FAQs on Morgan-Goldman changes

— -- The conversion of the last big investment banks, Morgan Stanley ms and Goldman Sachs gs, into bank holding companies will usher in sweeping changes to the nation's financial system.

The era of the giant investment bank is over, but the day of the gargantuan bank holding company could be just beginning. And with that rise is real danger that such outsized financial titans will become so big that they'd become, undoubtedly, too big to fail. Nevertheless, the changes give Goldman Sachs and Morgan Stanley — and the financial system — "more stability" for now, says John Foff, a senior analyst at SNL Financial. "They also give investors more transparency into these companies."

Here's a look at the latest reshaping of the financial world:

Question: Why are Morgan Stanley and Goldman Sachs doing this?

A: A major reason the banks decided to convert to bank holding companies was to gain access to a stable source of funding: customer deposits.

Investment banks have traditionally relied on borrowed money, rather than deposits, to turn a profit. But as the economy has faltered, and it's become harder — and more expensive — to borrow money, they've realized the appeal of plain-vanilla deposits.

Morgan Stanley and Goldman Sachs had been mulling the conversion for weeks, but Lehman's bankruptcy last week — along with Merrill Lynch's merger with Bank of America bac and the government's takeover of AIG — accelerated the decision.

Morgan Stanley further stabilized its finances Monday by striking an agreement to sell Mitsubishi UFJ Financial Group, Japan's largest bank, as much as a 20% stake.

The developments mean that Morgan Stanley's talks with Wachovia about a potential merger are on hold, according to a person with direct knowledge of the matter but who is not authorized to be quoted publicly.

Q: How is regulation different for a bank holding company vs. an investment bank?

A: Three ways.

First, bank holding companies have stricter requirements about the amount of capital they must hold — that is, the amount of money they have to offset losses. Historically, investment banks have had few restrictions on how much capital they must have.

Second, investment banks haven't had strong regulatory oversight. Although the SEC has had a watchdog role in investment banks' activities, bank holding companies generally have far more rigorous oversight from the Federal Reserve.

Finally, there are some things that bank holding companies just aren't allowed to do — use large amounts of borrowed money to buy and sell securities, for example. Much of the financial crisis has stemmed from exactly that.

Q: How will Goldman Sachs and Morgan Stanley acquire deposits?

A: Now that Morgan Stanley and Goldman Sachs are bank holding companies, they will aggressively try to expand deposits. Initially, at least, they may do so mainly through their existing brokerage and wealth-management clients, much as Merrill has done for years.

But Robert J. Ellis, a senior vice president at Celent, a financial-services research firm, said he wouldn't be surprised if the firms each struck a deal "within weeks" to merge with a bank, in an effort to quickly build their deposit base. "Our plan is to acquire (deposits) that will impact the balance sheet, but this won't result in ATMs on every corner," says Lucas Van Praag, a Goldman Sachs spokesman.

Q: Is the independent investment bank doomed?

A: Not at all, although the large investment bank is now a thing of the past. Many small and midsize investment banks have survived the carnage on Wall Street. If they make it intact through the current crisis, they could do quite well.

"Many smaller boutique firms will carry on," says Hugh Johnson of Johnson Illington Advisors. In fact, Johnson says, many of the more aggressive people from the big firms may well land in smaller investment banks. "That's where the risk takers go — those who can't operate in the new culture at Goldman Sachs and Morgan Stanley will go to small and midsized firms," Johnson says.

Smaller firms that are able to attract new employees will get another benefit: the business contacts of their new hires. "We see small and midsized investment banks increasing their market share," says Michael Turner, partner at Fort Lauderdale investment bank Farlie Turner.

Q: What effect will this have on consumers?

A: Gary Stein, a partner with Capital Performance Group, which consults with banks, says more players in the banking world leads to more competition. More competition, in turn, he says, could result in better loan terms for consumers.

Yet the reason such savings may not materialize, says Ellis, of Celent, is that historically, as banks have captured more market share, they've also raised their fees. That means, he says, that consumers could ultimately get "less interest on their deposits and pay more interest on their loans."

Q: What does this mean for securities underwriting?

A: In general, very little. Goldman Sachs and Morgan Stanley will still be able to bring new stocks and bonds to market, just as they always have.

But because stocks are in the grip of a bear market, new stock offerings will probably be scarce. At the moment, the new issues calendar is about as empty as the Bear Stearns employee cafeteria. "Given the market's volatility, it's not a good time to contemplate new equity issue," Turner says. And, because the debt markets are in such turmoil, there's not much demand for new bonds, either. Eventually, however, new issue demand will return.