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

by Ron Chernow

  Prohibited from maintaining dollar deposits in the United States, Brazilians customarily gave their Wall Street bankers wide latitude in managing their investments. It was later unclear whether Gebauer had permission to withdraw money from some clients’ accounts—something to which his lawyer would make cryptic allusion. Yet this couldn’t have been uniformly true, for Gebauer manufactured bogus statements on Morgan stationery, then mailed them to clients. To plug holes in the accounts, he secured Morgan loans of about $2.9 million. Why would he have resorted to these extraordinary measures if he were acting with the consent of his depositors?

  In 1982, even as Brazil teetered on the edge, Gebauer took $1.5 million from the account of a Brazilian named Francisco Catao. This money represented a “commission” Catao received from an arms dealer in exchange for the dealer’s being introduced to Gebauer. This, in turn, led to a $35-million Morgan loan to the arms merchant. Might Gebauer have had a proprietary feeling toward that particular $1.5 million? In an equally bizarre twist, he diverted embezzled money into his own Latin American business, using it to make loans at low interest rates—as if he were entering the banking field as a minicompetitor to the Morgan bank itself.

  Tony Gebauer lacked any of the standard motivations for committing a crime. Unlike the routine cases, his crime coincided not with failure but with stunning success in the sphere of international banking. He had no reason whatever to resent the bank or wish to embarrass it. In fact, he had a deep, abiding love for Morgan traditions, lining his bookshelf with Morgan history and taking great pride in his association with the bank. At tremendous sacrifice to his personal wealth, he remained there when he could have parlayed his connections into a $1-million-a-year income at an investment bank. It’s even conceivable that he resorted to crime so he could remain at the bank yet live in a style befitting his fantasies. He apparently let months pass without touching the Brazilian accounts and wasn’t consumed by his crime. It was more tangential, gratifying some psychic need left unsatisfied even by his exceptional career.

  Like many embezzlers, Gebauer planned to make restitution someday. Much like the Brazilians he rescued, he was defeated by the interest, not the principal, accumulating on his burdensome debt—$2 million of it. Late in the summer of 1985, after a twenty-four-year Morgan career, he left for Drexel Burnham Lambert, to work with Michael Milken on a special project to repackage Third World debt into junk bonds (the 1920s solution). Some at Morgans thought his career had been derailed by the controversial Brazilian debt rescheduling. Shortly after he left, the bank was alerted to his crime by a puzzled Brazilian client whose money supposedly on deposit in New York was wired from Venezuela. The timing seemed coincidental: neither Brazil nor the bank needed Tony Gebauer any longer. He was found out when nobody but he would suffer from exposure of the crime. The House of Morgan sent Price Waterhouse auditors and trusty Davis, Polk lawyers to Brazil to investigate. They netted an accomplice to Gebauer—Keith McDermott, a vice-president who allegedly received $200,000 in kickbacks for Morgan work on behalf of two clients. The bank’s investigators passed on their information to the Fed and the U.S. district attorney’s office. When confronted with the charges by Drexel Burnham officials, Gebauer resigned on the spot.

  When the affair hit the news in 1986, it made headlines in Brazil as well as in New York. How had the world’s best-run bank missed the scandal for nine years? Gebauer reportedly believed the millions were too trivial to warrant the attention of a bank grappling with billion-dollar debts. After the scandal broke, the bank was in a sticky situation, guilty of either incompetence or complicity. It portrayed Gebauer as a lone culprit and swore that no customer lost a penny in the end. “Our investigation convinces us that the responsibility for wrongdoing lies with one person. . . . We think it’s unfair that other people be implicated,” declared a spokesman.18 Gebauer quickly became a taboo subject at 23 Wall. Morgan officials still find it hard to utter his name and often refer to him as “that fellow,” as if they had never known him very well.

  Gebauer didn’t contest the charges. To avoid the stigma of embezzlement, he pleaded guilty to bank fraud, tax evasion, and doctoring statements. Because he had submitted some surreal tax returns—one year he banked over $1 million in taxable income but reported only $21,000—he owed the Internal Revenue several million dollars in back taxes and penalties. He also paid back $8 million in principal and interest to the bank. His clever lawyer, Stanley Arkin, referred obliquely to flight capital and hinted that Gebauer might have had authority to use some Brazilian money: “That authority was premised on the unusual and Byzantine relationships that often exist between bankers and flight capitalists.”19 Such loose talk made Morgans jittery and eager to strike a deal.

  In February 1987, a contrite Tony Gebauer stood in a blue pin-striped suit before Judge Robert W. Sweet for sentencing. The judge saw a large dimension of fantasy in Gebauer’s life, a venal excess characteristic of the age. “You are indeed a Lucifer, a fallen angel of the banking world,” he told him. “Although your employment at the top of your profession provided you with a princely income, you spent like an emperor.”20 Gebauer received a three-and-a-half-year prison sentence but served only half that time.

  The Gebauer affair left behind red faces and personal wreckage in the corporate suites at Morgans. Half a dozen executives were shifted about. In a sad conclusion, Tony Gebauer, so proud of his Morgan employment, ended up disgracing the bank.

  CHAPTER THIRTY-THREE

  TRADERS

  IN the early 1980s, as the final vestiges of fraternity among the Morgan houses disappeared and Morgan Guaranty abandoned wholesale lending to enter global investment banking, it ran into Morgan Stanley. It was also on a convergence path with Morgan Grenfell. When Morgan Guaranty occupied a sleek building of brown granite and smoked glass near the Bank of England—snobbishly named the Morgan Bank, disregarding poor Morgan Grenfell some blocks away—the ancient Anglo-American link, too, was threatened. Starting in 1979, the London-based Morgan Guaranty Ltd. became a major underwriter in the Euromarkets. How could Morgan Guaranty retain a one-third stake in Morgan Grenfell as they clashed in foreign outposts and invaded each other’s home turf? As Bill Mackworth-Young of Morgan Grenfell said, “It doesn’t make sense to be 33$$$ owned by one of your competitors.”1

  Morgan Grenfell needed expansion capital but couldn’t pry it loose from 23 Wall. The London bank’s home success had bred hopes for bigger things abroad, especially in New York, where it had had a small office since 1974. To transcend that token presence was impossible so long as Morgan Guaranty owned a one-third stake. So in 1981, the Morgan chairman, Lew Preston, and president, Robert V. “Rod” Lindsay, flew to London to inform Lord Stephen Catto, over dinner, that 23 Wall had decided to sell its stake. The House of Morgan petered out, mourned by few. “It was a bit of a twinge for me and a few seniors at Morgan Grenfell and a few others around here,” recalled Lindsay. “But it became clear to everybody that they needed more freedom to go their own way.”2 Lew Preston had grown uncomfortable with Morgan Grenfell as the old, aristocratic families faded from the scene, people who had all trained at 23 Wall. He explained, “The Bank of England expected us to share one-third of every loss, but there was a management evolution where we didn’t know the people who were running the firm.”3 The new breed was typified by chief executive Christopher Reeves, a former assistant personnel manager at Hill Samuel, who had never passed through the Morgan Guaranty training program.

  Thus ended a transatlantic axis more than a century old, the armature on which the House of Morgan had been built. Catto said, “I had seen it coming with regret. We had one request: that they not sell it all at once, which would look like a loss of confidence in us. They agreed to sell it piecemeal.”4 Within a year, the bank took its stake below 4 percent, pocketing $40 million and leaving the Lloyd’s insurance broker Willis Faber as chief shareholder, with 24 percent. In a declaration of freedom in 1981, Morgan Grenfell set up an investment bankin
g subsidiary in New York, expanding its money management and international M&A businesses. By 1985, it belonged to the New York Stock Exchange. The pretense of brotherhood had given way to raw competition.

  A creature of markets, J. P. Morgan and Company—the parent company of Morgan Guaranty—now operated by new principles. It raised billions of dollars daily in the money markets and was emancipated from dependence on loan spreads and deposits. Though the bank still had no retail branches, Morgan people joked that they had a retail bank—Merrill Lynch, whose money market fund bought Morgan CDs. The House of Morgan had all but given up on wholesale lending as an anachronistic business for a bank whose blue-chip clients could raise money more cheaply in the marketplace, as they increasingly did in the early 1980s. In 1983, international bond offerings, for the first time, passed global bank lending in scope. Lew Preston didn’t want to join an extinct breed. “Basic lending is never going to return to the profitability that existed in the Fifties and Sixties,” he predicted.5 Foreign bank competition also thinned loan spreads.

  The upshot was that the Morgan bank began making more money from investment banking fees and trading income. The future bank took shape in London, where Morgan Guaranty had become the top Eurobond underwriter among American commercial banks, with clients including Exxon, IBM, Du Pont, and even Citicorp. From number forty-six in 1980, it zoomed to second place in Eurobonds four years later. It also accelerated trading in gold bullion, foreign exchange, and financial futures.

  The locomotive behind these changes was Lew Preston, who embodied the bank’s old silken charm but imbued it with a new, sometimes fierce energy. A Harvard graduate from a rich Westchester family, he had started in the Morgan mailroom (as everybody did) in the early 1950s. He was first viewed by elders as a playboy, socialite, and jock. Tall and broad-shouldered, he played semipro ice hockey with the Long Island Ducks until he came home one night with six stitches in his head. “You damned fool,” his wife said, “why don’t you grow up.”6 His second wife, Patsy, was a granddaughter of newspaper publisher Joseph Pulitzer and mixed with Brooke Astor, Jane Engelhardt, and other socialites.

  This Lew Preston seemed all tradition. Among the antique furnishings in his office were an oil portrait of Jack Morgan, a rolltop desk, and a photograph of Pierpont and Jack striding manfully into the Pujo hearings. Wearing half-moon glasses and red suspenders and smoking Don Diego cigars, he could effect an extremely dignified presence. Once, after making a presentation to Noboru Takeshita, then Japan’s finance minister and later prime minister, the dignitary breathed with admiration. “You were prime ministerial in your presentation,” he said. “I am stunned.”

  The elegant manner and dryly mischievous wit covered early scars. When Lew was a boy, his father died of tuberculosis. He also struggled with dyslexia. (“It’s very fashionable now,” he remarked. “Everybody seems to have it.”7) At seventeen, he enlisted in the Marine Corps and was sent to China. He ended up as a bodyguard to James Forrestal, later Truman’s secretary of defense and a close family friend. Demobilized, Preston attended Harvard, from which he graduated in 1951. He would always be a cross between a Harvard socialite and a tough marine. Curt with fools, sometimes abrupt at meetings, he would show exemplary kindness to someone who was hospitalized, bereaved, or recently divorced. Some at 23 Wall revered Lew Preston, some were slightly afraid of him, and some both revered and feared him.

  This dual personality mirrored the Morgan transition. Preston tried to perpetuate the old Morgan culture of teamwork and subordination of the individual to the group: “I want people who want to do something rather than be someone.” With department heads, he held the traditional weekly meetings and encouraged senior people to lunch together in the executive dining rooms. This Preston conceded that “a little bit of conservatism in a bank is not a bad thing” and said rather loftily of Citicorp’s Walter Wriston, “He’s running a financial conglomerate and we’re running a bank.”8 He tended the bank’s image as if it were a stage set. “We spend an extraordinary amount of time just worrying about the environment,” he said.9

  At the same time, an avuncular style no longer worked completely in a bank with over fifteen thousand employees. Morgan elders had taken a fatherly interest in their staff, with talk of one’s being “brought up” at 23 Wall. Now in a vastly speeded up bank, there wasn’t time for prep-school camaraderie. Preston had to retrain masses of old-time commercial bankers and credit analysts, making them into risk-taking market whizzes. This meant encouraging aggressiveness and imagination, not just politeness and caution. Competing with investment banks, Preston had to pay huge bonuses and use other compensation methods that fostered divisiveness. By the 1987 crash, some Morgan traders earned more than Preston’s own $1.3-million salary. As the eighties progressed, many people left the bank or were gently nudged out. Even among those who stayed, there was a bittersweet sense that the bank was less fun and caring than in the old days. It was also a far more diversified firm. In 1984, for instance, Boris S. Berkovitch became vice-chairman of the bank—the first Jew ever to rise to the top of Morgan officialdom.

  A major protagonist in this shifting drama was Preston’s protégé, Dennis Weatherstone, the foreign-exchange wizard from London. A short, trim Englishman with crinkly hair and a quick smile, Weather-stone never lost his working-class accent. He had a natural grace and friendliness, not the cultivated polish of his Morgan colleagues. He joked about his early bookkeeping days as the time he had “no shoes.” During a brief Royal Air Force stint, he had scanned radar screens in simulated air flights, computing fuel usage for planes—an experience, he said, that sharpened his mind for foreign-exchange trading. Weather-stone was the quintessential Casino Age banker—a man versed in new financial instruments, interest swaps, and currency swaps. Early on, he saw the impact of “securitization”—the packaging of loans as tradable securities—on the traditional lending business. In 1980, he became chairman of the bank’s executive committee, right under the blue-blooded president, Rod Lindsay, and then succeeded Lindsay in 1987.

  Preston and Weatherstone were complementary and inseparable. “They spoke in a patois,” recalled a colleague. “They were like Siamese twins. One would start a sentence and the other would finish. They were very unlike, but they thought the same.” Since much Morgan influence with central banks derived from its Treasury operation, Weatherstone fit handily into the special relationship with the Fed. “Both he and Preston probably have more credibility with Washington policy makers and regulators than any other bankers I can think of,” said Anthony Solomon, former president of the New York Fed.10 The Preston-Weatherstone team was therefore, predictably, at the center of the 1984 rescue of Continental Illinois Bank and Trust Company.

  The Morgan role had some irony to it. The Chicago bank was a stiff competitor of Morgans and so similar in style and structure that it was called the Morgan of the Midwest. A prestigious, old-line wholesale bank, it had courted rich families and financed much American auto and steel business from its stately, pillared building on South LaSalle Street. In the early 1980s, it vied with Morgans for the title of premier corporate lender. Like Morgans, it had plunged into the roulette world of “liability management”—that is, it financed its operation from the money markets rather than by deposits. Rounding up $8 billion daily, it borrowed overnight Fed funds, sold CDs, or issued commercial paper. The House of Morgan had played this game with such panache since the days of Ralph Leach that its risks were often obscured. Continental’s collapse would show the extraordinary perils inherent in the new banking.

  Morgans had long suspected that Continental’s success was a mirage. It undercut competitors too vigorously on real estate, agriculture, and energy loans and rather cavalierly made loans to Chrysler, International Harvester, and other troubled firms. One Morgan official recalled, “All our younger bankers were saying, ‘How do these guys do it? They must be doing it with mirrors.’ They were making loans that any number of banks had shied away from.” Contin
ental was also paying exorbitant interest rates for its $8 billion. It relied mostly on “hot money”—large, volatile deposits from foreign and domestic institutions. Such jumbo deposits ran anywhere from $5 million to $200 million and far exceeded the $100,000 lid covered by deposit insurance. Managers of such deposits were skittish and apt to pull funds at the first hint of trouble. Yet even so conservative a bank as Morgan Guaranty drew 75 percent of its deposits from “hot money.”

  Continental began to unravel during the Fourth of July weekend of 1982 with the failure of the Penn Square Bank. This was the notorious Oklahoma shopping-center bank that had booked and resold to Continental $1 billion in bum energy loans. (One picturesquely modern aspect of Penn Square’s downfall was a run at its drive-in window.) To reassure institutions holding its paper, Continental began to pay higher rates on its CDs. When domestic money managers balked, the bank relied more on Japanese and European funds and sent its financial evangelists abroad to preach calm. “We had the Continental Illinois Reassurance Brigade and we fanned out all around the world,” said David Taylor, Continental’s chairman in 1984.11