A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

Author:Richard Bookstaber
Language: eng
Format: epub, pdf
Tags: Business, Economics, Finance, Systemic Risk
ISBN: 9781118045589
Publisher: Wiley
Published: 2010-12-31T16:00:00+00:00


INTO THE ARMS OF TRAVELERS

Triggered by Bankers Trust’s announcement to purchase Alex Brown in February 1997, merger mania was spreading around Wall Street as institutionally oriented firms started to see the value of retail distribution. There was then the merger of Morgan Stanley and Dean Witter in the spring, and in the summer the acquisition of Furman Selz by ING and the purchase of Montgomery Securities by NationsBank Corporation. On Wednesday, September 24, Travelers joined in the fray, announcing its intention to acquire Salomon.

The purchase made a lot of sense from various vantage points. For Travelers’ boss, Sandy Weill, it was a natural next step in his ladder of acquisitions. There were already rumors that he was looking to acquire a big bank, but at the time such a move would have met with legal and regulatory hurdles, because Washington often looked askance at commingling insurance and banking. He had already talked with Jon Corzine about acquiring Goldman Sachs, but without success. The acquisition of Salomon would not face the level of regulatory issues that would come with trying to acquire a commercial bank, and Salomon, because of its trading orientation where money talks, was far more likely to come to terms than Goldman.

The merger also looked good strategically. Salomon had Wall Street’s elite bond business and had developed a global trading network, while Smith Barney, Travelers’ brokerage arm, had retail business and a stronger connection to the smaller domestic businesses. Neither Salomon nor Smith Barney was particularly strong in investment banking, but in combination the two would be among the top five in both U.S. and global underwriting for both equities and debt, and would be No. 1 in municipal underwriting.

And the merger made sense for Salomon’s largest shareholder, Warren Buffett, who had been spending years trying to figure out a profitable exit strategy for his Salomon investment. Salomon was being purchased for more than $8 billion, nearly two times book value; in reaction, its stock had climbed 80 percent from its recent trading level. Buffett would be able to exchange his control of almost 20 percent of Salomon for a stake in Travelers Group, and with the Weill-led team he would have a firm that was run by the high-quality management he valued.

But the impetus for the merger, what led to discussions in the late summer between Weill and Maughan, was the weakening of Salomon’s trading position from the MCI/BT trade. Beneath Salomon’s trading power was a perilous foundation. Ever since the trading problems in 1994, Salomon had been teetering on the edge of its investment grade bond rating. The principal focus for our CFO, Jerry Bailey, was to keep the rating agencies abreast of developments with regard to our business and to argue for not dipping below the BBB watermark. The losses related to MCI/BT further weakened this foundation, underscoring our trading vulnerability and making our rating all the more precarious. It also further weakened our equity business, which was already the weakest link in the firm.



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