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Stalemate in Washington may dent Wall Street profits, report warns

Traders work the floor on the NYSE the first day of the government shutdown.
Adam Jeffery | CNBC
Traders work the floor on the NYSE the first day of the government shutdown.

As the end of the year approaches, Wall Street employees and those who watch New York State's coffers keep a close eye on just how much reward will be reaped by financial firm employees.

If the latest state report is accurate, this quarter may dash the hopes of many who are looking for a banner year.

Thomas P. DiNapoli, the comptroller for New York State, warned in a report on Tuesday that political gridlock in Washington could put pressure on Wall Street earnings in the second half of the year.

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Strong Wall Street earnings have been a boon to the state's finances, and the industry looked poised to match 2012 earnings earlier this year, after bringing in $10.1 billion in the first half of 2013.

But while 2012 turned out to be the third most lucrative year on record for Wall Street – and for the state, which collected $3.8 billion in taxes from the industry – the second part of this year could turn out to be disappointing.

"Failure to resolve the federal budget and debt ceiling impasse could disrupt the economy and hurt New York City and New York State," Mr. DiNapoli said.

After two years of record losses in 2007 and 2008, the securities industry was finally showing some firmer footing. It had four years of profitability fueled by low interest rates, including three years with the highest profits on record, as measured by broker-dealer profits of the member firms of the New York Stock Exchange, the comptroller's report said.

Yet now, there are some negative indications on the horizon. Even before the shutdown, Wall Street earnings in the third quarter were hurt by concerns about interest rates and other monetary policies.

Faced with new regulatory burdens and smaller returns in some business segments, Wall Street firms have had to scale back since the financial crisis. But rather than trim compensation, many firms have cut jobs in less lucrative businesses.

Average compensation, including bonus payments, has jumped to $360,700, the highest level for any year before the financial crisis with the exception of 2007. At the same time, the number of Wall Street jobs has shrunk 13.5 percent since 2007, the comptroller's report said.

(Read more: Budget battle's bite out of economy may cost billions)

For many firms, the cuts will continue this season and are likely to be largely concentrated in the trading desks where returns are slower and the risks are higher.

"There are going to be haves and have-nots this year," said Brad Hintz, an analyst at Sanford C. Bernstein.

Many of those who will see fatter paychecks will be employees on the investment banking side, where business can be lucrative and the pipeline for mergers and acquisitions is looking strong.

"How many mergers and acquisitions you have closed at the year-end will determine whether you are a have or a have-not," Mr. Hintz added.

In recent days, Wall Street firms, including Citigroup, JPMorgan Chase, Goldman Sachs and Morgan Stanley, all reported a sharp squeeze in fixed-income trading revenue as investors held tight to their positions in anticipation of a decision by the Federal Reserve to pare back its $85 billion-a-month bond-buying program.

The effect was most felt at Goldman Sachs, which said revenue dropped 44 percent in its bond, currency and commodity trading desk, prompting it to sharply reduce its pay and bonus pot.

The challenge in the next quarter will be for Wall Street to battle any lingering effects of a political impasse in Washington, which led to a 16-day partial government shutdown.

Ruth Porat, Morgan Stanley's chief financial officer, said last week that the biggest headwind for the economy and the markets would be continuing political uncertainty. For Morgan Stanley, the biggest worry is that the shutdown will hurt merger and acquisition deals that are still in the works.

Alan Johnson, managing director of Johnson Associates, said he also expected compensation as a percentage of total revenue to be down slightly this year across Wall Street firms.

"These banks are no longer the highest payers – we're no longer talking about the masters of the universe," Mr. Johnson said.

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