When two Bear Stearns hedge funds went belly-up this summer, Wall Street shook its head, tut-tutting that the collapse was inevitable, given how the funds were structured. For every $1 of equity in them, the funds’ managers­ had borrowed to make about $10 in investments. It’s a lesson investors apparently have to learn again and again: Leverage works wonders on the way up but can be brutal on the way down. That’s why Wall Street is worried about another entity on the edge—one that has an astounding $29.90 of assets for every $1 of equity. It’s called Bear Stearns.

The money world is undergoing yet another of its periodic bouts of fretting that it could lose one of its brethren. Concerns that Bear is in real trouble have filled traders with misty sentiment about troubled firms of yesteryear, from Drexel Burnham Lambert, which didn’t make it after the Michael Milken insider-trading scandal, to ­Salomon Brothers, which Warren Buffett bailed out, to First Boston, which fled into the arms of Credit Suisse. (Salomon was a famous headache for Buffett, which makes talk of his Bear Stearns rescue curious.)

Even when the deathwatch is for a firm full of cowboys, like Bear, the mood turns somber. Most investors and analysts comfort themselves with the belief that Bear is only down, not out: Investment-bank fortunes always swing wildly; that’s the way the business works. ’Twas ever thus.

Not exactly. These days, Wall Street’s five freestanding investment banks are looking something like those subprime-mortgage borrowers, who are now puttering around houses they can’t afford: The banks are loaded up with too many assets, supporting too much debt with too little down. The coming troubles stem from their effort to separate themselves from banking monoliths—the so-called universal banks like Citigroup and J.P. Morgan Chase. The independents have spent the past decade intentionally moving away from mainstay businesses and into riskier niches, where they made big bets for themselves. For a time, the shift was lucrative. But now the foundation is buckling.

Five big banks—Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, and Bear Stearns—define Wall Street today. Bear is in the crosshairs now, but it may soon have company there. “In past cycles, [Wall Street investment banks] came out of credit debacles very strongly because they didn’t take those risks,” says Charles Peabody, an analyst for Portales Partners, an independent research firm in New York. “There’s a strong chance that certainly one and maybe two will be rolled up into another entity in a forced marriage.”

Which of them that may be and how it may happen is, of course, the obsession on trading desks as winter approaches. And that question leads to a bigger one: Could the business models of the big independent investment banks be fundamentally flawed?

The Bravado Myth

Wall Street firms, in the popular imagination, have long been peopled with boundless, brash risk-slingers. But that was never exactly the case. Bravado aside, the investment banks made their money by advising companies planning mergers and by providing a market for investors to place their bets. It’s a nice, lucrative business, and it’s pretty safe.