THE LAST PARTNERSHIPS Inside the Great Wall Street Money Dynasties phần 8 pdf

Unlike Merrill Lynch,Hutton reached for the stars and became a blue-chip stockbroker.For more than fifty years it eschewed investment banking and wascontent to operate a series of branch

to almost 31 million Their average portfolio was less than $25,000and they represented about 79 percent of NYSE turnover, falling to

65 percent as mutual funds became more popular in the 1970s.16

By the mid-1970s, Merrill Lynch had achieved the top spot on WallStreet, a position it never relinquished Capital exceeded $500 mil-lion, several times that of second-place Salomon Brothers, and itstood atop the league tables of underwriting for both lead managerpositions and participations The firm had 250 offices, more than half

a million accounts, and 20,000 employees, far more in all three gories than anyone else on the Street As a testimony to the popular-ity and financial strength of retail brokers turned investment bankers,the other top capital positions were occupied by Bache & Co., E F.Hutton, and Dean Witter

cate-The addition of Fenner & Beane years before helped MerrillLynch become prominent in the new derivatives markets thatappeared in the early and mid 1970s Trading in listed options con-tracts was introduced after the oil crisis in 1973, and trading in com-modities futures contracts also increased markedly The firm’sexpertise in this sort of contract trading helped it substantially whenstock market commissions began to decline with the poor market atthe same time And it also provided something of a buffer when theNYSE introduced negotiated commissions in 1975, putting furtherpressure on traditional commission revenues, which previously hadbeen fixed.17Donald Regan eventually spoke out in favor of the newstructure, recognizing the handwriting on the wall The simple blue-print that Charles Merrill established years before was well suited for

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For years, Merrill Lynch was familiar to investors and televisionviewers for two reasons The first was the nickname “The Thunder-ing Herd” and the second was the slogan “Merrill Lynch Is Bullish

on America.” The second showed stampeding bulls, an idea evoked

by the nickname The original nickname had nothing to do withbulls but was associated with the long name that the firm used after

1940, Merrill Lynch Pierce Fenner & Beane Journalists gave thefirm the nickname because the name was the longest on Wall Street

at the time

the expanding markets in the 1970s and beyond And the basic maximabout customers having trust in their broker also lived on In an SECinvestigation of a broker in its San Francisco office suspected ofdefrauding customers in the early 1980s, staff members turned up aninternal memo written by the manager of the Merrill Lynch office tohis immediate supervisor In it he described the broker’s attitudetoward his customers once his clients had been fleeced of theirmoney It read, “He is now saying—just get rid of the customer—he

no longer is of any value to Merrill Lynch—he has no more money!Unconscionable behavior for a Merrill Lynch broker.”18Clearly, Mer-rill’s original business philosophy was still alive and well, if not beingalways adhered to

Merrill Lynch achieved its status by avoiding the limelight that thetraditional investment bankers sometimes found themselves in andcarved a niche out of a neglected but quickly growing demand forbrokerage services A high-visibility brokerage office was added inGrand Central Station in New York City during the 1960s so thatinvestors could check and trade their stocks on the way to work.Almost fittingly, it was also a Merrill product that provided the great-est challenge to banking regulators during the 1970s as the demandfor market-related instruments produced some serious cracks in thebanking structure During the tenure of Donald Regan as MerrillLynch CEO, the lines of distinction that separated banking from bro-kerage began to blur substantially Traditionally, bankers offered sim-ple banking services while brokers concentrated on stock marketaccounts But when interest rates began to rise in the 1970s, brokersfound that they could offer banking-related services that made regu-lators furious The public flocked to the services, leaving the banksseriously weakened

Merrill offered the cash management account (CMA) beginning in

1977 Investors left cash balances at their brokers that could beinvested or left to accrue interest at money market rates that were sub-stantially higher than the rates of interest that banks offered The bankswere limited by Federal Reserve regulations in the amount of interestthey could pay While individuals were able to beat the bank rate ofinterest, they could also write a limited number of checks against theCMA, getting the best of both worlds in a sense The concept caught on

quickly at other brokers, many of whom scrambled to open similaraccounts for fear of losing customers to Merrill Lynch Merrill scored amajor coup by introducing the account through its retail branch net-work The problems that it created with regulators were serious,although Merrill was not a bank and could not be found in violation ofbanking laws But the account provided another chisel that would grad-ually chip away at the somewhat privileged realm of commercial bank-ing Within several years time, brokers would be offering more bankingservices and banks would try to reciprocate by offering brokerage ser-vices The CMA proved to be one of the early battles in the war betweenbankers and brokers in the later 1980s and 1990s.

Rise of E F Hutton

Merrill was not the only successful retail broker of his era to survivethe Depression and rise to dominate retail brokerage The traditionalpath to Wall Street glory of the nineteenth century was now almostimpossible to plow, since the established investment banks were firmlyentrenched by the turn of the century But brokerage was a field thatdid not have any imposing barriers to entry, and it saw a wide array ofentrants after the panics in the earlier part of the twentieth century.Many of these entrants were as successful as Merrill, although theirmotives and business philosophies were markedly different

One such entrant was the firm E F Hutton & Co Founded byEdward Hutton, a native New Yorker, in 1903, the firm opened forbusiness on April 1, 1904 Despite the commotion caused by theshort-lived Panic of 1903, Hutton went into business to capture smallinvestors’ accounts after having worked as a broker previously andbeing a onetime member of the Consolidated Stock Exchange, asmall operation that specialized in trading odd-lot (smaller than 100)share orders He opened for business on the West Coast almostimmediately The firm was still young when the 1906 San Franciscoearthquake hit, decimating the city and making brokerage by wireimpossible Undaunted, the manager of the San Francisco office wentacross the bay to Oakland to transmit orders to New York so that hisclients’ trading would not be interrupted Dedication to clients madeHutton a success very quickly

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Hutton rapidly built his business through a series of dynastic riages His first was to the daughter of a member of the NYSE After

mar-she died, he married the daughter of the Post cereal empire Time

described him as an “aggressive, dapper hustler.”19And hustle he did.His firm opened brokerage offices in all the fashionable wateringholes of the day—Palm Beach, Miami, Saratoga, and several spots inCalifornia—to cater to wealthy clients using his own and his wife’sfamily connections Most of his successful offices were on the WestCoast As a result, E F Hutton was not a Wall Street brokerage oper-ation It was one that assiduously avoided the New York marketexcept to maintain a presence on the Street to be near the NYSE andhave access to clearing facilities for its trades Unlike Merrill Lynch,Hutton reached for the stars and became a blue-chip stockbroker.For more than fifty years it eschewed investment banking and wascontent to operate a series of branch offices to serve wealthy clients.The Depression and war years did not seriously hurt Hutton, becauseits clientele was from the strata of society not bothered by the eco-nomic slowdown

After the war, Wall Street went back to doing business as usual untilthe bull market brought about substantial change The retail side ofthe business was well represented Along with Merrill Lynch and E F.Hutton, notable retailers of the period included Paine Webber Jack-son & Curtis, Glore Forgan & Co., Dean Witter, Bear Stearns, SmithBarney, A G Becker, and later F I duPont & Co All participated inunderwriting to some extent, because the traditional investment banksstill relied on retailers to sell part of an underwriting to the publicwhen necessary But none of them could seriously affect the business

of Morgan Stanley, Kidder Peabody, First Boston, and Dillon Readuntil the bull market put demands on capital that the older firms foundhard to endure But Hutton remained almost aloof from underwritingduring the entire war and postwar period The niche it carved for itself

in the upper end of retail brokerage served it well

That was to change in the 1960s Investment banking became therage during the bull market when brokers discovered that they couldearn underwriting fees in addition to their ordinary commissions onissues of new stocks Most Wall Streeters were well aware of the for-tune that Herbert Allen of Allen & Co (no relation to the Allens of

upstate New York mentioned in the first chapter) made by bringingSyntex to market Syntex was a small Mexican-based company thatmanufactured the birth control pill, which Allen discovered andhelped market in the United States Hutton decided to enter the fray

by hiring John Shad to head its new investment banking division.Hutton did not make the mistake that many other entrants tounderwriting did in the 1960s Rather than try to compete againstMorgan Stanley or Merrill Lynch on their own terms, Shad insteadsought smaller companies to bring to market The field was moreopen, with many companies seeking an initial public offering orattempting to upgrade their status Shad, a graduate of the University

of Southern California and the Harvard Business School, decided on

a new strategy that would bring many companies with low credit ings to the market Among some of Hutton’s investment bankingclients during this period were Caesar’s World, the old Jay Gouldfavorite Western Union, and Ramada Inns None was a Fortune 500company, and more senior investment bankers would have frowned atthem, but they did help Hutton establish an investment banking pres-ence in a very crowded market

rat-During the backroom crisis, Hutton fared comparatively well andreceived only a minor censure from the SEC for its backroom prob-lems But the crisis only helped underscore its need for more capital

As a result, the firm, under its new president Robert Fomon, soldstock to the public in 1972, ending almost three quarters of a century

of partnership Fomon was a longtime Hutton employee who joinedthe firm after graduating from the University of Southern Californiaand being rejected as a broker trainee by both Merrill Lynch andDean Witter His subsequent reign at Hutton would last for the nextfifteen stormy years and was mainly responsible for the firm’s demise

in 1987 At the time, Hutton was doing what all other Wall Streetfirms were doing: trying to clean up a mess and benefit from it at thesame time The onetime stockbroker to the wealthy had come a longway since the early days After going public, the firm boasted 1,400 bro-kers in eighty-two offices and more than 300,000 customer accounts.The public offering netted it more than $30 million in new capital and

it ranked as the eighth-largest NYSE member firm.20It stood secondonly to Merrill Lynch in terms of size and reputation among the

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Street’s premier retail-oriented houses Then it had a stroke of goodfortune that helped it challenge Merrill even more.

In 1974, the duPont firm bailed out by Ross Perot was again in ble and needed outside assistance to survive DuPont actually hadmore branch offices than Hutton, and Fomon recognized an opportu-nity to present a real challenge to Merrill Remembering Merrill’s stel-lar reputation as a result of the Goodbody takeover, Fomon offered totake some of duPont’s branches from Perot After the deal was com-pleted, Hutton also was seen as a major power on Wall Street, capable

trou-of helping out a distressed firm in trouble and adding to its branches atthe same time Retail brokerage was still its forte and was continuallybeing built up by George L Ball Ball’s aggressive leadership led thefirm into some questionable sales, such as promoting tax shelters forits wealthy clients But for the most part, Hutton’s prowess in sales wassecond only to Merrill Lynch, although both firms had to make seriousadjustments because of negotiated commissions, introduced on May

1, 1975 The new structure caused some serious short-term distortions

on Wall Street, forcing many brokers to lower commissions to theirinstitutional clients by as much as 60 percent Many of the dire pre-dictions made about the new commissions never panned out, althoughthey sounded serious at the time The president of the SecuritiesIndustry Association claimed that the cuts were “a form of Russianroulette, forcing brokers to scramble for positions of leadership in amarch to the precipice.”21As commission margins eroded, a new prod-uct would be needed to shore up revenues

Flying a Kite

The new commission package charged by NYSE member firms in

1975 gave rise to the discount broker and a more competitive ronment among retail-oriented securities houses Much of the pres-sure was brought by institutional investors, several of whomthreatened to buy their own seats on the NYSE and trade for them-selves if their brokers did not charge lower commissions One of itsindirect by-products also caused a fair amount of distress for Huttonand eventually led to its being absorbed rather than continue as anindependent Competition and high interest rates were to blame

envi-After 1975, the next several years witnessed a relatively strong stockmarket accompanied by slowly rising interest rates Like many othermainly commission houses, Hutton needed a way to find revenues toreplace the lower commission margins One idea concocted at thetime proved enduring but found only a limited positive response fromcustomers Hutton introduced a commission-free brokerage accountthat would forgo commissions in favor of a flat fee (3 percent at thetime) leveled against accounts enrolled in the program By 1980, it had about 2,000 accounts enrolled, totaling $100 million, but that rep-resented only a small portion of its overall account base Clearly,

it needed other sources of revenues, especially if the stock marketturned down

Hutton’s response, under Fomon’s administration, was to begin asophisticated number of cash transfers between its branches and theirlocal banks By effectively keeping funds on the move at all times, itfound that it could also write itself checks for far more than the actualbalances involved Basically, it was writing itself interest-free loans atits banks’ expense But when it wrote the excessive checks, it wasengaging in what is known as “kiting,” or writing checks with insuffi-cient funds to back them By 1980, the firm was making more moneykiting than it was in any other single line of business Despiterepeated warnings from the individual banks and auditors involved,the practice continued unabated No one was going to stop the goosefrom laying the golden egg, especially when the entire practiceseemed to be invisible to everyone except the banks that occasionallycomplained

Hutton’s problem was compounded by the fact that float ment, which included kiting, was a hot topic among bankers and reg-ulators A major piece of banking regulation passed by Congress in

manage-1980 attempted to shorten the amount of time it took to clear a check,

so Hutton’s practice was clearly going against the grain of acceptedpractice Float management—the practice of trying to delay the cash-ing of a check in order to gain a few extra days of interest before it wascleared to the recipient’s account—was considered an art by cashmanagers When interest rates were high in the late 1970s and early1980s, many firms used out-of-state banks to write checks, knowingthat it would take extra days to clear them by customers and clients

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Merrill Lynch was fined for the practice But kiting was frowned upon

as being a sophisticated method of writing checks that could not becovered Inadvertently, Hutton adopted a practice not unlike thatpracticed by Clark Dodge during the Mexican War, using Treasuryfunds that it held on behalf of the government But Clark Dodge didnot face the trouble that Hutton found itself in when the scheme wasdiscovered

Finally, in 1981, two small upstate New York banks blew the tle after they discovered that Hutton branches had been kiting againstthem Both state and federal regulators became involved An exam-iner for the Federal Deposit Insurance Corporation wrote a memo inwhich he described Hutton as “playing the float but further inves-tigation revealed evidence of an apparent deliberate kiting operationalmost ‘textbook’ in form.”22When the facts became known, Hutton’sfate was sealed Regulators from almost every imaginable agencybecame involved with the case, and after considerable publicity, in

whis-1985 Fomon pleaded Hutton guilty to more than two thousandcharges of mail and wire fraud and agreed to pay a fine of $2 million The kiting case hurt Hutton’s position on Wall Street The 1984rankings of the top brokers found Merrill Lynch in the top spot, fol-lowed by Shearson Lehman Brothers, Salomon Brothers, Dean Wit-ter, and then Hutton.23The firm had given up ground to Shearson andDean Witter but was still doing a considerable business despite being

For years, E F Hutton was best known to the public for its sion slogan “When E F Hutton Talks, People Listen.” Commercialsshowed people discussing investments while attending polo matchesand sailing, the sorts of activities that Hutton liked to portray itsclients pursuing The commercial was developed by New York adagency Benton & Bowles In 1980, the agency was fired at the insis-tence of a young woman in her twenties who happened to be thegirlfriend of Hutton’s chief executive She became the head ofadvertising, and one of the most successful ad campaigns for a singlecompany ended abruptly Later in the 1980s, when the firm was onthe verge of failing, it briefly adopted the slogan “E F Hutton, WeListen,” but it was too late to save the firm from its own vices

televi-tainted by the scandal But the absence of a strong new product sion was clearly hurting the firm’s ability to market to customers.Investment banking was able to supply new issues to customers andalso devise other new products on occasion A breakdown of the firm’sprofits in 1984 showed just how important kiting for interest was.Investment banking accounted for 9 percent of its business, commis-sions 19.5 percent, and interest, by far the largest item, 33 percent.24

divi-Hutton was making more money by skinning the banks than it was inits traditional core business

After the kiting revelations, Hutton was excluded from a syndicateselling New York City bonds at the city’s request Several other simi-lar incidents occurred in rapid succession But internecine warfareand the past were beginning to erode the firm’s stature and position.John Shad already had departed to accept the chairmanship of theSEC in 1982 The departure was something of a public relations coup for Hutton, but the firm was not making significant strides inunderwriting In addition, the tax shelters sold in the late 1970s werecoming back to haunt, since many proved worthless in the long run orwere challenged by the Internal Revenue Service Stories alsoabounded of the firm procuring prostitutes for special clients andcharging the expense as a business write-off While not uncommon onWall Street, the practice leaked out to the press, causing further ero-sion of Hutton’s image as a blue-chip retail firm Pressure was build-ing on Fomon, who still retained the top spot at the firm In theaftermath of the kiting case, Fomon was still able to assert boldly, “Wefeel our record stands on its own.” The press was less hospitable,

especially about the paltry $42 million fine William Safire of the New

York Times described the small fine “like putting a parking ticket on

the Brink’s getaway car no personal disgrace for the perpetrators;

no jail terms; not a slap on one individual wrist.”25

Fomon responded to the scandal by hiring former attorney generalGriffin Bell to determine who was responsible for the kiting mess.Fomon always claimed that he did not have direct personal knowledge

of it But even more damaging, other defections followed The mostdamaging loss to Hutton at the time was George Ball, who left to joinBache & Co., another giant retail broker At the same time, Wall Street

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began to undergo its own version of merger mania, with many age firms and investment banks joining forces After the stock marketbegan to recover from the bear market in 1982, a record-setting num-ber of mergers and acquisitions were recorded in corporate Americathat was interrupted only temporarily with the stock market collapse in

broker-1987 At the forefront of the trend was the consolidation on WallStreet itself Many of the mergers would not stand the test of time, butthey were significant in the early and mid 1980s

The trend began in 1981 American Express acquired ShearsonLoeb Rhoades; Philipp Brothers, a commodities trading firm, boughtSalomon Brothers; and Sears, the giant retailer, purchased Dean Wit-ter None of the buyers was a traditional investment bank or securitiesfirm, and it appeared that Wall Street was being absorbed by outsidefinancial services companies Hutton was still stumbling at the time,living off its past reputation rather than its current market status.Fomon even offered to purchase Dillon Read but was turned down

by the traditional investment bank as far too pedestrian for a firm withDillon Read’s history and reputation The only question was how longHutton could afford to remain independent

Considering the firm’s problems, it remained independent longerthan anyone expected The vexing issues that plagued it—namely, thekiting issue that took three years to be aired—and problems with its trading portfolio and capital base kept potential buyers at arm’slength for fear of buying a firm that had hidden liabilities Complicat-ing matters was the fact that the Justice Department was taking

a hard line with the kiting issue, threatening to make Hutton the get of a new aggressive attitude toward white-collar crime At theheart of Hutton’s slow but steady decline, however, was its person-ality-oriented management structure that valued individuals over management expertise In contrast to Merrill Lynch, which was oper-ated in a regimented, corporate manner, Hutton was the apotheo-sis of the freewheeling, loosely organized firm that was the norm

tar-on Wall Street a generatitar-on before Management never caught up with the times or adopted new techniques to run the firm effec-tively Despite having moved into the era of the publicly held secu-rities house, it was still operated much as the partnership it used

to be, with lines of accountability often blurred by personality clashes.Whoever eventually bought it would have to take the firm without its top management, since they were no longer well regarded on the Street.

A suitor appeared in the form of Shearson American Express Thefirm, headed by Peter Cohen, had previously purchased Lehman Broth-ers and was itself owned by the American Express Co In the 1970s, ithad been headed by Sanford Weill, who sold it to American Expressafter merging with Lehman Brothers Hutton’s branch system was themain target of its affections Negotiations for the purchase were tortur-ous Originally, Hutton offered itself to Shearson for $50 per share, anoffer that Cohen thought too rich As the deal bogged down, severalsenior Hutton officials recognized that a change was needed at the top.Fomon was replaced as chairman by Robert Rittereiser, an ex–MerrillLynch executive recruited in 1985 But it was too late for the firm toresurrect itself from years of bad management and self-indulgence

A year later, in October 1987, the stock market suffered one of itsworst performances in years as the Dow Jones Average dropped 20percent The poor performance tied up many deals currently in syndi-cation and hit underwriters with serious losses Proposed mergers alsosuffered Hutton’s stock price dropped to $15, a far cry from the pre-vious asking price Hutton realized that it had to act quickly to survivedespite the depressed stock price The credit-rating agencies in NewYork were on the verge of downgrading its debt If they did, the firmwould technically have collapsed, because it would no longer be able

to raise funds necessary for day-to-day operations in the money ket Finding itself with its back to the wall, it again offered itself forsale and gave potential bidders only a week and a half to make an offer.Merrill Lynch and Dean Witter were involved in the bidding alongwith the Equitable Life Insurance Co., which eventually purchasedDonaldson, Lufkin & Jenrette Shearson again emerged, offering abuyout package worth slightly less than $1 billion, down about $500million from the price originally bandied around by Hutton before themarket collapse The offer was accepted Hutton had no choice.The price that was agreed upon was based on a share value of $29.The deal was worth $821 million in cash and $140 million in bonds.Some argued that Hutton was no longer worth that much money, but

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Shearson clearly was looking beyond the sagging market for betterdays Cohen remarked that “our industry is more and more becoming

an oligopoly, we’re a very high fixed cost business.”26 His assessmentwas right on the mark The trend was clearly toward larger, full-servicefirms that offered all sorts of investment banking and brokerage ser-vices The new firm had a combined capital of $3.75 billion, more than12,000 brokers, and 600 offices; only Merrill Lynch was larger Theconsolidation trend would continue into the 1990s, as many firms tried

to combine in order to add capacity while reducing back-office costs Looking back over its checkered history since the 1960s, Huttonappears to be a firm that never recovered from the backroom crisis of1968–70 The forays into investment banking eventually proved dis-astrous for the firm, and its sales practices began to give Wall Street abad name by the 1980s At the end of the day, the only real value ithad was its original core of branches that housed its account execu-tives, still a sizable sales force despite being poorly managed WhenShearson stepped in with its offer to buy the firm, it emerged as themost recent securities house that helped save another Without itspurchase, Hutton would have failed, giving Wall Street a black eye atthe time of the market collapse of 1987—something everyone des-perately wanted to avoid As Merrill Lynch and Hutton had donebefore it, Shearson assumed the position of white knight, ready tostep in to save another Wall Street appreciated the gesture butsecretly wished that competent management at some of its better-known firms could have avoided the problem in the first place

Salomon Brothers was the best example of a tiny marginal firm thatemerged from the shadows to vie with Merrill Lynch for the topunderwriting spot in the 1970s and 1980s At first glance, it appeared

to have all the traditional characteristics of a turn-of-the-century firm

in place, although it departed from the model very quickly Anotherexample was Drexel Burnham, the once proud firm that had beenaffiliated with J P Morgan for years prior to the Glass-Steagall Act.After years of decline, it too developed a specialty that vaulted

it into the top leagues of Wall Street underwriters But Drexel’s ond chance at success came much later, in the 1970s Oddly, Drexel’sspecialty—junk bonds—was one of Wall Street’s hottest financialproducts in years, although the new market bore an uncanny resem-blance to the type of bonds that a 1920s banker would have easily recognized

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The success of both Salomon and Drexel proved that firms on theway up often employed well-known but little-used techniques to vaultthemselves to the top of the Wall Street league tables Salomon began

as a money broker, making the rounds of established banks and kers in New York in much the same way that money brokers had done

bro-in London for over a century Usbro-ing the goodwill it established, it thenentered the bond business where it eventually made its fortune.Drexel, on the other hand, was a well-respected house that had goneinto decline after parting with J P Morgan in 1933 and resurfaced as

a Wall Street force with the advent of junk bonds in the 1970s Junkbonds, a new method of finance, were based on an underwriting feestructure that Morgan and his predecessors easily would have recog-nized because it was borrowed from earlier days when bonds werethe most popular and lucrative form of financing on the Street.Both firms suffered from serious cases of avarice in the late 1980sthat drastically changed their respective futures Salomon becameembroiled in a scandal involving the rigging of Treasury bond auctionsthat would begin a period of transition, ending when the firm was pur-chased by Citigroup Events surrounding Drexel were even moresevere The firm was shut down after Michael Milken pleaded guilty tocharges stemming from an insider trading scandal During the 1980s,both firms were known for their extravagances Salomon senior execu-tives were known for their well-publicized high living, while Milkenheld the famous “Predators Ball” each year in Beverly Hills where hewined, dined, and entertained investors and bond issuers alike Butthose events came at the end of the firms’ independent histories.Three quarters of a century before, each firm was cast in a differentbut classic mold of early Wall Street partnerships Drexel was a Morganfirm that was widely respected on the Street for its long list of corpo-rate connections Salomon, on the other hand, was the Jewish new-comer To survive it had to be opportunistic and, in its earliest days, bethankful for any crumbs that fell from a major bank’s table

The Jewish Jay Cooke

Ferdinand Salomon opened a money brokerage in New York in 1910

He learned the business from his father, who had been in a similar

business in western Germany in the nineteenth century He grated to the United States with his family as a boy and eventually set

immi-up shop not far from Wall Street Unlike other Jewish-American WallStreeters, Salomon did not deal in stocks or bonds but only in themoney market He was joined by three of his four sons—Arthur,Percy, and Herbert—when they came of age and settled down to amodest business Within a year, a family rift had caused the sons to setout on their own and Salomon Brothers was officially born at 80Broadway with $5,000 in capital Their business was the same as Fer-dinand’s: They dealt only in the money market, acting as middlemenbetween banks and brokers, offering to provide short-term callmoney to brokers in need, taking a tiny commission for bringing bor-rower and lender together As far as anyone on the Street was con-cerned, their business was of no consequence since they were onlybrokers and not very visible ones at that

Money brokers at the time paid business calls on their clients inorder to serve them on a daily basis This was a quaint but effective tra-dition that enabled the brokers to meet their better-known clients,especially the private bankers upon whom much of their businessdepended Paying calls on banking and brokerage clients had been atradition in the City of London, Britain’s financial district, for morethan a century and was a hallmark of the U.K money market In Lon-don, the Bank of England, like many other European central banks,imposed a regulation that all money dealers be within a mile of itselfand the London Stock Exchange so that their operations could bemonitored Ferdinand Salomon’s sons picked up his European her-itage and practiced similar methods in New York Arthur Salomonheaded the firm, and it was he who paid visits to the large banks, including Morgan, National City, and First National His dourdemeanor and natty, mustachioed appearance made him the ideal per-son to visit the captains of finance The other brothers divided the rest

of the work between themselves, while office operations were run byBen Levy, a former employee of Ferdinand, who left to join the sons.But the work was not highly rewarding for the fledgling partnership

In their first month of operation, the Salomons arranged forty-oneloans totaling slightly more than $7 million, earning gross commissions

of $2,800.1For their business to be profitable, they had to do a

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volume business because their commission structure suggested thatthey were living off the crumbs from larger institutions’ tables.Money brokering was too limited, and they quickly recognized thatthey had to expand The bond business was the next logical step,because most of the institutions with which they dealt were fiduciarybond investors Brokering bonds was much the same as money bro-kerage The firm simply purchased bonds for clients and deliveredthem without taking on the risk of being a principal in the transaction.The activity added another dimension to the firms’ activities, how-ever, and the brothers began to eye a seat on the NYSE But an NYSEseat was expensive at the time, well out of their reach Arthur decided

to seek a new partner who already had a seat and put him in charge oftrading on the exchange His choice was Morton Hutzler, who owned

a seat and operated as a “two-dollar broker.” Similar to the Salomons,Hutzler executed orders for others on the NYSE floor for a flat $2commission When approached, he was receptive to joining them andsigned a partnership agreement that changed the name of the youngfirm to Salomon Brothers & Hutzler It was still 1910, and the firmwas making great strides in expanding beyond its original, limitedbase of operations

Despite the NYSE connection, Salomon Brothers still did an activebusiness in the money market, discounting commercial paper forinvestors and borrowers and becoming an active part of the secondarymoney market In recognition of the activity, they changed the name

of the firm to the slightly grandiose The Discount House of Salomon

& Hutzler This put them firmly in the money market, and the NYSEseat became an adjunct of their money market activities rather thanthe primary focus of their attention The bond business continued todevelop rapidly, and the firm added Charles Bernheim as a partner in

1913 to look after the bond side of the business But the bond ness presented its own obstacles since it was the premier securitiesbusiness in the country at the time Salomon was an unknown toeveryone except insiders on Wall Street, and it was unlikely that itwould ever be involved in underwriting a corporate bond as long asthe business was dominated by J P Morgan and Kuhn Loeb Withoutjoining that fraternity, it was destined to remain nothing more than abroker Arthur Salomon realized his predicament and chose to cir-

busi-cumvent the problem, much as Jay Cooke had done fifty years before.The establishment of the Federal Reserve in 1913 and the out-break of war changed the structure of the securities markets Moneymarket dealers now registered with the government in order to sellTreasury issues, and the war made those issues, the Liberty Loans,extremely popular among investors When the first Liberty Loan wasissued in 1917, Salomon saw his opportunity and signed on as a dealer

in Treasury securities This was a strategic move of great importance,because he had the field mostly to himself The traditional, old-lineinvestment banks were busy underwriting bonds for foreign govern-ments while others were busy doing corporate deals Wall Streetassumed that the Liberty bond business was ephemeral and wouldend with the war In the interim, however, Salomon Brothers madesecondary markets in the bonds and learned a great deal about thebond trading business—more than it would have done during peace-time In fact, Ben Levy made his reputation at Salomon successfullyselling the war bonds and was rewarded with a partnership in 1918.Since 1913, he had followed in Arthur’s footsteps by paying a dailycourtesy call on the Federal Reserve Bank of New York Salomon wasquietly winning points with the New York establishment by acting like

a classic London discount house, seeking to continually act as dleman between the central bank and the rest of the market

mid-Salomon’s foresight and aggressive trading paid off once the warended Underwriting commitments from the major banks began beingoffered to the firm, although they were usually small But ArthurSalomon never demurred; he always accepted an underwriting regard-less of its size He realized that joining the club was time-consumingand entailed a certain amount of groveling by his young firm—a priceworth paying, he felt He worked as hard as any J P Morgan partner,hardly taking any time off Slowly, the firm began to depend on hisleadership and vision for the future He made many innovations thatspelled success for the firm but were at odds with standard Wall Streetpractice They never made the headlines, because they were mostlymatters of internal operation Unlike innovations at retail brokers,these innovations at institutional firms remained trade secrets

Because they worked for an institutional firm, Salomon’s salesmenand traders often had overlapping functions Salesmen sold bonds

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