The Wall Street Community - likened to a giant accordion or squeezebox - is beginning to contract while management presses the buttons, or keys, in an effort to produce melodious sounds.  At the start of 2011, though the Street appeared fully extended, it also looked like it could handle more expansion.   

Yet, during this summer season, firms are looking to diet in an effort to get smaller, more nimble - better able to handle the weak markets, an uncertain regulatory landscape, and world-wide economic upheaval.  Many of the biggest firms are preparing for deep cuts in jobs and other costs.

Recovery From the Financial Crisis.   While Wall Street firms have mostly recovered from the financial crisis and are reporting substantial profits again, such profits are not as big as they had been before the crisis.  And, it's expected that, in the coming months, it will be even more difficult for firms to make money.  Worries about debt in Europe and the shape that the Dodd-Frank financial overhaul rules will ultimately take, combined with the usual summer doldrums, are prompting banks to act.

Even Goldman Sachs, Wall Street’s most profitable firm, is retrenching.  Senior exec concluded the need to cut 10%, or $1 billion, of noncompensation expenses over the next 12 months, according to a person close to the matter who was not authorized to speak on the record.  The big pullback will cause Goldman employees, who have already been ordered to cut costs, to re-examine every aspect of their business.  While final targets for layoffs had not been set, Goldman was “certain” to shrink headcount in the coming months.  Decisions on bonuses are still months away, but they are sure to come down as well if business does not pick up.

Bank of America is doing the same and will likely cut some staff members from its securities division in the coming months.  Credit Suisse also is reportedly in the process of identifying people to cut in its investment banking unit.

Morgan Stanley had announced that it would cut at least 300 low-producing brokers in its wealth management division this year, more than the firm initially expected, and announced plans to cut $1 billion in noncompensation expenses over the next 3 years.  Unlike many of its rivals, however, the firm so far has no plans to cut staff members from its investment banking and trading division, which has added hundreds of employees over the last 2 years or so as part of a rebuilding effort after the financial crisis. 

Some firms have already wielded the ax. In January, Barclays Capital cut 600 people, or more than 2% of its worldwide staff, citing a business slowdown, and recently cut more employees for “performance-related reasons”  - 1/3 of the January cuts were in New York.

Impact of Regulatory Overhaul.   This has weighed on the decisions to cut back, senior bank executives say.  Regulation has caused some Wall Street banks to exit some businesses, like proprietary trading.  Rules that require banks to hold more capital will probably cause some firms to end certain business lines as they decide they can more effectively deploy the capital elsewhere.  On products like derivatives, firms will lose revenue as instruments once traded off exchanges will move into open markets.  Yet, while many financial rules are still to be written, some firms have decided that they cannot afford to wait any longer. 

Last Significant Industry-wide Job Cuts.   This took place in early 2009;  in Q1 of that year Goldman alone cut its work force by almost 9%.  Since then, most firms have held steady on their head counts or have added to them slightly. That will change this summer.

Not All Doom and Gloom.  Wall Street is benefiting from the boom in social media and technology public offerings.  The profit picture is also somewhat more stable for diversified companies - like JPMorgan Chase, Bank of America, Citigroup - which have large commercial retail banking operations in addition to those in trading and sales. JPMorgan reportedly has no immediate plans to cut head count in trading - although, the bank is trying to reduce noncompensation expenses.

Mortgage Sins Hurt, Trading Slow.   But firms like Bank of America are still paying for mortgage sins of days gone by, which have dimmed their profit pictures. Earlier this year Bank of America put aside another $1 billion to cover claims from outside investors who lost money and want the firm to buy back billions of dollars in bad Countrywide Financial mortgages. The Durbin Amendment, a proposed restriction on debit card fees, is also expected to reduce profits when it comes into effect next month.

And for firms dependent on trading, it is clear how much the engines of Wall Street have slowed.  Return on equity, the amount a firm earns on its common stock outstanding and an important measure of financial performance, has decreased significantly in the years since the credit crisis. Industry-wide return on equity was 8.2% in 2010, down from 17.5% in 2005, according to Nomura.

For additional details, go to:   [Dealbook, 6/16/11]