Well, the inevitable has happened- Morgan Stanley and Goldman Sachs will cease to be pure investment banks. This won't be news to readers of this blog.
The two firms were issued licenses by the Fed to commence banking operations in what must be record time. The Fed acted with alacrity because any delay could have resulted in Morgan and Goldman meeting the same fate as Lehman- the share prices could have quickly tumbled to zero. The ban on short selling may not have saved the two firms. Now that markets have sensed that the investment banking model was doomed, the bottom would have fallen out of their share prices.
This does not mean that the firms can succeed on their own as banks. Not by a long chalk- I can't see that happening without their having a branch network. No, the permission to convert to banks was meant to be a signal to markets: hey guys, please don't view these firms as investment banks, they are going to be banks soon, so there is hope yet. The odds are that both Morgan and Goldman will merge with some bank or find a bank as a strategic partner.
What happened to all those who proclaimed that these two firms had done a better job of managing risk and would survive? All this talk was baloney. All the top banks were dangerously leveraged, dangerously exposed to toxic securities. That one was more dangerously exposed than another is neither here nor there.
So, the short sellers were right in latching on to Lehman and then to the others. But that does not mean that short-selling of financial stocks in such an environment is justified. This cannot be justified on grounds of price discovery or discovery of information. After all, a central bank may know that a bank is in bad shape but it would certainly not think it necessary to broadcast the news to the world. In times of financial crises- as in times of war- the normal rules of reporting stand suspended. So the temporary ban on short-selling of financial stocks is justified.
One final thought. You could say that the Fed acted with commendable despatch in ensuring that Goldman and Morgan did not meet the fate of their peers. But cynics may take a different view. US Treasury secretary Hank Paulson was CEO of Goldman before moving into government. Does he still own a lot of stock in Goldman? If so, the cynics may take a different view of the Fed's decision......