Goldman and Morgan Stanley to become Fed-backed banks

By Mark Felsenthal and Jessica Hall

WASHINGTON/PHILADELPHIA (Reuters) - Goldman Sachs and Morgan Stanley got approval on Sunday to become bank holding companies regulated by the U.S. Federal Reserve, effectively killing off the investment banking model that has dominated Wall Street for more than 20 years.

The move by the only two big U.S. investment banks left standing independently after the failure of Lehman Brothers and the agreed takeover of Merrill Lynch last week, enables them to gain easier access to financing and gives them more flexibility to buy retail banks.

But the change, part of a wrenching transformation of the Wall Street landscape amid financial market turmoil in the past two weeks, means that previously freewheeling Goldman (GS.N) and Morgan Stanley (MS.N) will be subject to much tighter Fed regulation, including tough capital requirements.

In return they get long-term access to the Fed's discount window and access to bank deposits insured by the Federal Deposit Insurance Corp.

"It creates a perception of greater safety and supervision. It really rationalizes the regulatory system. It should be good for both Goldman Sachs and Morgan Stanley," said Chip MacDonald, mergers partner at law firm Jones Day. "It gives them better sources of funds through a commercial bank subsidiary."

The approval by the Fed came at the request of Goldman and Morgan Stanley, according to a source familiar with the application.

If confirmed after a five-day waiting period, the transition could also make it easier for the banks to buy retail banks.

To provide increased liquidity to the companies while they go through the transition, the Fed agreed to lend to the firms' broker-dealer subsidiaries on the same terms as the Fed discount window for banks.