Goldman Sachs and Morgan Stanley sought shelter with the Federal Reserve to survive a financial storm that has destroyed their rivals, effectively killing off the Wall Street investment banking model of the past two decades.
The move is Washington's latest effort to restore calm to chaotic markets and follows frantic talks between the Bush administration and Congress on a $700 billion bailout to prevent the crisis from pushing the economy into severe recession.
By agreeing to much tighter Fed regulation as bank holding companies, Goldman and Morgan Stanley moved to avoid the fate of rivals that either collapsed or were taken over in the worst financial crisis to sweep Wall Street since the Great Depression.
U.S. stock futures gained on the news but were still indicating a lower open on uncertainty over details of the bailout, cobbled together last week after panic-stricken investors drove Lehman Brothers to bankruptcy, Merrill Lynch into the arms of Bank of America and insurer AIG to nationalization.
With Bear Stearns collapsing earlier this year, Goldman and Morgan Stanley were the last of the big five investment banks that shaped 20 years of Wall Street history, partly by taking greater risks than their Fed-regulated rivals were allowed to.
In return for tighter regulation, Goldman and Morgan Stanley gain greater access to central bank funds and will find it easier for them to buy retail banks.
"It creates a perception of greater safety and supervision," said Chip MacDonald, mergers partner at law firm Jones Day.
After the Fed move, a mooted merger with the banking group Wachovia Corp. was no longer Morgan Stanley's priority, a person familiar with negotiations said.
And financial industry sources told Reuters that Japan's biggest brokerage Nomura Holdings and some other financial players have put in bids for Lehman's Asian and European operations.
Lehman's collapse shattered investor confidence and threatened to rupture the global financial system, battering stock markets around the world.
On Friday, stock markets worldwide added more than $1.5 trillion in value in their largest one-day gain ever on the news of the plan.
But by Monday the euphoria had ebbed. European stocks and the dollar fell and U.S. Treasury debt prices edged up as investors played it safe before the mechanics of the plan are worked out.
Elsewhere, central banks in Japan and Australia pumped more cash into their money markets and Australia's financial regulator slapped a ban on short selling to stabilize the stock market.
"The $700 billion plan should stem the bleeding. However, the patient is still fragile," said Thomas Lam, senior Treasury economist with United Overseas Bank in Singapore.
The largest-ever bank rescue would give sweeping powers to the U.S. Treasury to buy up toxic mortgage-related debt from financial firms, including U.S. subsidiaries of foreign banks.
STOP THE BLEEDING
Democratic leaders in Congress promised swift action, but also want to throw a lifeline to homeowners, not just Wall Street.
With the economy the No. 1 issue in an election less than six weeks away, lawmakers are striving to get a plan in place by week's end, fearing that delay could send markets reeling.
Two key questions remained unanswered even after Treasury Secretary Henry Paulson appeared on four television talk shows to press his case for emergency action. What price will the United States pay for these bad debts? And when will it start buying them? Paulson cast the proposed market intervention as a lesser evil, arguing the consequences of inaction would be so dire that the large burden on taxpayers would be worth it.
"This is not something that we wanted to do. This was something that was very necessary," Paulson said on the NBC Sunday program "Meet the Press."
"We did this to protect the taxpayer."
Democrats, who control both chambers of Congress, began to swap proposals with the Treasury, including suggested checks on the nearly unfettered power the administration sought for the Treasury secretary.
"Democrats believe a responsible solution should include independent oversight, protections for homeowners and constraints on excessive executive compensation," said California Democratic Rep. Nancy Pelosi, the Speaker of the House of Representatives.
As negotiations got under way, both the Democrats and the Republicans predicted lawmakers would quickly resolve their differences and were likely to pass a bill by week's end.
$15,000 PER FAMILY
Paulson said the final cost of the bailout should fall well short of the $700 billion initial price tag since the government would be able to hold the debt until markets stabilize and prices recover. "This is the least costly path," he said.
To cover the cost, Treasury asked Congress to raise the government's debt limit to $11.3 trillion from $10.6 trillion.
A $700 billion fund would come on top of other steps already taken by the U.S. authorities and would push the total pledged to combat the crisis to $1.8 trillion, or $15,000 per U.S. household.
The plan would cover both U.S. companies and U.S. subsidiaries of foreign firms and would even let the Treasury buy assets from nonfinancial firms and assets not tied to mortgages if it helped promote market stability.
Paulson confirmed, however, that hedge funds — investment vehicles for the wealthy — would not be eligible.
"We have a global financial system and we are talking very aggressively with other countries around the world, and encouraging them to do similar things, and I believe a number of them will," Paulson said on ABC.
Lawmakers said Paulson and Fed Chairman Ben Bernanke had offered starkly grave assessments of the economic cost of inaction in private briefings.
"What they told us was the contagion here and the depression in the market was such that you were going to see a shutdown of the lending businesses not just on Wall Street" but for all Americans, Barney Frank, the chairman of the House Financial Services Committee said on CBS.
