Banks: Beyond the Citi Carnage

Citigroup's (C) decision on Nov. 17 to ax 53,000 jobs—bringing total job cuts at the battered bank to 20% of its global workforce since late 2007—vividly demonstrates what many have been predicting for a year: The financial industry is shrinking.

The key question for both financial-sector employees and investors: Is the sector's decline permanent or temporary?

Many firms spent the early part of 2008 reluctant to cut staff, "in the hopes that revenues would rebound quickly and painful cost-cutting measures could be avoided," as a report from financial consulting firm Celent put it earlier this year. No such luck.

Losses in financial results have only mounted and key players—including Bear Stearns, Lehman Brothers, and Washington Mutual—have folded or been absorbed by rivals.

Sorry, No Bonus

Traditionally, November has been a popular time for layoffs on Wall Street, says Stephen McClellan, a former Merrill Lynch and Salomon Brothers analyst with 32 years experience on Wall Street, and the author of Full of Bull: Do What Wall Street Does, Not What It Says, To Make Money in the Market. With late-year layoffs, "brokerage firms can work their employees for 11 months and then not pay them a bonus," says McClellan, noting bonuses can total 75% or more of total income.

It's this lavish, well-compensated Wall Street culture that may be the biggest victim of the financial sector. Many financial sector observers say the financial industry of the future will be leaner, more efficient, and more highly regulated than that of the past.

"We're not going to go back to business like it was a year ago," says James King, president and chief investment officer of National Penn Investors Trust.

Key supports have been knocked away, especially the securitization industry in which Wall Street would generate fees by bundling assets backed by mortgages, credit card debt, and other investment products. The credit crisis has ruined many securitization markets.

Too Far Afield

Financial firms branched out into uncharted territories in recent years and "started doing too many things that were not their core expertise," says Michele Gambera, chief economist at Ibbotson Associates, a unit of Morningstar (MORN). "It was unsustainable."

Many foresee an end to the wild risk-taking that became characteristic of both pure investment banks and of commercial banks like Citigroup. For a variety of reasons—the lessons of the credit crisis as well as stricter regulations—these banks won't be able to take the same risks anymore. That means no more borrowing 30 to 40 times their assets, then investing that borrowed money to get extra returns.

That's a permanent change, says Robert Iati, head of global consulting at the TABB Group. "They won't have the capital any longer to risk," Iati says, and that forces firms out of certain roles on Wall Street.

To survive, for example, firms like Goldman Sachs (GS) and Morgan Stanley (MS) have switched from risk-taking investment banks to more conservative bank holding companies.

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