What happened to Goldman Sachs and Morgan Stanley?

Goldman, Morgan Stanley Bring Down Curtain on an Era (Update2)
By Christine Harper and Craig Torres

Sept. 22 (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...

Let's put this in perspective. I noticed that many people see this situation only as a move towards increased regulation. There another dimension though: convergence. American banking history is very interesting and full of weird events.

Two very important legislations: McFadden Act (1927) and Glass-Steagall Act (1933) put restrictions on geographic expansion of banks and separated commercial banks from investment banks. You may not know that the number of banks in USA is much greater compared to Germany, for instance. The idea was to not let one or two big banks to grab all business from local banks. hence, we ended up with many little regional banks. Also, commercial banks were not allowed to do underwriting, which was left to investment banks. Fed Reserve was to oversee commercial banks, which would engage only in traditional banking.

However, after the World War II, especially since 1980s, there was a steady trend of convergence of commercial banks and investment banks. For example, in 1987 commercial banks were allowed to underwrite commercial papers using section 20 affiliate of Glass-Steagall Act. In 1999 Gramm-Leach-Bliley Act removed even more restrictions on Bank Holding Companies, which eliminated even more differences between them and investment banks.

For instance, Citigroup and JP Morgan, bank holding companies, have investment banking affiliates which are comparable in size and in range of activities with typical investment banks such as Goldman Sachs and Morgan Stanley. The latter ones were regulated by SEC, not Fed reserve.

Therefore, I think that it's wrong to see the recent events as only as parts of a trend to tighten regulation. American banking regulation was going back and force from less regulation to more and vice versa. Do you remember the Regulation Q? Commercial banks were restricted on how much interest they can pay their deposit owners. In other words, there was a ceiling on the interest paid to deposit owners. It may sound strange, but it seemed reasonable back then. All banks were to have the same price of funds, i.e. interest on deposits. They also has usury ceilings, i.e. how much they charge for loans to borrowers.

I can bring up more examples of deregulation and regulation in American banking. There were some interesting events in late 1980' during Savings and Loans crisis. However, my point is that while regulation-deregulation theme is attracting a lot of attention today, the trend to convergence of commercial and investment banks was steady and consistent through all these years.