That Wall Street is transforming quickly goes without saying. How will it morph? Here's an idea from Barron's Michael Santoli:
The upshot is a massive capacity reduction in Wall Street. That won't matter for a while, until the business stabilizes, and returns may never get back to, say, 2006 levels. But before long, the brass at Goldman, Morgan and at a handful of smaller brokerage shops might allow themselves a smile at what the chaos has wrought.How to verify such a hypothesis? Look for the professional trajectory of the biggest yesteryear names in investment banking! They either join the Blackstones of the world or go into early retirement. Indeed, can you see these guys working for/under the management of some commercial bank?
Related to this, the wrenching markets are setting up an endgame for this phase of the hedge-fund boom, which will lead to a painful shakeout (1,000 funds closing?). It turns out -- Guess what? -- that there's not nearly enough "absolute return" to go around to drive incentive fees on a trillion bucks in assets when markets are weak. Everyone has the same software, and the easy trades get crowded an hour after they're discovered.
This will allow the largest elite hedge-fund shops to consolidate and continue morphing into fuller institutions -- true counterweights to the Street.
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"The independent investment banks -- Morgan Stanley and Goldman Sachs -- can survive and they must survive," says Byron Wien, chief investment strategist at Pequot Capital Management in New York and a former Morgan Stanley strategist. "Their survival is critical to New York as a financial center and to the health of the entire financial system. The culture of an investment bank is different from that of a commercial bank. I want to see the investment-bank culture preserved."
Wien notes that mergers involving investment and commercial banks generally haven't worked well, including Credit Suisse's tie-up with Donaldson Lufkin & Jenrette, and the integration of Salomon Brothers and Smith Barney into the unwieldy financial conglomerate that is Citigroup (C).
BOUTIQUE INVESTMENT BANKS like Greenhill (GHL) and Lazard (LAZ) have been in vogue lately as investors shun capital-intensive companies like Morgan Stanley in favor of pure advice givers. Shares of both companies look rich with Greenhill, at 78.25, trading for 25 times projected 2008 profits and Lazard, at 43.25, trading for 23 times estimated 2008 earnings. It's hard to square these stock prices with the sharply reduced merger and acquisition activity and overall deal flow in the market.
Moody's (MCO) share price, at 37, is half its 2007 peak, but the credit-rating company looks expensive trading for almost 20 times estimated 2008 profits. The company doesn't expect a recovery until 2009. Moody's long had a loyal investment base which viewed the company as a toll taker benefiting from higher bond issuance. With the formerly lucrative structured-products market dead, Moody's faces challenges. It and other credit-rating agencies need to restore their credibility after the mortgage meltdown.
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