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Changes in Business, Culture and Pay

The move by Goldman Sachs and Morgan Stanley to become regulated bank holding companies effectively unites U.S. finance into a single sector.

"This fundamentally alters the landscape," a Goldman Sachs spokesman told The Wall Street Journal. "By becoming a bank holding company and being regulated by the Federal Reserve, we have directly addressed issues that have become of mounting concern to market participants in recent weeks."

Along with investment banks, Wall Street's culture of "seven-figure bonuses and lavish perks for even midlevel executives" may be ebbing, notes the New York Times. The developments "effectively (return) Wall Street to the way it was structured before Congress passed a law during the Great Depression separating investment banking from commercial banking, known as the Glass-Steagall Act," the Times says.

One Headhunter's Perspective

Additional oversight and regulation of investment banking activities will tend to minimize the amount of risk taking, said Richard Lipstein, managing director at Boyden Global Executive Search in New York. That works against certain products and trading strategies that can give rise to "big years in any one year," Lipstein, a former M&A banker himself, told eFinancialCareers News.

Also, investment banks employed significantly greater financial leverage than commercial banks. One consequence of reducing banks' leverage is that the good years won't be as profitable as before, Lipstein says. That will tend to restrain compensation for those individuals who traditionally reaped large payouts from particularly good years.

"For a certain subset of professionals in this business - traders - that will most definitely impact their ability to generate significant amounts of revenue based on the financial leverage" they're accustomed to using, he notes.

On the other hand, Lipstein doesn't expect much impact for traditional capital markets business, or M&A business, and certainly not for private wealth business.

Another issue is cultural. Lipstein notes that commercial banks historically are more conservative in paying their people. "It will be interesting to see how B of A culture melds with Merrill," he says. "At the end of the day it will be commercial bankers that will increasingly make these kind of decisions." For instance, Barclays Capital, a subsidiary of the British commercial banking firm, has agreed to acquire Lehman Brothers' U.S. investment banking business. That will lead to "more of a conservative management of Lehman than in the past," according to Lipstein.

Buy Side To Suffer, Too?

"The next bubble to burst is the LBO and hedge fund space," declares Wall Street compensation consultant Alan Johnson.

More stringent capital requirements will permanently limit these players' access to credit, Johnson told eFinancialCareers News, because accounting and other banking rules will pressure risky lending and trading. Even when the next up cycle comes around, banks won't be able to lend as much for risky deals as in previous up cycles.

Before Goldman and Morgan threw in the towel on the standalone investment bank business model, many participants assumed that once the markets recovered, leveraged lending and leveraged deal-making would bounce back. That's far less likely now, Johnson says.

Advantages From Becoming Regulated as Banks

As bank holding companies, Morgan Stanley and Goldman can value their assets as "held for investment," as banks often do, as opposed to valuing them based on current market prices, the Journal points out. It also allows them to accept deposits, a source of real money that has aided banks like Citi, Bank of America (purchaser of Merrill Lynch) and JPMorgan weather the current crisis.

Morgan Stanley has been considering the move for several months, the Journal says. Spokeswoman Jeanmarie McFadden told the newspaper it will begin reducing its leverage ratios to be in line with commercial banks, whose rations are normally in the area of 10. Investment bank ratios are now over 20. (Bank of America and Wachovia had leverage ratios of 11 in the second quarter, the Journal says.)

The Times wonders if Goldman's and Morgan Stanley's decisions will lead the Federal Reserve to regulate hedge funds, "many of the largest of which closely resemble investment banks."

Both banks say the move will bolster their strength.

AUTHOReFinancialCareers News Insider Comment
  • GT
    26 September 2008

    High risking taking, ambitious individuals will simply defect to start their own companies or join smaller boutique banks. Eventually the commercial banks will lend again as they will inevitably want to achieve the best return possible on their balance sheet and for shareholders. Of course though, a lot depends on the regulation that develops out of the current crisis - an over regulated system is just as bad as a non-functioning financial system. Moreover, too much regulation will simply see banks relocate to be domiciled elsewhere. The financial system (and leveraged business models - albeit more conservative) will recover, the question is whether the US will remain the powerhouse it once was?

  • Ex
    25 September 2008

    Excellent article. The chickens have come home to roost. Far too long have risk-adverse, law restricted Commercial Bankers have had to play on a field with many, many rules, while the I-Bankers played with fewer rules and made 7-figure bonuses. Now that has changed, and the I-Bankers are coming down to Earth, much like the real estate they bet on. Don't get me wrong, at a VP-level in SoCal or NYC, a typical Commercial Banker can earn a $100K+ base +20% Bonus, but it's nowhere near the $900,000 Wall street I-Banker's bonus. Oh well, less risk, less return, right? But at least we have a place to go to for work.

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