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

by Ron Chernow

  Fisher found the answer to his handicap in the sedentary world of trading. Working out of a soundproof glass box, the so-called lean-to on the trading floor, he organized the new bond trading operation in the 1970s. (With nice symmetry, his brother David would head J. P. Morgan Securities.) It was a lucky choice. Like Dennis Weatherstone at Morgan Guaranty, Fisher’s stock rose at Morgan Stanley in direct proportion to the growing vogue for trading on Wall Street.

  Another critical figure was Lewis Bernard, nicknamed Brainy Bernard, the first Jewish partner and probably the best strategic thinker in the firm. He chaired a 1979 task force to devise a ten-year plan for Morgan Stanley. It was Bernard who introduced the computerized, multicurrency system for global trading that would make Morgan Stanley a trendsetter. In 1983, he headed a new fixed-income division that belatedly led the firm into the trading of gold, precious metals, and foreign exchange and the issuing and trading of commercial paper, municipal bonds, and mortgage-backed securities—all tools to please increasingly demanding corporate customers. These activities also required more traders and salespeople, further transforming Morgan Stanley into an anonymous global financial conglomerate.

  In a critical strategic step, Morgan Stanley, so averse to foreign markets in the early post-war era, made a major commitment to trade and distribute securities overseas. It wisely abolished all managerial distinctions between its domestic and international operations. As trading and mergers superseded underwriting at Morgan Stanley, elegance was out and brashness was in—a jarring experience for its once sedate culture. As the New York Times said in 1984, “Morgan executives, who for generations have seemingly enjoyed their reputation for being the aristocrats of investment banking, seem confused these days about their image.”28 As its exclusive ties with clients lapsed, it had to hustle for business and encourage aggression. As at Morgan Grenfell, a firm once mocked for stuffiness proved it could be ruthless if necessary in preserving its privileges.

  In the takeover area, Morgan Stanley shed all pretense of passivity. In 1978, merger specialist R. Bradford Evans had said, “We don’t pester our clients and say, ‘Why don’t you accept this company, or that company, anything to get a deal.’ ”29 In 1981, Morgan Stanley still led Wall Street with $40 million in merger fees, doing a third of all deals. Then Goldman, Sachs, First Boston, and Lehman Brothers leapt ahead. By 1983, under intense competitive pressure, Morgan’s takeover department of seventy-five professionals was scouring the landscape in search of target companies. They started banging on doors, using the hard sell. “In the past there was a reluctance to call people,” said Bob Greenhill. “It was the culture to let the client call you.”30 Now Morgan Stanley would increasingly serve as an engine of the takeover boom.

  As its underwriting business declined, Morgan Stanley turned to businesses it once would have rejected haughtily, entering the netherworld of junk bonds. These high-risk high-yield bonds were often issued to support takeovers by companies of questionable solidity. The new junk bond department coincided with Morgan Stanley’s sudden interest in small start-up companies. As Bob Greenhill explained, “Morgan was building a high-technology effort at that time, and I said, ‘How can we not be in a business that is so necessary for so many of our growing clients?’ ”31

  Junk bonds revolutionized Wall Street by magnifying the money available to corporate raiders. Where conglomerate takeovers in the 1960s used share exchanges, and cash was the method of choice in the 1970s, the junk bond market let corporate raiders flout the Wall Street establishment and finance their incursions by selling bonds to investors. The merger frenzy was also fueled by abundant money from commercial banks, whose dwindling prospects in wholesale lending attracted them to the financing of takeovers. Thus both sides of Wall Street—commercial and investment banking—found takeover work a salvation from the fundamental crises in their core lending and underwriting business. The razzle-dazzle of Wall Street in the Reagan years would obscure this underlying fragility, the irreversible decline of traditional businesses, the obsolescence of the traditional banker.

  With considerable hoopla, Morgan Stanley talked about gentrifying junk bonds, but self-congratulation proved premature. In mid-1982, Morgan Stanley joined with Hambrecht and Quist to sponsor the first public offerings of People Express, the pioneering no-frills discount airline. Buying up used Lufthansa planes and ripping out their first-class sections, People founder Donald C. Burr wanted to create cheap air travel for the masses; his feisty, hustling airline was the anti-thesis of a classic Morgan client. Between 1983 and 1986, Morgan Stanley underwrote more than $500 million in junk bonds for People. As if still leary of its junk bond departure, the firm overruled custom and let Charles G. Phillips, head of its junk bond department, take a seat on People’s five-member board.

  From modest beginnings at Newark International Airport, People rocketed to the top rank of American airlines. In the end, Burr was victimized by his own ambition, making an ill-fated purchase of Frontier Airlines and trying to beat the major carriers on their own turf. He financed his frantic expansion by a staggering accumulation of debt. Later it was alleged in lawsuits that Phillips egged on Burr to borrow and expand too quickly. Whatever the truth, when crisis struck People Express, some bondholders felt betrayed by Morgan Stanley. They not only suffered serious losses, with some paper trading as low as 35 percent of the original issue price, but accused Morgan Stanley of failing to maintain a market during the turbulence. By one account, Morgan Stanley bought People bonds until it had $40 million worth in its inventory.

  There was a second dimension to the controversy. For two and a half months, as bondholders suffered, Morgan’s M&A Department shopped People to potential customers, exposing the firm to a possible conflict of interest. Honoring the Chinese wall, Charles Phillips kept the merger talks secret and didn’t notify the bond traders of these efforts. Yet bondholders felt deprived of information that should have been provided by Morgan Stanley as the bond underwriter. The problem here was not that Morgan Stanley neglected its duties. The problem was that the conglomerate structure of modern Wall Street presented Morgan Stanley with incompatible duties. For People investors, the end was short, nasty, and brutish. When Frank Lorenzo of Texas Air bought People Express, he paid 75 percent on the face value of unsecured bonds and 95 percent on secured bonds.

  In the early takeover days, there had existed a clear-cut distinction for Morgan Stanley between its stalwart clients and their takeover targets. It would never represent a raider against a client because it then might sacrifice that client’s lucrative underwriting fees. But as underwriting ties with blue-chip companies decayed, there was no reason why the firm shouldn’t represent raiders as well. The very notion of a client list—a sacred group of companies—broke down. In the new transactional environment, Morgan Stanley might represent a raider one year, then defend another client against that same raider the next. So many deals were germinating in the big merger departments that shifting loyalties and conflicts of interest were inevitable.

  The inescapable danger was illustrated by Morgan Stanley’s relationship with T. Boone Pickens of Mesa Petroleum. Back in the 1970s, Morgan Stanley couldn’t have dealt with a corporate predator like Pickens, because he menaced its seven-sister clients. But as the big oil companies grew less loyal to Morgan Stanley, so the firm gladly dealt with other energy firms. In 1982, T. Boone Pickens enlisted Morgan Stanley to raid the Dallas-based General American Oil. “They were delighted to get the business,” recalled Pickens, “for GAO was not part of the establishment that Morgan caters to.”32 On January 6, 1983, Pickens signed a standstill agreement with GAO stipulating that he wouldn’t buy stock or try to gain control of the firm; it was bought the next day by Phillips Petroleum. Morgan brokered a deal by which Phillips Pete bought 38 percent of Mesa’s shares and even picked up its $15 million in fees to the bankers and lawyers. During the summer of 1983, Morgan Stanley and Pickens briefly thought of teaming up to bust up a major oil company. The deal fell t
hrough, Pickens thought, when Morgan decided not to “alienate some of their clients—the Good 01’ Boys in spades.”33

  In December 1984, Pickens tried to swallow Phillips Pete, now represented by Morgan Stanley’s Joseph G. Fogg III, a young, prematurely balding man who wore clear-framed glasses and had a cool, precise, intellectual look. As with Greenhill, clients found him abrasive but tolerated him for his brilliance. He was a whirling dervish in the nonstop oil takeovers. In 1984, he advised Standard Oil of California in its $13.4-billion takeover of Gulf Oil, the largest on record. Morgan Stanley banked a royal fee of $16.5 million for its work, even though it had committed no capital and used perhaps a dozen people.

  The 1984 battle for Phillips Petroleum ended up pivoting on the standstill agreement of early 1983. It was a ticklish situation. Fogg and Pickens, who were then partners, were now opponents, and their recollections of the agreement were different. Fogg said he and Joe Flom had told Pickens the agreement would apply to Phillips as well as GAO. Pickens had “recognized the fact, expressed lack of concern and proceeded to execute the agreement.” contended Fogg.34 “Other people involved in the GAO deal remembered it differently,” replied Pickens, who claimed that the deal applied only to GAO. And it was Pickens who won a favorable court ruling. He observed, “Since Fogg was working for us at the time, it cost him and Morgan credibility on Wall Street.”35

  Just as it seemed that Rule 415 had liberated companies from their Wall Street bankers and opened up a permanent distance between them, a new trend, called merchant banking, arose to obliterate the trend. Morgan Stanley had always been a service outfit, never compromising its objectivity by acting as an investor as well. Bob Baldwin had said in 1980, “We’re so client-oriented and so busy that most of us have done very poor jobs of investing our money. That would not be the case with some firms, which have had all kinds of entrepreneurial investments.”36 That year, the firm conquered its prudery. It took a share in an Exxon oil-shale project in Australia, scouted timber investments, expanded its real-estate portfolio, and started to invest in high-tech start-ups. For the first time, Morgan Stanley was acting as a principal (investing its own money) and not just as an agent (advising clients on investing their money.) These investments foreshadowed a Wall Street fad that would entail a retrogression to some of the worst excesses of the robber baron era.

  In 1982, to inaugurate the new merchant-banking operation, Morgan Stanley hired Donald P. Brennan, a former vice-chairman and fifteen-year veteran of International Paper. It was rare for an industrialist to work on Wall Street. The tough, fierce-willed Brennan would bring unique management skills, for he thought like a corporate executive. The firm set up a short-lived leveraged buyout fund with CIGNA Insurance, which reaped twenty-five times its original investment and whetted its appetite for more. Nobody envisioned how central the small merchant-banking group would eventually become to Morgan Stanley.

  Breaking with another tradition, Morgan Stanley in 1980 began managing money for individuals and institutions. Another Chinese wall went up around another department. Some Wall Street firms balked at entering the business, fearing possible conflicts as they invested money in companies that were also takeover or underwriting clients. Once again, Morgan Stanley’s decision conferred legitimacy on a dubious practice. As money manager Sanford Bernstein said, “If Morgan Stanley is in it, that means we’re kosher.”37 In 1980, the firm had less than $1 billion under management, an amount that swelled to $10 billion by 1985. After details appeared in the press about Citibank’s management of Kuwait’s money, the sheikdom switched over about $4 billion in securities to Morgan Stanley’s money managers. In the days of Harry Morgan, the firm had refused to do business with the Teamsters. Now it beat out twelve other firms for a contract to manage America’s largest and most controversial pension fund, the $4.7-billion Teamsters Central States fund.

  Morgan Stanley’s new wing caused a small revival of the relationship with Morgan Guaranty. The Morgan bank was still legally barred from distributing mutual funds but could offer investment advice. So it agreed with Morgan Stanley in 1982 to create the first Pierpont Fund, with Morgan Stanley managing and Morgan Guaranty advising it. This family of funds would attract $2 billion through a time-honored Morgan formula of scorning the vulgar herd. They had a $25,000 minimum, versus the standard $1,000, and unlike other mutual funds, they didn’t report their daily results in the newspapers. In the words of Morgan Stanley’s Matthew Healey, “We didn’t want to take the Pierpont funds into the competitive arena.”38 Everywhere else, however, Morgan Stanley was right smack in the middle of competition for the first time and was playing as rough as anybody.

  CHAPTER THIRTY-FOUR

  BANG

  IN late 1986, Morgan Grenfell presented a curious study in contrasts. Outwardly it maintained a sedate air. Upholding a tradition of nearly 150 years, the bank posted no nameplate outside—the old brass plaques hung in the reception area—and the interior paid homage to the past. In the thickly carpeted, arched hallways, there were prints of Saint Paul’s and the Bank of England, of hansom cabs rolling through gaslit streets in a fin de siècle City. Morgan Grenfell was said to have the last man in the City to wear a bowler hat—one Julian Stamford. It still seemed a civilized place.

  But the calm was deceptive. Morgan Grenfell had charted a course roughly parallel to Morgan Stanley’s, dispensing with politeness and becoming a tough, aggressive firm. For twenty years, it had revolted against its sleepy past. Starting with the American Tobacco fight for Gallaher in the late 1960s, it had enjoyed testing the rules. “They liked the image of being the most buccaneering firm in the City, of pushing out the boundaries,” observed an ex-merger specialist with the firm. “Every deal was a little more provocative and cheeky and less British than the one before.”

  Morgan Grenfell’s two leaders in the early 1980s reflected both the old and the new City. Chairman Bill Mackworth-Young had spent twenty-one years with the aristocratic brokerage firm of Rowe and Pitman, second in prestige only to Cazenove. If Morgan Grenfell wasn’t particularly well known for brilliant executives, the bookish Mackworth-Young gave the firm intellectual cachet. He had been a star Eton pupil, along with his classmate Robin Leigh-Pemberton, later governor of the Bank of England. The son of an English civil servant and archaeologist in India and married to an earl’s daughter, Mackworth-Young was a good salesman and a charming after-dinner speaker. He was especially adroit with Americans, having gone yearly to Bohemian Grove in California, the rustic stag camp for American power brokers. A warm, stocky man with a ready, avuncular smile, he lacked malevolence and was universally popular.

  A heavy smoker, Mackworth-Young died abruptly of lung cancer in 1984. Later, the City would ritually repeat that had he lived, Morgan Grenfell would have been spared the Guinness scandal. According to a rival executive, “Mackworth-Young would have given free rein to the takeover prima donnas, but he would have been quite aware of what was happening. He would have taken a longer term view of how the business should be conducted.” When things later went awry at Morgan Grenfell, Mackworth-Young only grew more saintly in memory.

  Morgan Grenfell’s chief executive and deputy chairman was Christopher R. Reeves, who epitomized the new, self-made City executive. A graduate of Malvern College, he worked at the Bank of England and the merchant bank of Hill Samuel before Sir John Stevens recruited him to Morgan Grenfell in 1968. He belonged to the first generation of Morgan Grenfell executives who didn’t come from the old families and hadn’t apprenticed at the Morgan bank in New York. Slim and blond with a chiseled, angular face, he had a photogenic grin and a look of gritty determination. In a firm once faintly embarrassed about seeking new business, Reeves didn’t mind the hard sell. Tough and adept, he was enigmatic to his subordinates. “He was a superb presence but a bit of a sphinx,” a former corporate finance director recalled. “Silence was his partner.” He was drawn to the tough tactics of “corporate finance”—a term that in England signifies takeover wo
rk.

  Neither Reeves nor Mackworth-Young was a master strategist. Unlike Morgan Guaranty or Morgan Stanley, Morgan Grenfell never operated by a blueprint or comprehensive vision of the financial future. Its history was devoid of planning conferences or retreats during which the firm could strategically reorient. Its postwar history had no Bob Baldwins or Lewis Bernards, no Henry Alexanders or Lew Prestons, and certainly no Siegmund Warburgs. Its moves seemed improvised, a snatching at sudden opportunities. To paraphrase Winston Churchill, it was a pudding without a theme, and this absence of a clear design would be its downfall. Both Reeves and Mackworth-Young ran a series of successful, often unrelated businesses without any single thread binding them together. By comparison, Morgan Guaranty and Morgan Stanley had a seamless quality, a smoothly coordinated approach to business that seemed to anticipate changes in financial markets.

  Morgan Grenfell had enjoyed some remarkable successes, which masked long-term problems. It managed money for the world’s two richest people—the sultan of Brunei and Queen Elizabeth II—and surpassed all other British banks in handling American pension funds. It specialized in international portfolios when many short-sighted asset managers were still mired in local markets. After years of torrid growth, by the 1987 crash it managed $25 billion. This dwarfed America’s top asset manager among wholesale firms, Morgan Stanley, with its meager $11 billion. At 23 Great Winchester, pension money for San Francisco, the state of California, Fort Worth, and the Rockefeller Foundation was handled.