Goldman Sachs Group Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS), Wall Street’s last remaining investment banks, are converting to holding companies now that the collapse of The Bear Stearns Cos. Inc. and Lehman Bros. Holdings Inc. (OTC: LEHMQ) have drained clients and investors of any remaining confidence in the companies’ business models.

Both Goldman and Morgan received approval for the transition from the U.S. Federal Reserve Sunday night. The two companies can now offer Federal Deposit Insurance Corp. deposit insurance and gain access to cheaper more stable sources of funding via the Federal Reserve Bank Discount Window and customer deposits.

The trade off is increased regulatory oversight and slimmer profits, but both Morgan and Goldman felt the move was justified by the current market conditions. Bear Stearns and Lehman Bros. collapsed entirely under the weight of subprime defaults and resulting credit crunch, and Merrill Lynch & Co. Inc. (MER) last week was all but forced into a merger with Bank of America Corp. (BAC).

The result was a panic on Wall Street that led investors and clients to abandon even the most secure investment banks.

“There’s blood in the water in the industry and the sharks are circling,” Peter Kovalski, who helps oversee about $10 billion at Alpine Woods Capital Investors LLC told Bloomberg News. “It all comes down to perception and the current trust within the community.”

Goldman Sachs, the largest and most profitable U.S. securities firm, will take its place behind Bank of America, JPMorgan Chase & Co. (JPM), and Citigroup Inc. (C) as the fourth-largest U.S. holding company.

“Goldman Sachs, under Federal Reserve supervision, will be regarded as an even more secure institution with an exceptionally clean balance sheet and a greater diversity of funding sources,” Lloyd Blankfein, the company’s chairman and CEO, said in a statement.

“While accelerated by market sentiment, our decision to be regulated by the Federal Reserve is based on the recognition that such regulation provides its members with full prudential supervision and access to permanent liquidity and funding,” Blankfein added.

Goldman already has $20 billion in customer deposits in two subsidiaries and hopes to boost that amount to $150 billion through the creation of a third - GS Bank USA. Goldman will bolster its deposit base “through acquisitions and organically,” the company said.

Morgan Stanley, formerly the second biggest U.S. securities firm, had $36 billion of deposits and three million retail accounts at the end of August, Bloomberg reported. The company will also convert its Morgan Stanley Investment Bank, an industrial bank based in Utah, into a national bank.

“This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position,” said company Chairman and Chief Executive Officer John Mack. “It also offers the marketplace certainty about the strength of our financial position and our access to funding.”

Of course, Morgan Stanley’s new structure also means the company will have to reevaluate its partnerships going forward.

“This means Morgan Stanley is reassessing its plan for a merger with [Wachovia Corp. (WB)],” Tony Plath, a finance professor at the University of North Carolina. “Morgan Stanley is going to try to go it alone, and I expect it will try to buy a bank with a market-to-book ratio that is next to nothing. It means they are walking away from Wachovia.”

Also, Mitusbishi UFJ Financial Group Inc. (ADR: MTU) yesterday (Monday) agreed to purchase a 10%-20% stake in Morgan Stanley for about $8.4 billion. MUFJ Chairman Ryosuke Tamakoshi said that his company would start due diligence on the stake before settling on a price, after last week saying he would shy away from making any immediate investment in U.S. banks.

“The purpose of the investment is to strengthen the investment banking business globally,” Hirokazu Ushio, a spokesman at Mitsubishi UFJ told Bloomberg.

A 20% stake would make Mitsubishi UFJ Morgan Stanley’s largest shareholder, which means a company representative will be appointed to the bank’s board.

Source: Goldman Sachs, Morgan Stanley Seek Fresh Start as Holding Companies