firms’ ability to take out direct loans from the central bank, granting access against a wider pool of collateral. That step was made “to provide increased liquidity support to these firms as they transition to managing their funding within a bank holding company structure,” the Fed said.
The Fed Board also authorized the New York Fed to lend to the London-based broker-dealer subsidiaries of Morgan Stanley, Goldman Sachs, and Merrill Lynch & Co., the securities firm that agreed to a takeover by Bank of America Corp. earlier this month.
The Wall Street Journal says the desire for increased supervision was the reason for this move:
The steps effectively mark the end of Wall Street as it has been known for decades, and formalizes a quid-pro-quo that regulators have warned about in the months after Bear Stearns’s near collapse — in return for access to the Fed’s emergency lending facilities, the firms would need to subject themselves to more oversight. The step could have far reaching effects on their profitability and their business models.