What will a smaller Wall Street look like?

Are the boom times of Wall Street over for good? That's the topic reviewed for a story in the New York Times, and how a slimmed-down financial sector might impact the overall economy:

As the tectonic shifts within the American financial industry shook the world’s markets on Monday, many experts predicted that events of the last 72 hours heralded a new period of painful change for Wall Street.

The predictions were sobering. Investment banks will be smaller. Their profits will be leaner. Jobs in finance will be scarcer. And the outsize role of Wall Street in the nation’s economy will shrink...

A debate is raging over what lies ahead for Wall Street now that only two major American investment banks, Goldman Sachs and Morgan Stanley, remain independent. While Wall Street has gone through tough times before only to emerge bigger and stronger, some question whether the industry can rebound quickly after using high levels of leverage, or borrowed money, to binge on risky investments. Those investments have proved to be disastrous. Worldwide, financial companies have reported more than $500 billion in charges and losses stemming from the credit crisis — a figure some experts say could eventually exceed $1 trillion....

“We are all in this business conditioned to cycles in crises and we’re also conditioned to markets snapping back relatively quickly because the crisis can be identified and measured,” said Donald B. Marron, chief executive of the private equity firm Lightyear Capital, which is focused on financial services, and former chief of PaineWebber Group. “What’s different now is you can’t do either."

A marriage of Bank of America and Merrill Lynch in a sense would hark back to the past. During the Depression, Congress separated commercial banks, which take deposits and make loans, from investment banks, which underwrite and trade securities. The investment banks were allowed to do business with less oversight, while commercial banks operated with tighter supervision.

But after Congress repealed those Depression-era laws in 1999, commercial banks began muscling in on Wall Street’s turf. As the new competition whittled down profit margins, investment banks used more of their capital to trade securities and also began developing financial derivatives to fuel profits.

Now, executives like John A. Thain, the chief executive of Merrill and a former Goldman executive, say investment banks will need large bases of deposits to shore up their capital for times of trouble. “As we go forward, size is going to matter,” Mr. Thain said Monday...

Meanwhile, the Federal Reserve is expanding its back-door channel for financing what officials hope is an orderly shakeout on Wall Street.

But the Fed, and ultimately the taxpayers, could get left holding the bag. In allowing investment banks to post collateral that includes stocks, junk bonds and subprime mortgage-backed securities, the Fed said it would be mirroring the rules of two industry-operated overnight lending systems, known as tri-party repo systems, operated by JPMorgan Chase and Bank of New York.

Fed officials have themselves expressed concern that those lending programs needed to reassess their practices because lenders were holding collateral that might prove difficult to sell. .. What seems to be clear to most everyone on Wall Street is that the era of high-octane trading profits and deals fueled by extreme bank borrowing is over, at least for now. That will clamp down profits across the industry for some time. Just as Americans are finding it harder to borrow to build a new room or to buy a new car, big players on Wall Street are being forced to rein in the amounts they borrow...

Already, Wall Street firms are reducing their debt levels, and regulators are expected to create new rules about leverage, liquidity and capital levels. The rules, if strict, could force Goldman and Morgan Stanley to merge with a bank that has customer deposits, a steady source of capital, and thus is buffered from collapse.

Wall Street veterans are divided over the extent of the industry’s problems. Some point out that Wall Street tends to go through a downturn or outright crisis every four or five years, and that it usually recovers quickly. But others argue what is happening now represents the end of a 30-year credit “superbubble” that affected the financial sector just as much as it did consumers.