Monday, September 15, 2008

The end of the broker-dealers?

First it was Bear Stearns that went under, sold at the last moment in a fire-sale deal to JPMorgan Chase back in March.

Then it was Lehman Brothers, who filed for bankruptcy early Monday after unsuccessfully attempting to strike a quick takeover/rescue deal this past weekend.

Now Merrill Lynch has announced it will be taken over by Bank of America in an all stock deal valuing Merrill at $50 billion. The deal was arranged quickly over the weekend, as fears of a possible Lehman failure were starting to spread to other major investment banks.

Bloomberg reports on the "'Tectonic' shift on Wall Street as Lehman Fails, Merrill Sold":

"In the biggest reshaping of the financial industry since the Great Depression, two of Wall Street's most storied firms, Merrill Lynch & Co. and Lehman Brothers Holdings Inc., headed toward extinction.

New York-based Lehman, founded 158 years ago, said early today that it plans to file for Chapter 11 bankruptcy protection after failing to find a buyer. Merrill Lynch, 94 years old and also based in New York, agreed to sell itself to Bank of America Corp. for $50 billion in an emergency deal hashed out yesterday...

...The five New York-based securities firms that dominated Wall Street have been reduced to two: Goldman Sachs Group Inc. and Morgan Stanley. While both firms are scheduled to report a drop in third-quarter earnings this year, their business has remained profitable throughout 2008 -- unlike Lehman and Merrill. "

Interesting to see that Merrill Lynch is being acquired at a nice premium ($29 a share) to its closing price of $17.05 on Friday. Especially when you consider that this deal was quickly cobbled together in what had to be a desperate attempt by Merrill to avoid Lehman's fate.

Marc Faber had a few things to say about that, and other aspects of the Lehman and Merrill news, in this latest Bloomberg interview.

So now that Bear, Lehman, and Merrill have been swallowed up or gone bust, what will become of the remaining "big five" broker-dealers? Is their business model fatally flawed? Will a similar fate befall Goldman Sachs and Morgan Stanley?

Here's what Nouriel Roubini had to say back in July:

"The broker/dealer business model is "inherently unstable" and the four remaining major firms will not be independent in a few years, says Nouriel Roubini, economics professor at NYU's Stern School and chairman of RGE Monitor.Embattled Lehman Brothers is likely to seek a buyer "within months," Roubini says.

Lehman Brothers ceasing to be independent is not such a shocking outcome, but Roubini ultimately sees a similar outcome for Goldman, Merrill Lynch, and Morgan Stanley.The problem, he says, is that broker/dealers use the same model as banks -- borrow short and lend long -- only they borrow on even shorter timeframes, use more leverage, and don't have the kind of government backstop banks enjoy."

We are not rooting for the failure of any of these firms, but it seems this weekend's developments have really shined a light on the remaining independent US investment banks.

As the financial crisis rolls on, and losses from the credit crisis steadily rise, some venerable US financial institutions are now having to face the music as sentiment regarding government-backed bailouts has turned.