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Wall St. movers feeling a pinch

As investment houses' stocks are hit by mounting debt woes, many fear that the good times may be over.

August 08, 2007|Walter Hamilton | Times Staff Writer

NEW YORK — Until a few weeks ago, life on Wall Street was as good as it gets, with a nearly 5-year-old bull market, takeover deals galore, record profits and jaw-dropping bonuses. America's financial princes once again lived up to their image as Masters of the Universe.

But after a market upheaval that has hit like a bad case of whiplash, the fear on the Street is that the good times are coming to an abrupt halt.

Many of the premier names in the Big Apple's financial core are on the defensive as their own stocks have tumbled by as much as a third on the expectation that their revenues and profits could sink. Some of these firms have been stuck with billions of dollars in risky debt used to finance corporate buyouts because investors have been unwilling to assume the loans.

And if Wall Street hoped the Federal Reserve would come to its rescue by cutting interest rates, the central bank Tuesday gave no sign it was entertaining such a move -- even if it would also benefit anyone with a recently shrinking 401(k) account.

"The next 12 to 18 months on Wall Street could be an extremely trying period," said Richard Bove, an analyst at Punk, Ziegel & Co.

The reversal of fortune stems from the meltdown in the market for sub-prime mortgages -- home loans taken out by people with poor credit. During the housing boom, Wall Street firms made huge sums by buying pools of home loans, in effect turning them into bonds and selling them to big investors.

But with home prices now falling and mortgage delinquencies soaring, the demand for such securities has fallen off a cliff, drying up funding for sub-prime lenders and even some mortgage firms that hadn't touched the sub-prime sector. That has sparked a crisis of confidence in the corporate-bond market, ending an era of easy money that fueled Wall Street's fortunes.

Investors, rattled by fears of potentially broad economic damage and no longer able to count on a wave of easily financed corporate takeovers to pump up share prices, have yanked the stock market down from its record highs of less than three weeks ago.

No firm has been harder hit than Bear Stearns Cos.

Founded in 1923, the company had a reputation for being able to control the risks it took, especially in its specialty of trading mortgage-backed securities and other bonds. But it may have taken on too much risk when it created a unit to manage hedge funds, lightly regulated investment pools of money raised from institutional investors and rich individuals.

Two such funds, which borrowed billions of dollars to buy securities backed by sub-prime mortgages, collapsed last month. A co-president of Bear Stearns became the highest-level casualty of the unfolding sub-prime fiasco when he was forced out of his job last week. Bear Stearns shares are down 32% from their January peak.

The stocks of other big Wall Street firms are also down sharply from their highs this year. Lehman Bros. has fallen 29%, Citigroup is down 14% and Goldman Sachs Group is off 18%.

The standstill in the bond market has threatened to derail a boom in private equity, a field in which investment firms use mostly borrowed money to buy companies with the hope of profiting by cashing out years later. Many firms have had to rework their planned financing and pay higher interest rates to complete deals. The number of companies able to sell junk bonds, many of which are used to pay for buyouts, plunged into the single digits in July from about 40 in June.

Shares of private equity giant Blackstone Group, which sold a stake to investors in June, have plummeted 20% since the initial public offering.

Private equity firms have been known to make their money in part by chopping payrolls of companies they acquire, so for workers fewer buyouts may not be such a bad thing. On the other hand, private equity investors have stepped in to keep some struggling companies afloat. So a drop in buyouts also could threaten some workers' jobs.

Firms that manage hedge funds could also face a contraction stemming from the sub-prime woes. Like the two Bear Stearns funds, many are likely to have suffered losses on mortgage-backed debt. In some cases, the losses have been big enough to lead investors to demand their money back, prompting some funds to bar all such withdrawals. That could make investors think twice about keeping money in any hedge fund, as could the elevated level of market uncertainty.

The financial industry has endured many a bust following a boom, but today's looming troubles stand out because Wall Street was doing so well and the reversal was so quick.

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