Where did "Wall Street" go?

Here is my summary of what happened to "Wall Street." There are probably a few hundred questions that aren't tackled here, so if you have any, please feel free to post them in the comments section and I will try my best to address them.

Q: What is going on here?
A: Up until a few weeks ago there were four main Investment Banks in the United States. Those being: Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs. Essentially, these four financial institutions made up the bulk of “Wall Street”. As of today, this number has effectively been reduced to zero.

Q: What happened to the Investment Banks?
A: September 13, 2008: Lehman Brothers declares bankruptcy .
September 14, 2008: Merrill Lynch is acquired by Bank of America.
September 22, 2008 Morgan Stanley and Goldman Sachs agree to convert from investment banks into commercial banks.

Q: What’s the difference between an Investment Bank and a Commercial Bank?
A: A bank is a financial institution that acts as an intermediary for people who want to borrow and lend money. The main difference that applies here lies within where the money (i.e. equity/capital) comes from.

In a Commercial Bank, the money that is used for lending comes from “depository accounts.” Basically, what we are talking about here are savings & checking accounts. It is also important to note that Commercial Banks are regulated by the Federal Reserve.

For an Investment Bank, capital is raised by issuing and selling securities (i.e. stocks/bonds) in the capital market (i.e. the stock market). The primary regulator for this type of bank is the Securities and Exchange Commission.

Q: Uh… that wasn’t very helpful. What does that really mean?
A: Unless we are dealing with a “run on the bank,” the total of all depository accounts does not tend to change much. People need a place to put their money, and it turns out that placing it underneath a mattress isn’t very secure. Also, depository accounts are backed by the FDIC which ensures your deposits up to $100,000. This makes depository accounts very attractive when it comes to creating a solid foundation on which to loan money out. The depositors have assurance that their money will be there when they need access to it, thus preventing a “run on the bank” type situation.

As for security backed lending (again, think stocks and bonds) there is a large chance of having a significant variance in capital, especially in times of turmoil when people are more inclined to sell their riskier assets (and reduce available capital), instead of purchase more (and increase available capital).

Q: Come on, get to your point already…
A: Ok. The big key here lies within the regulation… Commercial Banks are required by the Federal Reserve to keep a “required reserve ratio” of 10. In short, for every 1 dollar of “deposits” they have, they are able to loan out 10 dollars.

Investment banks on the other hand, have no such requirement. To compare to the reserve ratio that is required by the Federal Reserve of 10, Investment Banks were carrying ratios as high as 33. In other words, for every one dollar they had in cash they loaned out 33 dollars. In regards to profits, this WAS a great thing. In retrospect, this was incredibly stupid and many people are now saying "I told you so!"

Q: Ok... So using my superior puzzle skills, what you are saying is that:

Due to very little regulation, Investment Banks loaned out too much money. When s*** hit the fan, people started selling for fear that the securities they had purchased would soon be reduced to a value of 0. At this point the Investment Banks realized that they didn’t have enough capital on hand to pay out. As a result, some Investment Banks declared bankruptcy (Lehman Brothers), while others merged with an existing bank to gain access to additional capital (Merrill Lynch) or in the case of some Investment Banks who hadn’t quite hit the fan (Goldman Sachs and Morgan Stanley), decided to convert to commercial banks, thus giving them access to more secure capital through depository accounts.

A: Exactly, except that I would also add that Commercial Banks can also gain access to short-term capital via the fed funds (i.e. overnight borrowing from other depository institutions) or the discount window (borrowing directly from the federal reserve).

Q: Why didn’t you tell me that before?
A: I guess I forgot. Sorry.

Q: Anything else you “forgot” to tell me?
A: I guess the big takeaway here is that historically “Wall Street” was made up of these large Investment Banks. While they haven’t just disappeared, they have certainly changed form. What we are seeing is a shift from the “Wall Street Model” of Investment Banks, to a new model in which Commercial Banks are one stop-financial shops. Essentially we are talking about institutions like CitiGroup, J.P. Morgan Chase and Bank of America that will now be the face of the “New Wall Street.”

-dunkie