Wall Street model broken by credit crisis

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

A trader works on the floor of the New York Stock Exchange, September 24, 2007. REUTERS/Brendan McDermid

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 may file for bankruptcy before 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.


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.

Since suffering massive mortgage trading losses late last year, Morgan Stanley has been shrinking the balance sheet and pulled in its horns. When Morgan reports results on Wednesday, investors will decide whether they have come down far enough.

“There is a new way coming, but the old way is gone,” said Robert Doll, chief investment officer at BlackRock Inc. “I think parts of the old model have been destroyed, or at least cyclically challenged. We’ll have to figure it out when the dust settles.”

Investors meanwhile have already seen the future of Wall Street in the form of small boutique advisory firms such as Lazard and Greenhill & Co. These smaller firms do not engage in trading or lending but rather focus on advice, much like the way Wall Street’s big investment banks operated until the 1980s.

Having avoided credit losses or having assets mired on their balance sheets, listed and closely held boutiques are gaining advisory-business market share and snagging top-tier bankers now available amid the turmoil.

In a world where capital is constrained and relationships again paramount, their old school model suddenly looks very attractive to bankers and clients.

“I think we’re going to see boutique firms growing in importance, the Greenhill type M&A firms as well as hedge funds that specialize in human capital-intensive trading,” said Bill Wilhelm, a finance professor at University of Virginia’s McIntire School. “We see dominating those firms with the view there are limits to what they can do.”

Additional reporting by Jennifer Ablan