A leading industry analyst suggests that Goldman Sachs Group Inc. and Morgan Stanley may consider dropping their status as bank holding companies to avoid expenses tied to the Volcker rule.  The rule in its current form would impose costs on lenders and drive capital to non-bank market makers, causing the two New York-based firms to consider whether to stop being banks,  David Hilder, an analyst at Susquehanna Financial Group LLP, says in a note. Goldman Sachs and Morgan Stanley were the biggest U.S. securities firms before they converted to bank holding companies after the September 2008 bankruptcy of Lehman Brothers Holdings Inc. Both became subject to regulation by the Federal Reserve and won access to central bank programs such as the discount window, which are designed to protect deposit-taking banks. “The regulators have proposed a massive new compliance burden on banks to prove that their market-making activities are just that, and not proprietary trading in disguise,” wrote Hilder.  “If these regulations are adopted in anything close to their proposed form, there will be large additional costs imposed on banks as market-makers that will not apply to market-makers not owned by banks.” David Konrad, a bank analyst at KBW Inc., says Goldman Sachs and Morgan Stanley (MS) are unlikely to change their status as bank holding companies to dodge the Volcker restrictions. “If they tried to do that, Congress would amend the rule to say systemically important banks rather than bank holding companies,” Konrad said in an interview. “This is part protecting deposits, but also part too-big-to-fail. I don’t think there’s any interest from the investment banks in doing that, and I don’t think it would serve that purpose.” Goldman Sachs Chief Financial Officer David Viniar said Jan. 21, 2010, the same day President Barack Obama announced his support for the Volcker rule, that it was “unrealistic” to imagine the firm won’t be a federally supervised bank. Goldman Sachs and Morgan Stanley made “modest profits” from pure proprietary trading, which is why they willingly shut down those desks, David Trone, an analyst at JMP Securities, said in another note.  He says the rule’s draft indicates regulators won’t interfere with customer flow trading. Goldman Sachs may be hurt by provisions that limit investments in hedge funds and private equity.  Had those restrictions been in place in recent years, they would have cost the firm about $700 million, or 9 percent, of annual earnings, he wrote. Increased regulation and capital rules may mean the largest banks have to split off some “crown jewel” businesses, says Roy Smith, a finance professor at New York University’s Stern School of Business and a former Goldman Sachs partner. “You have to ask which parts of the business are they simply not going to be able to continue to do or maintain the talented people who do it because those guys would have better options if they left the firm and went to a hedge fund,” Smith said. “You don’t want to be left with the third team running your expensive market-making trading desk.” It’s too soon to say whether banks affected by the rule would have to break up to remain competitive and the costs of the proposal are likely to shift some business to smaller players. Companies and investors are likely to push back during the comment period to alter some parts of the rule.  [bloomberg 10/12/11]