http://www.ft.com/cms/s/0/3da53cc0-88d6-11dd-a179-0000779fd18c.html
September 22, 2008 Financial Times
The Age of Leverage Is Over Gillian Tett
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The news that Morgan Stanley and Goldman Sachs -- which were the last surviving big investment banks on Wall Street -- have become regulated banks is a particularly compelling sign of this trend. On a micro level, the move packs a powerful historical punch, since it essentially spells the end of the old broker-dealer business model, with its bold, buccaneering approach to life.
In a broader sense, it also provides further evidence that the era of high leverage is over. After all, one key factor that has marked the brokers out in recent years is that they did not face the type of strict leverage rules that were applied to US commercial banks. Thus, while the latter group was generally forced to keep tangible equity at 5 per cent of assets, or more, brokers operated with a lower equity ratio. That let them have leverage ratios of more than 30 times -- which in turn turbocharged their profits.
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Separately, international regulators in Basel are now tweaking the so-called Basel Two capital rules to force banks to hold more capital against esoteric assets. And efforts are now under way to toughen the rules for a putative central clearing house for credit derivatives -- which, in turn, would prompt lower leverage in that sector too.
In the long term, all this is utterly desirable. Indeed, it is also overdue. However, nobody should forget that the shift also presents policymakers with yet another headache. After all, even at the best of times, deleveraging is never an easy process; and right now, it threatens to produce a particularly unpleasant downward drag on asset prices and growth.
Some industry analysts estimate, for example, that if investment banks were to cut leverage ratios from 30 times (or recent levels) to 20 times, this would trigger $6,000bn worth of asset sales, excluding likely deleveraging by hedge funds too.
Of course, such deleveraging will not happen overnight, or necessarily in such a simplistic way. But what these rough calculations show, as George Magnus at UBS points out, is that the putative $700bn RTC fund cannot be considered an all-encompassing solution to the current woes. Deleveraging, in other words, still has a long way to run -- at Morgan Stanley and Goldman Sachs, for starters.
Copyright The Financial Times Limited 2008