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

by Ron Chernow

  The bank never fully recuperated from Penn Square, which led to the first global electronic bank run in May 1984. It began with a fugitive rumor floating around Tokyo that an American investment bank was shopping Continental to possible buyers. This triggered the sale of up to $1 billion in Continental CDs in the Far East, spilling over into panicky European selling the next day. The Continental run was like some modernistic fantasy: there were no throngs of hysterical depositors, just cool nightmare flashes on computer screens.

  The bank’s new chairman, David Taylor, pencil-slim, aristocratic, and with a grave voice, struggled to contain the damage. To spike rumors, he sent what he thought was a reassuring telex to two hundred banks around the world. By spotlighting Continental’s troubles, however, it only intensified fears. The next day, Paul Volcker was on the phone with Lew Preston, who expressed skepticism about a private safety net. But in Washington, there was hope that a private credit raised by big banks could restore confidence in Continental. It was a political preference: Reagan administration ideologues were tantalized by a “market solution.” Bankers also thought they could more legitimately claim expanded securities powers if they didn’t always beg for federal protection. Even as the private credit was being organized that Friday, Continental borrowed $4 billion from the Chicago Fed. During the next week, the “private rescue” would have a slightly fictitious flavor, masking the federal government’s far deeper and more critical involvement.

  Why did Continental choose Morgan to lead the rescue—a choice so reminiscent of 1907 and 1929? “Morgan Guaranty was the obvious choice,” explained a former high Continental official. “It had the strongest financial situation and an unquestioned reputation.” Morgans was also Continental’s twin. “We felt Morgan was a similar institution that didn’t have the problems we had, but was similarly funded,” Taylor recalled.12 Morgans also got the job by default. Citibank had earlier tried to invade Continental’s Illinois turf, leaving behind acrimonious feelings.

  Through a Mother’s Day weekend, with telephone circuits jammed, Preston and Taylor assembled a $4.5-billion credit line from sixteen banks. These sophisticated bankers relied on primitive methods. Often, they simply called banks, got the security guards on duty, and had them track down their chairmen. Amazingly, the Federal Reserve Board didn’t possess emergency home phone numbers of America’s most powerful bankers. Security Pacific’s chief credit officer was found windsurfing. While bankers haggled over their credit shares, they all knew the gravity of the crisis. As a Continental official said, “They knew that Continental’s problems could spill over into a couple of other banks.” There was a fear that Continental would focus unwelcome attention on Manufacturers Hanover’s Third World debt or the Bank of America’s bad real estate loans. “There were also fifty-odd Midwestern banks that had more than their entire bank capital on deposit at Continental,” said Preston. “That’s why it was worth saving.”13 By Sunday night, the $4.5-billion credit line was ready.

  On Monday morning, global markets yawned at this show of strength by America’s richest banks. A Pierpont Morgan might have commanded the gold market, but private resources now paled in global markets. The runs continued amid telephone calls between Volcker and Preston. “That Monday, Volcker didn’t call anybody else but Preston, not even the administration,” recalled Irvine Sprague of the Federal Deposit Insurance Corporation. “It became clear the bankers’ rescue plan was not going to work. Obviously, the government would have to step in the next day.”14

  The stakes were tremendous: Continental was larger than all the banks that failed during the Depression combined. As a “hot money” bank, it was insured for only about 10 percent of its $40 billion in “deposits.” Could the world really cope with $36 billion in losses? Nobody wanted to find out. At a meeting on Tuesday morning, May 15, Volcker, Comptroller of the Currency Todd Conover, and William Isaac and Irving Sprague of the FDIC agreed that a Continental failure would be cataclysmal and decided on an FDIC capital infusion.

  They sold this idea to Treasury Secretary Donald T. Regan, who wanted to keep alive the private rescue. The banks were to put up a portion of the money. After lunch, Volcker phoned Preston and asked him to set up a summit of seven bank chairmen in New York the next morning. They met in secrecy at Morgan Guaranty’s offices at Fifth Avenue and Forty-fourth Street, an assemblage including the chairmen of Morgans, Chase, Citibank, Bank of America, Chemical, Bankers Trust, and Manufacturers Hanover and the top bank regulators, including Volcker. Chaired by Lew Preston, the meeting had both a sentimental and a combative mood. Some bankers made resounding speeches about past days of Wall Street glory, when the House of Morgan managed private rescues. John McGillicuddy of Manufacturers Hanover argued that the bankers should go it alone. Preston, low-key and conciliatory, let the more vehement bankers talk themselves out. “His style was quite cool,” recalled Irvine Sprague. “He lay back and sort of nudged people. I thought he was very skillful.”15

  There was an element of make-believe in this “bankers’ rescue,” for they pretended to mount a rescue without the necessary resources. Some bank regulators saw the bankers trying to grab credit but pushing the real risk and responsibility onto the government. Citi vice-chair Thomas C. Theobald (later Continental’s chairman) laid down especially stringent conditions for his bank’s participation, asking for absolute government guarantees against risk. As Sprague later wrote, “They wanted it to look as if they were putting money in but, at the same time, wanted to be absolutely sure they were not risking anything. I said I would not vote for such a sham.”16

  That day and the next, restless regulators invited the bankers to provide $500 million of a $2 billion capital injection. At the last minute, Citi tried to insert language protecting the bankers from losses. Only a call from Volcker to Citi chairman Walter Wriston in California ended the impasse. It was largely sham heroics by the bankers: after agreeing to their $500 million, they sat around arguing about how to “lay off” the risk on other banks. William Isaac of the FDIC has said flatly: “The bankers lost no money, and in hindsight their participation was unnecessary.”17

  In the end, the FDIC effectively nationalized Continental, taking an 80-percent ownership stake. Setting a breathtaking precedent, it decreed that all depositors were insured; it had never before given such a blanket insurance for small bank failures. Washington was now saying that some banks were too big to fail. Yet even the full faith and credit of the U.S. government couldn’t immediately stem the bank run. “Bankers around the world said, ‘So what?’ “ recalled Preston. “They weren’t impressed that the deposits were guaranteed by the U.S. government. That surprised me.”18 Continental Illinois’s aftermath was ironic: although the affair exposed the unacceptable peril of large bank failures in modern financial markets, the government had created new incentives to bypass small banks and keep deposits at large ones.

  Continental Illinois served as a warning about the state of commercial banking in the 1980s. As banks lost their core lending business and tried to maintain profits, they ran into a lengthening list of disasters—in shipping, real estate investment trusts, energy loans, farm loans, and Latin American lending. The Glass-Steagall Act had attempted to insulate commercial banks from risk by separating them from securities work. Instead, it had confined them to a dying business and starved them of profits that might have kept them sane and healthy. By 1984, bank failures were running at a post-Depression high. During the 1980s, the commercial banks faced chronic instability while securities houses raked in record profits. This reversed Glass-Steagall’s intentions and confirmed J. P. Morgan and Company in its decision to move further in the direction of becoming a global investment bank. By the 1987 crash, it would be earning more money from such fee business than from standard loan spreads.

  FUNERAL rites for the old Wall Street were held in March of 1982, when the SEC enacted Rule 415, which provided for “shelf registration.” This bland technical name masked a bold revolution. Instead o
f registering each new security issue separately, blue-chip companies could register a large block of stock and sell it off piecemeal on short notice over two years. Thus corporate treasurers could capitalize on sudden dips in interest rates. Rule 415 converted underwriting into a world of fast trades and split-second decisions rather than the old Morgan Stanley world of elegant syndicates formed over several weeks. Companies could even dispense with investment banks and sell straight to institutions. As one Dillon, Read executive gloated, “A lot of Morgan’s biggest clients are the most sophisticated ones. They’re more likely to say, ‘Take a walk, pal.’ ”19

  For Morgan Stanley syndicate chief Thomas A. Saunders III, a sinewy Virginian with thin lips and a wide mouth, the potential of Rule 415 hit him while out jogging one day. Staggered by the implications, he came into work the next morning and spluttered, “Hold it, fellers, this thing is unbelievable.” Before long, he was phoning around the Street, telling people, “Holy God, this is insane.”20 As with the Mayday end to fixed commissions in 1975, Bob Baldwin led the effort to quash the ruling, again dressing up the effort as a crusade to save the regional firms. He hand-delivered a protest letter to the SEC: “The rule may produce fundamental changes in the capital-raising process . . . with undesirable consequences that have not been explored.”21 His warnings that Rule 415 would damage smaller firms and lead to a Wall Street monopolized by a few large, well-capitalized firms duly materialized.

  Though Morgan Stanley claimed twenty-eight of America’s one hundred largest corporations as clients, many of them favored Rule 415. Exxon, U.S. Steel, and Du Pont even plied the SEC with supporting letters. These rich captives were finally shrugging off their chains. Some critics feared 415 would sweep away fifty years of “due diligence,” with investment banks vouching for the soundness of issues. A Morgan Stanley stamp of approval had always reassured investors. In the Casino Age, however, blue-chip firms no longer needed bankers to certify their health. They often had better credit ratings than their bankers.

  The force of 415 was swiftly revealed in its trial usage by AT&T in 1982. A year earlier, Morgan Stanley had mustered a traditional AT&T syndicate of 255 houses. Now, for a $100-million shelf issue, AT&T invited bids from twenty-one underwriters. Instead of syndicates, Rule 415 operated through “bought deals” in which a firm or group of firms bought the whole issue and quickly resold it. Salomon Brothers and First Boston had been doing such deals for years. Morgan Stanley felt itself under excruciating pressure to win the open contest. “We had been AT&T’s banker previously for all of their equity, as well as much of their debt, and we needed to show that we still were,” said Saunders.22 An internal memo warned of “reputation risk” on the AT&T deal: “We don’t need to be first, but it will help establish our role.”23 This set the stage for a rash attempt by Morgan Stanley to show it could measure up in the savagely competitive new environment. That the crazy stunt succeeded didn’t detract from its folly.

  On May 6, 1982, Morgan Stanley agreed to buy two million shares of AT&T stock at $55.40 a share, $.15 above the current market price. It hoped to resell the entire parcel the next day. This “bought deal” was really a block trade from AT&T to Morgan Stanley with no syndicate to cushion the risk. Morgan’s chief equity trader, Anson Beard, passed a miserable, sleepless night and later admitted that it was a reckless deal done “for the bragging rights.”24 Luckily, he disposed of the two million shares the next day, mostly at $55.65 or a $.25 profit over cost. If clever advertising, the maneuver exposed the risks associated with 415. For carrying a $100-million exposure overnight, Morgan Stanley netted a paltry $400,000. Later in the year, when AT&T raised $1 billion through a traditional syndicate, Morgan Stanley suddenly had to tolerate four co-managers. Corporate treasurers were the new potentates, and soon even General Motors relied on four investment banks, including Morgan Stanley.

  In 1981, Morgan Stanley reigned as number one in underwriting, as it mostly had since 1935. By 1983—after the 415 shake-up—it plummeted to sixth place, with the trading-oriented Salomon Brothers arising as the new leader. Underwriting was now a banal commodity business in which capital and trading prowess counted for far more than did contacts with companies. In a stunning rout, trading firms that were once the outcasts of Wall Street high society toppled the patricians. Morgan Stanley was hardly impoverished: it remained first in stock underwriting and second in the Euromarkets, but it had slipped in relative position and lost its special halo of success. It sometimes seemed to resent this new world. As syndicate chief Saunders griped: “But corporate treasurers are the same as you and me. They want to be innovative, they want to tell the board, ‘Look what I did! I created this competitive situation, I got those five banks beating a path to our door, and wasn’t it wonderful? I’ve taken the shackles off. The issuer is now in control of the world, and here I come.’ ”25

  The arm’s-length relationship between companies and bankers advocated by Louis Brandeis now evolved in response to market forces and at the behest of corporate America. Far from democratizing Wall Street, this market-based reform merely led to reshuffling among the top firms. Only the Wall Street powerhouses—Morgan Stanley; Goldman, Sachs; First Boston; Merrill Lynch; Salomon Brothers; and Shearson Lehman—had the capital to take big blocks of shares and unload them quickly. Where the six major firms handled a quarter of new debt before 415, they underwrote almost half of it afterward. So the demise of relationship banking didn’t open the doors to scrappy newcomers, as reformers had hoped, but only strengthened the position of those firms that were already dominant.

  Rule 415 came near the end of Bob Baldwin’s tenure at Morgan Stanley, bringing down the curtain on his world of syndication. He once said that if Glass-Steagall were repealed, he would be first on line at Morgan Guaranty’s doorstep the next morning. Yet as chairman of the Securities Industry Association in 1977-78, he had vigorously contested expanded underwriting powers for the commercial banks. “He dealt us a couple of mortal blows,” said Jack Loughran, then Morgan Guaranty’s lobbyist.26 After his SIA stint, Baldwin returned to a Morgan Stanley he understood less and less well. Colleagues thought him lost in a new world of trading and risk that he himself had created.

  One ex-partner observed, “When Baldwin came back from the SIA, he became an obstacle. He had lost control of the firm and only made more enemies. He treated everybody like a kid. He would start making a speech and nobody could talk. He was always trying to relive his days of glory as Under Secretary of the Navy. He wouldn’t listen. At the end, nobody wanted him around.” Said another: “He talked at people, he postured, he always liked to be the lordly guy from Morgan Stanley. He was always talking about himself, telling stories where he was the hero.”

  To the last, Baldwin remained hypercompetitive and bent on having his way. Yet for all his flaws, the tough, tactless Baldwin had emerged as the most important person in modern Morgan Stanley history, giving the firm the market skills to compete in a world no longer based on old-school ties. He had saved it from genteel obscurity, a languid demise. As the Baldwin era ended in late 1983 without an obvious successor, there was nervous jockeying among three prime contenders—Bob Greenhill, Dick Fisher, and Lewis Bernard. Much was at stake. In a decade, Morgan Stanley had grown tenfold. It now employed about three thousand people and had about $300 million in capital. Although there was no black or female managing director, the ethnic mix among its eighty managing directors was otherwise surprisingly diverse. But it was more tense and confrontational than in the old days, full of ambitious overachievers.

  To prevent squabbling, Baldwin was replaced by a surprise choice: forty-nine-year-old Yale-educated S. Parker Gilbert, who claimed a unique Morgan lineage. His wunderkind father was the agent general of Germany in the 1920s and a J. P. Morgan partner in the 1930s. Tall and polished, with a wide face, aquiline nose, and urbane manner, Gilbert had his father’s boyish smile but the reserve of Harold Stanley, his stepfather. “Parker was a compromise who wouldn’t piss off Greenhill,
Fisher, or Bernard,” explained one former partner. Among the hard-charging deal makers, he had a light touch in arbitrating disputes. According to Robert A. Gerard, a former managing director, “Parker has two things going for him. He has a tremendous instinct for minimizing awkward situations and getting people to work together. Everybody respects his integrity. He really is the glue that holds the firm together.”27

  Gilbert was the most international of the top executives, having done tours in Paris and handled Middle East business. As one would expect, he was close to Morgan Guaranty and specialized in preserving old clients. One Morgan Guaranty vice-president called Parker “the old breed. It was the barracudas down below who had no sense of the relationship.” He was meant to connote tradition at a time of rapid change. Said a former colleague: “Parker is where he is because his father and stepfather were where they were. He’s a symbolic figure, like Harry Morgan.” According to another ex-partner: “The general fiction that people lived by at Morgan Stanley was that he wanted to prove that he was getting ahead for reasons other than being Harold Stanley’s stepson. Then he would go off and play golf.” In fact, whatever the original plans, Gilbert turned into more than a figurehead and became an unexpectedly strong-willed chairman. His caution would be credited with sparing Morgan Stanley some of the ravages of the 1987 crash.

  The real heir to Bob Baldwin was probably Dick Fisher. A polio victim who was paralyzed from the hip down and walked with a cane, Fisher applied for a job at Morgan Stanley upon graduating from Harvard Business School, but first he needed to conquer his own doubts about his ability to perform. Partners also had wondered how a handicapped person could take business trips and move around freely. Bright, sociable, and popular, he would prove a master politician and an adept handler of people. “Dick is tough underneath but doesn’t appear so,” remarked a former colleague. “He can be a ruthless man with velvet gloves.”