The House of Morgan

by Ron Chernow

  When Mexico startled the world in August 1982 by announcing that it could no longer service its $87-billion foreign debt, it blackened the image of all Latin American debtors. They were being drowned in a common economic deluge of rising interest rates, global recession, and steeply falling commodity prices. On September 21, 1982, Langhorne Motley, the U.S. ambassador to Brazil, told the State Department that Mexico’s troubles were sparking flight from Brazilian debt: “Japanese banks are out of the market, European banks are scared, regional U.S. banks don’t want to hear about Brazil, and major U.S. banks are proceeding with extreme caution.”9

  In October 1982, under cover of a UN speech made by Brazil’s president, Netto and Galveas visited 23 Wall for clandestine talks. Frightened by Mexico, banks had pulled up to $3 billion in short-term Brazilian loans. Netto and Galveas didn’t see how Brazil could escape default without an emergency loan of $2.5 to $3 billion, plus a rescheduling to reduce interest and stretch out payments of principal. In the protocol of such crises, the bank with the largest debt exposure ordinarily managed the rescheduling. But the Brazilians’ faith in Tony Gebauer was such that they wanted Morgans to preside over this mammoth rescue, even though four other American banks had larger stakes. With $4.6 billion in loans to Brazil, Citibank was the natural leader. To avoid bruised feelings, Gebauer suggested that Citi co-chair the committee. “You have to go and do proper protocol,” he told the Brazilians, to whom Citibank acquiesced. Gerard Finneran would be the Citibank representative.

  The choice of Morgans and Citi had an intricate political backdrop. Some on Wall Street thought Morgans grabbed at the co-chairmanship in its frustrated quest for a Brazilian branch—a view that infuriated the bank. Perhaps more pertinent was the extremely intimate relationship between Fed chairman Paul Volcker and Lewis T. Preston, Walter Page’s successor as Morgan chairman in 1980. This hidden relationship never surfaced in the press. Yet behind Preston’s moves during financial crises, the cognoscenti sometimes discerned the fine hand of Paul Volcker. In 1980, Preston led a $1-billion rescue for the Hunt brothers when their attempt to corner the silver market collapsed, nearly dragging down Bache and other brokerage houses. The Hunts were hardly typical Morgan clients, yet the bank performed the rescue at the behest of Volcker.

  With Brazil, Volcker apparently again used Preston as his proxy. Just as the House of Morgan in the 1920s provided a convenient back channel for government action, so Volcker could direct bailouts through Preston without advertising his presence. Morgan’s smaller lending to Brazil was advantageous. A Preston confidant explained: “In the fall of 1982, Volcker told Lew that Morgan had to be in charge of the committee. He wanted Morgan to take on the Brazilian loan because we had far less exposure than other banks on Wall Street. We could, if necessary, take on more Brazilian debt without getting screwed up.” (Other bankers, it should be said, pooh-pooh this story, stressing the Gebauer link.) More than any chairman since Henry Alexander, Preston was imbued with a Morgan sense of noblesse oblige and Wall Street statesmanship. “Lew has been thinking more and more of the system, even to the detriment of the bank,” said the confidant. He tended to gripe at Citibank, which he often saw as acting selfishly and unilaterally without consulting the general good.

  As in interwar days, the debt crisis produced bad blood between American and European bankers. More than half of Brazil’s debt was held by non-American banks, yet Morgans and Citibank alone ran the show, as they had many of the earlier syndicated loans. Some in the City suspected that Brazil had groomed Morgans as its pet banker to secure lenient treatment. Guy Huntrods of Lloyds International Bank feared Brazil’s strategy was to cook up a sweetheart deal with New York bankers, then foist it on the Europeans. That October, he turned down Brazil’s request for an emergency loan unless accompanied by an IMF loan and stiff emergency measures. So the all-American team of Morgans and Citi led the first phase of Brazil’s rescue.

  The debt rescues of the 1980s reflected global political realities as well as financial stakes. Again and again, steering-committee banks were predominantly American. Japan was second to the United States in Third World lending, yet in the early rescues it typically settled for a single, token representative from the Bank of Tokyo, which had the largest Latin exposure. Much as the rising financial power—the United States—had deferred to Monty Norman’s intellectual leadership in the 1920s, so the Japanese, even while starting to overtake Wall Street, bowed to Paul Volcker’s authority. Not until the late 1980s would Japan begin to demand a voice at the IMF and the World Bank fully commensurate with its new financial power.

  Back in the 1920s, Tom Lamont had represented two hundred thousand Mexican bondholders worldwide. In the unwieldy modern debt crisis, Morgans and Citibank had to deal with a bureaucratic monstrosity—some seven hundred banks with large and small loans to Brazil. After secretly hatching a rescue plan with Brazil and the IMF, the two banks summoned Brazil’s creditors to New York’s Plaza Hotel on December 20, 1982. Carlos Langoni shocked them by stating that Brazil couldn’t service debt coming due in 1983. Jacques de la Rosiere, the IMF’s managing director, unveiled a complex, four-part Morgan-Citi plan for saving Brazil. Citibank would reschedule $4 billion in principal; Chase would maintain trade credits; and Bankers Trust would restore short-term “interbank” lines to Brazil. The linchpin was a Morgan-led effort to raise a new $4.4-billion loan for Brazil, the biggest in Morgan history.

  The plan set a fateful precedent of “curing” the debt crisis by heaping on more debt. In this charade, bankers would lend more to Brazil with one hand, then take it back with the other. This preserved the fictitious book value of loans on bank balance sheets. Approaching the rescue as a grand new syndication, the bankers piled on high interest rates and rescheduling fees. It was hard to stop the greed so prevalent for so many years. The Europeans watched sourly from the sidelines. “It was very much an American party,” said Guy Huntrods, a dogged, balding, talkative banker who became British point man on Latin American debt. “The Brazilians had taken no advice from anybody except Citi and Morgan Guaranty. We were told to go home and do what we were instructed. This created the most awful impression among us.”10

  Tensions rose between Wall Street banks, with their huge and irrevocable commitments to Brazil, and regional banks, which wanted to cut their smaller losses and run. One German banker observed, “I come into these sessions and I find all these hillbillies. The big American banks have made the loans and sold part of them to the little ones. And these fellows, who don’t know the Baltic from the Barents Sea, were all crying, ‘I want my money back.’ ”11 This split produced bitterness between the large and small banks and poisoned the atmosphere of the first rescue.

  In early 1983, Morgan credit officers worked around the clock to raise the $4.4 billion. Although the megaloan was assembled in a remarkable two months, it left a residue of ill will toward Tony Gebauer, who embodied the big-stick approach of the Wall Street banks. The smaller banks felt they had been browbeaten into participating, and some, piqued by Gebauer’s high-handed manner, balked at providing new money.12 But afraid of antagonizing the Fed and the Wall Street banks, they grudgingly abided by the plan.

  On February, 24, 1983, Brazil hosted a dinner at the Waldorf-Astoria to thank their bankers for the rescue loans. Over dessert, the Brazilians let slip that they might not make timely payments on these new loans either. Nevertheless, the next day, several hundred bankers, bruised and battered, signed copies of the loan agreement that Morgans and Citi laid out for their signature at the Plaza Hotel. The IMF chipped in a $5-billion loan for Brazil in what appeared a successful finale.

  This success was illusory. While the banks had committed $4.4 billion for the Morgan-led loan, they had also drained off a corresponding amount in short-term credit lines to Brazil. Thus some banks got their secret revenge. This financial legerdemain neutralized the loan’s effect. Gebauer was furious as he saw banks sabotaging the agreement. The whole sham got him hopping mad because
among the banks he suspected of bad faith was Citibank—his co-chair in the rescue operation. By the spring of 1983, Brazil was missing its IMF economic-reform targets, and the fund and the banks halted their emergency payments. The Fed was alarmed by Brazil’s eroding short-term credit lines. On May 31, Volcker called in Preston and other chairmen to discuss the rescue. The Fed was disturbed by reports of Gebauer’s treatment of the regional banks, and Preston feared that he was alienating the British bankers. Gebauer was squabbling openly at meetings with Citibank’s Finneran, demoralizing the bankers further. A decision was made to replace Gebauer with William Rhodes of Citibank, who had headed the effort to rescue Mexico.

  This came as a blow to Morgan pride, especially in view of the Morgan-Citi rivalry. “The Morgan bank was very high on Brazil and I think they were a little unhappy that the chairmanship had to be taken away,” remarked Anthony M. Solomon, then New York Fed chief.13 Some Morgan people grumbled about a power-hungry Citibank bringing Brazil into its fold along with Mexico and Argentina. Yet it was Preston who urged Citibank chairman Walter Wriston to relieve Morgan of the leadership burden. And there was secret relief at 23 Wall, which was uncomfortable with its unaccustomed high-profile role in the debt talks. Said one former Morgan official, “People had never identified Morgan that much with Latin America, and it suddenly became a liability.” Gebauer’s role drew attention to the bank’s embarrassingly huge Latin American exposure.

  In a second Brazil rescue, Bill Rhodes didn’t want to work with Gebauer, whom he saw as tainted. To appease the bank, he brought in Leighton Coleman of Morgans as deputy chairman; to appease the British, he brought in Guy Huntrods of Lloyds as the other deputy chairman. The reschedulings became more global, creating tremendous creditor unity and averting the internecine feuds among nations that had so weakened the banks in the 1930s. Instead of the largely private bank solution of phase 1, Rhodes wanted to get creditor governments more involved and touched base with the IMF, the World Bank, the U.S. Treasury, the Fed, and the State Department. His actions confirmed the intrinsically political nature of sovereign lending—an old story.

  The specter of Tony Gebauer wasn’t yet banished. As Brazil’s economy deteriorated during the summer of 1983, Rhodes opted for secret talks, hoping that blunt language would shock the Brazilians into strong action. On August 16, 1983, Rhodes, Huntrods, and Coleman flew to Brazil in a private plane. Rhodes and Huntrods were faintly nervous about having Coleman along, not on a personal level, but because they feared he might have shared information with Gebauer. In Brasilia, they believed their worst fears had been confirmed. Meeting with Netto, Langoni, and other powers at the home of Finance Minister Galveas, they delivered a stern warning. Rhodes began: “We can’t keep the banks on board much longer.” Coleman chimed in: “You’ve got to speak with one voice.” Huntrods delivered a dramatic peroration: “There is a smell of defeat around the streets of Brasilia that reminds me of France before Dunkirk.”14 Because Netto had never heard of Dunkirk, a short lesson in history ensued.

  Huntrods felt they had lost the critical element of surprise: he believed somebody had tipped off the Brazilians. “We had absolute certain proof that Gebauer, who was Coleman’s boss, had already telephoned the Brazilians what our game plan was,” said Huntrods adamantly. “That we knew beyond a shadow of a doubt.” He thought that Gebauer was either ingratiating himself with the Brazilians or, motivated by envy, was trying to sabotage phase 2. In the end, Gebauer never got back into the game and some say that his career at Morgans stalled afterward. Among bankers, the new Rhodes team would be credited with creating a more cooperative atmosphere and a spirit of shared sacrifice among the banks.

  In the last analysis, phase 2 was simply a more workable way of muddling through the debt crisis and postponing the inevitable. The collective power of the commercial banks kept the lid on the pressure cooker in a way impossible in earlier times. These giant global banks had many more levers than the investment banks of the 1920s with which to keep debtors from outright repudiation. Among other things, they could cancel the trade credits of defaulting countries or reduce their overnight “interbank” credit lines. In consequence, as the 1980s progressed the banks were able to boost their loan-loss reserves and weather the crisis, while living standards tumbled in indebted Latin American countries. For most of the 1980s, the Baker Plan—the principle of lending new debt in exchange for economic reforms—was enshrined as the solution to the crisis, and it enjoyed the support of Lew Preston. But the promised economic growth never appeared. Instead, oppressed by interest payments and despite a prolonged boom in the industrial countries, Latin America suffered through a severe depression. How Latin American debtors could withstand the next global recession without widespread default was unclear as the 1980s came to an end.

  In February 1987, Brazil, stifled by a $121-billion debt, which had grown monstrously through the reschedulings, declared a moratorium on repayment that lasted for a year and a half. The country seen as the model debtor in the 1970s had rudely disappointed the House of Morgan. In early 1988, Argentina stopped payment on its debt and fell billions of dollars into arrears. For all the power and ingenuity of the banks in dealing with the debt crisis of the 1980s, the upshot appeared frustratingly similar to that of earlier waves of default. In 1989, the new administration of President George Bush conceded that the only real solution was debt forgiveness. By that point, mobs were ransacking supermarkets in Argentina, as they had earlier in Brazil. In September, 1989, the Morgan bank acknowledged that its Latin debt was a hopeless fiasco by adding $2 billion to its loan loss reserves, fully covering its longer maturity loans. The Morgan fling with the Third World was temporarily over.

  THERE was another coda to the Brazilian debt crisis that tattered the image of Morgan invincibility and belied any notion that it alone was immune to the corruptions of the Casino Age. Even as he chaired Brazil’s rescue, Tony Gebauer was leading a secret, illicit life as an embezzler—a term everyone later danced around in embarrassment, for it savored of small-time crooks and greasy hands in the till, not of the world’s toniest bank. Embezzlement was rare in the world of high-finance for obvious reasons: people made stupendous amounts of money, and if they wanted more, there were legal ways to get it.

  At 23 Wall, there had been a curious negligence about Gebauer, a tendency to look the other way. He enjoyed an entrepreneurial freedom that was rare at Morgans. Later people would recall the fruits of his suspiciously profligate spending—a $5-million Manhattan duplex coop, two homes in East Hampton worth a combined $2 million, an apartment in France, and a share in a Brazilian coffee farm. This didn’t square with a $150,000-a-year salary. With mild shock, Walter Page learned of a yacht that Gebauer had bought from a wealthy friend on Long Island’s Shelter Island. Only later did such details cohere into a telltale picture.

  There were two reasons why no one examined Gebauer critically. Everybody had a vague, somewhat correct notion that he came from a wealthy Venezuelan family. More significantly, he had reaped tens of millions in profit for the bank, compensating for its late start and patrician discomfort in Latin America. From 1981 to 1984, as senior vice-president for Latin America, Gebauer controlled most of Morgan’s Western Hemisphere lending outside North America. He was one of the few irreplaceable stars at a bank with a chronic glut of talented young executives.

  Along with the big loans, Gebauer supervised the accounts of several hundred Latin American businessmen. Technically, they weren’t personal accounts but belonged to executives with whom the bank had commercial dealings—an honored Morgan technique to please and befriend the influential. In 1976, Gebauer had started to divert money from some Brazilian accounts in order to furnish his duplex apartment. In the end, he would dip into four accounts, including those of a landowner and a construction mogul. The money mostly resided in six Panamanian holding companies from which he issued cashier’s checks to himself. These illegal diversions lasted over nine years and amounted to $6 million—thi
s at a bank that prided itself on tight internal controls. The thefts, remarkably, persisted right through the Brazilian debt rescue.

  This was more than a straight embezzlement case, for Gebauer apparently drew on some form of “flight capital”—money smuggled from Latin America to evade taxes or exchange controls. Even as he withdrew the money, there was discussion of how such capital was jeopardizing the debt-rescue effort headed by him and the Morgan bank. As Brazil, Mexico, and Argentina raised billions of dollars in new loans, their disloyal, unethical nationals were stuffing suitcases with bills and flying north to open bank accounts. The big Wall Street banks making the Latin American loans wooed the flight capital and ended up taking as deposits money they had recently lent out.

  Behind the title of international private banking, Morgans and other banks helped wealthy Latin Americans to invest in offshore trusts and investment companies. These devices could aid the unscrupulous in dodging taxes. In the 1970s, Morgan Guaranty and other banks also opened Miami subsidiaries to tap the personal wealth of visiting Latin Americans. In the wrong hands, confidential Morgan accounts could serve as excellent cover for illegal activity. All the Wall Street banks had mysterious Latin American depositors who seldom appeared in person. “They particularly don’t want monthly statements or any other mail sent to their home countries,” noted Fortune in 1982. “Their accounts at places like Morgan are labeled ‘hold mail.’ They drop by in person from time to time to look at the statements.”15

  By extreme estimates, commercial banks were booking more in deposits of flight capital than they extended in new Latin American loans, making them net borrowers from the region. Flight capital siphoned off an estimated one-half of Mexico’s borrowed money, one-third of Argentina’s. Among those bemoaning the problem was Morgan economist Rimmer de Vries. “Capital flight accelerates, enhances, and aggravates a problem that exists,” he stated.16 Morgan chairman Lew Preston was no less disturbed, telling one annual meeting, “It’s a terrible problem for the banks. If the amount of Mexican investment abroad—if that interest—were brought back into Mexico, it would cover their debt service.”17 Even though American banks could legally accept flight capital, Morgans had a stated policy of questioning depositors about the origin and purpose of any suspect accounts. Yet Gebauer was apparently plundering “hold mail” checking accounts. Otherwise, why did years elapse before depositors detected the theft? Why weren’t they monitoring their accounts more closely? One raided Brazilian depositor reportedly hadn’t shown up in five years.