Wall Street forever changed?

Yesterday evening the Federal Reserve instituted a change to the bank charters for the two remaining, surviving large investment banks. Goldmann Sachs and Morgan Stanley's banking charters are changing, literally overnight, from an invtestment banking charter to a commercial banking charter. This is yet another unprecendented change in how our financial systems are structured. As I commented just this morning on another web forum, it is hard to get my mind around the amount of change we're seeing moment by moment in the financial world right now. The entire financial landscape is literally changing form right before our very eyes. These changes will inevitably have lasting and profound effects on our collective futures. Whether these changes are for better or for worse, remain to be seen.

What does this change in banking charters for Morgan and Goldmann mean? It means that these two investment houses will be converted into bank holding companies overnight. It means that, once put into effect, just like any other commercial bank, these two entities will be able to form retail banking establishments that can take your deposit monies. This is a way to allow the struggling entities to re-capitalize over time. It also means that the era of the highly leveraged investment houses with limited oversight has come to end this week. Commercial banks have much more stringent capital requirements and are subject to much stricter and more invasive oversights than investment houses were ever subjected to. So, these two entities, which are currently leveraged well over 20:1, will need to de-leverage down to somewhere in the ballpark of 10:1. That is quite a large delta. Now, no doubt taking on additional customer deposits will help close to gap, but this is assuming there are a large number of depositors willing to take on the additional risks, even if those risks are FDIC insured, with their deposit monies. It'll be most interesting moving forward to see how these huge fundamental shifts in the banking sector will take shape over the next several months.

As this week starts out, as per my last blog post, there is much to debate surrounding the impending bailout legislation, and I've been a part of several forum conversations where opinions range from a full endorsement of a bailout to those that are deadset against any bailouts what-so-ever. For the most part, people fall somewhere in the middle. Many feel that we need to outline a lot of punitive measures as part of the initial bailout bill. I disagree, now let me explain why.

If we hold up this legislation arguing over specifics, and a financial meltdown triggers in the meantime, there will be no stopping it at some point. Timing is of the essence here. We have about a week, and if we don't see the government step in within a very short timeframe, we're in real trouble whether or not we "normal folks" can understand what's going on behind the scenes here. Very few people have a really good understanding of the critical importance of the credit markets for businesses to function day to day. The destruction of commercial credit, if "allowed" to occur, will bring on a 1930's style problem, and I don't think that is in anyone's best interest.

Yes, we need serious regulatory reform, and we need consequences doled out over the next several years to those responsible for these problems, but we don't need this verbage in the bailout bill, we need the bailout bill to be passed now, then we can dealve into the required regulatory reform and legal ramifications over the next few months. The bottom line is that the best and brightest on Wall Street are having a difficult time unravelling the complexities of the derivative securities with respect to how to move forward with any bailout. I personally don't want Congress even attempting to alter established law as they're a bunch of lawyers who don't have a good understanding of economics or finance.

Let's use an example here to drive home my point. Wall Street was just wheeled into the ER complaining of severe chest pain, akin to a heart attack in progress. That's not the time to argue over how the patient's diet over the past 20 years led them to the position they're currently in. It's also not the time for the doctor's to argue over methods of treatment, and order a bunch of tests and scans that take hours to get a result back. It's time to get the small number of key medical tests done immediately that give the doctor's enough info to administer life-saving drugs and/or surgeries in an effort to save the patient's life ASAP. Once the damage to the patient's heart has been minimized and they've made it through the initial heart attack, then the doctor's can argue over the best course of treatment and how to alter the patient's lifestyle permanently in order to give the patient the best chance to live a long, prosperous life moving forward.

Some may argue we're not in dire straits per the above example, and I would very much disagree based upon the statistics we're seeing in the commercial credit markets, housing markets, and financial markets. Introducing even more regulatory change into what is already clearly an uncertain market may have severe unintended consequences in the short term, and may in fact make any chances of a bailout succeeding much less likely. Paulson is very aware of this fact, hence his reservations. No doubt this is going to be a very interesting week on Capitol Hill. I for one will be watching quite intently day to day to see what happens.