Filling the Bear Stearns void

Now that Bear has been taken over by JPMorgan Chase, buyout firms, hedge funds and Canadian banks could become new members of Wall Street's elite.

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By David Ellis, staff writer

Now that Bear Stearns has been absorbed by JPMorgan Chase, there may be an opening for another financial firm to take Bear's place among Wall Street's elite.

NEW YORK ( -- Wall Street's inner circle contracted significantly after JPMorgan Chase officially completed its historic acquisition of Bear Stearns.

So who could fill the hole in the investment banking world that's being left by Bear? Industry analysts think a host of buyout firms, hedge funds and foreign banks are lining up for that spot.

"Is it a possibility? Absolutely," said Kris Niswander, associate director of research at SNL Financial in Charlottesville, Va. when asked if another firm could take Bear's place. "It's a time of market chaos."

Blackstone Group (BX) and J.C. Flowers & Co. are two firms on the top of analysts' short list of firms who might find themselves moving up Wall Street's investment banking ranks.

Difficult financing conditions have sent private-activity deals grinding to a halt. But Blackstone has diversified its offerings in recent years from its bread-and-butter leveraged buyout business into hedge funds and asset management and has even advised on some mergers and acquisitions.

J.C. Flowers, on the other hand, reportedly made a bid to buy Bear Stearns in March. So it would appear to be interested in becoming a major player on Wall Street.

While neither New York-based buyout shop may want to sign up for all the trappings involved with being an investment bank, the possibility is not that outlandish, said James Ellman, head of San Francisco-based Seacliff Capital, a hedge fund specializing in financial services.

"They are pretty good at generating cash, have relatively sophisticated risk control personnel and are increasingly competing against investment banks for business," he said.

And if fickle private equity firms can become major players on Wall Street, why not hedge funds?

To that end, the Chicago-based Citadel Investment Group has been on the lips of many market observers in recent days as a possible suitor for Lehman Brothers (LEH, Fortune 500). Lehman is rumored to be looking to raise more capital to shore up its balance sheet.

Over the past year, Citadel's reach has expanded into different regions of the financial services industry. It acquired a 20% stake in E*Trade Financial Corp. (ETFC) last November and purchased the credit portfolio of fellow hedge fund Sowood Capital last summer after the credit markets went into a tailspin.

What's more, like many of the so-called bulge bracket firms on Wall Street, Citadel already operates its own prime brokerage division - a profitable business which handles hedge fund transactions.

Finally, other analysts say that you can't rule out the possibility of Wall Street's next big investment bank emerging from our neighbor to the north.

Canadian financial services giants Bank of Montreal (BMO) and Royal Bank of Canada (RY) have, for the most part, fared much better than their American counterparts during the credit crisis.

Factor in the recent strength of the Canadian dollar and it is not unreasonable to believe that either firm could have a greater presence on Wall Street in the coming years, argues David Easthope, senior analyst at independent research and consulting firm Celent LLC.

"I think these Canadian banks have a good hand to play," he said.

Opportunities but also challenges await

At first blush, it may seem impossible for another firm to come in and take Wall Street by storm. But history has shown that new contenders can quickly emerge from the ranks of Wall Street's also-rans.

In just over a decade, Lehman Brothers transformed itself from a lowly securities subsidiary of American Express into a worthy adversary of Wall Street's most established firms.

Even the modern day incarnation of Merrill Lynch (MER, Fortune 500) didn't get its start until the 1940s when co-founder Charles Merrill dived headfirst into the retail brokerage business. A decade later, the company name became synonymous with investing in American households.

"If that could happen in 1940, why not in 2008?" said Richard Sylla, a professor of the history of financial institutions and markets at New York University's Stern School of Business.

Still, it won't be that easy. Duplicating such a rapid rise to prominence is a lot more difficult nowadays.

For starters, becoming a major player requires having a foothold in some of the world's fastest growing economies including China and India. That could preclude firms like J.C. Flowers or Citadel, whose international reach, while impressive, does not approach that of a Morgan Stanley (MS, Fortune 500) or Goldman Sachs (GS, Fortune 500).

"To be a major player you have to operate around the world now," said Sylla.

To complicate matters, bulge bracket firms don't just rely on fees from advising on deals or underwriting initial public offerings anymore. All of the top tier firms generate a portion of their revenue from their massive sales and trading operations, where they swap commodities, currencies and complex derivatives.

That business can not only be quite costly to enter, argues Celent's Easthope, it also takes plenty of cash to maintain the technology behind these operations.

"If you want to be in the trading world...that is a massive investment in terms of technology more so than ever," said Easthope.

At the same time, the established players are not sitting idly by. They too are competing to win business and attract clients that at one time relied on Bear Stearns.

"What you'll find is that the deals Bear would have potentially picked up are going to be spread among other bulge brackets," said SNL's Niswander. "They are pushing that much harder to get those deals."  To top of page

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