Such a lovely place

March 17, 2010

Cross-posted from today’s NYT.

Wall Street’s closest link to the lyrics of “Hotel California” had been the indulgent pink champagne. But Senators Christopher Dodd and Bob Corker are bringing a more modern slant. A provision Corker added to Dodd’s plan to overhaul financial regulation stipulates that even if Goldman Sachs and Morgan Stanley, or other banks that received funds from the Troubled Asset Relief Program, check out as bank holding companies — they can never leave the Federal Reserve’s embrace.

The two firms signed the Fed registry at the height of the financial crisis in September 2008. The last surviving independent investment banks were granted bank holding company charters to gain access to emergency credit from the central bank. Two months later, the status enabled them to sell government guaranteed debt through the Federal Deposit Insurance Corp. Goldman announced it would be the first to use the scheme the day its shares hit a low of $47.41. Were it not for that program, Goldman was a goner.

All these carrots came with a theoretical stick: oversight by the tougher Fed instead of the more lax Securities and Exchange Commission. But with survival no longer in question, whispers started circulating that one or both banks might want to slip out the back door without paying the price — by dropping their charters in a game of regulatory arbitrage.

The temptation must be as inviting as the warm smell of colitas. Deposits are a complete after-thought for Goldman, and still remain a minor component of Morgan Stanley’s business despite plans to add Smith Barney deposits to its brokerage and closer ties to a Japanese commercial bank. Such funds can’t be used to finance investment banking activities, which remain a hallmark of both Wall Street denizens. What’s more, Goldman is losing money by parking its small pool of deposits at the Fed.

It’s true neither firm has said or suggested it wants out from under the Fed’s thumb. But as the bankruptcy examiner for Lehman Brothers starkly reminded, Wall Street has a way of shrewdly finding regulatory loopholes. The senators are smart to stab this beast with their steely knives.

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