Morgan Stanley emerged in 1935 out of a global financial disaster, as one of Wall Street's leading firms. In a rare shred of consistency in the United States' turbulent markets, history has repeated itself. But it was a close call.
An ill-timed infatuation with debt ahead of the 2007-2008 financial crisis threatened to add it to the industry's towering funeral pyre, which consumed all its big competitors with the exception of Goldman Sachs.
Of the two, Morgan Stanley came out of the crisis the more tarnished, less for what it did than for what it was: less profitable; less connected, through its former employees, to political power; and less respected for having evaded disaster.
But after the release of financial results from the fourth quarter of 2017, Morgan Stanley's valuation has surpassed Goldman Sachs. This reflects not only the improvement in its profitability but also investors' greater confidence in how it is managed.
Goldman, with some justice, finds the comparison unfair.
The two firms make roughly equivalent returns and each is top dog in global league tables for segments of the capital markets. Goldman might easily reclaim its edge in the next quarter. But its approach has a growing legion of doubters.
Fixed-income, currencies and commodities, the mysterious profit center from which its chief executive, Lloyd Blankfein, graduated, has had a rough stretch that reflects more than bad luck. Its newest growth initiative — to profit from small clients that it ignored in the past — has yet to prove itself more than an interesting idea.
The rise of sobriety
The rising esteem for Morgan Stanley came grudgingly at first, and then fast. The firm and its chief executive, James Gorman, are seen as having attributes common in many businesses but oddly rare on Wall Street: a long-term vision; a plan to execute it; and a record of bringing it to life. All the more unusual, these attributes omit the defining trait of the historically successful investment bank — wild, euphoric, glorious years of profit (often then paid out to staff and lost in subsequent busts).
Since the financial crisis, Morgan Stanley's results have improved steadily, albeit only to their current level of barely adequate. Its return on equity in the recently completed year (adjusting for the oddities of the United States' recent tax reform) is 9.4 percent, not quite up to that of a run-of-the-mill utility.
Gorman's new targets are for 10 to 13 percent, somewhat closer to the overall market average.
On a recent conference call a financial analyst asked him why the target was not higher. After all, Morgan Stanley will enjoy a big boost from the tax overhaul, which will cut its tax rate from over 30 percent to the mid-20s.
Gorman demurred, stressing that the firm would only project returns it felt were feasible even if conditions become rough. To aim higher — and in particular to replicate the pre-crisis returns on equity of more than 20 percent — would mean "doing something you don't want us to do."
Some of this coyness stems from Wall Street's new arithmetic. Since 2006, Morgan Stanley's capital has grown from $35 billion to $77 billion and it has slashed its debt: that has eaten into returns on equity.
Capital requirements may fall a bit as regulatory models are tweaked — Morgan Stanley has been especially affected by some of their quirks — but the permissive mood of the past is unlikely soon to return. Often, when a chief executive explains barriers to profitability, a company's share price sinks.
Gorman's comments had the opposite effect. Sobriety is in vogue.
A different approach
Underlying the results are large changes to the firm.
Pay as a share of investment-banking revenue has dropped from a peak of 78 percent in 2008 to 35 percent. Investment banking itself is less important these days, accounting for about half the overall business.
In contrast, the firm's wealth-management income has grown sharply since the crisis, and has become even more central to its operations since it bought into Citigroup's wealth-management business in 2009. Controversial then, the move appeared foolish a year later when the process of integration faltered. It is now cited as an obvious and unrepeatable opportunity.
Revenues and profits have grown quickly. Margins, Gorman said, had reached levels only ever achieved by a broker in 1999 during the dot-com bubble (by Smith Barney, whose remnants were picked up in the Citi acquisition). That, he suggested, might mean they were peaking.
