The Shrinking of Fat City

By John Greenwald

The rumors mounted by the hour as Wall Street lunged and lurched through its wildest week. Many of the country's biggest brokerage firms and investment houses were said to be in trouble, even sinking: E.F. Hutton; Merrill Lynch; First Boston; Goldman, Sachs. Speculation swirled so briskly around Hutton that President Robert Rittereiser had to assure employees that the firm's financial resources were "strong and fully adequate." Though similar reassurances echoed up and down Wall Street, they left many doubts. As the stock-trading chaos continued, what would happen to the $50 billion American securities industry?

One Wall Street response was to turn to Madison Avenue. Sober television commercials popped up between World Series innings to reassure investors that their money was safe, and full-page ads appeared in major newspapers. Declared Prudential-Bache in large black type: "Now, especially now, you need an investment firm that is rock solid." That, of course, is exactly what Prudential claimed to be. Shearson Lehman implored readers to "talk with us" because "we share the concerns of every serious investor." Admonished Merrill Lynch: "The worst thing to do right now would be to sell at distressed prices."

While the brokerages tried to talk up investor confidence, the extent of the damage they had sustained was not known. The financial impact of Black Monday was delayed by a New York Stock Exchange rule that allows five working days to pass before traded securities must be paid for. But the 15 biggest U.S. firms clearly had taken huge losses -- by one estimate, anywhere from $50 million to $250 million each -- as they were caught with immense inventories of stocks that they could not sell. For those behemoths, with more than $20 billion in total capital, the bloodletting was serious but not fatal. For at least half a dozen small brokerages, however, the selling pressure was too much to withstand. Some agreed to be swallowed by larger firms to avoid bankruptcy court. Predicted Edward Altman, professor of finance at New York University: "There will be more blood on the Street before this is all over."

Even before Black Monday struck, there were signs that Wall Street's five- year stay in Fat City was ending. Profits were shrinking: during the second quarter of 1987, U.S. brokerages generated $553 million in pretax income, in contrast to $2 billion in the first three months of the year. Retrenchment of some kind was already in the cards. Last week's crash guaranteed that it will be harsher than was previously expected.

There is plenty of shrinking to do, since during the long bull market U.S. securities firms simply grew and grew. Employment in the nationwide industry rose from 273,900 in 1982 to 450,600 last August. Wall Street jobs, which account for one out of every three U.S. securities positions, grew 57% in that time, to 157,000.

But in the month before Black Monday, some 1,100 Wall Streeters, including many with salaries in the six-figure range, suddenly lost their jobs. In a startling move that rocked the financial community, prestigious Salomon Brothers announced it would stop trading municipal bonds, and 800 employees were told to clean out their desks. Kidder Peabody followed suit by letting 100 bond traders go. Said Samuel Ehrenhalt, New York regional commissioner for the Bureau of Labor Statistics: "What happened at Salomon is a portent of things to come."

What had happened was, in a word, overexpansion. "We grew much too rapidly," concedes Robert Salomon, a managing director of the firm. Salomon's staff jumped 40% as the company added 2,300 people in the past twelve months. The rapid buildup helped entrench Salomon as the leading municipal-bond trader just as rising competition caused profits in that area to fall. Other big firms were suffering too. Merrill Lynch lost $275 million last spring when a slump in bond trading left the company with a mountain of unsold inventory. The price collapse gave Merrill Lynch a $145 million loss for the second quarter. First Boston admitted to losses of $100 million.

The booming mergers-and-acquisition field, focus of so much stock-market frenzy in the '80s, was also slipping into trouble. Last year the largest securities firms made an estimated third of their profits by financing merger mania. Butinterest-rate hikes and proposed anti-takeover legislation in Congress hobbled the pace of takeovers. Fearing a sharp fall in business, many houses were considering staff cutbacks. Among them: E.F. Hutton, First Boston and Prudential-Bache.

Last week's crash deepened the investment firms' concern by forcing corporate raiders to halt attacks on major takeover targets like Dayton Hudson and Gillette. The stock of such companies was suddenly worth far less than the raiders were offering. But at the same time, the drop in prices raised the possibility that takeover artists might spot new target shares that are now a bargain. Wheeler-dealers like T. Boone Pickens, Carl Icahn and Irwin Jacobs were said to be on just such a prowl.

Black Monday worsened the problems of so-called risk arbitragers, who buy stock in targeted takeover companies in the hope that they can sell the stock to a higher bidder. Monday's crash wiped out many of their assets. Among those severely affected was Abelow Ihasz & Co., which had 45 employees at the time of the crash. "We're not going to be trading until the market stabilizes," said Robert Levine, a general partner of the firm. "More than that I can't say." Recalled George Kellner of Kellner, DiLeo & Co., which sustained unspecified heavy losses: "It was humbling and humiliating. Someday I'd like to learn my lessons in an easier way."

The hardest hit of all last week were Wall Street's specialist firms, the traders who are charged with maintaining orderly markets. That task requires them to purchase stocks when there are no other buyers and to make sales when other sellers disappear. Until last week, a total of 52 specialist firms worked on the floor of the New York Stock Exchange; each handled the shares of 20 to 30 specified Big Board companies. On Black Monday, the specialists grimly fulfilled their responsibilities, buying millions of shares as prices plunged all around them. Their losses could amount to as much as $750 million. The shock was too much for A.B. Tompane & Co., a 60-year-old specialist company that survived the 1929 Crash and traded in USX Corp. and Royal Dutch/ Shell Group, among other stocks. Last week Tompane sold out to Merrill Lynch for an undisclosed sum. Also merged out of existence was W. Damm M. Frank & Co., an American Stock Exchange specialist that traded in 30 Amex stocks before the crash. The firm was acquired by Bear, Stearns. That could be only the beginning. Says Samuel Liss, an analyst at Salomon: "We are going to see more specialist firms merging with better-capitalized parents."

Securities firms outside Wall Street also felt mortal pain. In Grand Rapids, H.B. Shaine & Co., a regional brokerage with 107 employees, wound up in a merger after Monday's debacle pushed it into bankruptcy. The 4,500 accounts of the New York Stock Exchange member were taken over by Rodman & Renshaw, a Chicago firm.

In the weeks and months ahead, Wall Street's high-to-higher-flying style may be further crimped by additional Government regulation. David Ruder, chairman of the Securities and Exchange Commission, ordered the SEC staff to consider immediately ways to limit future mammoth market swings. Edward Markey, the Democratic chairman of the House Telecommunications and Finance Subcommittee, has called for hearings into the role of computerized trading programs that dump securities when the market falls.

Yet amid all the gloom, some firms found a few rays of hope glimmering for the future. Shearson reported opening a record 9,000 new customer accounts in one day last week. "We think this was a flight to quality," said Shearson Chairman Peter Cohen. "People are feeling that it's probably better to be housed in big firms rather than smaller ones." Whatever the reason, the new business was balm to the brokerage that announced last month it was firing 150 workers in its London offices and cutting back its trading of municipal bonds.

On one issue there was near unanimity. "There will be more layoffs," said Perrin Long, an analyst at Lipper Analytical Services, which studies securities firms. "The brokerages could run much leaner than they are now." Concurred Jack Barbanel, senior vice president of Gruntal & Co.: "The message is clear -- Wall Street is tightening its hatches." Long predicts that as many as 24,000 securities-industry employees will lose their jobs over the next twelve to 18 months -- and even that, he believes, is not enough. If Wall Street hopes to stay profitable in the troubled times ahead, Long thinks a safer number of layoffs would be 42,000.

With reporting by Rodman Griffin and Frederick Ungeheuer/New York