Profiles of the Troubled Financial Giants
Goldman Sachs and Morgan Stanley, the last surviving members of the big five investment banks that ruled Wall Street for the past 20 years, were given approval by the Federal Reserve to turn themselves into bank holding companies as the financial sector continues to buckle under the weight of bad mortgage bets. The agreement, announced late Sept. 21, effectively eliminates the investment bank model synonymous with Wall Street.
The changes will allow the institutions to set up commercial banks that will be able to take in deposits, increasing the amount of financial resources available to the firms and allowing them access to permanent emergency loans from the Fed. But by becoming more conventional depositary institutions, Morgan Stanley and Goldman Sachs will be subject to much tighter regulation and closer supervision from several government agencies, not just the Securities and Exchange Commission.
Goldman Sachs will become the fourth largest bank holding company in the United States under the current deal. Going into the move, Sachs was a leading global investment banking, securities and investment management firm that advised individuals, governments and corporations on their financial holdings. It was founded in 1869 and was one of the oldest and largest banking firms on Wall Street.
On Monday, Morgan Stanley announced that Mitsubishi IFJ Financial Group, Japan’s largest bank and the world’s second largest bank holding company, agreed to buy up to a 20 percent stake in the prestigious 73-year-old investment bank. As bank holding companies, both Morgan Stanley and Goldman Sachs will be required to provide more upfront liquidity for investment ventures, as opposed to the more free-wheeling model that supported the companies in the past.
Lehman Brothers is the largest and highest-profile casualty of the global credit crisis. Once the fourth-largest investment bank in the United States, Lehman fell under the weight of $60 billion in weakened real estate holdings, and the credit market’s dislocation ultimately forced it to seek court protection on Sept. 14. At the end of August, Lehman had $600 billion of assets financed with just $30 billion of equity.
The U.S. government refused to help prevent Lehman’s bankruptcy the way it assisted Bear Stearns’ sale to JPMorgan Chase earlier this year. Prospective bidders refused to buy Lehman without government support, and Lehman was allowed to fail, forcing the 158-year-old company to file Chapter 11.
The British bank Barclays announced Sept. 17 that it agreed to buy out Lehman’s core capital markets businesses for just $1.75 billion. The deal could save up to 10,000 jobs for Lehman employees and allow Barclays to expand its reach with the U.S. financial market.
Bank of America‘s $50 billion acquisition of Merrill Lynch marks the end of the 94-year independence of Merrill, the world’s largest brokerage and Wall Street’s third-largest bank. The merger, announced on Sept. 14, also creates the one of the nation’s biggest banks by far. Bank of America also gets Merrill’s 45 percent stake in the asset manager BlackRock Inc.
Bank of America was already the nation’s largest retail bank, credit card issuer and mortgage provider following its July purchase of Countrywide Financial Corp. Bank of America has announced more than $150 billion of acquisitions in the last five years.
Also hit by rising mortgage defaults and plunging home values in the U.S., Merrill had a $19.2 billion net loss in the last year.
AIG (American International Group), one of the world’s largest insurance companies, was taken over by the U.S. government Sept. 16 as part of the Federal Reserve’s most far-reaching intervention into the private sector ever. The government will get a nearly 80 percent stake and the power to remove top officials in exchange for an injection of $85 billion in taxpayers’ money.
The New York-based company was forced into restructuring because of billions of dollars in losses tied to the deterioration in the mortgage and credit markets. AIG says it will repay the money in full with proceeds from selling some assets.
The Fed said a disorderly failure of AIG could have hurt the already struggling financial markets and the economy, saying it also could “lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.” The government’s bailout was similar to its seizure of mortgage giants Fannie Mae and Freddie Mac earlier this month.
The Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, known as Freddie Mac, are government-chartered, shareholder-owned mortgage firms.
Neither corporation lends directly to homebuyers but they both play critical roles in the availability and backing of home financing in the U.S. Together, the companies own or guarantee almost half of the $12 trillion of U.S. home mortgage debt.
Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt’s New Deal to provide liquidity to the mortgage market, support the secondary market for mortgages and guarantee that mortgage lenders had enough funds to lend to home at reasonable interest rates. It became a publicly traded company in 1968.
Freddie Mac was created in 1970 in part to ensure that Fannie Mae didn’t hold a monopoly on the government-backed mortgage market. The company has expanded the secondary market for mortgages — mortgages that banks sell to other banks and institutions as a product, rather than simply adding the loan to the individual lender’s portfolio. Both Fannie Mae and Freddie Mac buy loans and package those loans into securities or sell them to investors to generate fresh funds for lenders to make more home loans.
Concerns over the stability of Fannie Mae and Freddie Mac due to the subprime mortgage fallout intensified in July as the companies’ shares hit a free-fall. By early September, the federal government took the unusual step of rescuing the faltering mortgage giants by putting the firms in a “conservatorship.” The move was designed to keep the firms viable into 2009, but leaves the next administration and Congress to determine the long-term structure of the companies.
The government will provide up to $100 billion to help shore up each company.