by Ron Chernow
The prospect was for a progressive erosion of the free balances. For the House of Morgan, without a cushion of consumer deposits, the specter of losing corporate deposits was especially ominous. Some inside the bank saw the dismal future of wholesale banking with remarkable clarity. Thomas S. Gates, Jr., who would succeed Alexander as chairman, used to say to him kiddingly, “You know, this isn’t a very good business to be in.”25
Emancipation was at hand. In 1961, George Moore and Walter Wriston of First National City figured out how to circumvent the regulatory cap on interest rates. By law, banks couldn’t pay interest on deposits held under thirty days. But by selling “negotiable certificates of deposits” that matured in more than thirty days, banks could pay interest. These CDs could also be traded (hence, the “negotiable” in their name). Their use sparked a revolution in the way commercial banks operated, freeing them from reliance on deposits. Bankers no longer had to wait for deposits and were liberated from both companies and consumers. Now they could roam the world and raise money by selling CDs in overseas wholesale markets. The new system was known as managed liabilities. (In banking parlance, loans are assets and deposits, liabilities.) So relationship banking was crumbling on two sides—that of the restless corporate treasurers, who demanded yields from their deposits, and that of the freewheeling bankers, who could dispense with deposits and turn to money markets.
The Morgan innovator was the tall, florid Ralph Leach. A University of Chicago graduate and a disciple of Milton Friedman, he started out as a Federal Reserve Board staffer and tennis partner of Fed chairman William McChesney Martin: the two would dash from morning meetings of the Federal Open Market Committee to grab the Fed’s court by noon. When Leach left for Guaranty Trust in the early 1950s, Martin, who’d been the first salaried president of the New York Stock Exchange, told him, “Don’t forget, Ralph, your associates in the next year or two will be people we could have put in jail fifteen or twenty years ago.”26 As Morgan Guaranty’s treasurer, Leach still advised the Fed and coached its board of governors and staff on money market operations. In the new era, Morgans’ intimacy with the Fed would come not through lending, as in the Twenties, but through its Treasury operation. It would act as the Fed’s eyes and ears in the marketplace and sometimes receive central-bank intelligence in return. It would now have better connections at the Washington Fed than it did during the New Deal. In the 1950s, Morgans had hired Arthur Burns as a consulting economist, and he would follow Martin at the Fed.
At Guaranty Trust, Leach had peppered Cleveland with memos showing how the bank could manage its capital more aggressively. The patronizing Cleveland would reply, “Young man, go upstairs and run the portfolio and we’ll run the bank.”27 After the merger, Leach got to pursue his experiments and pioneered in the Federal funds market. Fed funds were reserves that commercial banks deposited with the Fed. Some banks would temporarily have “surplus” Fed funds—that is, reserves beyond their legal requirements. Morgans began to take the temporary, unused reserves from small interior banks and either use them or lend them to other banks on an overnight basis. The size of these short-term loans rose spectacularly, to $1 billion or $2 billion a day. Some banks believed the new market shouldn’t be used for trading profits. Leach, however, a born trader, viewed the Fed funds market as a source of profit.
For commercial bankers, the world of negotiable CDs and Fed funds signified a dramatic change. As banking switched from a deposit to a money-purchase business, the center of gravity shifted from the banking floor to the trading room. The business acquired a new speculative cast as banks built up huge, diversified investment portfolios. Banking became not only riskier but more impersonal. The old-fashioned banker lunched with corporate treasurers to make sure they kept deposits at the bank. But traders were a lean, hyperthyroid breed who spent days on the telephone, riveted to the changing prices; they didn’t need to be particularly polite or cultured. The leisurely pace of deposit banking was replaced by the traders’ snap judgments.
The Fed saw perils in this volatile new form of banking. Would savings and speculation become jumbled, as they had in the 1920s? Hadn’t Glass-Steagall shielded banks from such fast-moving markets? Morgans handled its trading operation with great panache, and its trading desk would be a postwar strength. But how would the new system work in clumsier hands? Would it turn into a dangerous instrument? “The Fed would say to us, ’It’s all right for Morgan to do it, but what if Bank of America or City did it?” recalled Leach. “Their feeling, in many cases, was, ’It’s good for you guys, but bad for the country.’ When they asked how other banks would fare, I would duck it by saying that I wasn’t arrogant enough to answer.”28
Gradually the House of Morgan drifted back into capital and money markets. Banned from corporate securities by Glass-Steagall, it became the most active dealer in Treasury and municipal securities in the 1960s. Unlike the straitlaced bankers of old, Leach would place large bets on the direction of interest rates. Now a commonplace banking practice, this was a frighteningly novel departure for conservative souls at 23 Wall. In 1960, Leach saw an excellent chance to speculate on one-year Treasury notes being auctioned by the Fed. When he calmly proposed a huge bet to the Morgan board, Henry P. Davison, the vice-chairman, asked, “Ralph, what kind of numbers are we talking about?” Leach said airily, “Oh, $800 million to $1 billion.” Swallowing hard, Davison replied, “This is going to take us time to digest, Ralph. That was the size of our entire bank a year ago.”29
This new banking would wake up the drowsy Wall Street of the 1950s. Soon the tenth floor of Morgan’s building at 15 Broad Street had scores of frenetic young traders taking positions in T-bills, negotiable CDs, foreign exchange, and Fed funds. Before long, Leach oversaw $ 1 billion of market transactions daily. In 1966, Fortune claimed that Leach “very likely handles more money in the course of a year than any other man in private industry.”30
At one point, Leach became too assertive, and the government stepped in. In August 1962, the Treasury auctioned $1.3 billion in bills maturing in three months. Leach placed a shockingly large bid—$650 million, then the largest bid ever submitted for T-bills. Wall Street saw an attempt to corner the market. Although Leach blandly denied any sinister intent, Treasury Secretary C. Douglas Dillon promulgated a new policy, courtesy of the Morgan bank. Henceforth, no single bidder would be awarded more than a quarter of the bills offered at any weekly auction. The Morgan allotment was halved to $325 million.
It would take the general public many years to catch on to these changes. The rise of bought money, negotiable CDs, and daring trading would have an enduring effect on banking. Bankers formerly had been preoccupied with the “asset” side of the business—that is, making loans. Now the liability side—the money on which loans were based—took on equal importance. Profits could be expanded in two ways—by securing higher interest rates on loans or by buying money more cheaply in the marketplace. In this new environment, that bastion of conservatism, the House of Morgan, elevated the trader to unaccustomed eminence.
Unfortunately for the banks, this new world of wholesale money markets also worked to the advantage of their corporate customers. Just as the Morgan bank could sell its CDs around the world, so a General Motors or a U.S. Steel could circumvent the bank and sell promissory notes called commercial paper at interest, rates lower than those they would pay for a bank loan. In the wholesale corporate world in which Morgans operated, the banker was shedding his unique place as an intermediary between the providers and the users of capital. In the Casino Age, large corporations would increasingly serve as their own bankers, creating a crisis in the wholesale lending business, which had seemed so safe to the J. P. Morgan partners back in 1935.
THE rise of the Euromarkets accelerated the banking revolution of the early 1960s. With scarcely a whisper of public protest, these unregulated overseas markets subverted the spirit of Glass-Steagall. In the 1950s, so long as America was rich and other countries poor, bright young Mor
gan bankers avoided international banking. Henry Alexander’s career was emblematic: he lacked the ties to foreign ministers that were symbolic of the careers of Tom Lamont and Russell Leffingwell. Yet he foresaw foreign trade and investment as the next phase of American economic life. American companies were expanding overseas at a rapid clip. Soon after the Morgan-Guaranty merger, Alexander and Walter Page went abroad to set up Morgan offices in Frankfurt, Rome, and Tokyo, resurrecting the old international network. Morgans used the 1919 Edge Act, which allowed American banks to take equity stakes in foreign banks if a country didn’t allow U.S. bank branches. By 1962, the House of Morgan had interests in eleven financial houses from Australia to Peru to Morocco. Once again, in the Casino Age, American banks were trailing after their multinational customers, not leading them.
To round out the foreign side, Henry Alexander recruited Thomas Sovereign Gates, Jr., Eisenhower’s last defense secretary. They had complementary contacts: Alexander knew the corporate heads and central bankers, Gates the prime ministers and foreign secretaries. It was also hoped Gates would use his administrative talents to organize the larger, more bureaucratic bank produced by the merger.
Gates seemed a rare lateral entrant into the Morgan hierarchy but really had true-blue Morgan roots. His father was a Drexel and Company partner and president of the University of Pennsylvania. As a Drexel bond salesman in the 1930s, Tom, Jr., had apprenticed at J. P. Morgan and Company. Drawn to intrigue, he served with Naval Air Intelligence in World War II. Starting his Washington career in 1953, he served as under secretary and secretary of the navy and finally succeeded Neil McElroy as defense secretary.
Rich and affable, a cowboy in well-tailored suits, Gates gave off an easy air of authority, an engaging conviviality. A macho hero to subordinates, he loved wine, women, and warplanes. “Gates liked living and liquor better than anybody I knew,” recalled an admiring associate. At the Pentagon, he was a blunt, no-nonsense manager. After receiving a bulky study arguing for the retention of a troublesome traffic light that caused congestion near a Virginia navy arsenal, Gates scrawled across the top, “Turn off the damn light.”31 He took flak as navy secretary by closing useless bases. When he closed one in Texas before consulting Lyndon B. Johnson, the future president never forgave him and later harassed him with an FBI investigation.
As defense secretary, Gates loved covert activity. Through the National Security Council, he contributed to a four-point plan to topple Fidel Castro, an early blueprint for the Bay of Pigs disaster. He revered Secretary of State John Foster Dulles, a frequent dinner guest at the Gates household. Gates was closely involved with the U-2 spy plane and authorized its final flight, even though Ike told the CIA to stop such activity. “It was just an unbelievable thing, that U-2,” he said nostalgically while Morgan chairman. “I often dream about the U-2.”32 When the plane was shot down, just before Ike’s summit in Paris with Nikita Khrushchev, Gates advised the president to take responsibility. He also added to the controversy by putting U.S. forces on alert during the tense summit. “The timing of the exercise was just a shade worse than sending off the U-2 on its perilous mission two weeks before the Summit,” noted Walter Lippmann.33
The day before his inauguration, John Kennedy was briefed by Gates, who painted an alarming picture of the imminent fall of Laos to the Communists and advocated limited American military involvement. He said it would take a couple of weeks to get American troops into Laos. An early plan had Gates being reappointed as defense secretary, with Bobby Kennedy his under secretary, and a year later Bobby would succeed him. This scheme ran into trouble when JFK’s advisers pointed out an embarrassing discrepancy between Kennedy’s campaign rhetoric about a U.S. Soviet “missile gap” and a Gates reappointment. When Robert S. McNamara, president of Ford Motor, got the job instead, Henry Ford II proposed a “swap”—Gates as president of Ford and McNamara as defense secretary. Gates was also asked to head General Electric. Nonetheless, he chose Morgans. “He said he was always a banker and didn’t want to learn how to make toasters,” said his son-in-law Joe Ponce.34
Gates brought an easygoing style to the bank. One subordinate remembered a meeting between Gates and Jimmy Ling, head of Ling-Temco-Vought, the acquisitive aerospace and electronics conglomerate. Gates was bubbling over in his enthusiasm for a favorite warplane, while Ling kept asking whether Morgan would finance his acquisition of Wilson Sporting Goods. “No problem, Jimmy,” Gates said, then returned to his beloved warplane. When Gates at last dispatched a subordinate to Stuart Cragin, head of the Credit Policy Committee, the latter flatly turned down Ling’s request and overrode the casual Gates. Morgans thus became the first Wall Street bank to stop Ling’s acquisitions binge.
Gates never fully recovered from Potomac fever. He was a good friend not only of Eisenhower, who volunteered to back him for a Senate seat, but of two later Republican presidents, as well, Richard Nixon and Gerald Ford. (His subordinates speculated as to whether the second phone on Gates’s desk was a hot line to the White House.) His connections extended everywhere. He belonged to an exclusive group formed by Stephen Bechtel, Sr., of the secretive San Francisco-based construction firm and an active Morgan director after 1954. At the Carlyle Hotel, Bechtel regularly convened a study group that included Pan Am founder Juan Trippe, Texaco chairman Augustus Long, General Lucius Clay, and Gates. These brandy-and-cigar discussions might feature Bechtel on Saudi Arabia, Long on oil-price trends, and Gates on NATO and the Russian threat.35 Gates would exploit his numerous contacts to spread Morgan influence around the globe.
WHEN Kennedy first took office, nobody could have foreseen the international thrust of banking in the 1960s. What was apparent was that the president had to staunch a massive outflow of American capital. In early 1962, Eisenhower convened a meeting of his old cabinet and Republican leaders. Tom Gates was impressed by a talk by Arthur Burns, who warned that a continuing drain of U.S. dollars and gold abroad would so badly damage the country’s balance of payments that JFK would have to resort to extreme measures. Burns “believes the only thing left will be some direct controls,” Gates warned Alexander. “The Administration does not wish such controls, but is drifting into a situation where they will probably be the only answer.”36 The House of Morgan braced for a new era in which American multinationals would get their financing abroad. As Alexander said, “As business goes, so goes banking.”
In late 1962, Alexander, presiding over a turbulent meeting, asked a question that had not been heard for thirty years: should the House of Morgan return to underwriting, this time in Paris? In a decision that produced mild wonder at 23 Wall—wonder that the bankers kept to themselves—the Fed had passed a tentative ruling that Glass-Steagall would pose no obstacle outside the United States. But would it withstand a legal challenge? People were wary. “There was reluctance on the part of the other senior people to do something that could be seen as skating close to the edge of legality,” recalled Evan Galbraith, then with the bank and later ambassador to France. “But Henry was quite visionary about it.” Alexander went around the room listening to antagonistic opinions. At last, overriding objections, he said, ” ’Well, I think this will be what you call a business decision.’ ”37 The plan called for a new Parisian underwriting subsidiary, Morgan et Compagnie, Societe Anonyme, with Morgan Grenfell and Mees and Hope of Holland as passive, minority shareholders. (The name Morgan et Compagnie had been dormant since the Guaranty merger.) Content with its American business, Morgan Stanley spurned this first invitation to enter Europe.
On July 18, 1963, Kennedy proposed an Interest Equalization Tax to throttle the dollar outflow. By penalizing the sale of some foreign securities to American investors, it provided incentives for banks to flock abroad. Hearing the news, Alexander divined a watershed. Assembling Morgan officers that afternoon, he made a quick, prescient judgment: “This is a day that you will all remember forever. It will change the face of American banking and force all the business off to London. It will take years to g
et rid of this legislation.”38 Two years later, Lyndon B. Johnson imposed voluntary restraints on lending to foreign borrowers and personally stressed their importance in White House meetings with Gates.39 Suddenly overseas banking became the preferred career path for the ambitious.
Luckily, dollars abounded outside the United States—in part from the payments deficit itself—forming a pool of stateless money. The first Eurodollars had come into being after World War II, when the Soviet Union, wary of reprisals by American authorities, deposited its dollars at the Banque Commerciale pour l’Europe du Nord in Paris and in London’s Moscow Narodny Bank. In time, Euro came to signify any currency held outside its country of origin. In other words, Eurodollars are dollars held outside the United States, Euroyen are yen held outside Japan, and so on. By the mid-1980s, this free-floating unregulated market—a free marketeer’s pipe dream—would swell to $2.5 trillion in deposits.
A wholesale world catering to big business, governments, and institutions, the Euromarkets were immediately congenial to the House of Morgan. Here banks didn’t pay deposit-insurance premiums on dollar deposits or set aside mandatory reserves against deposits; they could lend dollars as freely as they pleased. Conditioned by New Deal legislation, American bankers were initially edgy about this freedom but soon adapted. Along with the new trend of buying money instead of gathering deposits, the creation of the Euromarkets lifted restrictions on growth. If the Fed tightened credit in the United States, banks could sell large CDs in London and use Eurodollars to finance their domestic lending.