Will The Last Investment Bank Turn Out The Lights Please?

Late last night the Fed put an end to the era of the independent investment bank. Goldman Sachs and Morgan Stanley are now bank holding companies, now making them subject to commercial bank regulation and oversight.

The move allows Goldman and Morgan to scoop up retail banks and to streamline their borrowing from the Federal Reserve. The shift also is aimed at removing them as targets of nervous investors and customers, who brought down their former rivals Bear Stearns, Lehman Brothers and Merrill Lynch this year.

But it also puts Goldman and Morgan under the Fed's supervision, increasing the agency's regulatory oversight and possibly forcing them to raise additional capital. As banks, Lehman and Goldman will be forced to take less risk, which will mean fewer profits.

And it brings to a close the era of the Wall Street investment bank, a storied institution that traded stocks and bonds, advised mergers and showered lavish bonuses on its executives.

"The separation of investment banking and commercial banking has come to an end," said Bert Ely, an independent banking consultant.

The conversion is but the latest in a series of unprecedented events on Wall Street as it convulses through the global credit crisis. In the past eight days, the federal government announced a $700 billion plan to rescue the financial sector by buying up troubled mortgage assets and an $85 billion emergency loan to insurance titan American International Group. Also, Lehman filed for bankruptcy and Bank of America took over Merrill Lynch.

Morgan (MS, Fortune 500) and Goldman (GS, Fortune 500), whose shares plummeted last week before the $700 billion bailout was unveiled, will likely avoid those fates with the conversion, experts said.

"They were afraid they'd get killed if they didn't [convert]," said Christopher Whalen, managing director of Institutional Risk Analytics. "The Fed is scrambling to take the remaining targets off the radar."

It's certainly a start. Lack of capitialization requirements, the rules that commercial and retail banks had to follow by having enough cash on hand at all times, certainly contributed to the downfall of the industry. But there's now a second problem.

The duo is expected to quickly add to their tiny existing retail banking divisions, which will give them access to a cheaper and more stable source of funding - customer deposits - rather than the volatile short-term funding they rely on. The companies, which both requested the conversion, signaled as much in separate press releases Sunday.

They have plenty to pick from now that the credit crisis has devastated the banking sector.

Morgan, which has $36 billion in deposits, may already have a partner in mind. Rumors have flown on Wall Street in the past week that it would hook up with Wachovia (WB, Fortune 500), a large but troubled bank. Sunday's shift would make such a merger easier.

With $20 billion in deposits, Goldman said it plans to grow its deposit base through acquisitions and internally. It is also shifting assets from other divisions into its Goldman Sachs Bank USA, which will become one of the 10 largest banks in the United States with $150 billion in assets.

Yep, that's right: now Goldman Sachs and Morgan Stanley can be like the rest of the commercial banks with trillions of bad paper on the books, and their assets will now primarily be customer deposits. So when these derivates blow up, it's the FDIC and the Fed "lender of last resort window" to the rescue, or the loss is of grandma's savings account.

Who's going to save the Fed lending window and the FDIC when they go under? The taxpayer, once again. The government is converting these brokers into too big to fail commercial banks. Privatized profit, socialized losses...the American way.

Meet the new suckers. Same as the old suckers.