Could the End Be Near for the Big Wall Street Brokerage?

NEW YORK, Sept. 17 -- The traditional model of investment banking came under renewed threat Wednesday as Morgan Stanley and Goldman Sachs, the two remaining giants of this beleaguered Wall Street industry, suffered stunning losses only one day after they reported quarterly earnings that exceeded analysts' expectations.

Morgan Stanley shares plunged 24 percent. Its bonds also declined, while derivatives meant to gauge the likelihood of a bond default by the firm suddenly signaled impending doom.

Goldman Sachs fared only slightly better, with a 14 percent drop in its shares and derivatives spreads that did not imply default but a much higher risk of one.

The turmoil at the two vaunted institutions -- which only a year ago had the company of three other major investment banks -- follows an unprecedented week in American finance that has rattled investors, reshaped the landscape of the investment-banking business and raised questions about the viability of stand-alone brokerages.

In years past, brokerages could depend on a steady stream of short-term financing to keep their ledgers balanced. But now that the credit crunch has made it prohibitively expensive, if not impossible, to unwind positions in unwanted securities, lenders have become more reluctant to extend financing.

Those were the dynamics that pushed Lehman Brothers Holdings into bankruptcy and Merrill Lynch into the arms of Bank of America on Monday, and they had investors questioning whether the remaining independent brokerages could maintain enough confidence among lenders to keep their massive trading portfolios going.

The pain rippling across Wall Street was magnified by the brokerage industry's reliance on leverage, a strategy that allowed them to put up little of their own capital and place huge bets on investments mostly with borrowed money. While neither Goldman Sachs nor Morgan Stanley was as entrenched as Lehman in the mortgage markets, they, too, built up their proprietary trading portfolios with liberal use of leverage.

Morgan Stanley, which had tried to get out ahead of investor anxiety by reporting its earnings a day early on Tuesday, was sucked down Wednesday by the relentless undertow of the markets.

"I don't think you can justifiably suggest that Morgan Stanley shouldn't be a going concern. But we've moved past the idea of rationalization to one of palpable market panic, and it's tough to say exactly what's going to break that cycle," said Scott Colbert, director of fixed-income investments at Commerce Bank in St. Louis.

Morgan Stanley chief executive John J. Mack blamed the steep drop in the company's stock on short sellers who would profit from a decline in the shares.

In a memo to employees, Mack said he and fellow executives had contacted major shareholders, clients and counterparties, along with Treasury Secretary Henry M. Paulson Jr. and Christopher Cox, chairman of the Securities and Exchange Commission.

"What's happening out there? It's very clear to me -- we're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down," Mack said in the memo.