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.
This act is an admission that there was insufficient liquidity for MS and GS to function on Monday.
NYT puts it in this context:
“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 debt 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. Morgan Stanley currently has a debt-to-equity ratio of 30:1, while Goldman Sachs has one of about 22:1.
Bank of America, on the other hand, currently has about an 11:1 leverage ratio, while JPMorgan has about 13:1 and Citigroup about 15:1. Because they can borrow less, bank holding companies typically have lower earnings multiples.”
I respectfully disagree.
I strongly support this move. It’s part of a systematic approach to reducing leverage in the system. As both Buiter and Bernanke have pointed out HYPERleveraging was a key factor in the creation of this asset bubble.
The capital ratios GS and MS now must adhere to are FAR more stringent than the crazed world of casino capitalism back in the ancient era of investment banks.
Someone much smarter than me simply disagrees that the new bailout can work. “The banks won’t sell at a big discount as the losses will bankrupt them.” The banks “will sell the assets they already marked down, but getting rid of those doesn’t help their equity base at all, and preserving this is why they aren’t doing anything.”
I hope the FDIC has the loot to backup their accounts.
Nevertheless, this doesn’t solve the core problem, which is a jacked up, overleveraged balance sheet.
Your mentioning of the Glass-Steagall act almost brought chills down my spine. The current panic has been like reading an economic history of the US in fast forward. What took a year then takes 10 minutes now. Have we finally just set the stage for “the depression” by supposedly doing everything we can to avoid it? Is it already sealed by this move?
So is this the other half of the bailout? If Goldman and Merrill are levered 20-30:1 and will need to get down to 15:1, are they going to sell assets to the TARP to get there? Is there a plan B if the TARP fails to clear Congress on schedule?
“Depression” is what’s on my mind too. Ron Paul showed up earlier today and said that if the Fed/Treasury does nothing, things will work themselves out in a “rough year.” Mark Zandy cannot give a time line but resorts to the sports-metaphors Republicans and Dems who want to talk like them use: If Paulson gets this, it will put us in the 6th inning of the game – and oh, it ain’t a double header. Before I logged back here to see what’s up, I caught Bloomberg News doing its Asia Market report, and there’s some professional claiming that the dollar has already seen its lows, that what Paulson will do won’t devalue the dollar … But then I ping over to the Politico site and find another host of economists who all assert that something must be done, but not this. (I found the Luigi Zingales essay succinct.) But what I don’t find is a specific plan – I find parameters, but not a plan. So then, if the consensus is that Friedman was right about at least one thing – that the Great Depression occurred because banks froze in place – then how does one get money in motion again? (Even as a “m” marxist, I can get that point.)
Small wonder that those of us who doubt that economics is a science are amused by the fact that a fair proportion of the greater economists did not even think of finance AS economics – it is derivative (no pun intended). But as the Zingales essay suggests, we got ourselves a temporal problem: the logical tendencies of finance move things faster than the real economy can produce the goods and services needed to satisfy what debt claims.
Something is wrong with the SEC 799 count. I’m only coming up with 797. I doubt there’s any subterfuge involved, but one has to wonder these days.
Isn’t this development connected with your recent posts about banks being able to use FDIC-insured deposits to fund their IB operations?
Do such moves necessarily mean they are out of the woods? What about citi? Would potential bank failures then mean certain doom, after all, what next in terms of rescue options?
So terminal, as in other instances your remark strikes me as dead on accurate: this is a tacit but complete admission that neither GS nor MS had the kind of capital and asset depth they have trumpeted for fourteen months, and that they face ruin in the markets in the next week, yes perhaps even on Monday. Guess their Tier 3 paper stiffs aren’t worth the scarabs on their scrota. It was telling that MS tried to climb inside a bank and hide under the government’s frock this past week, that was the _only_ part of the Wachovia rumor to make sense. Now they are both cheeping like robin chicks since snakes in the grass will be toasted in the immediate future. *icckkkkk*
You _know_ things are dire when the yachting class is demanding to be allowed a place in the lifeboats. My reaction, and you can quote me, is “Let the zombies eat ’em—and get it on film.”
Oh, and BTW, I hope you folks all have cash in hand. We may well see the first bank holiday of most of our lives this week. Not plastic, not drafts: cash.
So, becoming a bank overnight has become as easy as getting a mail-order diploma from Whatsamatta U., or becoming a high priest in the Church of the Exalted Defloration.
I’m having my biz cards printed already — Chairman/CEO of the All-American Worker/Sucker Bank. Wanna pawn your watch? Line right up, folks. This way to the egress! Mwa ha ha ha …
“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.”
Well, after the Goldman Sachs takeover of the US fedgov, “federal regulations” and “waiting periods” are no issue at all anymore. Rule by decree — pulling new “laws” out of your rectum — man, this is the life!
Hoosier Daddy is onto something, too, with the notion that these newly minted “banks” will dump their dog-doo securities into the TARP, then go on a Willy Sutton-style acquisition spree: “You sell to us at pennies on the dollah, or our buddies in the Fed pull your lines and liquidate you. You wanna be reasonable, or you wanna be dead?”
They didn’t even wait for the KongressKlowns to act. Roving bands of gangster-capitalist looters are already fanning out across the countryside to forage with stolen Treasury cash, and torch the barns of non-cooperators.
Feel the mailed fist of Kleptofeudalism, as your nose gets pulverized. We was born to lose.
Yves–Thank you for insight, coverage, and the forum you provide. Thank you for all the hard work and thought you put into making this site work the way it does, so well.
This metamorphosis may point to bigger problems on the point of surfacing in London where the “Lion’s Share” of forex trading takes place etc.
First Paulsen’s proposal was “domestic headquartered” and “mortgage and mortgage-related”
then it moved into a general foreign component, after all they have an effect on the US too, and a far broader potential selection of paper assets.
Becoming “banks” permits the Treasural Reserve to lend to the subsidiaries, and there they are doing it — overseas.
What more to come — over there?
As I previously stated in this forum, it’s payback time now for the Federal Reserve.
Children should not be able to play with what Warren Buffet calls the “weapons of mass destruction” of the financial system without adult supervision.
The “traders” at Morgan and Goldman with their inferior mathematical models of derivatives that assumed lognormal price distributions, coupled with their HYPERleveraging provoked such an emergency in the financial system that the Federal Reserve had to open up the PDCF (primary dealer credit facility) to help them.
Now both are paying the price.
The investment banking era is dead. I dance on its grave.
Next in line: the hedge funds.
It’s payback time at the Fed.
We’ll know when things have begun to shift toward fixing problems, rather than creating them by watching the Wall St. Journal. As soon as they stop lying, the world will be on the mend.
Gets tiresome scrolling past the canned ham. Anyway I wanted to add that free markets work non-Marxist magic. Bid, ask, presto! Morgan Stanley has a new owner. Goldman’s head office moves to Tel Aviv. Personally, I wouldn’t give either of them a Federal license to take deposits — but that doesn’t I bought CDs at JPM and WFC because they looked like the strongest and safest places to park some money. Oh, and by the way, I agree that we all need to keep cash and some silver coin handy for the coming Wasssup? Personally, I plan to leave the country. But that’s because I saw it coming half a dozen years ago. Be prepared and all that.
Look at Paulsen’s handling of Frannie. It was another emergency that required the Treasury be granted almost unlimited power to (mis)manage the situation. Part of the bait was that the blank check would never have to be used, and if things got really bad, only $25 billion “might” be at risk. Now the estimates are $100 billion and climbing. Paulsen knew all along what was going to happen, but as usual, he mislead congress and the public.
It should be obvious that once again this is a bait and switch. MS and GS are no longer investment banks, folks, they are regular banks (the switch). Now you can feel confident that they and the financials are sound (the bait). Simply put, Paulson has known all along how bad the financial crises really is, and is once again misleading everyone. He is delaying until he can dump it on a new administration and fade to background, just like Greenspan.
«First Paulsen’s proposal was “domestic headquartered” and “mortgage and mortgage-related”
then it moved into a general foreign component, after all they have an effect on the US too, and a far broader potential selection of paper assets.»
That means that the Congress rolled over and barked “yes, yes”.
The tactic is part of negotiation-for-gangsters 101: first you hit them with an outrageous request, and if they say yes, then you ask for more, because that means that you did not ask enough and they are desperate.
«tactic is part of negotiation-for-gangsters 101:»
It is more “shakedowns-for-gansters 101” of course.
I can imagine Bernanke and Paulson going to visit Dodd and Pelosi and opening
“Nice plush office you keep here, senators. Wouldn’t it be terrible if some mob came here to smash it all because you didn’t hire us for “protection” against recession? It is going to cost you only 700 billions of other people’s money.”
Then Pelosi and Dodd look scared, bark “Yes, Yes”, and the next day Bernanke says “Oh well, we could have asked for more” and Paulson replies “we still can do that”.
Second meeting: “you know senators, your party’s nice election campaign. Wouldn’t it be a very sad accident if it went horribly wrong? Well, it turns out that if you want our “protection” you got to add also add some little extras…”.
September 21, 2008
In this day of super-quick-sand descent, 09-21-08, a day of infamy beyond any other, a trivial question comes to mind. What will the bail-out-ees pull out of their “you know what’s” and offer up to Hank’s TARP. My guess is all of their, “off balance sheet” toxic waste that has been heretofore “legally” hidden from public view much less considered to be important by what we used to call “regulators”.
My guess is that this amount will be in the $1.5 trillion range, if we’re lucky, before we even get to the $850 billion, again “if we’re lucky”, that Hank-en-Gang are estimating to be “on balance sheet”. And please, don’t even go down the rat hole about “how can you offer up something that you don’t even own.” The rule now is “There are no rules” much less that old fashion thing called “Laws”.
On the Beach, and getting ready to swim to Japan.
I am at a loss of how regional banks will compete with these behemoths for deposits. I’ll laugh if Goldman announces tomorrow 6 month CDs yielding 7%. Ah the marvels of leverage.
Adam Bonin, Attorney and Chairman, Netroots Nation:
Indeed. It’s starting to remind me of that scene in Blazing Saddles when Sheriff Bart rode into town to find all the townspeople’s’ guns angrily pointed at his head. Reduce…
As in the movie, Paulson’s responding to the crowd by pointing a gun at his own head, swearing that if anyone makes a move against this bailout plan he’ll shoot the economy, while shrieking “Do what he say! Do what he say!” out of the corner of his mouth on all the Sunday talk shows.
September 22, 2008
I was in a CA. WaMu branch last week helping a client empty their safe deposit box. I pulled out all of the cash two months ago. The teller counter was covered with flyers announcing 5% yield, one year, CD’s. I think your 7%/six month estimate might be a little low.
«It is more “shakedowns-for-gansters 101” of course.»
Apparently Dodd and Pelosi decided not to take the offer of “protection” from recessions as it was. At least a bit of pushback…