Even after the record $8.4 billion write-down for bad debts at Merrill Lynch & Co., the unprecedented ouster of three chief executives within five months and the elimination of $84 billion of market value at the five largest securities firms, Wall Street still is poised to report its second-most profitable year.
And 2008 may be better.
"As the bombs are dropping and the mines are exploding, it's a bit of a surprise," said Kenneth H. Crawford, who helps oversee $950 million Argent Capital Management LLC, of St. Louis, which holds Morgan Stanley and Merrill shares.
The collapse of the subprime mortgage market derailed the careers of Merrill Chief Executive Officer E. Stanley O'Neal, Citigroup's Charles O. Prince III and UBS AG's Peter A. Wuffli. Together, those companies accounted for about 60 percent of the $45 billion in write-downs reported by the world's biggest banks and securities firms so far this year. The industry also has cut 10,000 jobs.
Despite the losses, Goldman Sachs Group Inc., Merrill, Morgan Stanley, Lehman Brothers Holdings Inc. and Bear Stearns Cos. will earn a combined $28 billion this year, down 8.3 percent from the record $30.6 billion in 2006, according to a survey of analysts by Bloomberg News. Analysts estimate the firms' net income will reach $32 billion in 2008.
Goldman and Lehman will report their highest earnings ever this year, while profits will drop 42 percent at Merrill, 34 percent at Bear Stearns and 6 percent at Morgan Stanley. In 2008, analysts predict all the firms except Goldman will post higher profits. Goldman, led by CEO Lloyd Blankfein, will earn a Wall Street record $11 billion this year and then $10.5 billion in fiscal 2008, analysts estimate.
"When you look to next year, you're back to earning money once these write-downs are taken," said Benjamin B. Wallace, who helps manage $750 million at Grimes & Co. and owns Merrill and Morgan Stanley shares.
While revenue from fixed-income sales and trading is declining for most securities firms during the credit market turmoil, fees from investment banking, providing brokerage services to hedge funds and trading stocks are increasing, Bank of America analyst Michael Hecht wrote in a Nov. 5 report.
A record $3.6 trillion in mergers and acquisitions were announced this year, average daily trading on the Nasdaq stock exchange rose 10 percent, and equity market price swings measured by the Chicago Board Options Exchange SPX Volatility Index surged to the highest since 2003, creating trading opportunities.
"Not all of those positive drivers are going to come to an end right away," said Wallace, of Grimes & Co., of Westborough, Mass.
This optimism comes during the biggest rout for Wall Street stocks since 2002.
Merrill, the world's biggest brokerage, has plummeted 41 percent this year in New York Stock Exchange trading, Bear Stearns has slumped 40 percent, Lehman has dropped 24 percent and Morgan Stanley has declined 19 percent. Goldman shares have advanced 8 percent.
The slide began after Zurich-based UBS, Europe's biggest bank by assets, shut its Dillon Read Capital Management LLC hedge fund unit in May because of losses on subprime mortgages. A month later, two hedge funds managed by Bear Stearns started receiving margin calls from lenders after bets on mortgage bonds and collateralized debt obligations went sour.
Wall Street executives remained sanguine. Lehman's then-chief financial officer, Christopher O'Meara, told investors on June 12 that "subprime market challenges are and will continue to be reasonably contained."
Later that month, Merrill's O'Neal called subprime defaults "reasonably well contained."
O'Neal's 21-year career at Merrill ended last month when he lost the confidence of investors and his board by disclosing write-downs that were almost double the firm's forecast of just three weeks earlier. The charges led to a $2.2 billion third-quarter loss, the worst in Merrill's history.
Prince stepped down Nov. 4 as Citigroup's CEO after the largest U.S. bank warned of as much as $11 billion in write-downs on subprime mortgages and related securities, on top of more than $6 billion in charges reported for the third quarter.
The tumult followed the most profitable first half in Wall Street history, boosted by record merger and acquisitions, high-yield financing, commodities trading and stock market gains.
Still, the business mix at the biggest securities firms is diversified enough that earnings should be strong in 2008, analysts estimate. Merrill's net income will climb about 60 percent to $6.9 billion next year, according to the survey of analysts by Bloomberg.