After Decades Of Consolidation, Wall Street Is Fragmenting

The EconomistAs New York's lefty mayor Bill de Blasio likes to say, the Big Apple is a tale of two cities, one on the ups and one on the downs.

It might surprise Mr de Blasio that this is true even of Wall Street. Large banks, hammered for their own failures and those of the government, are going through endless rounds of cost cuts and redundancies to pay for fines and ever more compliance.

In contrast, a handful of smaller financial institutions, many created by refugees from big firms, are doing well.

So-called "boutique" investment banks have gained a much larger share of the lucrative business of advising on mergers and acquisitions (M&A) since the financial crisis (see chart) and are gaining other footholds.

Their flourishing has put paid to the belief that consolidation was inevitable as one institution after another was crushed or absorbed by bigger rivals. The giants who offered advice, credit, trading, research and underwriting on top of the technological capacity to track what was going on used to seem unstoppable.

But technology now comes cheap and breadth is as likely to result in fines as in synergies. Minnows, often still under the management of a charismatic founder, are snaffling the business that once belonged by right to Wall Street's titans. Their main product is one in which personal relationships matter a lot and scale very little: advice on M&A.

Another strength is restructuring, since in a bankruptcy or reorganisation, the institutions that provide capital--the large, established, banks--have too many conflicts to participate. Over time, a third business has emerged: providing advice on how best to exploit capital markets.

The publicly traded quartet of Moelis, Evercore Partners, Greenhill & Co and Lazard are flourishing. They trade at profit multiples many times higher than their larger rivals, some of which are deemed to be worth less than the value of the assets on their books. That there has been a surge in M&A while other bits of investment banking are struggling probably helps.

The tiddlers' success has resulted in a transformation in the perceived wisdom. In the period leading up to the financial crisis Lazard and the family-controlled Rothschild, both founded in the 19th century, were seen by many outsiders as relics for maintaining their independence and focus; now they represent models to be emulated. Their revenues, the biggest among boutiques, have become benchmarks.

The current flock of competitors caught on to the new environment early on. In the 1990s Robert Greenhill left Morgan Stanley to work for a key client, Sandy Weill, who was in the process of assembling numerous investment firms into what would become the disastrous amalgam of Citigroup.

Mr Greenhill later went on to create a new firm as narrow as Citi was broad. Privately-held Perella Weinberg was set up in 2006 by men who had worked at Credit Suisse, Morgan Stanley and Goldman Sachs. Ken Moelis began his firm in 2007 after stints at various big investment banks.

There are more potential businesses to pick off, most notably asset management, which does not require capital. But one of the big selling-points of boutique banks is round-the-clock access, often to senior executives. That requires minimising distractions and maintaining flat managerial structures. It also makes it hard to take part in heavily regulated activities such as taking in deposits, making loans, holding physical commodities, structuring derivatives and trading.

Clients distrust mega-banks, where conflicts of interest abound. Cost-cutting is also hampering those banks' efforts to fend off the upstarts. In a small example, one big bank is said to be drastically curtailing travel to reduce expenses in the current quarter, despite an ongoing frenzy in the merger market. None of the boutique banks would skimp on plane tickets when opportunities beckoned.

Having firms so heavily dependent on individuals carries risk of its own. But it is employees and shareholders, not taxpayers, that have to worry about that: the boutiques are not "too big to fail". Their recent growth is a welcome sign that America's beleaguered financial markets are evolving. Even more heartening is their capacity, should their business dry up, to disappear without causing chaos.

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