Updated from 10:56 a.m. EST

A calamitous 12 months on Wall Street lurched closer to conclusion Thursday as a trio of top investment banks disclosed steep profit declines and made cautious remarks about the coming year. Some worried the sector's cost-cutting campaign is getting close to the bone.

Goldman Sachs

(GS) - Get Report

,

Lehman Brothers

(LEH)

and

Bear Stearns

(BSC)

saw earnings plunge due to the recession, soft equity markets and the Sept. 11 terrorist attacks.

Each company reported diminished revenues in underwriting, stock issuance, and mergers and acquisitions fees, with business in all three categories drying up in the hangover from the go-go 1990s. Strength in bond underwriting couldn't offset the equity-side weakness.

Investors already knew the reports would be bleak and the market reaction wasn't severe. "The good news is that they've generated profits in what has probably been the toughest market in a decade for them," Peter Algert, head of growth equities at Barclays Global Capital said. "Compare that to tech, where companies have been losing money left and right."

Goldman was recently falling $2.01 to $92.40, while Bear Stearns was off 28 cents to $58.70 and Lehman was gaining 17 cents to $66.70. The stocks, which investors often use to bet on a broader economic recovery, are all up considerably since the market reached its lows on Sept. 21.

Damage

"So far, all the brokerage earnings have been disappointing on the revenue side, with possible exception of Lehman," said Reilly Tierney, senior vice president and bank analyst at Fox-Pitt Kelton. Still, the results weren't so dismal as to scare off investors who think the shares are a sound recovery play. "They want to own this group so bad they're trying to ignore the negative signs in the fundamentals."

Lehman said quarterly earnings fell 50% to $201 million, or 73 cents a share, from $399 million, or $1.46 a share, in the same period last year. The result matched the consensus.

Lehman, which is moving its headquarters to midtown Manhattan in the wake of the Sept. 11 attacks, reported revenue of $1.20 billion, compared with $1.70 billion last year. Investment banking revenue fell to $461 million from $552 million, while bond-trading revenue tumbled 42% to $378 million. Bond underwriting rose to $217 million from $166 million, but equity underwriting revenue dropped to $76 million from $135 million. Revenue from advising on mergers dropped 38%.

"The Lehman story is pretty much about gaining market share in the businesses that matter," Tierney said.

Let Down

Tierney found Goldman Sachs' results disappointing. "We'd all been gearing up for a very powerful quarter from Goldman relative to others and what we saw on revenue side was pretty unimpressive," he said.

Goldman said fourth-quarter earnings fell 17% to $497 million, or 93 cents a share, from $601 million, or $1.16 a share, in the same period last year. Analysts on average expected Goldman to earn 90 cents a share, according to market research firm Thomson Financial/First Call.

Investment banking revenue was $797 million, down from $1.22 billion for the fourth quarter of 2000, while advisory revenue dropped to $381 million from $624 million, reflecting lower levels of worldwide activity in mergers and acquisitions. Underwriting revenue was $416 million, compared to $596 million last year. Fixed income, currency and commodities revenue rose 80% to $867 million.

Goldman, which said it maintained its lead position in global IPO and M&A deals, said it was "cautious about the near-term operating environment," but "confident" about longer-term growth prospects.

"The strength of their underwriting wasn't as powerful as you might think, given some of the large, high-profile deals they did over the last quarter," Tierney said. Two of the firm's multibillion IPOs,

Anthem

(ATH) - Get Report

and

Principal Financial

(PFG) - Get Report

, weren't as profitable as expected, Tierney added.

Meanwhile, Bear Stearns reported a 21% drop in quarterly profit, earning $154.9 million, or $1.08 a share, in the latest quarter compared with $195.2 million, or $1.36 a share, last year. Analysts on average expected the company to earn 87 cents a share.

Quarterly revenue was $1.1 billion, down 18.7% from $1.4 billion last year. Like its rivals, the firm experienced declining revenue in many business segments. Capital Markets net revenue, which includes institutional equities, fixed income and investment banking, fell to $790.8 million, down 8.8% from $866.8 million.

Creeping Forward

The stocks may have had a quick recovery since Sept. 11, but they were oversold to begin with, said Barclay's Algert. Valuations relative to forward earnings forecasts remain "pretty fair," Algert said.

Algert said he expects the brokerages to be able to maintain their low margins and position themselves conservatively in order to generate growth. "I think earnings levels they're reporting are easily sustainable next year. If you look at a company like Bear Stearns and the multiple it's trading on relative to next year's earnings, I don't think there's a lot of downside," said Algert.

"The beautiful thing about the brokers is that they've grown expenses so much that they're able to really cut expenses to generate the profits," Algert added.

Tierney disagreed. "The biggest factor is that the compensation accrual in the fourth quarter, which helped them so much, won't benefit

them in the first quarter."

As such, the bottom could be ahead. "Unless the market really improves from here, you're not going to see a kick in the revenue side," Tierney said. "People were certain the trough could be in the fourth quarter, but I look out there and think there's a potential that you could see sequentially down quarters in some of these companies."