With Morgan Stanley’s decision to re-file as a holding company and Goldman Sach’s compelled decision to follow suit, the end of the large independent broker-banking model of investment banking is finally over. With this switch in designation to holding companies, these banks now have access to the Federal Reserve’s vault to secure their balance sheets but this also places these banks under the regulatory arm, scrutiny and restrictions of the Federal Government. As it follows, the more regulated an industry, the lower the profit margin of that industry. The newly enacted federal oversight will mean that these banks can no longer highly leverage their positions as they had operated in the past (it was rumored that Goldman was 36X levered, compared to the ailing insurance giant AIG at 11X and commercial banks at 10X)*.
It was the highly leverage balance sheets of the banks such as Lehman and Bear Stearns coupled with the bad positions of their bets on the subprime mortgage loans that contributed to their demise. So with federal regulation, there will be some much needed risk management injected into these banks at the opportunity cost of reducing overall industry margin (profits).
What should the future hold for students looking to enter into the industry in the upcoming years?
While no one is able to predict (accurately) how the industry will react or adapt to this recent crisis, it is clear that the notion of the broker-bank model will undergo a metamorphoses – the future of the giant broker-bank seem unsustainable. As investment banks rush to sell themselves to commercial banks or develop commercial banking arms, we can assume the financial industry will somewhat reflect the state of the industry before the existence of the Glass -Steagel Act. With the past success of banks such as JP Morgan Chase and UBS (commercial bank and wealth management firm respectively with substantial investment banking division), the future is not as gloom as Main Street anticipates, although still unpredictable. The job market will be tight as the overall available positions have suddenly contracted, but the future of investment banking is not doomed. There will still be roles and functions for these banks, as long as they are willing to adapt to the direction that the market is now leading them.
As for me, I will continue down my set path. I can hope that the four years that I will spend in school will be adequate time for the market to rid itself of the toxic assets out there, free up credits for transactions and allow deal making to resume. Until then, I will keep my eyes on that prize and keep on chugging along.
* These numbers are estimates that come form word-of-mouth information. These numbers are not backed by any data.
