Morgan Stanley to Buy E-Trade: Is it too big to fail?
The recent headlines regarding Morgan Stanley’s acquisition of E-Trade, an online discount brokerage firm, may seem like a leg up for the company in that industry. The move, however, is simply keeping pace with the industry’s trend towards providing cheaper services and expanding the firm’s clientele to include the middle class. Rollbacks on post-crisis financial regulations have made these sorts of acquisitions easier, and Morgan Stanley is not the only company taking advantage. For now, consumers may be the ones to benefit as banks race for size. However, with no clear end in sight, acquisitions such as this one leave spectators wondering whether banks will grow, once again, “too big to fail”.
Morgan Stanley’s move to acquire E-Trade is a large step towards procuring new types of investors, and an expensive one as well. The 13-billion-dollar all-stock agreement is the largest takeover by a major U.S. bank since the 2008 global financial crisis. If the deal closes by the end of the year as expected, Morgan Stanley will add E-Trade’s $360 billion of client assets to its own $2.7 trillion.
The takeover signifies modern structural changes in the brokerage industry. Just a decade ago two-thirds of Morgan Stanley’s profits came from buying and selling securities. However, this sector was out-earned last year by Morgan Stanley’s wealth management. Since the financial crisis, major financial firms have opted for lower risk transactions. The fees and stability of wealth and investment management provide a more reliable source of revenue for companies. After the closure of the deal, it is expected that wealth and investment management will bring in over fifty percent of Morgan Stanley’s pre-tax profits, compared to just twenty-six percent a decade ago.
The acquisition of E-Trade provides Morgan Stanley the opportunity to expand its client asset base beyond just large companies and wealthy individuals. Founded in 1982, E-Trade has made a name for itself in the discount brokerage industry. Its online trading platform has attracted a younger generation of users who prefer to interact less with typical banking institutions. Morgan Stanley is betting that the wealth of this clientele will grow, and they’re not wrong. Over the past decade, stock and mutual fund holdings for Americans below the top 1% has doubled. Morgan Stanley has struggled to generate deposits in recent years due to competition from other companies who have made large investments in web platforms. The acquisition of E-Trade’s 5.2 million clients, which generate about $56 billion per year in deposits, is an attempt to rectify this.
The timing of Morgan Stanley’s decision to tap into the smaller-volume trade market comes as no surprise either. Last October, Charles Schwab announced that they were eliminating fees on the trading of stocks and exchange-trade funds. Shortly after this announcement, other discount brokers such as E-Trade, TD Ameritrade, and Fidelity matched their rates. Since then, smaller discount brokerages have struggled to remain competitive. After the fee cuts, TD Ameritrade stood to lose $900 million in annual revenue. In November, Charles Schwab agreed to buy TD Ameritrade for $26 billion, amounting their combined assets to $5 trillion. The pressure from near zero prices and yet another bigger firm to compete with make the acquisitions of smaller brokerage firms like E-Trade and TD Ameritrade look more probable in the future.
The Morgan Stanley and E-Trade agreement is not the only hefty deal recently made to help companies size up. Due to roll backs made by President Trump to the Dodd-Frank Act, disincentives to merger and acquisitions have been removed. The very purpose of these regulations set up in 2010 were to ensure that these banks would not, once again, become so large that their failure could lead to the collapse of the financial system. The end of 2019 witnessed the merger of SunTrust and BB&T Trust, creating the 6th largest bank in the United States. It was the largest U.S. bank merger since the financial crisis. The E-Trade acquisition must still be passed by the Federal Reserve, however, it is expected to be approved. Approvals of such large entities raises speculation as to whether similar deals will emerge.
Those that oppose the E-Trade acquisition fear that it will give Morgan Stanley too much market power. With more market comes greater potential risks and a larger sum of taxpayers’ money in case of a bailout. However, it is this very belief held by investors that the government will bail out these large banks that helps perpetuates their growth. Smaller discount firms that have cut their commission as much as possible cannot afford to stay in business if clients still do not deviate from the safer deposits of big banks. Whether it be through acquisitions or driving out competition, larger banks have the advantage to gaining market power.
Although the Morgan Stanley and E-Trade agreement could set a precedent for larger mergers in the future, it is not clear whether that is the likely outcome. With promises from many Democratic candidates to tighten regulation around Wall Street, the outcome of the U.S. election will play a decisive role on this. In the meantime, CFO of Morgan Stanley Jon Pruzan, recently announced that, “the bank plans to keep its eyes open for smaller mergers”, insinuating that the company has not yet satisfied its appetite for growth.