The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance

by Ron Chernow

  However grand its global operations, the House of Morgan remained a New York City bank. It had always regarded the city’s credit as a proxy for America. To that end, it had saved New York in the 1907 panic, in August 1914, and in 1933. These earlier crises illustrated the strength of the Morgan bank. But by 1975, New York had a population the size of Sweden’s and a budget as big as India’s. During the city’s fiscal crisis that year, the Morgan role would seem marginal compared with that of the three earlier rescues.

  Starting with the administration of Mayor John V. Lindsay (brother of Morgan Guaranty’s Rod) in the 1960s, New York City had borrowed heavily for expanded social welfare programs. By late 1974, city paper saturated the markets, driving up interest rates and causing steep losses for underwriters, including Morgans. (Commercial banks could underwrite municipal issues backed by taxing power.) That December, Mayor Abraham Beame held an emergency breakfast with bankers at Gracie Mansion. There an advisory group of three influential bank chairmen was formed—David Rockefeller of Chase, Walter Wriston of First National City, and Ellmore C. Patterson of Morgans. Patterson became the leader, because Wriston was ideologically hostile to government and Rockefeller’s brother, Nelson, was then the nation’s vice-president.

  Ellmore (“Pat”) Patterson was very midwestern, with a relaxed manner and a slow drawl. His description of the Morgan staff might apply as well to himself: “We’re not known for geniuses charging around, but for good solid people with a strong feeling toward the bank.”19 Tall and straight, with a friendly grin, he wasn’t a brainy executive, but he was popular and unpretentious. After Nixon devalued the dollar and imposed an import surcharge, Patterson lunched with the head of the Sumitomo bank, who wanted to know how Patterson could let Nixon take steps harming Japan. “I don’t know the president,” Patterson said breezily. “I never met him.” His luncheon guest was shocked. “You—the head of Morgan Guaranty—don’t know the president of the United States?” Patterson, smiling, said no. If the story says something about Japan, it also says something about Patterson’s candor. He would express no fake altruism about the New York City rescue: “I just didn’t want to have that much debt going bust—just protecting my own hide, so to speak. I sure didn’t want to write off all those investments we had.”20 His Financial Community Liaison Group held its (mostly unpublicized) meetings at 23 Wall.

  In early 1975, when financial markets wouldn’t swallow more city paper, the Patterson group began to function as a de facto government. However Beame might bluster in public, he had to submit to the bankers’ coup. There was a transfer of power from the city’s highest elected official to a new, unelected mayor, Pat Patterson. The humiliated Beame would badger Patterson for news, sometimes telephoning him after midnight. When Patterson went golfing, he would see a golf cart speeding toward him and know it carried a message from the mayor. “He kept calling me and he’d say, ‘What’s going on?’ ” Patterson recalled. “As Beame lost more control, we gradually had to tell him what he could and couldn’t do.”21

  Despite such seeming banker omnipotence, 1975 would actually demonstrate reduced banker influence. Unlike earlier Morgan-led rescues of the city, the bankers were as vulnerable as the city itself. They had granted multibillion-dollar credits to the city and held its paper; at one point, Morgan Guaranty alone had an estimated $300 million of city notes and bonds in its portfolio. By May, trading in New York City debt wound to an eerie halt. Along with a balanced budget and a commission to review city finances, the Patterson group wanted federal guarantees to pry open the closing market. From now on, their “rescue” would involve lobbying Washington and Albany. They were appealing to the government to rescue them and not just the city.

  Patterson set up a White House appointment with President Ford, against whom he’d played college football. Accompanied by Rockefeller and Wriston, Patterson argued in the Oval Office that a New York City default would trigger general damage, depressing all municipal bonds. President Ford, thanking the group for coming, offered nothing in return. Long afterward, Beame would stand in Patterson’s office staring at a photograph taken during the Oval Office meeting. “If Ford had said yes that day,” sighed Beame, “he would have been president today.”22

  The New York City crisis presented an ideological clash among conservative businessmen. Said Treasury Secretary William Simon: “It was one of the saddest days of my life when financial giants like Pat Patterson of Morgan Guaranty and Walter Wriston . . . caved in and finally joined the others in asking Washington for federal aid.”23 Yet the House of Morgan had never adhered to extreme laissez-faire Republicanism. Much like Pierpont Morgan, it placed a premium on financial order. It was close to the Federal Reserve and favored government action to avoid financial disruption. It would never produce as ideological a hawk as Walter Wriston.

  On May 26, 1975, Dick Shinn, head of Metropolitan Life, hosted a meeting at his home with Felix Rohatyn of Lazard Freres and other representatives of New York governor Hugh Carey. They worked out a plan for a Municipal Assistance Corporation (“Big MAC”) to issue, under state auspices, bonds backed by city sales taxes. This permitted banks to exchange $1 billion in shaky city paper for new debt with an A rating. It was Carey’s involvement, not the banks’, that was the critical turning point. With the city again facing default in September, Carey created an Emergency Financial Control Board to assume budgetary powers from the city.

  In mid-October 1975, world financial markets experienced one of those queer moments of falling pressure that sometimes presage storms. Amid fears of a New York City default, Patterson, Wriston, and Rockefeller pleaded for federal help before the Senate Banking Committee. Patterson warned that they were drifting into an unpredictable no-man’s-land that could create an “economic downpull of general economic activity.”24 The three bankers asked for a direct federal loan or loan guarantee to prevent otherwise certain default.

  In November, New York State announced a moratorium on $1.6 billion of short-term debt. Now fearing a generalized crisis, President Ford got spooked and had Congress approve a $2.3-billion line of credit to the city. Much as the state had put the city in its power, so the federal government put New York State under its control. Patterson felt vindicated: “There were a lot of people who would just as soon have seen New York go bankrupt. They thought it was a good thing to clean it out and get rid of the labor contracts. But our committee, fortunately, stuck with it.”25 Patterson was praised by labor leaders and government officials for his constructive, conciliatory approach.

  In the end, the bankers exchanged their risky short-term paper for safe long-term MAC bonds. It had proven necessary to enlist state and federal help. The House of Morgan no longer presided over financial crises. As banks dwindled in power, they could cooperate with government-sponsored rescues instead of leading them. Even the largest could no more control the vast financial markets than they could bid the Red Sea part. The days when a Pierpont Morgan could sit down and extemporaneously write out a single sheet of paper to save the city were long gone.

  CHAPTER THIRTY-ONE

  TOMBSTONES

  TO the outside world, Morgan Stanley still presented a debonair facade in the late 1970s. An Atlantic Monthly reporter, visiting its six floors atop the Exxon Building, marveled at its aplomb, its artfully modulated decor in brown and ocher. “To stroll through the hallways of Morgan Stanley is to move through a landscape of rolltop desks and Brooks Brothers suits,” the reporter declared.1 If it stumbled in the Middle East, it profited handily from the oil boom, arranging an astounding 40 percent of the money raised by the big oil companies. As investment banker to Standard Oil of Ohio, it did a record $1.75-billion private placement for the Trans Alaska Pipeline. In 1977, it supervised Wall Street’s end of a $1-billion offering of British Petroleum shares owned by the British government, the largest stock offering in history. Right through the mid-1970s, it ranked first in the stock and bond offerings it managed.

  It didn’t seem a place in fer
ment, yet it was. Each year, it sprouted a new wing: portfolio management (1975), government bond trading and automated brokerage for institutions (1976), and retail brokerage for rich investors through its purchase of Shuman Agnew and Company in San Francisco (1977). The pride, even smugness, of the old Morgan Stanley stemmed from its extreme selectivity in hiring. Now, in a decade, the firm grew from about two hundred to seventeen hundred employees, with capital soaring from $7.5 million to $118 million. It was growing too fast to preserve a homogeneous culture.

  As architect of this brave new world, Bob Baldwin often seemed disoriented by the range of new businesses. He had instinctively understood the need to trade and distribute securities yet never quite mastered these alien operations. He found it hard to adjust to a bizarre new world of fluctuating market signals and elevated risk. Risk, after all, had been foreign to the old Morgan Stanley, which only wanted sure things. When a $20-million bet on long Treasury bonds went the wrong way, Baldwin, in a sweat, summoned a meeting of all the senior partners. Another time, when bad news from Washington sent the market tumbling, Baldwin appeared on the floor insisting, “The market should go up. The market’s wrong!” This world couldn’t be controlled, even by somebody as strong and willful as Bob Baldwin.

  Bob Baldwin probably saved the firm and destroyed its soul. This new Morgan Stanley was a monument to his force and clear vision, a brilliant adaptation to altered circumstances. Yet he badly politicized a firm long unified by a special esprit de corps. His management philosophy played people off against each other. If meant to improve performance, it produced a tense, unpleasant atmosphere. For the first time in the firm’s history, senior partners defected for other firms. To some extent, turf fights were inevitable in a larger, richer firm. Baldwin, however, exacerbated the tensions. One example involved extremely close friends, Luis Mendez and Damon Mezzacappa, the two stars of the new trading operation. Yet Baldwin gave Mendez a $25,000 bonus, then went out of his way to tell Mezzacappa about it, saying Mendez was doing a better job. This was either obtuse or insensitive. As Baldwin became more abrasive and difficult, Bill Black, son of the former World Bank president, functioned as the great mediator, pleading for those who found it hard to deal directly with the difficult Baldwin. By softening Baldwin’s rough edges, Black held the firm together and prevented an outright split between bankers and traders, such as would later shatter Lehman Brothers.

  The major threat to Morgan Stanley’s preeminence was its celebrated but increasingly tenuous policy of appearing as sole manager atop tombstone ads, those black-bordered boxes of underwriters’ names that appear in newspapers. Tombstone positions were a life-and-death matter for Wall Street firms. Those in higher layers, or brackets, received larger share allotments, while the smaller firms tried to struggle their way upward. Within brackets, firms were listed alphabetically. During the Great Alphabet War of 1976, Halsey, Stuart adopted its parent’s name, Bache, just to bootstrap up a few lines in tombstones. This was no joking matter. On May 13, 1964, Walston and Company had been demoted from a top bracket in a Comsat offering; the next day its managing director, Vernon Walston, shot himself, giving a macabre new aptness to the term describing the ad.

  In the late 1960s and early 1970s, the top tier—called the bulge bracket—consisted of Morgan Stanley; First Boston; Kuhn, Loeb; and Dillon, Read. The first two originated most business, and Morgan Stanley was reluctant to relinquish the undivided profits of sole managership. A former managing director explained, “When I first went to Morgan Stanley, a senior person laughed and said to me, We only have to scare people into using us as sole manager 50 percent of the time and we’re still better off.” There was a touch of narcissism in wanting to appear alone in the top left corner of tombstones. There was also an unstated agenda: before the 1970s, Morgan Stanley lacked selling power and disguised this weakness by leading syndicates and having other firms do the selling. As Lewis Bernard later said, the firm “had to keep the Street from realizing the emperor had no clothes.”2 While other firms tried to ape the sole-manager strategy, none succeeded nearly as often as Morgan Stanley.

  In order to make the policy stick, Morgan Stanley had to sacrifice even powerful clients who demanded co-managers on issues. (The Japanese rebuff was an early and notorious example of this.) It skipped one underwriting after Houston Industries insisted on rotating lead managers. It skipped another when Singer wanted to reward Goldman, Sachs for some merger work by appointing it co-manager. But such was Morgan Stanley’s evergreen mystique that many firms, from Du Pont to J. P. Morgan and Company itself, still submitted to its golden chains on all their underwritings.

  Because up to two hundred firms participated in Morgan Stanley syndicates, they feared its displeasure. Before 1975, Morgan’s syndicate manager was Fred Whittemore. Bright, sardonic, and voluble, an avid collector of Pierpont Morgan memorabilia, he was called the Godfather or Father Fred. He had a pervasive power on Wall Street. When William Simon wished to return to Salomon Brothers after serving as treasury secretary, it was Father Fred who interceded with John Gutfreund. In the early 1970s, many attributed E. F. Hutton’s stunning rise to Father Fred’s patronage, and he didn’t hesitate to thwart competitors, such as Lehman Brothers. After each issue, Father Fred filled out large yellow cards listing each firm’s performance. Sometimes participants lied or took losses just to look good.

  There was always suspicion that Morgan Stanley exploited its sole-manager power to fend off competitive threats. “We could be talking to their clients about an investment banking relationship, and if Morgan saw this, instead of giving us half-a-million shares, they might hold back on us,” one rival told the New York Times in 1975.3 Morgan Stanley bristled at these anonymous snipes in the press, which appeared periodically. Father Fred created the modern Wall Street lineup. He kicked out the fading Kuhn, Loeb and Dillon, Read from the bulge bracket and brought in Merrill Lynch, Salomon Brothers, and Goldman, Sachs. After Kuhn, Loeb—historically the most redoubtable Morgan adversary—was absorbed by Lehman Brothers in 1977, senior partner John Schiff met Harry Morgan at a board meeting of the Metropolitan Museum of Art. When Morgan asked how this had happened, Schiff replied, “Henry, you chose your partners better than I did.”4 Schiff’s remark pointed to a continuing strength of the Morgan houses—the sheer excellence of their people.

  But by the late 1970s, Morgan Stanley’s sole-manager policy was a gilded anachronism. How could you handcuff clients in global financial markets when corporate treasurers enjoyed so many options, so much room in which to maneuver? The firm, significantly, had never made the sole-manager policy stick at its Paris joint venture with Morgan Guaranty. A loyal home client like General Motors Acceptance Corporation openly used other bankers abroad. In April 1977, in a final break with 23 Wall, Morgan Stanley closed up shop in Paris and set up Morgan Stanley International in London, linchpin of its Euromarket operations. The new operation had a rude shock when Australia, a faithful client since 1946, jumped to that old Morgan nemesis, Deutsche Bank. The event underscored not only the new power of global distribution, but the far more anonymous world of interlinked financial markets.

  Even at home, there were new forces corroding the chains that bound companies to bankers. Since the days of Louis Brandeis, political reformers had advocated an arm’s-length relationship between companies and investment bankers. It was the theme broadcast by Robert Young during his testimony before Judge Medina and in his fight for the New York Central. The system had survived, however, because companies craved the association with the august House of Morgan, a vestige of the days when capital was scarce. But how could bankers still lord it over companies when capital was no longer rationed—when it was available in many markets in many forms? What leverage did they have as new financial intermediaries sprang up? From the clients’ standpoint, was there any longer a rationale for having an exclusive banker relationship? The answer was no.

  So corporate America now did the work that was once solely the cause of reform
ers. One by one, corporate treasurers broke the links in the bankers’ chains. In the 1970s, Texaco, Mobil, International Harvester, and other clients circumvented Morgan Stanley and placed their debt directly with institutional investors. Other companies used dividend-reinvestment plans or employee stock purchase plans to raise capital. Having to cope with inflation and unstable exchange rates, corporate treasurers were receptive to bright ideas thought up by competing banks to deal with the new volatility. Jack Bennett of Exxon delighted in making Morgan Stanley spar with other firms. “We decided that any time a banker came up with a good idea, we’d talk to him,” said Bennett. When he set up “Dutch auctions” for issues, encouraging several competing syndicates, Morgan Stanley began to sense that its sole manager policy faced a mortal threat.

  For Morgan Stanley, the doomsday trumpet sounded in 1979. That year, IBM asked the firm to accept Salomon Brothers as co-manager on a $1-billion debt issue needed for a new generation of computers. It was a telling sign of corporate autonomy in the Casino Age that IBM had a $6-billion pile of cash on hand. It had never needed a public debt offering. (Some Morgan people say the IBM relationship—nominally Bob Greenhill’s account—was mishandled because nobody ever expected the company to require money.) In applying its sole-manager policy, Morgan Stanley had never before been obliged to turn down a client of such stature. Now here was one of the world’s largest corporations, a twenty-year client with a triple-A rating, undertaking the largest industrial borrowing in history.