The most respected newspaper in the land in its most widely read edition of the week had indicated that I might soon be fired. I have to concede that the Times story was neither unexpected nor entirely unfair. The mid-1970s had been a difficult period for Chase. A series of problems adversely impacted the bank’s performance and profitability, which raised questions about my effectiveness as chief executive officer.
The first problem was an almost total collapse in our operations management systems—the document-processing and record-keeping function that lay at the heart of the bank—producing an alarming deterioration in service, a commensurate increase in customer complaints, and a steep decline in earnings. This was followed by a forced restatement of our balance sheet as a result of an overvaluation in our bond trading account that cost us $33 million.
Soon after that we had a disastrous run of losses in our real estate portfolio that culminated in the eventual bankruptcy of Chase Manhattan Mortgage and Realty Trust (CMART), the real estate investment trust that, regrettably, carried the bank’s name.
During the same time we were overtaken by our archrival, Citibank, in terms of total assets and earnings.
The final indignity was the flaunting of our problems in a front-page Washington Post story, picked up by other national media, that hinted at a potential Chase insolvency.
The confluence of these events placed the bank and my management under a microscope where every decision was dissected and every misstep recorded. Few companies, then or since, have been held to such a level of public scrutiny.
During the first half of 1976, Business Week called Chase a “floundering giant.” Institutional Investor asked on its cover, “Can David Rockefeller Ever Get His Act Together?” And in perhaps the most ignominious of all, Financial World ran a seventy-two-point, all-cap headline on its cover: “WHY DAVID ROCKEFELLER SHOULD FIRE HIMSELF.”
Even as these difficult problems were aired by the press, Bill and I had already taken a number of concrete steps to correct the problems for which we were being pilloried and which had long characterized Chase’s “culture.” Through it all I continually reaffirmed my confidence that the bank would regain its position of leadership in terms of both profitability and respect and that I would remain as CEO to see it reach these goals.
But sitting in my living room that cold winter morning and reading the Times story that picked apart my management style and business acumen, I realized most people would not give me much of a chance of achieving my goals or even of serving out my full term as CEO.
HERSTATT HARBINGER
The first years of the 1970s were characterized by worldwide inflation and recession, disruption in the balance of payments between nations, and the gradual breakdown of the international monetary system. The huge increase in energy costs occasioned by the OPEC price increases provided the coup de grâce to the steady economic growth and relative stability that had characterized most of the post–World War II era, ushering in a period of great risk and uncertainty. In the early summer of 1974 we found out just how risky and uncertain the world had become.
On June 26, Bankhaus I. D. Herstatt, a small family-owned bank in West Germany, went belly up. The cause of Herstatt’s collapse was a $100 million loss they had taken speculating in the increasingly volatile foreign exchange market. Chase was Herstatt’s principal correspondent and dollar-clearing bank; all claims against their account came through us.
Under normal circumstances the monies paid into each correspondent bank’s account would cover the debits to that account by the end of each business day. However, during the course of any given day, claims against an individual customer would often exceed its balance with us so that for a few hours we would be extending, in effect, a loan to that bank. Prior to the 1970s these amounts were quite modest, but as the speculative fever in the foreign exchange markets mounted, “intraday” loans in the millions of dollars suddenly became the rule rather than the exception. The income from the balances in these accounts made it a profitable business for us, but we also faced much greater risks.
In Herstatt’s case we were lucky. The foreign exchange trader at our Frankfurt branch learned of the failure at 4 P.M., European time. He called New York, where it was 11 A.M., and we immediately froze the $156 million we had on deposit. By the end of the day the claims against Herstatt considerably exceeded the $156 million. By acting quickly Chase avoided any losses. Other banks holding unpaid claims had to wait months for the American courts to allocate limited funds among the many claimants.
We had dodged the bullet, but the broader lessons of Herstatt’s failure could not be ignored. International financial markets had evolved to the point where the old regulatory mechanisms could no longer manage them properly. The collapse of a small bank in Germany, which most people had never heard of, had disrupted markets for a significant period of time. The insolvency of a major bank could have produced a world economic crisis. While the central bankers of the world struggled to replace the existing system of fixed exchange rates with something more flexible, the private sector also needed to adjust.
Chase had been struggling for some time with the inadequacies of our operational systems and internal controls. Indeed, by the mid-1970s problems with the bank’s back office had become as critical as any that faced the institution.
THE BACK OFFICE
Chase had been among the first of the major banks to automate its operations beginning in the late 1950s. Banks had enormous record-keeping requirements—an avalanche of paper. Accordingly, the new technology was introduced to all of the bank’s operational areas: check processing, demand deposit accounting, stock transfer services, payroll, installment credit, and the like. The computer also allowed us to centralize our back office operations in a new building especially constructed for that purpose and to begin to apply rigorous cost analysis methods so that management had the tools to measure quickly and by sector the profitability of our products and the effectiveness of our organizational units.
That was the good news.
The bad news was that the new electronic technology changed frequently and was quite expensive to install and operate. In addition, automation required a host of new employees, programmers, systems analysts, and operations research technicians. Integrating these new employees with those handling the more traditional tasks of banking, and ensuring that the technical personnel communicated effectively with the credit officers, proved to be a daunting task, especially when most of us at the senior level of the bank had only a superficial understanding of computers and their capabilities.
In the summer of 1972, I invited Frank Cary, the chairman of IBM, which was an important Chase customer, to have lunch with me. Frank took advantage of the occasion to warn me that Chase was not doing a good job in managing its back office operations. He said we would never correct the situation until the top management of the bank understood the basics of computer technology and how to integrate it into our daily operations. He invited me to make use of IBM’s special weekend course on computers for senior corporate executives. Although I was intrigued by the idea, I did not follow up on it until two years later.
At that time about twenty of Chase’s top executives, including Bill Butcher and me, traveled to IBM’s training center in Poughkeepsie. It was an eye-opener for all of us. By that time, however, we had experienced several painful and well-publicized operational glitches. The most embarrassing of them occurred in February 1974. Shortly before we were scheduled to exchange our obsolete UNIVAC for a new IBM mainframe, disaster struck. An overzealous janitor mistook the spare parts of the UNIVAC for junk and threw them out. The UNIVAC soon gave out completely, and we were forced to rely on a manual record-keeping operation for a number of months before the new IBM system was ready. Even after the new IBM began operating in July, there were many glitches and delays. We had, as our operations vice president put it, “garbage in, garbage out, and a backlog of garbage.”
In the midst of this debacle th
e bank examiners from the Comptroller of the Currency arrived for their annual visit. Not unexpectedly, they found deficient operating systems in a number of our departments and issued a report to the Chase directors that termed our operations “horrendous.” Bill and I devoted a good deal of our time over the course of 1974 and 1975 to solving this problem and assuaging the complaints of customers. It was an embarrassing period, and our operational problems contributed significantly to a number of our difficulties during those years. By mid-1975 we had largely overcome these problems and returned our operations to a high level of efficiency. But the damage, in terms of customer relations and public perception, had been done.
SCANDAL IN THE BOND DEPARTMENT
Technology was not our only problem. Chase was also bruised by a scandal that was even more damaging to our reputation. The scandal involved the bank’s bond department, which, in addition to trading bonds for others, held U.S. government, state, and municipal bonds for our own account. Securities law required banks to issue quarterly reports on their holdings, but establishing a fair market value for state and municipal securities, which at that time were usually long in term and thinly traded, was not an easy proposition. Most banks, including Chase, solved this problem by using a formula that estimated their current market value. Federal regulations also required that whenever bonds dipped below their book value, the shortfall had to be reported in a bank’s quarterly income statement.
What got us into trouble in October 1974 was that the senior vice president in charge of the bond department guessed wrong on interest rates. Anticipating that rates would fall and prices would rise, he loaded up on government bonds—adding about $1 billion to our portfolio by the middle of 1974. Unfortunately, interest rates did not perform according to his prediction. He held on as interest rates moved up, gambling that the market would correct itself and his position would be covered. Unfortunately, he failed to report the accounting loss, thus violating the law.
Unaware of this omission, Chase issued an inaccurate third-quarter statement at the end of September 1974. After a routine internal audit revealed the truth, the bond department head admitted he had purposely concealed the losses in the hope that values would recover.
Bill Butcher and I were in Washington for the World Bank/IMF meetings and were hosting Chase’s annual dinner when we received the news. Without finishing dessert we left our guests and flew back to New York. We arrived at my house on 65th Street at about 11 P.M. Chase director Dick Dilworth, our outside counsel, and several senior officers were assembled. They had been working at a frenzied pace all day, and none of them had taken time for dinner. Peggy cooked hamburgers and prepared hot chocolate while they briefed Bill and me on the situation.
The next day, after informing all the bank’s officers, we released a statement admitting that serious errors of judgment had been made and that the senior vice president in charge of bond trading had been asked to resign. We estimated that the bond trading account had been overvalued by some $34 million and that this would lower Chase’s published after-tax earnings for the preceding nine months by $15 million. It was front-page news in both the Times and The Wall Street Journal the following day. Ironically, within a few months interest rates did decline, and the $15 million unrealized loss was erased.
It made little difference. The debacle brought into question the effectiveness of Chase’s supervision and reporting, damaged the bank’s hard-earned reputation for integrity, and raised questions about the competence of its chief executive officer.
MEDIA ONSLAUGHT
Recessions are rarely kind to business and frequently disastrous for banks. The steep 1974–75 recession was particularly damaging to large commercial banks in the United States. And as our problems at Chase accumulated and our earnings plunged by more than 42 percent, from $182 million in 1974 to $105 million in 1976, the media singled out Chase and me for special attention.
Part of the problem was the impressive performance of Citibank. Capitalizing on its aggressive expansion overseas in the 1950s and 1960s—when I was arguing vainly that Chase pursue a similar course—Citi had moved decisively ahead of Chase by the mid-1970s. In 1970 the two banks were in a dead heat in terms of earnings; by 1975, Citi’s earnings had moved well ahead of ours, thanks largely to its enormous international advantage. As Citi swept past Chase, the critics let us have it. Chase management, they reported, had gotten flabby. They pointed to the failure of Herb Patterson’s presidency, the bond trading fiasco, a $97 million loan to bankrupt retailer W. T. Grant, Chase’s large holdings in suspect New York City obligations, and finally and most particularly, the bank’s mounting problems with real estate loans.
The pressure on the bank and me was unrelenting. Time magazine reported “rumors that Rockefeller’s job is at stake.” Newsweek indicated that Chase directors were “sounding out at least one prospect to succeed the sixty-year-old Rockefeller as chairman.” A Newsweek reporter asked Treasury Secretary William Simon if he would be my replacement. Simon responded, “I could turn that situation around in six months to a year.”*
All in all, it was not a happy time to be chairman of Chase.
THE CHASE REAL ESTATE INVESTMENT TRUST
The primary cause of my many woes at the bank was the collapse of the national real estate market. With the onset of the recession in late 1973 the real estate market, which for several years had been exceptionally strong, began to weaken. Chase had been a major and successful real estate lender, but when the recession hit, we discovered we had taken greater risks in our real estate lending than we had realized.
Our principal problem was Chase Manhattan Mortgage and Realty Trust (CMART), the real estate investment trust (REIT) we had created in April 1970 to take advantage of the surging property market. REITs became fashionable as a result of changes in the tax code designed to encourage broader private investment in commercial real estate. Before then, commercial real estate development had been financed almost exclusively by commercial banks and insurance companies. To make stock ownership of REITs more accessible and attractive to individual investors, Congress decreed that they would be taxed at a lower rate than other corporations as long as they paid out 90 percent of their revenue annually to their shareholders. REITs quickly became popular investments. On the other hand, the stockholder payout requirement also added a substantial element of risk by preventing the accumulation of reserves that might be needed in an emergency. When the recession deepened in early 1974, this element would lead to disaster for REITs in general and CMART in particular.
Chase had been in the real estate business for a long time and had developed substantial expertise and extensive connections throughout the country. Ray O’Keefe, the executive vice president who ran the department, was considered the dean of the industry. That is why when Ray extolled the benefits of a REIT as a potential generator of profits, I listened. General Lucius Clay, a senior partner at Lehman Brothers, whom I had first met in 1947 when he was one of the Allied military governors in Berlin, was also a persuasive proponent of the REIT, as were most of my senior bank associates. Despite some misgivings about the risks, I was finally persuaded by their arguments and gave my approval.
In 1970, Lehman Brothers and Lazard Frères underwrote the successful offering of CMART stock. Although the REIT was a legal entity totally independent of Chase and with its own board of directors, it carried the bank’s name. This proved a significant mistake. As we would learn, when investors purchased CMART securities, they looked to us to take care of them if things went wrong.
For its first three years CMART prospered, generating large fee income for the bank and impressive dividends for its shareholders. However, the initial success experienced by CMART and many other REITs played a large role in their eventual downfall. New capital flooded into the REIT marketplace, and the pressure increased to find new projects. In response, REITs and their sponsors lowered their lending standards. Chase’s Real Estate Department was no exception.
; CMART was highly leveraged, drawing its funds from capital markets, bank loans, and commercial paper. The commercial paper it used was in turn backstopped by bank lines of credit. This meant that if CMART could not pay off its debt when it came due, the bank was committed to lend it the money necessary to make good on the REIT obligations. This leverage would turn out to be Chase’s undoing.
By the spring of 1975, CMART had loans to developers approaching $1 billion and bank credit of over $750 million, including $141 million from Chase. At the same time, 46 percent of its assets were no longer producing income, and CMART was operating at a loss. In July 1975, CMART announced a $166 million six-month loss. This resulted in a negative net worth of $50 million. CMART was technically bankrupt.
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