And Then There Were None: Goldman, Morgan Become Bank Holding Companies

This post first appeared on Minyanville.

Regulators were at it again over the weekend, rewriting the rulebook of America’s financial landscape.

Late Sunday, Goldman Sachs (GS) and Morgan Stanley (MS) announced plans to become banks, seeking the sounder funding base of traditional deposit-taking institutions. The last remaining independent Wall Street brokerages will be transformed, now supervised by the Federal Reserve and other national regulators.

According to the Wall Street Journal, the Fed allowed Goldman and Morgan to reorganize themselves as bank holding companies, thereby subjecting them to more restrictive rules and regulations. The new designation offers greater access to federal lending facilities and gives the 2 firms the chance to open retail branches and accept customer deposits -- widely considered a more reliable method of funding.

The money markets, until recently the brokerages’ primary source of liquidity, were in a historic state of disorder following the collapse of Lehman Brothers and the governments’ seizure of Fannie Mae (FNM), Freddie Mac (FRE) and AIG (AIG). The uncertainty surrounding once-strong firms made access to cash highly unreliable.

Rather than merging with commercial banks, Goldman and Morgan decided to retreat, delever and rebuild under a more conservative business model.

Deposit-taking institutions face tighter capital requirements and can’t use leverage as freely as investment banks, which reduces their ability to make outsized profits when times are good. It does, however, create more insulation to protect against losses when bets go sour.

Bad bets by the truckload saddled both Goldman and Morgan with assets of such questionable value that investors feared the once-proud institutions would sheepishly follow Merrill Lynch (MER) into the arms of a big commercial bank.

Morgan had been holding talks with Wachovia (WB) about a potential merger, while Goldman adamantly refused to even consider the idea of a buyout.

When traders went to bed 10 short days ago, 4 big investment banks -- storied firms deeply entrenched in the American ideology of entreprenuership and risk-taking -- still existed, however tenuously.

Now, there are none.

William Isaac, a former chairman of the Federal Deposit and Insurance Corporation, told Bloomberg: "The decision marks the end of Wall Street as we know it. It's really too bad, as our country has benefited greatly from the entrepreneurial risk-takers on Wall Street."

Many, fearful of free markets, wary of trusting men and women to make their own decisions, will welcome Wall Street’s demise, calling it a victory for the little guy, a much-needed punishment for the greediest of the greedy. And while some of the bankers who poured into lower Manhattan each morning certainly exemplified self-interest at its worst, the positive impact Wall Street’s risk-taking has had in building this country cannot be downplayed.

Bridges, skyscrapers, our highway system and countless other industrial cornerstones of our economy would not have been possible if crafty financiers hadn’t figured out how to use credit and risk to enhance economic growth. Risk-taking is a natural, healthy part of capitalism. In fact, without it, the free markets cannot function.

We got out over our skis, to be sure, but that doesn't mean the entire concept of lending, borrowing and taking on projects that may or may not turn out well should be condemned in its entirety.

The destruction of debt required to bring our economy back into balance and enable healthy growth to sprout anew must be led by those willing to take risk, to wade bravely into markets before they're fully healed. Now that the foremost private risk-takers in this country are out of the way, public speculators are poised to step in and sop up $700 billion in toxic assets sitting on the financial industry’s collective balance sheet.

Don’t forget to pay your taxes this spring.