The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance
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Blunden called in Sir Leslie O’Brien, the former Bank of England governor who had set up the Takeover Panel and, ironically, chastised Morgan Grenfell a generation earlier for its behavior in Gallaher-American Tobacco and News of the World battles. In an odd turnaround, O’Brien was now on Morgan Grenfell’s International Advisory Council. Blunden laid down the law, citing Section 17 of the Banking Act, which gave the Bank of England authority to oust officials for imprudently managing a bank. This apparently didn’t have the desired effect on Reeves and Walsh. The firm issued a statement denying any further dismissals.
Now Thatcher began to pressure Nigel Lawson, chancellor of the Exchequer, to draw more blood from the Guinness affair. In an extraordinary intervention, she reportedly told Lawson, “I want Reeves and Walsh out today, not next week or next month, but by lunchtime today.” This was duly communicated to the Bank of England and transmitted, in turn, to a Morgan Grenfell delegation led by Lord Catto. In the office of Robin Leigh-Pemberton, governer of the Bank of England, the Morgan men were bluntly warned that if certain actions weren’t taken, Lawson would appear before the House of Commons to announce that the government was selecting a new Morgan Grenfell management. Afterwards, Catto and Sir Peter Carey, a Morgan director, met with Reeves and Walsh who were, as a Morgan Grenfell official phrased it, “politely forced out.”18 As Thatcher had demanded, the heads rolled by lunchtime. It was a breathtaking reversal: the free-market prime minister striking down the City’s most entrepreneurial firm in the worst disaster to hit a City firm in many years. A columnist for London’s Financial Times, reflecting on the double disaster of the Collier and Guinness scandals, said, “It seems that there can be no end to the disasters that the market can dream up (or wish upon) Morgan.”19
The Guinness scandal had broad repercussions for the City. There were parliamentary calls to crack down on the bankers. As part of Big Bang, the government had set up a new Securities and Investment Board to oversee a cluster of self-regulatory groups. After Guinness, reformers wanted to toughen up the SIB, making it more like the SEC and less of a City-dominated body. There were proposals to outlaw guarantees for third parties who bought shares during a takeover (the “Seelig clause”) and to avert share buying by companies with a commercial stake in the outcome (the “Riklis clause,” after Meshulam Riklis of Schenley Industries). The City shifted further from the old-boy network to a strictly policed financial center.
Awaiting the outcome of the interminable government investigations, Morgan Grenfell found itself in a terrible limbo. In May 1987, Ernest Saunders was arrested for allegedly destroying and fabricating Guinness documents. Later that year, Roger Seelig was arrested and charged with faking £2.5 million in invoices that were used, at least in part, as covers to indemnify members of the “fan club.” Seelig was further charged with conspiring to create a false market and stealing £1 million from Guinness two weeks after the Department of Trade and Industry’s first raid on Morgan Grenfell in early December, 1986. Five other prominent City figures were arrested.
That year, the Takeover Panel ruled that Guinness had violated the code in the Distillers battle. This later made Guinness liable for compensatory payments of £85 million to former Distillers shareholders. Guinness could survive such a blow. But if the company turned around and filed a counterclaim against Morgan Grenfell, the smaller bank would clearly stagger. Throughout the DTI investigations, Morgan Grenfell officials lived with this constant nightmare; it was feasible that Guinness could deliver a mortal blow.
Short of such an outcome, however, it didn’t seem that Guinness would do lethal damage. The firm’s long-time rival, Warburgs, stepped briskly over its bleeding body to gain the number-one takeover spot, but Morgan Grenfell clung to second place in 1987. Looking only at publicly quoted companies, it actually remained in first place that year. Clients generally stuck by the firm, and there was no mass defection of staff. Perhaps most upset were the Third World countries that dealt with Morgan Grenfell for its classy aura and now had a tainted banker.
For several months in early 1987, Morgan Grenfell remained a ward of the Bank of England, which installed Sir Peter Carey—a short, mustachioed, highly respected former civil servant—as chairman. The firm could no longer indulge its takeover stars and give them free rein. Committees, bureaucracy, regimentation—these were the necessary correctives. Guinness exposed an absence of strong leadership and the managerial defects of an “oligarchy” that ran the firm like a private partnership. These older executives seemed a universe apart from the young takeover artists. As merger specialists were now subordinated to more organizational discipline, some people quit, notably George (“Teddy”) Magan and much of the takeover team in New York.
“They were putting a saddle on a horse that never had one,” said one departing star. “It had been an organic, free-wheeling organization of entrepreneurial spirit. People had booked into that. The most buccaneering of merchant banks started forming committees. But it was a franchise that hadn’t been built on caution and procedures and checks and balances. Reeves and Walsh had created a magic bubble, a hothouse, and there wasn’t the opportunity to do that anymore.” Many people in Britain would have said “Amen.”
Shortly after the takeover, a Morgan Grenfell official had told the press, “No man of the calibre of Ernest Saunders is going to employ Morgan Grenfell if we just tell him that Takeover Panel rules suggest that something can’t be done.”20 This habit of bending or rewriting the rules had been growing remorselessly for twenty years. Now it had led Morgan Grenfell straight over the precipice. The Morgan name had always been synonymous with integrity and trust. Now, with Guinness, it became a byword for scandal in the modern City.
CHAPTER THIRTY-FIVE
BULL
WALL Street in the Reagan era self-consciously retraced the experience of the 1920s. Commentators noted eerie parallels between the decades—a booming stock market, Republican tax cuts, a Latin American debt crisis, fluctuating currencies, a merger wave, trade wars, farm and energy slumps. Fed chairman Paul Volcker served up the disinflation tonic, much as Ben Strong had in the 1920s, and the world suddenly swam in cash. Newspapers superimposed stock market graphs from the Coolidge and Hoover days onto those of the Reagan years, comforting bulls and bears alike. As in the 1920s, sages said old value measures were outdated and again worried about a shortage of common stock. The speculative froth on Wall Street was again regarded as a sign of economic dynamism.
In the 1920s, the United States was the world’s chief creditor, a rising power with a bulging trade surplus. Armed with superior technology, American companies expanded around the globe. But the heady Wall Street of the 1980s masked America’s declining economic position relative to that of Japan and Europe. Thanks to Reagan’s tax cuts and budget deficits, the United States became a net borrower from the world. The stock market frenzy neither enhanced American competitiveness nor trimmed the trade deficits, which had been persistent since the early 1970s. Morning headlines screamed of billion-dollar deals that were supposed to improve the economy, but they never seemed to strengthen America’s position in world markets.
As Wall Street returned to favor, America’s youth flocked to the casino. By 1986, one of every ten Yale College graduates applied for a job at First Boston and over 30 percent of Harvard Business School graduates ended up at Morgan Stanley; Goldman, Sachs; Merrill Lynch; or First Boston. They came to a world that had little in common with the sedate, gentlemanly Wall Street of the early postwar years. Even the name now seemed a misnomer. “Except for Brown Brothers Harriman,” said Martin Turchin of Edward S. Gordon Company, “I can’t think of a major investment banking firm that has its headquarters on Wall Street.”1 They had all trailed their clients uptown.
The Reagan years saw the demise of relationship banking and with it the end of grace and civility on Wall Street. Wall Street was tougher, meaner, smarter, and more macho than ever before. The leisurely syndicate world faded after Rule 415, and the Gentl
eman Banker’s Code was fully obsolete. As the taboo against raiding clients and making cold calls broke down, investment bankers clashed with one another. There was no longer any agreed-upon etiquette to temper the greedy impulses that always existed in finance. Wall Street was run by bright, young executives who seemed curiously devoid of larger political or social concerns in their narrow pursuit of profits.
In 1985, Morgan Stanley named Eric Gleacher to succeed Joe Fogg as head of Mergers and Acquisitions; at Lehman Brothers Kuhn Loeb, Gleacher had been Adrian Antoniu’s boss. A short, trim former marine commander of a rifle platoon, he had an MBA from the University of Chicago, believed in a gung-ho takeover style, and ran his department with martial discipline. Called a “steel wall” at the bargaining table, he had tremendous stamina and skied, golfed, and ran marathons in his spare time. Through Gleacher, Morgan Stanley would branch out from takeovers in behalf of blue-chip corporations to more direct involvement with corporate raiders. For example, Gleacher recruited as a Morgan Stanley client the cigar-smoking Ronald O. Perelman, who acquired Revlon Incorporated in a bitter 1985 fight.
In his merger factory, Gleacher had a team of ten bright young people who did nothing but cook up deals for the firm to sell to clients. In 1978, Bob Greenhill had said that Morgan Stanley was simply executing clients’ deals, not iniating them.2 Now passivity was scrapped: every deal announced in the morning newspaper was studied for a profit angle. Each morning, the ten high-priced well-educated dreamers lined up outside Gleacher’s office to pitch their ideas in rapid-fire style. When a subordinate brought a three-inch-thick notebook full of figures for a possible deal, Gleacher dropped it in the wastebasket. “Come back when you know what you’re talking about,” he said.3
Wall Street no longer seemed subservient to corporate clients or simply the executor of their wishes; it had assumed a disturbing life of its own. Far from taking his cues from clients, Gleacher believed “deal makers should never take no for an answer,” asserted Fortune.4 The magazine told how he had badgered Robert Cizik of Cooper Industries in Houston into buying McGraw Edison. “Let me fly down and talk to you,” Gleacher had said on a cold call. “It’s my nickel.”5 His persuasive presentation the next day convinced Cooper Industries to make the $1-billion acquisition, netting Morgan Stanley $4 million. Gleacher also convinced Pantry Pride to take over Revlon, bringing in $30 million in fees in a Ronald O. Perelman raid financed by a flood of junk bonds. A decade earlier, naive bankers had trembled to ask for a $1-million fee.
The portion of corporate America now passing through the merger mills was staggering. Morgan Stanley handled $8.5 billion in merger transactions in 1982. Within two years, that figure zoomed to a record $52 billion. After some backsliding under Fogg, Morgan Stanley nosed out the First Boston team of Bruce Wasserstein and Joe Perella in 1985 to recover first place in merger work, booking an awesome $82 million in fees and giving Morgan Stanley Wall Street’s highest return on equity. In the four years leading up to the 1987 crash, Morgan Stanley was involved in $238 billion worth of mergers and acquisitions. As Joe Flom would say in 1989, “We’ve gone through the most massive corporate restructuring in history over a period of 15 years.”6 The figures were now so fantastic that they seemed to have dazed and stupefied the public.
Many deals were spurred by needed change. At a time of technological flux, mature companies had to transfer money from dying industries to thriving ones. Foreign competition and deregulation were stimulating radical shifts in hitherto protected industries, including airlines, telecommunications, energy, media, and finance itself. Investment banks were the agents for the global integration of markets, much as they had welded together national markets in the era of Pierpont Morgan.
But too many deals seemed to be hatched by investment banks and corporate raiders merely for self-enrichment. The prototypical 1980s raiders—Boone Pickens, Carl Icahn, and Sir James Goldsmith—talked self-righteously about “cleansing” or “liberating” companies from “entrenched management.” They claimed target companies were the victims of a harsh, Darwinian necessity, implying that they were invariably poorly run companies. Yet in 1978, before this became the party line, Bob Greenhill had said, “The acquiring companies are not simply looking for bargains, or corporations in trouble. Typically, they are interested in well-managed companies.”7 This was often the case.
Aside from the painful dislocations suffered by towns and workers, as a result of mergers, the takeover flurry penalized companies with clean balance sheets, little debt, and lots of cash. To stay independent, they had to cripple themselves by loading up on debt. The old Morgan Stanley had favored sound, conservative finance and was protective of the credit ratings of clients. The new Morgan Stanley stampeded companies into taking on debt, whether to conduct raids or to ward them off.
The firm’s M&A people dismissed the existence of any problem. In 1986, with nationwide takeovers running at a robust $200 billion a year, Eric Gleacher said, “When you look at the debt of the world, the debt of the country, and the debt of the private sector, you can’t with a straight face tell me that a few speculative merger deals are going to tip the balance and create disaster?”8 Note that Gleacher doesn’t praise the debt: it’s more of a defensive everybody-is-doing-it kind of argument. There were also now more than “a few speculative merger deals.” In 1970, only 10 takeover deals passed the million-dollar mark; by 1986, the figure had surged to 346 in a wave of consolidations that engulfed the economy.
Joe Fogg similarly had dismissed any problem. When asked whether the debt binge wasn’t draining capital from productive uses, he called that notion “very silly and superficial. . . . The fact is, acquisition transactions merely reflect a change in ownership of capital assets. The money does not disappear. It is then used for other investments.”9 This was surely true of money changing hands in a takeover. But how was that additional takeover money raised in the first place? Typically by bank loans or junk bonds whose interest payments then siphoned off money from productive investment. This bias in favor of debt was strikingly at odds with the old Morgan Stanley, whose culture Bob Baldwin had described as “risk-averse” as recently as 1980.
Merger mania on Wall Street produced a stunning paradox in the 1980s: corporations grew financially weaker during the sustained Reagan boom. By the 1987 crash, nonfinancial corporate debt stood at a record $1.8 trillion, with companies diverting fifty cents of every dollar of earnings to pay off creditors—a far greater percentage than in earlier years. It was hard to see how corporate America could weather a severe recession without unspeakable destruction. As in the Jazz Age, much of the era’s financial prestidigitation seemed premised on an unspoken assumption of perpetual prosperity, an end to cyclical economic fluctuations, and a curious faith in the Federal Reserve Board’s ability to avert disaster.
Not surprisingly, Morgan Stanley was drawn to that most lucrative of 1980s fads—the leveraged buyout, or LBO. As a dangerous form of leverage, LBOs rivaled the pyramidal holding companies of the 1920s. In a basic LBO, a company’s managers and a group of outside investors borrow money to acquire a company and take it private; the company’s own assets are used as collateral for the loans, which are repaid from future earnings or asset sales. (Interest payments, significantly, are tax deductible.) In the 1970s, they were called “bootstrap financings” and seldom exceeded $100,000. André Meyer of Lazard Frères had taken equity stakes for years, but Wall Street didn’t take notice until 1979, when First Boston did an LBO for a conglomerate called Congoleum. LBOs became popular as the conglomerates of the 1960s were dismantled and managers took over pieces of them. They became rampant as a byproduct of takeovers, with managers resorting to them to fend off raiders or even flush them out. The LBO was thus a natural sequel to the merger wave.
With its unerring instinct for profitable activities, Morgan Stanley noted the LBO profits at First Boston and Merrill Lynch. In 1985, it joined with CIGNA Insurance to create a leveraged buyout fund. It struck spectacul
ar deals that made merger profits look like small change in comparison. In 1986, it joined with an Irish paperboard concern, Jefferson Smurfit, to purchase Container Corporation of America from Mobil for $1.2 billion. Morgan and Jefferson put up only $10 million apiece, borrowing the rest. Morgan Stanley pocketed a fast $32.4 million: $11 million for arranging the buyout, $20.4 million for underwriting nearly $700 million in junk bonds to effect the purchase, and a $1-million advisory fee. Such fees recalled investment banks feasting on new trust issues at the turn of the century. In LBOs, the target company suffered the pain and carried the risk, having to sell assets and cut costs to pay off the debt. Meanwhile, as a limited partnership, the Morgan Stanley buyout fund couldn’t lose more than its tiny, original $10-million investment. The risks were remarkably limited in view of the enormous potential profits. And only three years later, Morgan’s $10 million stake was worth $140 million.
Soon afterward, Morgan Stanley helped Kohlberg Kravis Roberts, the leading LBO firm, take over Owens-Illinois for $4.2 billion. Again it scored triple fees, this time of $54 million. Even though it had only $1.5 billion in capital, Morgan Stanley made a temporary $600-million bridge loan to effect the deal. (What bank would have gotten away with that? Yet investment banks could bypass SEC safeguards by issuing bridge loans through their holding companies.) Where the old Morgan Stanley minimized its capital risk and remained a financial intermediary, the new Morgan Stanley was gambling more of its capital in a new push into “merchant banking.” Although Wall Street relished the historical associations of the term, it bore little resemblance to the mercantile financing engaged in by George Peabody and Junius Morgan. It simply referred to management buyouts, taking equity stakes in takeovers, or making temporary bridge loans to finance takeovers.