The Match King

by Frank Partnoy

  Pierpont Morgan had always been the leading lender to France, and his son Jack had assumed he would inherit any French business. That assumption had been true through 1926. Both Jack Morgan and Ivar had made overtures to the French government during 1924 and 1925, but Jack had won the beauty contest each time. Ivar had made progress in some smaller countries, but the titans of Europe - France, Germany, and Italy - remained wedded to Morgan.

  Yet in July 1926, when France fell into financial crisis and Raymond Poincaré was reinstated as prime minister, Poincaré immediately sought help, not from Jack Morgan, but from Ivar. The reasons were both financial and personal. France already owed J. P. Morgan & Co. 100 million dollars at an interest rate of 8 percent, and Morgan had refused to lend any more. Jack Morgan in particular worried that the French franc might follow the German mark’s plunge into oblivion.

  Unlike Morgan, Ivar was willing to offer a loan. And he was willing to accept a lower interest rate than 8 percent.

  During the previous decade, Ivar quietly had built a strong relationship with France in general and Poincaré in particular. He advised Poincaré about the global economic scene and various industries the French government owned and administered. He assisted the dysfunctional French Monopoly Administration. Through Swedish Match, he sold matches, match-making machines, and raw materials to the French government. Most important, Ivar and Poincaré discussed France’s fiscal needs. France’s predicament was straightforward, but not easy to resolve: it needed to reduce its annual obligations so that it could afford various government programs without going deeper into debt. Ivar saw an opening here, and his chance to compete with Morgan.

  With the rise of the investor class in America, the financial power base was shifting from banks to investors, and this shift was very much to Ivar’s advantage. Previously, banks had played the primary economic and financial roles, and a handful of bankers, led by Morgan, had exercised control of the financial system. But now that investors were becoming more important, the bankers were losing their grip. Jack Morgan might have the minds of other American bankers, but Ivar had the hearts of American investors, and those investors now had the power. Ivar didn’t need to lend his own money to France. Instead, he could act as an intermediary, raising money from the Americans and lending their money.

  Once Poincaré was firmly in control of the French government, Ivar approached Durant and Berning with an idea for a fifth securities issue in the United States. Lee Higginson had sold International Match’s gold debentures in 1923 and three different participating preferred issues for the company from 1924 through 1926. Overall, American investors had bought 70 million dollars of International Match’s securities, which made Ivar’s company one of the most widely held stocks in the US. Investors were delighted by Ivar’s inroads into the match markets of Poland and other smaller countries, and the rising prices of International Match’s preferred shares reflected their optimism about Ivar’s future match deals.

  Now, Ivar proposed something truly bold: one massive 50 million dollar issue backed by an arrangement with the French government. It would be one of the highest-profile deals in the history of the American markets. Ivar told Durant and Berning he finally was ready to close his first blockbuster loan to one of Europe’s powerhouses.

  It was an audacious proposal, but by 1927 Americans were ready for audacity. Everyone, including investors, was developing a taste for novelty and adventure. This was the year Charles A. Lindbergh flew from New York to Paris. It also was the year a record 270 new shows opened on Broadway, many of which would have been regarded as scandalous a few years earlier.42 Even experts in the dismal science of economics were giddy in 1927: world-famous economist John Maynard Keynes pronounced that, “We will not have any more crashes in our time.”

  During that summer, the Federal Reserve lowered interest rates to 3.5 percent and flooded the market with cash by purchasing government securities. 43 Brokers made unprecedented amounts of call loans, which permitted investors to buy stock “on margin,” borrowing a portion of the purchase price. Investors responded by purchasing record numbers of shares at record prices. The Dow Jones average of leading US companies’ shares rose on twenty-four of twenty-seven straight trading days. At the New York Stock Exchange, as many as 3 million shares traded each day. On a single day, 651 of 1,100 separate issues were traded, a new record.44 Previously, on a typical day for most companies, not even one share would change hands.

  Poincaré was as bullish as the Americans, and he was intrigued by Ivar’s loan-for-monopoly idea. However, most French government officials turned up their noses at the notion of a Swedish businessman telling them how to conduct business. At first, the manager of the French match monopoly rebuffed Ivar.45 Marius Moutet, the socialist party spokesman, argued that Ivar was an unwelcome foreign intruder who would squelch their liberty: “If you wish to let the French government associate itself with a world power of this nature, do you really believe that this would be an arrangement between equal partners? That is why I say that the real issue is not what you are discussing, but whom you are dealing with.”46

  Initially, even Poincaré could not overcome this criticism. The Chamber of Deputies, the lower house of France’s parliament, rejected Ivar’s initial monopoly proposal by a vote of 281 to 243. It seemed that the French government’s monopoly was too deeply cemented for Ivar to budge. As one journalist wrote, “le Napoleon des allumettes has met his Waterloo.”47

  Still, Ivar was determined. He knew that, without a French loan deal, his bold new securities issue would fail. American investors were primed to give him money. Berning, his auditor, was in his hip pocket. Durant, his banker, was as friendly as ever. All of Ivar’s ducks were in a row. Except in France.

  Ivar quickly took a new tack. He abandoned the monopoly idea, and instead persuaded Poincaré to propose a twenty-year contract that gave Ivar more limited rights. The new proposal would reorganize the country’s match business, as Ivar originally had suggested, but no one would use the word “monopoly.” Nor would Ivar take over any responsibilities from the officials who ran the French match business. Ivar’s new proposal seemed far less intrusive: the French government merely would agree to pay Ivar higher prices for matches, match-making machines, and raw materials, and to buy more of each.

  The French deal wasn’t called a monopoly but it was one in everything but name: the agreement with the government gave him exclusivity and the right to charge high prices. The French government agreed to enforce the restrictions, too. If someone brought even a dozen foreign matches into France, they would pay a heavy fine.48 Even the French left wing could accept this deal politically.

  Meanwhile, Ivar argued to the Americans that the new proposal was a minor concession, given that Swedish Match already had been selling these items to the French government for years. International Match would make the same amount of money; it was merely a semantic change to persuade the French. Overall, the compromise was a brilliant political move.

  Ivar also dangled a loan with unprecedented terms. He would lend France 75 million dollars at a rate of just 5 percent, a full 3 percent less than Morgan had been charging. France would have the right to redeem the loan early, but would not be obligated to repay the full amount for forty years.

  Why would Ivar offer the French such incredibly attractive loan terms? He certainly wanted the fame, and he longed to unseat Morgan as the leading lender to Europe. He also believed that a revitalized France would be good for the global economy overall. But Ivar wasn’t being entirely magnanimous - he planned to make some money, too.

  Although the French public would see this loan as being for 75 million dollars, Ivar insisted that he issue the loan at a price of 93.5 percent of par. Par referred to the amount of the loan on the face of the loan documents. For each 100 dollars of par amount France agreed to repay Ivar in forty years, it would receive just 93.50 dollars today, substantially less than par. In other words, France actually would receive about 70 million
dollars upfront, but would have to repay 75 million dollars. That higher repayment meant that the effective interest rate France would pay on the loan would be higher than 5 percent and would depend on when it repaid. If France actually repaid the loan over forty years, the difference in cost would be minimal. But if Poincaré decided to repay the loan early, Ivar would make a much higher return. In effect, Ivar would get an extra 5 million dollars if France prepaid its loan right away.

  It was unclear whether the members of the French Chamber of Deputies understood all of these details. What everyone clearly saw was that France needed money and that Ivar’s new proposal permitted the government to keep its precious match monopoly. With the last canards in place, Ivar closed the loan in November 1927. He promised to send 70 million dollars to France.

  Jack Morgan followed these negotiations closely. Ivar was becoming a real threat, and his new proposal would harm Morgan’s business. It wasn’t just that Ivar’s loan would erode Morgan’s franchise in the area, though that was important. In addition, the Morgan partners were counting on the 8 percent annual interest payments from France. If Ivar’s loan replaced the lion’s share of Morgan’s loan, Morgan would lose that income.

  Indeed, Jack was right to be concerned, and Ivar’s deal caused him some pain. In anticipation of receiving Ivar’s money, Poincaré prepaid Morgan’s loan, thereby releasing the government from its obligations to pay the higher 8 percent interest rate. Because Morgan’s loan had not been issued at a substantial discount, like Ivar’s loan, Morgan did not benefit in the way Ivar would from prepayment. By refinancing with Ivar, France raised an extra 5 million dollars - the difference between the amount of Ivar’s loan and the portion of Morgan’s loan it prepaid - and it reduced the government’s annual interest burden by nearly 2 million dollars a year. That was money Jack Morgan had been expecting, but would not receive.

  The deal brought hope to Paris. If Poincaré could maneuver loan negotiations so skillfully, perhaps he could save the economy as well. Not only did the French government now have money to spend, but the French people finally had some much-needed confidence. Soon French investors would be as optimistic as the Americans.

  As usual for Ivar’s match-for-monopoly deals, one question remained: How would he come up with the money? This question was especially important, given the size of the obligation. Ivar owed France 70 million dollars. Swedish Match and Ivar’s various subsidiaries could cover almost a third of the loan.49 But the remaining 50 million dollars would have to come from International Match. Indeed, “have to come from International Match” was a written commitment he had made as part of the deal with Poincaré. The directors of International Match had given Ivar wide-ranging powers to negotiate on their behalf, and Ivar had done so. He had contractually obliged International Match to cover 50 million dollars of the French government loan.50 Ivar had made a similar promise before to Poland, but this new one was three times as large.

  Obviously, Ivar now faced intense pressure to close a deal in America. Without fresh capital from American investors, International Match wouldn’t have enough money to pay France. If Ivar couldn’t deliver the cash to Poincaré, his reputation would be ruined.

  The new 50 million dollar issue of International Match securities would be Ivar’s most innovative yet. He wanted International Match’s payments on the new securities to match the interest payments promised from France as closely as possible, so that he could simply pass through to American investors any money he received from France while the loan was outstanding. The easiest way to match the 5 percent interest payments owed by France was to promise investors a 5 percent return. But he also wanted to build in some profit potential, both for investors and for himself. He invented a new financial gadget to achieve these goals.

  Ivar designed a new kind of “convertible debenture derivative,” with three key components. First, the “debenture” component would pay a flat interest rate of five percent, in the same way that International Match’s first issue from 1923, the “gold debenture,” had paid a flat rate in dollars or gold. (Given Ivar’s stature, a promise to pay in US dollars was fine; investors no longer needed his promise to be backed by gold.) An investor who bought 100 dollars of the new debenture would receive 5 dollars of interest each year. That money would match the payments from France.

  Second, the “convertible” component would give investors the right to convert their debentures into shares of International Match. For example, an investor with a 100 dollar investment might have the right to purchase one share of International Match common stock. As long as the price of that share was less than 100 dollars, the investor would just keep the convertible debenture, and pocket 5 dollars of interest payments every year. But if International Match’s common stock became more valuable than 100 dollars, the value of the convertible debentures would rise, too. Theoretically, the investor’s upside was unlimited. The higher the price of International Match stock, the more valuable the convertible debentures. These first two features meant that investors would both receive a 5 percent return and also would have the upside associated with International Match shares.

  Ivar also added a third “derivative” feature, which gave investors yet more upside. The 5 percent interest payments would increase along with any increase in dividends paid by Kreuger & Toll, International Match’s Swedish parent company. Specifically, investors would receive an additional payment of 1 percent for each percentage point of dividends above 5 percent declared by Kreuger & Toll. If Kreuger & Toll paid a dividend in Sweden of less than 5 percent, the holder still would be guaranteed the 5 percent interest payment from the first “debenture” feature, but if Kreuger & Toll paid a higher dividend, the holder would benefit one-for-one along with Swedish shareholders from this third feature. For the previous nine years, Kreuger & Toll had paid double-digit dividends, most recently as high as 25 percent, so there was substantial additional upside that was derived from Kreuger & Toll’s dividends. If Kreuger & Toll paid 25 percent, investors in these new instruments would receive 5 percent interest plus an extra 20 percent.

  Ivar had to decide how long these “derivative” payments should last. The French obligation to pay Ivar 5 percent interest was for forty years, although the government could prepay. Ivar decided on a twenty-year maturity with a feature known as a “sinking fund.” The sinking fund meant that Ivar would return a portion of the investment periodically - he would allow it to “sink” over time - for twenty years. Ivar couldn’t be sure when, or if, the French government would prepay its forty-year obligation, but, hopefully, the maturity of the debentures would roughly match the maturity of the French loan.

  The convertible debenture terms were first publicized in November 1927.51 The deal was widely advertised as backed by a Who’s Who of Wall Street, including the era’s most prestigious bankers (Lee Higginson, National City, Brown Brothers, and Dillon, Read) and lawyers (Ropes, Gray, Boyden & Perkins and Carter, Ledyard & Milburn). Everyone was involved. That is, everyone except Jack Morgan.

  Would Ivar’s new product be too complex for investors? Ivar thought people were ready for some financial innovation and would see and understand the potential upside. He was right. The convertible debenture derivatives looked too good to be true, and that was exactly what investors wanted. They were thrilled by the derivative component and the idea of payments linked to Kreuger & Toll’s dividends. Similar instruments issued in Europe were trading at 650 percent of their face value. Americans gobbled up these new instruments, whether they understood the details or not.

  Indeed, investors were so excited about the new convertible debenture derivatives that they agreed to pay more for the debentures than France would receive from its loan. In other words, Ivar would raise more money from the Americans than he owed France. Because investors were willing to pay so much for the expected upside from the derivatives component, Ivar was left with a substantial difference, which he could keep. It required only a little bit of math to see that Ivar would ma
ke a fortune from the new issue.

  Whereas France would receive just 93.5 cents for each dollar of loan, American investors agreed to pay 98.5 cents for each dollar of debentures - or one extra nickel more per dollar. Those nickels added up, and the difference between what International Match received from investors and what it paid to France was 2.5 million dollars. It was simple subtraction:

  International Match receives: $49.25 million (98.5 percent of $50 million)

  International Match pays: $46.75 million (93.5 percent of $50 million)

  International Match keeps: $2.5 million

  This profit of 2.5 million dollars represented one of the largest fees for any financial transaction in history. Ivar simply played the role of intermediary, putting together American investors who had money with a French government that needed money. The market regarded International Match’s credit risk as substantially better than that of the French government, so International Match could raise 98.5 cents from the market, give 93.5 cents to France, and keep a nickel for itself. So long as the payments matched over time, and the derivative payments did not increase too much, International Match would retain the full amount of the upfront profit. Indeed, if France repaid the loan early, International Match might make even more money.

  As with Ivar’s other sales of securities in the United States, most of the money raised - all but 2.5 million dollars - left the country immediately. But this time, everyone knew that the money was leaving, and they knew where it was going and why. The 46.75 million dollars didn’t go into some secret subsidiary in Liechtenstein or Holland. It didn’t go to Ivar or even to Swedish Match. This time, it went directly to France.

  With the French deal, Ivar saw that it would be possible for him to replace Jack Morgan as the leading financier to the world. Ivar had, as one writer put it, “bearded Morgan in his den.”52 The French people found Ivar to be a truly great and powerful man. The international media compared him to the Medicis and Fuggers, history’s other great private funders of governments.