Investment banks and brokerage firms rallied magnificently to get going again. Now comes the hard part - finding some business to do
By Jenny Anderson and Hal Lux
October 2001
Institutional Investor Magazine
On September 10 Lehman Brothers inaugerated a new, $35 million equity trading floor. The next day it was forced to flee. It will be many months before Lehman can return to the trading room and the rest of its heavily damaged World Financial Center headquarters, just across from where the World Trade Center stood. The firm’s traders are working out of a packed Jersey City, New Jersey, disaster recovery center; its investment bankers have taken over a midtown Manhattan hotel.
In the grand scheme of things, Lehman can count its blessings. The investment bank, which had 600 employees in One World Trade Center, lost only one in the terrorist attack.
Still, Lehman had to scramble to avoid a business catastrophe. Minutes after a second hijacked plane smashed into the World Trade Center, senior Lehman executives made a mad dash for what proved to be one of the last ferries crossing the Hudson River to Jersey City. Executives struggled to locate employees and find 1.2 million square feet of office space. But two days later, when the bond markets reopened, Lehman was up and trading on a makeshift floor, in Jersey City, with names of employees and departments scrawled on white copy machine paper and taped to walls. “It was a Herculean effort by everybody,” says Lehman chief financial officer David Goldfarb.
In small ways and large, Wall Streeters displayed remarkable, grim determination and no small amount of ingenuity - and altruism - in getting back into business after the September 11 disaster. Brokerage firms restarted the world’s biggest capital and trading markets on the fly - from disaster recovery sites, hotel rooms and home offices often using cell phones and BlackBerry wireless messaging devices.
With surface and rail transportation curtailed, Goldman, Sachs & Co. hired ferries to deliver critical employees to its 85 Broad Street headquarters. Salomon Smith Barney employees, forced to evacuate their Wall Street buildings at 388 and 390 Greenwich Street, stood on the West Side Highway swapping emergency telephone numbers as fire raged in the twin towers. (The firm’s extensive contingency plans provided for an empty building as a backup trading site in East Rutherford, New Jersey, and another disaster recovery area in Midtown.) And in a borrowed mid-Manhattan conference room whose walls were posted with attendance lists for funerals, Sandler O’Neill & Partners’ remaining bankers resolutely worked on Securities and Exchange Commission filings for upcoming deals.
Unfortunately, having responded so resolutely to the World Trade Center catastrophe, Wall Street faces another crisis that could prove to be even more economically devastating: a virtual depression in financial services worldwide that makes the Street’s indefinite future look as bleak as it has in decades. Even before the attack, investment banks and brokerage firms were mired in an industrywide slump. The terrorist attacks, by worsening the economic slowdown in the U.S., Europe and Asia and provoking uncertainty among corporations, threaten to create the most difficult business environment since 1973.
“It will take months for business to return to normalcy,” says Lehman investment banking chief Bradley Jack, who spent the 70 hours following the attack driving from San Francisco to New York aboard a chartered bus. “The hardest part is that our clients are trying to decide what to do now, and there’s less business.”
As of the middle of September, U.S. equity underwriting was off by more than one third from the previous year, and merger activity had plunged by more than half, according to Thomson Financial Securities Data. Not one initial public offering came to market in September, the first time that has happened in any month since 1975. “It’s a lot like 1973-1975,” says Peter Solomon, a former Lehman Brothers partner who now runs his own banking boutique. “There are not many people on Wall Street who remember it, but that was a very bleak period of time. There was no business. There is going to be only de minimus business for the next three months. Firms have to get their costs down. I think at year-end you’ll see huge layoffs.”
Major firms that tacitly imposed a humanitarian, and public relations, moratorium on layoffs in the immediate aftermath of the disaster are going to have to start cutting staff again. Soon. “Everyone is dancing around the issue because of the perceived insensitivity,” says Guy Moszkowski, a financial services industry analyst with Salomon Smith Barney. “But what happened last week exacerbates the situation. All the firms will have to face the issue.”
Indeed, by the first week of October, Morgan Stanley was reportedly preparing to fire as many as 200 investment bankers, or 10 percent of its banking staff. Rumors were rife that Goldman Sachs, J.P. Morgan Chase & Co., Merrill Lynch & Co. and other large investment banks would join in a new round of cutting.
A Morgan Stanley spokeswoman declined to comment on “rumors.” A Goldman Sachs spokeswoman said overall head count at the firm would remain flat from the level at year-end 2000. At Merrill Lynch, a spokeswoman allowed that there could be staff reductions, depending on business conditions. J.P. Morgan Chase laid off 5,000 employees as a result of its September 2000 merger and could cut up to another 5,000 because of the state of the markets.
“I’ve been in the business since 1968, and I have not seen anything like it,” says Lon Gorman, head of Charles Schwab Corp.'s trading and capital markets division. “We’re dealing with the worst crisis in modern American history on top of the worst bear market in 30 years.”
The terrorist attack produced an extraordinary display of unity and altruism along Wall Street, as firms, literally, opened their doors to accommodate rivals that lost space - and employees - in the attack. Citigroup CEO Sanford Weill made 450,000 square feet of midtown office space available to Lehman; the New York Stock Exchange took in the equity trading floor of its once bitter rival, the American Stock Exchange, which had been knocked out by the attack.
But the prevailing mood of goodwill generated by the disaster within and among firms is going to be tested fast. Inside the firms investment bankers stand to suffer the most. Following years of record underwriting volume and deal activity, firms have acquired bloated staffs of bankers who have become used to being paid sums that would have been seemed preposterous, even on Wall Street, just five years ago. Until recently, second-year technology banking associates were commanding as much as $400,000 per year. And that’s not to mention a load of expensive perks intended - originally - to keep young bankers from jumping to dot-com start-ups.
Making matters worse for many banks, most conspicuously Credit Suisse First Boston, they had handed out guaranteed multiyear pay packages to scores of professionals during the boom times. Now new CSFB CEO John Mack is trying to coax and cajole these gilt-edged employees into relinquishing those generous pay contracts out of a sense of loyalty to the firm.
Wall Street’s weakened condition was brought home on September 21, when Morgan Stanley announced a 41 percent drop in third-quarter earnings, its worst three months since the Russian default crisis and the blowup of Long-Term Capital Management in 1998. The firm’s businesses suffered across the board: M&A advisory fees plunged 30 percent; underwriting, 34 percent; and institutional sales and trades, 8 percent. Lehman and Bear, Stearns & Co. had similarly grim tidings: Both saw earnings decline more than 25 percent for the quarter.
The rest of Wall Street is feeling the same squeeze on margins. And the prospects for a quick recovery are not good. “I don’t know anyone who’s predicting a dramatic pickup in investment banking activity anytime soon,” says Salomon Smith Barney CEO Michael Carpenter. The best evidence that brokerage executives can offer for a quick recovery is the resiliency of the U.S. economy.
“This is very emotional because it’s the community around us,” says Merrill Lynch retail chief James Gorman. “But look back in time - World War II, the assassination of Kennedy, the impeachment of Nixon, the Cuban missile crisis, the Gulf War. It is a fact that the U.S. economy has rebounded in the year following all of these events.”
Adding to the misery, for now, many firms are being forced to write off much or all of the large principal investments they made in technology and telecommunications companies during the Internet-bubble days. J.P. Morgan Chase wrote off $1 billion in private merchant banking investment for the second quarter, Goldman Sachs wrote off $445 million in venture capital investments in late September, and Morgan Stanley posted a $58 million loss on principal investments in its latest quarter, compared with a positive return of $55 million for the same quarter last year.
Retail businesses, from discount brokerage to Nasdaq market making, are in no position to pick up the slack from investment banking. Discount brokers Schwab and Ameritrade have reduced their already flaccid earnings projections because of the four-day stock market shutdown. And although trading activity was brisk in the week after the New York Stock Exchange reopened - largely because of near-panic selling - it’s not expected to stay at that level.
“Retail investors are likely to pull back from the market,” says Morgan Stanley analyst Henry McVey. Instead of buying stocks, they will park their money in government securities or bank deposits. Equity market making firms such as Knight Trading Group and Herzog Heine Geduld (now owned by Merrill Lynch), as well as Schwab and Ameritrade, would be among the firms to suffer most from investors’ disenchantment with stocks.
Nor will getting back into business be cheap for Wall Street firms. The cost of the collapse of the twin towers and the collateral damage to nearby buildings has been calculated at $40 billion. Everything from computer servers to oriental carpets was destroyed. Firms had to set up duplicate trading floors literally overnight and scramble to beef up security and expand their contingency plans. Morgan Stanley, which had occupied 22 floors in Two World Trade Center, estimated in late September that, counting relocation costs, property damage and business-interruption costs, it sustained $150 million of damage.
Merrill Lynch is facing the prospect of being out of its building in the World Financial Center until the end of the year. Lehman, which rented the entire 650-room Sheraton Manhattan for emergency office space, is facing an even more protracted displacement. Insurance should cover most of the firms’ expenses, assuming of course that insurance companies can meet the staggering claims arising from the World Trade Center disaster.
To be sure, harsh as it sounds, tragedy invariably means opportunity. The derivatives business should enjoy increased earnings from a spike in volatility and companies’ urgent desire to hedge their risks amid economic uncertainty. The Federal Reserve Board’s interest rate cuts and an attractive yield curve will likely result in a rise in short-term financing activity. Indeed, the bond business, which has enjoyed a banner year thanks to Fed rate cuts, seems likely to benefit for some time.
Equity trading and market making will receive at least a temporary boost from surging trading volumes as well as volatility. “Not that anyone would have wished it,” says Lehman analyst Mark Constant, “but volatility and volume are way up. This zero-revenue picture that some people now have about the investment banking industry is not accurate.”
The memories of suffering and heroism in the World Trade Center disaster won’t soon fade. “Don’t underestimate the emotional impact it’s had on many people,” says Salomon CEO Carpenter. “A lot of people in this building saw everything.” But Wall Street being Wall Street, the spirit of altruism will wane, and firms will begin competing as fiercely as ever, or more so, amid continuing upheaval and punishing markets. “It could be a great opportunity for some firms to pick up market share,” says Morgan Stanley’s McVey, referring to the business slump.
Before the attack, Wall Street was fixated on the growing inroads commercial banks were making into investment banking. Citi’s balance sheet ballooned by $50 billion in the week after the attack as corporate clients leaned on the bank’s massive credit capacity. It was, in many respects, a persuasive demonstration of the case for Citi’s business model of combining lending capacity with investment banking abilities. “That’s having the ability to step up for companies in a crisis,” says Carpenter. “In this environment we we were not thinking about pitching advisory work.” But after the crisis passes, those same clients may well feel favorably disposed to discuss deals with Salomon’s investment bankers.
