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Goldman, Morgan, & Paulson's big plan

Last night's surprise announcement that investment banks Goldman Sachs and Morgan Stanley were changing their status to bank holding companies marks the end of an era for big Wall Street investment banks.

As mentioned last week in, "The end of the broker-dealers?", Goldman and Morgan were, at that time, the last two survivors of the "big five" independent Wall Street investment banks.

Even before Lehman Brothers had filed for bankruptcy and Merrill Lynch was swooped up by Bank of America, some, like Nouriel Roubini, had said that the broker/dealer business model was flawed and doomed to failure.

Now that the last two major independent investment banks have restructured themselves as Fed-regulated banks, it seems that the end of the independent broker dealers has come about quicker than many of us might have imagined.

More on this from Bloomberg:

"The Wall Street that shaped the financial world for two decades ended last night, when Goldman Sachs Group Inc. and Morgan Stanley concluded there is no future in remaining investment banks now that investors have determined the model is broken.

The Federal Reserve's approval of their bid to become banks ends the ascendancy of the securities firms, 75 years after Congress separated them from deposit-taking lenders, and caps weeks of chaos that sent Lehman Brothers Holdings Inc. into bankruptcy and led to the rushed sale of Merrill Lynch & Co. to Bank of America Corp.

``The decision marks the end of Wall Street as we have known it,'' said William Isaac, a former chairman of the Federal Deposit Insurance Corp. ``It's too bad.'' "

But here's the really interesting feature of this development: it not only helps Goldman and Morgan to stay afloat (by extendeding access to the Fed's discount lending window), it also puts the two banks in a position to buy up other failing banks in a "roll-up strategy".

Quotes from the NY Times Dealbook blog:

"By becoming bank holding companies, Goldman Sachs and Morgan Stanley gained some breathing room in the immediate term. But the change also may lay the groundwork for additional deal making. Given the number of bank failures expected this year, it is possible that Goldman and Morgan Stanley could seek to buy those banks cheaply in a “roll-up” strategy.

Before the move to make the two investment banks into holding banks, federal regulations prohibited them from pursuing such deals. Indeed, Morgan Stanley’s recent talks with Wachovia revolved around Wachovia buying Morgan Stanley."

We know that more bank failures are coming down the pike. Now Goldman and Morgan, having been thrown a lifeline by the Federal Reserve, are also in a position to bulk up from the acquisition of banks that won't be saved from failure. Interesting...

Also, reading through some of the comments at the Dealbook blog, it's apparent that many are wondering how Hank Paulson's connections to Goldman Sachs have influenced this latest "save" of troubled financial institutions.

For the more cynical among us, here's one trader's take on how Hank Paulson has personally benefited from taking on the position of US Treasury secretary (it involves his Goldman stock holdings).

Speaking of the Treasury secretary, we should also mention that despite all the latest news and rumination on Paulson's big plan to have the Treasury take on $700 billion or so in "troubled assets" from financial institutions' balance sheets, no one knows exactly how much all this will cost taxpayers in the end.

But as the FT reports, It will help push us towards our first trillion-dollar deficit:

"On top of a string of unprecedented events stemming from the credit crunch, the US Treasury’s $700bn rescue plan for distressed mortgage assets seems likely to give us another: the trillion-dollar deficit.

The long-term cost – or even profit – of the operations being launched in Washington depends on a number of known unknowns and possibly some unknown unknowns as well. But whatever the final cost to American taxpayers will be, they are now directly or indirectly providing a backstop for assets worth a great deal more than the federal government’s current $5,400bn (£2,950bn, €3,750bn) in debt."

For now, let me just say that I agree with others who have noted the likely indirect costs we will all suffer due to heightened inflation risk and increased moral hazard resulting from these bailouts and intervention schemes.

And if you don't like it, you can do as Mish suggests and notify your Senator today to register your displeasure with bailout actions and the proposed "dictatorial powers" for Paulson and Bernanke.

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