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The Great Wall Street Money Squeeze

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Before the Fails problem could be resolved in 1969, it was eclipsed by a more serious crisis, the great Wall Street money squeeze that accompanied the downturn in stock prices. In January 1969, at the time of Richard Nixon's inauguration as President, Standard & Poor's index of 500 common stocks (1941-43=10) stood at 102.04, down 4.44 points from its December 1968 peak. By May 1969 it was up again to 104.62; then it started on a steep decline, sinking to 99.14 in June, down to 91.11 in December, and dropping to a low of 75.59 in June 1970.

In the eighteen months between December 1968 and June 1970 the index lost 30.89 points, a decline of some 29 percent, while the market value of all listed stock (common and preferred) fell from $759.5 billion in 1968 to $680.7 billion in 1970, a loss of almost 10.4 percent.

The eighteen-month-long bear market that started with the June 1969 break owed much to the Nixon administration's decision to fight a mounting inflation by continuing the tight money policy initiated during Lyndon Johnson's last months in office. The monetary curbs, combined with the war in Vietnam, threats of new conflicts in the Middle East and elsewhere, and uneasiness about the general state of the economy drove investors out of the stock market and into bonds, where interest rates on high-grade corporate debt (Moody's AAA-rated bonds) rose from a yearly 6.18 percent in 1968 to 7.03 percent in 1969, and up to 8.04 percent in 1970. Stock sales on the nation's exchanges which had peaked at 5.40 billion shares in 1969 were down to 4.83 billion shares by the end of 1970. The steep drop in share volume shrank the profits of investment houses at a time of increased operational costs, when many firms had added expensive computer equipment to meet an expanding brokerage business that suddenly declined sharply. Computers, unlike clerks, could not be dismissed so easily when trading volume plunged as it did after June 1969. And while most firms did succeed in reducing expenses, the cuts usually did not match the drop in income, with the result that the industry suffered a severe profit and capital squeeze that forced upwards of 100 houses to liquidate or to seek life-saving mergers.

It was not only small houses that closed or had to merge to prevent collapse. The capital squeeze threatened some of Wall Street's largest and most respected firms, among them Hayden, Stone, Inc., Goodbody & Co., and Francis I. duPont & Co. The failure "of any one of them," wrote The New York Times' financial reporter Terry Robards, "could have triggered a run on all brokerage firms," a view widely shared by most of the industry's leaders.

Timely action by the New York Stock Exchange prevented the crisis from turning into a financial panic, the kind that had occurred earlier in American history when a prominent Wall Street brokerage house suspended operations and its customers suffered heavy losses. During the 1969 to 1970 crisis the New York Stock Exchange's Special Trust Fund, established in 1964 after the widely publicized Ira Haupt & Co. failure, stood ready to protect an insolvent firm's clients. The money in the Fund, originally $25 million-$10 million in cash and the balance in standby bank credit-was raised by assessing the Exchange's members 0.375 percent of their annual net commissions. Late in October 1970, when the Fund's pool was near exhaustion and the need for emergency cash was still large and growing, the Exchange imposed a special surcharge of 0.50 percent. Congress, meanwhile, also concerned itself with Wall Street's crisis, and in December boosted the sagging confidence of brokers' clients by passing the Securities Investor Protection Act. The law provided investors with government-backed insurance against broker insolvency, much as the Federal Deposit Insurance Corporation protected depositors against bank failures.

Money from the Exchange's Special Fund also went to provide emergency capital to tottering member houses that might be saved by a hurriedly arranged merger. Salvage operations of this kind were entrusted to a special Surveillance Committee, better known as the Crisis Committee. Set up in May 1970, the six-person top-level group was headed by Felix Rohatyn, a partner in Lazard Freres & Co., and included Bernard J. Lasker, the chairman of the New York Stock Exchange, and Ralph D. DeNunzio, vice chairman of the Exchange and then executive vice president of Kidder, Peabody. The three of them conducted the long, difficult negotiations that resulted in saving Hayden, Stone, one of the Street's largest houses, from liquidation by merging it with Cogan, Berlind, Weill & Levitt, Inc. to create the new house CBWL-Hayden, Stone. That rescue, accomplished in September, was followed immediately by two others, each involving major firms. Goodbody & Co. was saved from collapse in October when Merrill Lynch, Pierce, Fenner & Smith was persuaded to take it over; and in November Rohatyn, DeNunzio, and Lasker succeeded in preventing the failure of Francis I. duPont & Co., a house closely connected with and bearing the name of one of America's oldest and wealthiest industrial families. The duPont rescue, the last of the Crisis Committee's major operations, was accomplished by a merger with Glore, Forgan & Staats and Hirsch & Co., and a huge infusion of Texas money from H. Ross Perot.

Catastrophe had been averted, but the Crisis Committee's work did not strike at the fundamental cause of Wall Street's troubles: the dangerously thin and impermanent nature of so many firms' capital. Much of it was in securities whose value eroded quickly in a falling market, or in subordinated loans which the lenders could demand on relatively short notice, in some cases no more than ninety days. "Many Wall Street firms…" said Merrill Lynch chairman Donald T. Regan, "…have what they call a capital structure, but which more closely resembles a scaffold." The very fact that the New York Stock Exchange had to establish a special committee to monitor its members' capital position, a job regularly performed by the Big Board's staff, not only appeared to confirm the truth of Regan's comment but it also disclosed the extent to which so many of the country's investment firms-the acknowledged experts in raising capital for giant businesses and governments-seemed unable to finance themselves.

Kidder, Peabody was not among the inadequately capitalized houses. Nor did it suffer a cash squeeze. The fact that the firm escaped embarrassment owed much to Gordon, De Nunzio, and other senior officers, some of whom had not forgotten the difficult years of the 1930s. Gordon, still an active policymaker particularly in matters of money, had decided at the time of the 1931 reorganization that no effort would be spared to avoid the kinds of situations that had brought the old Kidder, Peabody to the brink of bankruptcy. That experience, followed by the Pure Oil and Bethlehem Steel underwriting debacles of September 1937, made lasting impressions. Never again, Gordon resolved, would the firm get caught with inadequate capital. If there was one topic on which he and the policy group were in complete agreement, it was to make certain that Kidder, Peabody had adequate permanent capital and sufficient cash. To achieve this Gordon urged the partners to add to their investment in the firm by not withdrawing all their annual profits and after incorporation, he and the policy committee relied heavily on retained earnings to strengthen the firm's capital position. Gordon's financial conservatism-"he's as tight with the firm's money as he is with our clients' funds," said one of the old partners-not only allowed Kidder, Peabody to survive the great money squeeze of 1969 and 1970 but made it possible for the house to add a million dollars to its capital, from $30 million in December 1969 to $31 million in December 1970. And Kidder, Peabody continued to add to its capital every year after then, reaching $53.7 million in 1975. The firm's capital position in the 1970s placed it among the top 25 of the country's 100 leading under-writers, usually among the first 20 houses in the industry. In November 1975 the firm's ratio of net capital to the New York Stock Exchange's net capital rule reached 5.61 to 1, or almost six times more than the Big Board's requirement.

Building capital depended upon profits, and it was the lack of these that bankrupted some houses and drove others to the brink of collapse. "Inadequate profits are the central problem," said Clifford W. Michel, a Loeb, Rhoades & Co. partner and head of the Association of Stock Exchange Firms, the group that included the industry's leading houses. The same view was expressed by a senior member of another major house, Reynolds & Co. "The one thing we need in this business," he said, "is profitability and it's obvious there is a tie-in between profits and capital. The very firms that need it most are the ones that are hardest pressed to get it."

Profitability, of course, accounted for Kidder, Peabody's ability to add to its capital at a time when other firms were being squeezed. Efficient internal management and care in conserving capital and maintaining its liquidity, refusing to allow capital to be tied up in unsold securities even if it meant taking a loss, prevented the firm from incurring deficits. But these policies, important as they were, did not increase profits. Only new business could accomplish that, and then only if the firm had diversified strength so that losses in one area could be offset by gains in another. Diversification made it possible for Kidder, Peabody to register gains even during the long two-year stock market downturn that precipitated the severe Wall Street capital crunch of 1970. Between 1969 and 1970 the securities commission income of the country's broker-dealers fell by almost 26 percent, from $2.93 billion to $2.18 billion. Kidder, Peabody's stock market business stood up much better than the industry's average. Gross income from brokerage commissions in 1969 and    1970 remained almost the same, about 44 percent each year.

But it was the firm's investment banking activities-syndicate managements, underwriting participations, and direct sales-that swelled its total 1970 profits. That year, one of Wall Street's worst since the depths of the great depression, Kidder, Peabody registered a large increase in the dollar value of the corporate public offerings it managed (from $1.74 billion to $3.08 billion), a more modest rise in the municipal financings it headed (from $1.46 billion to $1.78 billion), and a considerable gain in the volume of its underwriting participations (from $3.64 billion to $5.18 billion). The firm's leadership in these areas, as well as the mounting volume of its tax-exempt offerings, were exceeded only by its preeminence in private placements. In three of the six years between 1970 and 1975 Kidder, Peabody ranked first in the number of private placements, and only once in that period did it drop below second place; in 1974 it occupied third place. By the end of 1975 the firm ranked ninth among the nation's twenty-five leading underwriters, measured in terms of the dollar volume of total negotiated corporate managements, and sixth if ranked on the basis of leadership in competitive sales. That year the editors of Institutional Investor, a widely cited trade journal, credited Kidder, Peabody with being the investment banker of fifty-two of the country's largest companies, a number which placed the firm in seventh place among the thirty-seven top houses in the United States.
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