01.11.13

Morgan Stanley Retreats From Investment Banking and Trading

The white-shoe firm is cutting back on bankers and traders, and doubling down on the old-fashioned brokerage business.

And then there was one.

Today’s headlines are about Morgan Stanley, the famously white-shoe investment bank, cutting up to 1,600 posts in banking and trading—not in back offices or low-margin areas, but in the sexy, white-hot heart of the financial-services industry.

As Tom Wolfe documented in this space, Wall Street’s Masters of the Universe—beset by high-frequency trading, the triumph of Silicon Valley nerds, limits on leverage, years of poor stock performance, and a host of new regulations—have morphed into the Eunuchs of the Universe. And now Morgan Stanley is about to neuter 1,600 more.

It’s all happened very fast. Five years ago, there were five huge, New York–based investment banks: Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns. These big-shots controlled the lucrative advisory and initial-public-offering businesses, ran internal hedge funds, managed assets, and traded with abandon. Using huge amounts of borrowed cash, they minted giant profits, paid large bonuses, and bolstered the economy of the tristate metropolitan area—all without pesky government oversight. Each employed tens of thousands of people, and sent its top executives to key posts in Washington.

But when the mortgage crisis hit, the wheels came off.

Bear Stearns, the runt of the litter, was the first to go. Undone by excessive leverage, poor management, and bad bets on subprime mortgages, it was taken over by JPMorgan Chase (with the assistance of the Fed) at a fire-sale price in March 2008.

Five months later, Lehman Brothers, undone by excessive leverage, poor management, and bad bets on subprime mortgages (sense a theme?), hurtled into bankruptcy, and nearly took the whole global financial system down with it.

Merrill Lynch saw the writing on the wall: the day Lehman Brothers went down, Merrill CEO John Thain sold the company to Bank of America.

That left two investment banks standing—Goldman Sachs and Morgan Stanley. Both took prompt evasive action to maintain their independence. They quickly transformed into bank holding companies, which would allow them to access Federal Reserve funding. They struck alliances to raise new capital from outside investors. Goldman raised cash from Warren Buffett, while Morgan Stanley sold a 20 percent stake to Japanese bank Mitsubishi for $9 billion in September 2008. They also took TARP money—$10 billion each.

But from there the two followed separate paths. Goldman, long the province of sharpies, got on with its business—trading, investing, advising, managing money, and figuring out how to game whatever new system was going to be put in place. The precrisis management remained intact. Love it or hate it, the Goldman of 2013 is very much like the Goldman of 2008, except with better public relations, less debt, and somewhat lower profits.

Morgan Stanley, which traces its lineage to the J.P. Morgan complex that dominated haute finance in the early decades of the 20th century, was always a significantly different creature than Goldman. Founded in 1935 after New Deal efforts required the separation of investment and commercial banking, Morgan Stanley was more snooty and genteel (read “less Jewish”) than other firms. It also had less-sharp elbows, and for good reason. While the company may not have had the sharpest proprietary traders or a reputation for innovative and aggressive financing deals, it didn’t need to. It was the trusted adviser. Morgan Stanley bankers were the guys with the right suits and the right connections—solid, highly respectable, and generally free of scandal. Sure, there were internal disputes over strategy and diversification efforts that went awry. But the drama, detailed excellently in Blue Blood & Mutiny: The Fight for the Soul of Morgan Stanley, by Patricia Beard, was before the current crisis.

Morgan Stanley may not have had the sharpest proprietary traders or a reputation for innovative and aggressive financing deals.

Since the financial meltdown, Morgan Stanley has pursued a different route. Seeking more stability, it chose to invest heavily in the old-fashioned brokerage business. In January 2009, it agreed to combine its brokerage unit with Citigroup’s Smith Barney unit. The guiding spirit behind this massive agglomeration, which boasts 16,829 representatives around the world, was James Gorman, an Australia-born management consultant from McKinsey and veteran of the asset-management business. In 2009, Gorman, who helmed Morgan’s asset-management business, was tapped to succeed John Mack as CEO.

And so the company is now run by a guy who is neither a banker nor a trader—which is rare for Wall Street. Not surprisingly, Gorman has doubled down on the financial-advising business. In September 2012, the company agreed to buy the rest of Morgan Stanley Smith Barney that it didn’t own—acquiring a chunk of Citi’s stake and agreeing to buy the remainder by 2015.

This seems like a sound strategy. The asset-management business is totally respectable and a good strategy for survival. Morgan Stanley repaid its TARP funds in June 2009 and has generally avoided the big trading scandals that have tripped up other big banks. But there are challenges, of course. The advisers are essentially independent contractors who can—and do—leave and take their assets and clients with them. And in the emerging world of self-directed savings plans and discount brokerages, relying on expensive commissions and asset-management fees doesn’t sound like a plan for growth. 

And so Morgan has languished behind its peers and the market at large. Here’s a chart of Morgan Stanley, Goldman Sachs, and the Standard & Poor’s 500 over the past five years.

MS Chart

MS data by YCharts

Morgan Stanley isn’t giving up entirely on the high-risk, high-reward businesses that once set the hearts of young MBA aflutter. It will still compete with Goldman Sachs and other banks in those lucrative areas. But it is certainly retreating.

Goldman may be wounded, too. But it increasingly looks as if it will be the last man standing.