Robert Peston thinks that much of the recent sell-off can be attributed to the decision by Goldman Sachs and Morgan Stanley to convert into banks:
It was caused, to a large extent, by an exceptional and unprecedented shrinkage in the prime brokerage industry, which in turn led to a serious reduction in the volume of credit extended to hedge funds, which in turn forced hedge funds to sell assets, especially those perceived as higher risk…
Morgan Stanley and Goldman are – by far – the biggest prime brokers, with Morgan Stanley the number one.
But as banks, they’re prevented by regulators from lending as much relative to their capital resources as they had been as securities firms.
So the US authorities should have known – and presumably did know – that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.
I’d love to see some datapoints here. Is it true that the prime-brokerage operations of Goldman Sachs and Morgan Stanley have been shrinking, even as competitors such as Lehman Brothers and Bear Stearns have gone bust? It might be the case that the total amount they’ve lent out to hedge funds has declined, even if their client count is rising. And I’m sure that there’s been a lot of pressure both internally and externally for those shops to derisk and deleverage.
But the fact is that as soon as the investment banks started getting access to the Fed’s money, they were bound to become much more tightly regulated — whether they became banks or not. Has that process been sped up by their move to become banks? Frankly, I doubt it — no one at Treasury or at the SEC is interested in giving Morgan Stanley and Goldman Sachs a hard time right now over the fact that they don’t immediately conform to all the requirements of banks. These things take a certain amount of time, and everybody understands that.
But are hedge funds being forced to sell assets because their prime brokers are derisking? That’s entirely possible. But I’d be more convinced if I was shown an actual instance of it happening.