Wall Street model broken by credit crisis

By Joseph A. Giannone - Analysis

NEW YORK (Reuters) - The future of Wall Street is up for grabs -- and changing by the minute.

In the course of a few hours Sunday, Lehman Brothers Holdings Inc, the fourth-largest investment bank hobbled by toxic real estate assets, was left for dead and filed for bankruptcy early Monday.

Merrill Lynch, the No. 3 investment bank and weakest remaining firm after $40 billion of write downs, rushed into the arms of Bank of America Corp for $29 a share -- less than half its 52-week high but almost $12 higher than its closing price Friday.

These moves, coming after the U.S. government's takeover of Fannie Mae and Freddie Mac and six months after the meltdown of Bear Stearns and its shotgun marriage to JPMorgan Chase & Co, renew questions of what Wall Street will look like in an environment of lower leverage and reduce appetite for risk.

Now there are questions whether any of the independent firms will still be around. Certainly, for those that survive the current 100-year storm, Wall Street will look a lot different.

"It seems perfectly clear leverage is going down, that banks will be more careful who they do business with, and that there is a desire to be more of an agent than a principal," said Donald Marron, head of private equity firm Lightyear Capital and former CEO of PaineWebber Group.

"There will be a trend toward specialization. It's hard to be in too many different places. Firms will concentrate on their strengths."

After more than 13 months of a global credit crunch, the rules of the marketplace have changed.

Capital is harder to come by and risk must be kept on a shorter leash. The engines that powered record profits for years -- leveraged deal finance, mortgage securities and all kinds of complex debt instruments -- have all seized up.

In recent months, Lehman CEO Dick Fuld and Merrill CEO John Thain had both said they could weather the storm.

Now, recent events show it may be only the largest banks, such as Bank of America and JPMorgan Chase, that have the capital and deposit base to withstand rising flood waters.

SURVIVORS?

Analysts also question whether No. 1 investment bank Goldman Sachs Group, which has avoided major damage so far and earlier this year considered acquiring a commercial bank to reduce reliance on market funding, can confidently stand above the crowd.

Goldman, which releases its third quarter results Tuesday, is widely expected to report lower profit with revenues down across the board.

Morgan Stanley, the second largest, has been busy shedding assets since its brief flirtation with "the Goldman Model" three years ago, which prompted greater principal risk taking just as the market was peaking, and a Lehman-style expansion into the mortgage business.