Tearing Up the Street

The bear's toll on investment banks and brokerages is devastating

The masters of Wall Street's top five firms pocketed checks for pay and bonuses totaling $154 million last year. It was their reward for the fat earnings their firms racked up on the back of the Nasdaq's rise. But they'll be lucky to see such large chunks of change again.

The long-running bull has metamorphosed into a mean bear. Not only is it savaging their clients' portfolios, but it's also ripping into the Street's once golden stream of revenues, a record $245 billion last year. The number of initial public offerings, which typically earn fat 7% fees, has slumped to just 21 so far this year, down from 85 at the same point in 2000. The volume of mergers plummeted 66%, to $327 billion over the same period. And junk-bond sales--investment banks' latest hope for jump-starting earnings--are sputtering. "The Street is in the process of adjusting to lower revenue expectations," says Amy S. Butte, securities-industry analyst at Bear, Stearns & Co. All told, analysts expect Morgan Stanley Dean Witter (MWD ), Goldman Sachs (GS ), and Lehman Brothers (LEH ) to post combined revenues of $11 billion in the first quarter--less than half the $26 billion they made a year ago, according to Thomson Financial/First Call Corp.

DISMAL. The bear's impact on brokerage house profits and share prices is devastating. The Standard & Poor's brokerage and bank index has fallen 26% this year--twice as much as the S&P 500-stock index. And more damage is on the way. Analysts foresee brokerage earnings plummeting 25% in the first quarter, before ending flat for all of 2001, vs. a 26% rise last year, according to First Call. Yet even such dismal numbers may be way too optimistic. They assume that Wall Street, as in the past, will roar back in the final quarter. "There is clearly more probability at this point that estimates will be declining," says Guy Moszkowski, securities analyst at Salomon Smith Barney.

With such a big fall, the Street's heavy hitters are making a frenzied search for ways to save money. Memos from top management demanding $1 billion packages of cuts are fluttering around executive suites like confetti. Insiders say that J.P. Morgan Chase & Co. (JPM ), for example, plans to sell its headquarters at 60 Wall St. in an effort to wring $2 billion in savings by 2002. Once it moves, no big investment bank will be headquartered on Wall Street any longer.

Fat payrolls are a prime target. Since 1992, securities-industry jobs have soared 72%, to a record 772,200. More than 150,000 workers have been added since early 1998 alone. Paychecks reached new heights, too. The New York Stock Exchange's broker-dealer members racked up record expenses-- much of it for salaries--of $58 billion, on $61.4 billion of revenues in the fourth quarter of 2000. Already, merged giants such as Credit Suisse First Boston and J.P. Morgan Chase, had, with other banks, announced 10,000 layoffs last year. But a second torrent of pink slips is in store. On Mar. 6, Bear Stearns announced 400 layoffs--3.6% of its payroll. Goldman Sachs, Morgan Stanley, and Merrill Lynch (MER ) are all conducting internal reviews and may cut up to 10% of their workforces this year, analysts say. "All of the large firms are probably going to make some announcement," says Frank Fernandez, research director at the Securities Industry Assn.

If market doldrums continue, the number could get much larger. Some headhunters figure 15% of Wall Street's jobs could disappear in several waves of layoffs by yearend. "There is going to be a lot of pain," predicts Alan Johnson, managing director of compensation at consultants Johnson Associates.

Of course, Wall Street has seen markets stumble before, most recently in 1998. Top brass vows to avoid the same mistake made then: firing employees across the board--only to have to hire back the same people at higher salaries once the market rebounded. So this time, financial headhunters expect Wall Street firms to delay layoffs as long as they can. Initially, they will quietly weed out the lowest-producing 5% of employees on their payrolls. But even if Wall Street can avoid the worst, it needs to bring its stratospheric compensation down to earth. "We were hiring kids right out of college who were making $500,000 their first year," says an executive at an investment bank who asks not to be named.

To avoid savage cuts, firms must get growing again. Most say they want to focus on higher-margin, higher-growth businesses. Merrill Lynch & Co., for example, plans to invest in investment banking in Germany, in its global equities business, and in improving fee-based services for its wealthy clients--those with $1 million portfolios. "We want to be more targeted in what we do," says Thomas H. Patrick, Merrill's chief financial officer.

But those efforts alone can't rescue the firm from the current downdraft. Although Patrick is mum on the specifics, he admits that there are "some things we will just stop doing." And analysts remain skeptical: On Mar. 12, after Chairman and CEO David H. Komansky and other top Merrill managers met with analysts, five of the 12 who report to First Call downgraded their earnings estimates. Other analysts are unimpressed by another popular play among investment banks to take advantage of choppy markets to sell more derivative and hedge products.

That's why austerity is increasingly the buzz word on Wall Street. "There are constant reminders to be cost-sensitive," says a financial analyst at a small investment bank. "We're told: `If you can do it on the phone, rather than getting on a plane, do it."' Even outside the office, at locations such as the popular watering hole at 14 Wall St., investment bankers are more stingy. "Corporations are not having as many parties," says General Manager Patrick Barragan. His sales are off 10% to 15%.

"ANOTHER SWING." Investment banks are not the only financial outfits struggling with the moribund market. Asset managers are pulling in their belts after getting hammered--as investors yanked $3.6 billion out of mutual funds in February alone. Commercial banks, too, have announced a litany of cost-cutting measures. And that may just be the tip of the iceberg, says ING Barings bank analyst Andrew B. Collins. "It starts with the capital-market players, and then spreads to the bread-and-butter bankers" as lending weakens, too, he says. Collins predicts Bank of America (BAC ) will "take another swing" at reducing its staff at both its Charlotte (N.C.) headquarters and in California, where the bank has a big presence. Bank of America cut staff twice last year.

But perhaps online brokers may take the biggest hit. On Mar. 14, following layoffs at Ameritrade Inc., Credit Suisse First Boston's online brokerage said it would cut 150 jobs, or 10% of its workforce. "We expect a lot of these firms to lay off people," says Sang Lee, online broker analyst at Celent Communications. So far, E*Trade Group Inc. (EGRP ) insists it has no plans to trim jobs. But analysts believe it will have to slash its $400 million marketing budget to protect its bottom line.

No one is going to get off easy. Many of Wall Street's giants spent the '90s in hot pursuit of a Holy Grail: The ultimate diversified financial engine able to grab on to good times, and steer clear of the bad. Now, there's nowhere to run. Brokers may have to get used to stagnation for a while.

By Emily Thornton, with Heather Timmons and Mara Der Hovanesian, in New York, Ben Elgin in San Mateo, Calif., and Pallavi Gogoi in Chicago

    Before it's here, it's on the Bloomberg Terminal.