(FORTUNE Magazine) – There are three things on FORTUNE's mind at the end of January: Is Crouching Tiger, Hidden Dragon really as good as everyone says? Why did Ricky Martin agree to sing at W.'s inauguration? And why have tech mergers and acquisitions dried up?

Entertainment Weekly probably has the answers to the first two questions; we'll take a stab at the third. First, some background: Bankers put together a record number of tech deals during the first nine months of 2000--an average of 1,162 per quarter. But the dot-com crash soon put the deep freeze on this action. By the end of last year the pace of dealmaking had slowed by 27%, and the average deal size had plummeted by 13% from 1999 levels, to $367 million.

The activity of the first three quarters should be enough to save the banks' year--they assembled a record $1.83 trillion in U.S. mergers in 2000, up from $1.57 trillion in 1999--but forecasts are gloomy for Goldman Sachs, Morgan Stanley Dean Witter, and smaller, tech-focused firms such as Thomas Weisel Partners. Analysts predict fourth-quarter bank profits will contract 17% from last year's because of the falloff in underwriting fees and trading revenues. This year analysts project a 12% rise in bank earnings and a paltry 3.1% increase among brokerages. Already there are portents that the situation is going to be pretty bad: Merrill Lynch laid off 60 analysts this month; there are rumors Credit Suisse First Boston may cut almost 300 investment bankers.

The worst part? The M&A business isn't likely to pick up until the market stabilizes. Even under the best circumstances, getting two companies to agree on a price is tricky. But when the market caps of both parties are plunging, dealmaking becomes Herculean. "You feel like the sands are shifting under you in the middle of a negotiation," says Alec Ellison, a co-president of technology investment bank Broadview International. The increased volatility in tech valuations means fewer deals will be done and they will take much longer to complete.

Sellers are having a hard time recognizing that they're not worth what they were a year ago, a condition that investment bankers call "reality lag." "There have been plenty of examples of a young company pausing in a deal because it used to be worth $10 billion and now it's worth $4 billion," says Matt L'Heureux, head of Goldman Sachs' technology M&A practice. "They ask themselves, 'Is this an anomaly? Or is this the world I'm going to have to live with?'"

The most active tech buyers, who relied on a growth-by- acquisition strategy, have understandably soured on the idea. The market has had a change of heart regarding M&A, punishing CEOs for being overly acquisitive. Some of the biggest buyers have more specific problems: JDS Uniphase and WebMD are digesting huge or multiple purchases; Yahoo and DoubleClick are struggling with slowing revenues in their core operations. Even M&A king Cisco is being prudent, hoping to pick off Gucci-like companies at Gap-like prices. "We're starting to see some desperation," says Ammar Hanafi, vice president of business development at Cisco Systems. "Private company valuations are changing. Now is a good time for us to be patient."

There are two factors that will bring companies to the table this year. First, although unemployment is rising, engineers and scientists are still in high demand, so much so that semiconductor and optical networking outfits are doing more of what bankers call HR deals (HR for Human Resources). In these acquisitions the employees are seen as more valuable than the company's product. Some banks are applying metrics like price-per-engineer to value these deals. (For example, Broadcom paid $18 million per engineer to buy chipmaker SiByte in November, a bit of a premium but far from a record.) "HR buys are becoming more prominent. If a company can buy another firm cheap enough and pick up 50 or 100 networking engineers who have skills in key technologies, it's not a bad idea," says Mark Shafir, co-director of investment banking at Thomas Weisel Partners. These deals, though, will work only if the talent can be retained, he adds.

A whole other cadre of deals this year will be driven by seller desperation. The most ready sellers will be those with less than a year's worth of cash. Some bankers predict an increase in private-to-private mergers. "It will put them in a better position to take on incumbents and survive," says Shafir.

For Wall Street, this slowdown in deals couldn't come at a worse time. Banks and brokerages are desperately looking for creative ways to goose profits. One possibility: disaggregation--the pulling apart of companies that they helped put together in recent years. Look no further than AT&T's planned four-way breakup for evidence.

Banks are also looking beyond tech for M&A opportunities. Some of the biggest mergers so far in 2001 have been far from the high-tech sector. In January, American Airlines announced plans to buy Trans World Airlines. And a few days later packaged-goods company Nestle announced a $10 billion buyout of Ralston Purina.

Now, if only we could figure out that Ricky Martin thing.

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