Investment banking kills.
In the carnage of the Great Depression, Congress hoped to safeguard small investors by separating stock-touting investment banks from deposit-taking commercial ones.
Now that it is clear that one small investment bank, Bear Stearns, had the potential for ruining the financial markets, the best way to protect the public may be the most ironic one of all: to push commercial and investment banks ever closer together.
The hope would be to absorb the volatile side of investment banks with more capital and stable deposit bases. It is like burying a live bomb in a sand pit.
Around Wall Street there is a rising, albeit reluctant, acknowledgment this may be the best path for the likes of Merrill Lynch, Morgan Stanley and maybe even Goldman Sachs Group.
Speculation has in recent weeks mounted that one of the Street's brokers may even buy a commercial bank. Whether true, the rumors speak to three deep changes under way.
• First, looming Federal Reserve assistance and regulation could force brokers to keep reserve ratios similar to those of deposit-taking banks.
• Second, short-term bank funding now is regarded with suspicion. It is capable of being yanked at a moment's notice, sending a bank such as Bear Stearns to the brink of bankruptcy (it is now part of JPMorgan Chase).
• Third, the securitization markets also have contracted, which is in turn forcing the investment banks to shrink their balance sheets.
In theory, these problems are all solved by putting a large, plodding typical bank — with stable deposits and returns — next to the more-speculative realms of investment banking and trading.
Citigroup, the prime "universal bank," sounded good in theory, too. It has performed miserably since its creation after Congress rolled back the Depression-era limits a decade ago. That misses the relative success of JPMorgan Chase and Bank of America, the other big universals.
"Three or four years out, the investment-banking model is coming to an end," says Brian Sterling, co-head of investment banking for boutique adviser Sandler O'Neill & Partners. "If it walks like a bank and quacks like a bank, it's going to have capital ratios like a bank."
Of course, now is a terrible time to be buying an investment bank or commercial bank. Both still are littered with securities and loans that are nearly impossible to value.
Investment-bank chiefs would do well to resist this change for as long as possible. The return-on-equity for an investment bank is typically above 20 percent, while commercial banks generally deliver a middle-teen return. Why rush to cut your own profitability?
The contrary answer would be to find the best partner possible, before a rival snaps one up. Among the big commercial banks, troubled Wachovia is trading at slightly less than half its book value. The likes of PNC Financial Services Group or SunTrust Banks may be attractive to a Wall Street firm looking for a steady deposit base.