Era ends as Wall Street big two lose their status

The two financial powerhouses were last night granted approval by the Federal Reserve to become bank holding companies subject to far tighter regulation by the central bank.

It allows them to take deposits from investors — likely to be institutions rather than retail savers — and gives them far greater access to emergency funding from the Fed. As investment banks rather than commercial banks, they had limited access to Fed loans.

The move comes as Goldman Sachs, led by Lloyd Blankfein, and Morgan Stanley, led by John Mack, battle to survive the worst financial crisis for decades, with Treasury Secretary Hank Paulson, a former Goldman chief excutive, urging both banks to find partners as soon as possible.

It was a watershed moment on Wall Street and effectively marked the end of the once-mighty US investment bank.

"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 really too bad, as our country has benefited greatly from the entrepreneurial risk-takers on Wall Street."

Chip MacDonald, mergers partner at law firm Jones Day, said: "It creates a perception of greater safety and supervision. It really rationalises the regulatory system. It should be good for both Goldman Sachs and Morgan Stanley."

The credit crunch has exposed the business models of investment banks. Shares in Morgan Stanley and Goldman Sachs, two pillars of Wall Street and the last remaining independent investment banks, were hammered last week as the financial crisis reached fever pitch.

Whereas commercial banks raise money by taking deposits from investors, investment banks rely on short-term funding through the money markets, which has dried up in the past 12 months.

The collapse of Bear Stearns early this year was last week followed by that of Lehman Brothers and the emergency takeover of Merrill Lynch by Bank of America.

The escalation of the crisis — which has also seen the bailout of Fannie Mae, Freddie Mac and AIG — prompted the US government to announce a $700billion bailout plan to prevent further turmoil and stave off recession.

Under the plan, the US Treasury would get sweeping powers to buy up toxic debts from financial institutions. Paulson has also strongly encouraged both Goldman Sachs and Morgan Stanley to find partners to secure their futures.

Morgan Stanley was last night said to be in deep talks about a merger with regional banking giant Wachovia. Such a move would put more pressure on Goldman Sachs to follow suit.

However, analysts said the Fed's decision to grant a change of status to both banks could jeopardise a deal.