How Will Wall Street Make Money?

It’s been 24 hours and some of the dust has settled. Given the fate of one of the world’s largest investment banks, I think the market held up very well. In fact, I would give Bernanke and Paulson a high five if I saw them in person for what they orchestrated this weekend. By cutting the discount rate on Sunday evening and offering a six-month lending facility to both commercial banks and investment banks (otherwise known as primary dealers), they truly put a floor under the major banks and broker dealers. The stocks may not have reacted that way in trading yesterday,y but part of their underperformance yesterday was due to the ongoing fear about further writedowns and earnings. Goldman Sachs (GS) and Lehman (LEH) report today. Morgan Stanley (MS) reports tomorrow. Expectations on all accounts are not good. The one to watch will be GS. They have been the gold standard. Any cracks in their numbers and the market could get rocked.

 
As I’ve mentioned in past blogs or as you can see on my bio, I worked on Wall Street for eight years at Goldman Sachs and Morgan Stanley in their equities divisions. We made money by taking on risk. The commission rates today are a fraction of what they were 10 years ago because the execution business is now almost entirely electronic. Many on the buy-side (mutual or hedge funds) can do their own trading and many on the sell-side (investment banks) already have intricate technological systems and algorithms in place.

 
If there is one take away from Bear Stearns, it is that leverage and risk are a dangerous game! Where will Wall Street make its money in the future? Without risk and leverage, I don’t see how banks can. Believe me, there will be layoffs everywhere. There will be cost cutting initiatives. VAR (Value at Risk), a measurement many on Wall Street use to make sure that risk levels are in place and properly hedged will be scrutinized. Boards will want to know which divisions have more risk than others. Complex derivatives and securities will change and transparency with the customer will be crucial. So you tell me: How will Wall Street make money for the next couple of years?