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So Who is Smarter: Nomura or Goldman?

As Goldman Sachs exits stand-alone investment banking, the Japanese bank doubles down on the model by buying the Lehman franchise in Asia and Europe

Some observers argue that the high-leveraged investment banking era is over, and that Goldman Sachs has made a graceful exit from stand-alone investment banking to a bank holding company (BHC) model at just the right time. If they are right about Goldman, it would seem difficult to be bullish on Nomura's expansion of that same investment banking model in Asia and Europe.

The weakness of the investment banking model embodied by Goldman Sachs and Morgan Stanley is nicely summarised in the September 20 issue of The Economist as stemming from: the higher risk of insolvency, due to higher leverage and the reliance on the short-term wholesale markets; the requirement to mark-to-market; and weaker future demand for their services, especially in structured finance.

Reiko Toritani, chief banking analyst at Fitch Ratings in Japan agrees: "investment banking is facing difficulties due to an overall reduction in risk appetite and a reduction in the leverage to stimulate returns. Morgan Stanley and Goldman have had to become more risk averse after being forced to change to bank holding companies (BHCs), and by more difficult markets," she says.

Goldman's woes seem to reflect those problems. The bank has gone through an expensive capital raising exercise with Warren Buffett of Berkshire Hathaway. Buffett will invest $5 billion in perpetual preference shares with a 10% annual dividend and retain an additional $5 billion worth of warrants. And on Wednesday, the bank raised another $5 billion through an accelerated book-build.

BHCs are closely regulated by the Federal Reserve, and leverage levels will be capped closer to commercial bank levels (around 10 times for the sector, compared to 30 times for the non-commercial bank sector pre-crisis). That will make it hard to maintain previous earnings levels.

The exit of Morgan Stanley and Goldman leaves Nomura as the last major stand-alone investment bank in the world. Nomura is fiercely proud of its independence from Japan's mega-banks, and it is likely that it is hoping its raid on Lehman Brothers will give it the international scale to sustain that independent model. The question is, has Nomura just put off the fateful day when it is wrapped in the arms of a mega-bank, or at least changes its status?

One sceptic of the stand-alone model points out how close even Goldman may have come to disaster, despite its high reputation.

"Goldman has a similar business model in many ways to Lehman and Bear Stearns. It's a tribute to its franchise and mystique that it managed to retain investor confidence," he says.

One could argue that Goldman played its cards wrong and that it could have avoided its exit from stand-alone investment banking by raising capital much earlier. Indeed, the firm famously made a lot of money shorting the mortgage-backed market in 2007 and early 2008. Goldman must have understood the negative macro-economic implications of the development of these instruments, and should have spent less money on the famously lavish bonuses, and more on plumping its equity cushion.

But, says a former Goldman banker "not paying bonuses (almost a year ago) would have resulted in people leaving the firm; raising capital would (even though it would have been cheaper then than now) have sent a danger signal to investors at a time when sentiment was jittery. Raising money now from Buffett is the right thing to do, as is adopting the BHC model. People are more accepting of the need to do so, and it will help the firm ride out the downturn," he says.

It isn't clear if there is anything preventing Goldman from reverting to independent status when it finds the right moment.

In the meantime, over in Tokyo, Nomura has taken the opposite tack. It saw some investment banking assets going cheap and couldn't resist. The $225 million Nomura reportedly spent on the Lehman operations in Asia, and the 'nominal price' paid (according to senior Nomura advisor Sadeq Sayeed, as quoted by Bloomberg) for its European operations, is low

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