Investment banks' squeezed

Ladenburg Thalman's managing director sees weak bank earnings for 1-2 years during the change to a commercial-bank model.

You have been in this industry for a while, uh, through a lot, this is certainly a shocking time. Why do you think that Goldman Sachs and Morgan Stanley would make an announcement like this, with this timing?

Well, I think there were a few reasons. The first one was that last week they couldn’t refund their debt. In other words, because so many investors questioned the value of their assets, the people who were supposed to roll over their debt wouldn’t do it. They just didn’t have confidence in the companies. And therefore, the companies needed assistance immediately from the United States Treasury, which I believe is forthcoming with Mr. Paulson’s new plan. Second point was that they knew that they were gonna be regulated, because virtually, every person in Congress has indicated pretty clearly that they want to regulate the investment banking business, you know, when the next Congress comes to meet. Thirdly, they wanted to show stability, they wanted to show that they US government was controlling them, that they had deposits that would be backed by the FDIC. In other words, they wanted to show some degree of solidity, so they took the step to do what was inevitable, in my estimation.

Dick, was this the only option really facing Morgan and Goldman, I mean, Would we have seen a run on the bank within a week or two if this hadn’t happened?

I think so. Well, I think you were seeing a run on the bank, and I think that the actions that the Treasury took is what stopped the run on the bank, as oppose to, you know, their declarations of being bank holding companies. I think because they are bank holding companies, it makes it easier for the Treasury to buy assets from them, which probably wouldn’t have been that easy if they remained strictly investment banking companies.

This has to lower/ their risk-reward profile, so when we look ahead to quarterly earnings reports, I mean, are we going to see shrinking profit for these stocks because of that?

Well, yeah, I mean, you are gonna see the fact that, but this would have happened anywhere, right? In other words, the companies are de-leveraging, they are getting smaller and smaller because people don’t want to give them money. Alright, so that another fact is / when you de-leverage a balance sheet, your earnings are gonna be substantially less. Also, you’re in a cycle which is very negative at the present time, which means that there just isn’t business out there. You can’t do IPOs, you can’t bring in new private equity deals, prime brokers business, you’re shrinking, you can’t do mortgage deals, so earnings are gonna be very weak for at least a year, maybe two years for these companies, whether they are bank holding companies or not. The fact that they are bank holding companies, I think, creates a little bit more stability to their earnings but they’re just not gonna have good earnings for quite some time.