Feb. 11 (Bloomberg) -- Less than a decade after Wall Street's last major partnership went public, stockholders are paying the price for bankrolling the industry's expanding risk appetite.

Four of the five biggest U.S. securities firms lost about $83 billion of market value last year, almost 90 percent of their net income since 1999, data compiled by Bloomberg show. That cut the annual average return for Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. during those nine years to 9.7 percent from 16.8 percent.

The private partnerships that once dominated Wall Street guarded their capital, used less leverage and limited their risk to trading blocks of stock for clients and shares of companies in mergers, said Roy Smith, a finance professor at New York University's Stern School of Business and a former partner at Goldman Sachs Group Inc. Since raising money from the public, many of the biggest firms have abandoned that caution.

``If you're betting with other peoples' money, you're more willing to take risk than if it's your own,'' said Anson Beard, 71, who retired from Morgan Stanley in 1994 after 17 years at the New York-based company, where he ran the equities division and helped with the initial public offering in 1986. ``You think differently if you're paid in cash and not in ownership. It's heads you win, tails you don't lose.''

Shareholders, stung by the securities industry's losses last year on subprime mortgage-backed bonds and leveraged loans, may be in for more pain.

Shrinking Fees

Morgan Stanley, Merrill, Lehman and Bear Stearns have lost between 3 percent and 19 percent of their value this year in New York Stock Exchange trading on concern that they may be forced to take more writedowns if bond insurers like MBIA Inc. and Ambac Financial Group Inc. are stripped of their top credit ratings. Revenue from structured credit and leveraged finance has dropped and demand for takeover advice and underwriting may dwindle as the U.S. economy slows, analysts say.

Even Goldman has faltered. New York-based Goldman, which went public in May 1999, evaded last year's market losses and reaped record earnings. This year, the biggest and most profitable securities firm has lost 13 percent in NYSE trading, while analysts predict earnings will drop as equity stakes in companies such as Beijing-based Industrial & Commercial Bank of China Ltd. lose value and investment-banking fees decline.

Merrill, which went public in 1971, outperformed the Standard & Poor's 500 Index in just five of the past 10 years. The largest U.S. brokerage paid more to employees last year than it collected in revenue. Morgan Stanley, public since 1986, beat the index in four of the past 10 years. Both New York-based companies diluted investors' stock last year when they sold stakes to foreign governments to shore up capital.

Other People's Money

``Shareholders share in the downside and not necessarily in the upside, that's the whole story,'' said John Gutfreund, 78, who ran Salomon Brothers in the 1980s when it was renowned for the size of its trading bets. ``It's OPM: Other People's Money.''

To be sure, the firms have been good investments over a longer period. Merrill rose at an average annual rate of 14.7 percent, including dividends, from 1980 through the end of 2007, according to data compiled by Bloomberg. Bear Stearns returned an average 15.2 percent since the end of 1985 and Lehman's average annual gain was 25.5 percent since it became a separately listed company at the end of 1994.

While none of the companies are more than one-third owned by employees today, senior executives typically receive at least half their pay in shares. At Merrill, top managers get 60 percent of their compensation in stock; they're required to keep three quarters of it each year and are prohibited from hedging it, according to the brokerage's proxy statement.

Cash Bonuses

James E. ``Jimmy'' Cayne, who stepped down as Bear Stearns's chief executive officer last month after the firm reported its first quarterly loss, is the company's fourth- biggest shareholder, according to Bloomberg data. The value of his 5.7 million shares has dropped to about $460 million from $971 million at their peak in January 2007.

Cushioning the blow are the millions in cash bonuses that Cayne and other Wall Street executives took home during the profitable years. While he forfeited a 2007 bonus, Cayne collected almost $40 million in cash payouts in the prior three years on top of salary, stock options and restricted shares, according to company filings.

``The employees and executives at Bear Stearns own a significant portion of the firm; as such our interests are closely aligned with outside shareholders,'' company spokesman Russell Sherman said. ``We are intensely focused on delivering value to our shareholder base''

No Refunds

Spokespeople for Goldman, Morgan Stanley, Lehman and Merrill declined to comment. Merrill is a passive, minority investor in Bloomberg LP, the parent of Bloomberg News.

``We're essentially running all these investment banks and even the large universal banks on the same basis as if they were hedge funds,'' said Smith, the NYU finance professor. Executives ``make big gains on any gains in the firm's income, whereas they're not exposed, they don't have to pay it back in the loss.''

Going public allowed partners to take home some of the money they'd locked up in their companies. It also provided funds to expand internationally and enter new, riskier businesses like derivatives and leveraged finance.

``The firms had to go public because to do these businesses you need so much balance sheet,'' Beard said. ``When the firms were private partnerships, you had to worry about how you were going to replace the capital'' when a partner retired. ``After we went public, we upped the cash compensation dramatically.''

Bigger Borrowers

The businesses exploded in size. Goldman had 50 partners in 1973, 75 partners in 1983 and 150 a decade later, according to Lisa Endlich's 1999 book ``Goldman Sachs: The Culture of Success.'' As of Dec. 17, partners and managing directors numbered more than 1,700, according to the bank's Web site.

The companies also borrowed more. Goldman's leverage ratio, which measures assets relative to equity, was 26.2 times at the end of November, up from 17.1 times in November 2001, regulatory reports show. At Morgan Stanley, the ratio jumped to 32.6 from 23.6 in 2001.

For most of the past decade, the securities industry has been churning out profits, fueled by low interest rates, economic growth, expansion into fast-growing countries like China, and the explosion of derivatives markets. Goldman's pretax earnings surged to $14.6 billion in 2007 from $3 billion in 1997 as its balance sheet grew to more than $1 trillion.

Record Defaults

``These firms are vastly bigger than they were, they're not privately owned partnerships any more that are filled with people worried about getting their own money back,'' said Smith, the former Goldman partner. ``They're in everything, everywhere in very large quantities.''

Last year demonstrated the pitfalls. The business of packaging home loans into securities soured when declining U.S. house prices triggered mortgage defaults and foreclosures rose to the highest level in 28 years, according to data compiled by the Mortgage Bankers Association in Washington.

Morgan Stanley, Merrill, Lehman and Bear Stearns wrote down a combined $38 billion of bad debt in 2007 -- more than the four firms' $30 billion of revenue from fixed-income trading in 2006. The writedowns ranged from $24.5 billion at Merrill to $1.5 billion at Lehman. Only Goldman profited by positioning itself to make money on the decline in subprime mortgages.

Pass the Check

Merrill's then-CEO, Stan O'Neal, was forced out in October after the company reported a third-quarter loss that was six times what it had forecast less than two months earlier. Rather than fire him, the board allowed him to retire so he could keep $161.5 million in restricted stock and options he'd been awarded during his tenure. In the prior two years, he'd also received $32.6 million in cash bonuses.

``There are no partners of Merrill Lynch, there are employees,'' said Peter Solomon, a former Lehman executive who's now chairman of New York-based investment bank Peter J. Solomon Co. ``So they don't share in the losses and gains the way they should, they are able to shed those on to shareholders.''

John Mack, Morgan Stanley's chairman and chief executive officer, reported the first quarterly loss in the firm's history as a public company on Dec. 19. He sold about 10 percent of the bank to state-controlled China Investment Corp. for $5 billion to help replenish capital.

`Casino Operators'

Mack, 63, who had presided over a strategy of taking bigger trading risks since he returned to Morgan Stanley in 2005, said wrong-way bets on mortgage-related securities yielded the ``embarrassing'' loss.

``I'm going to be and this firm is going to be much more cautious in some of these larger bets,'' Mack said on the Dec. 19 conference call with analysts. ``We have been sprinting and I think we are going to be jogging right now for a while.''

Mack, like Cayne at Bear Stearns, forfeited his annual bonus for 2007 and has seen the value of his stock, including $40 million of restricted shares awarded in 2006, drop about 40 percent in value since its peak in June. Unlike Cayne and O'Neal, Mack didn't take any cash bonus for 2006.

``The partners at Lehman Brothers and the partners at Goldman Sachs and the partners at Morgan Stanley didn't take risk that was disproportionate to their resources, and when they did, they paid the consequences so they tried not to,'' Solomon said. These days, ``shareholders and the customers are the people who are financing these guys. They're financing casino operators.''

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

Last Updated: February 10, 2008 19:07 EST