Goldman, Morgan Dive Into Banking System's Safety Net

(MoneyWatch)  All of a sudden those down-to-earth neighborhood bank accounts are looking pretty good next to a couple of Wall Street's fallen stars, Goldman Sachs and Morgan Stanley.

In scrapping the pure investment banking business model and opting to become bank holding companies, the duo will be allowed to attract and hold billions in federally-insured customer deposits. That money helps shore up the former investment banks' all-important access to funding and capital base, which will likely stabilize them to pursue a survival strategy that ranges from selling out to going it alone.

All this comes with many strings attached. Goldman and Morgan, which for years thrived under lax securities regulation, will now come under the jurisdiction of federal bank regulators. The most immediate result? Both investment banks will have to get their capital ratios in line with bank regulations, which means gone are the days of tapping outside investors for short-term funding and pumping up earnings by having a 30-to1 leverage ratio or higher.

Over the years, those super-high ratios helped produce windfall profits for the investment banks and fat bonuses for many of their workers. But investors and funding dissappeared in recent weeks and the investment banks' stock price fell, as serious concerns surfaced about the viability of the independent investment bank business model.

Federal bank capital ratios essentially require lenders to keep more real money in the vault.

This is a bitter pill for Goldman and Morgan, which just last week vowed to remain independent as investment banks despite the bankruptcy of Lehman Brothers and takeovers of rivals Merrill Lynch and Bear Stearns.

Access to federally-insured customer deposits for funding and capital will provide a much-needed safety net for both firms which is expected to ease the anxieties of nervous investors and customers. But in return, the duo will be compelled to become much more conservative in their business dealings. Look for both to "de-leverage" by slicing expenses and staff, leaving many traders, merger and acquisition specialists and other corporate investment advisers in search of new jobs or professions.

In its announcement Sunday, Goldman said it was immediately poised to become a viable commercial bank once the Federal Reserve accepts its application to become a bank holding company. In doing so, Goldman will compete with JP Morgan Chase, which recently absorbed some of the investment banking operations of Bear Stearns, Bank of America which is acquiring Merrill, and Citigroup, the first of the mega-banks with interest in traditional banking and other global financial services.

Looking to shore up its operations, Morgan plans to sell a 20 percent stake to Japan's Mitsubishi UFJ Financial Group Inc. The move seems to end the possibility of a merger between Morgan and Wachovia, which was discussed last week.

Dick Bove, bank industry analyst with Ladenburg Thalman, notes Goldman and Morgan are not new to commercial banking. Goldman has two commercial bank entities within its system and will become the nation's fourth largest bank holding company. Meanwhile, Morgan already has $36 billion in bank deposits.