End of Brokerage Business As We Know It?

As a former stockbroker and full time trader, I like to keep an eye on the brokerage industry. I entered the business in 1989 when it was dominated by the old traditional wire houses: Bear Stearns, Dean Witter, Goldman Sachs, Kidder Peabody, Merrill Lynch, Morgan Stanley, Paine Webber, Prudential Bache, Salomon Brothers, Shearson Lehman Hutton, Smith Barney. A tombstone in the Wall Street Journal used to take up a full page just listing the underwriters in the syndicate. Discount brokerage was in its infancy. I remember my manager at Merrill Lynch proudly telling us rookies that when a reporter asked him what he thought about a Charles Schwab office opening across the street he replied: “I am glad that finally there is somebody to take care of the small accounts.”

Over the next 20 years the traditional brokerage industry went through a lot of change – financial supermarkets, consolidations – remolding its sales force from stock and bond brokers to account executives to financial planners to wealth managers. But I think it’s the conversion to public ownership that precipitated the downfall 20 years later.

Traditionally, Wall Street brokerages were partnerships, with partners putting their own capital at risk. When your own money is on the line, chances are you are not going to recklessly lend it to every joe shmo who can affix his signature to an application. It’s the ability to play with OPM (other people’s money) that allowed these guys to take oversized risks in areas they knew little about, ultimately bringing them down.

Menawhile, discounters, no-load mutual funds, online brokers, and independent RIAs (registered investment advisors) kept diligently chipping away at the traditional brokerage business. The wire houses responded by rewarding analysts for bringing investment banking business instead of picking stocks (remember WorldCom/Enron?) and turning brokers into asset gatherers so that the Street could live comfortably off the 1% asset management fee.

The latest push has been “wealth management” – going after high net worth and ultra high net worth individuals. What if you are not (yet) one of them? Forget it, pal! Nobody wants your business if you don’t have a million bucks! I mean: isn’t it amazing how many people are out there eager to manage your million dollars but hardly anybody to help you figure out how to make it?

The end result: the traditional brokers have pushed the majority of regular investors away through abuse, mismanagement, and arrogance. Regular folks have found alternative ways to manage their portfolios: online brokers, subscription newsletters, stock picking services, financial planning calculators, investment groups… On time, on demand. It may come piecemeal but in cyberspace it’s all still under one roof – yours, with you in charge.

The high end asset gatherers spurned the low net worth regular folks. Now the regular folks don’t need the high cost “advisors.” If the Lehman/Merrill brokers had truly provided a valuable service at a competitive price, their employers wouldn’t have needed to take outsized risks with “liar” mortgages to survive and prosper. Now many of these guys are out in the street circulating their resumes. We may still need banks to clear payments and fund loans but there is certainly little demand for overpriced arrogance.

I see more fundamental transformation of the financial services industry ahead, in ways we couldn’t even imagine just 20 years ago. The guy with a funny handle peddling his stock picking on Yahoo message boards may just represent the future. Don’t laugh. The Internet has already spawned multiple new ways of producing and delivering financial services people need and are willing to pay for. I see more opportunities with video and online collaboration. When was the last time online stock message boards and investment groups “laid off” people? Globalization has made it possible to get what you need when you need it at a competitive price. And it does not matter where the provider is. The stock picking group I belong to has active contributors from the US, the UK, South Africa, India, Brazil, and China – all trading US listed equities, all on the same wavelength.

True, the new online providers are highly fragmented and largely unregulated, and there is tremendous potential for fraud and abuse. A consolidation may be coming – once somebody figures out how to make money off of all that online potential. But I just don’t see how overpriced unemployed brokers fit into this picture. What do they have to offer? Investment advice? Nah… These guys are glorified asset gatherers. I bet some of them still think LEH is a good investment – if you hold it really long term.

Slav Fedorov is a full time stock trader and founder and managing member of TradingZoom, LLC – a provider of proprietary trading data that swing traders can put to work right away. http://www.tradingzoom.com/

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