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Salomon Brothers

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Salomon Brothers
Company typeSubsidiary of Citigroup
Founded1910
Headquarters
New York
,
USA
ProductsInvestments
This article deals with Salomon Brothers. For other uses of the name Salomon, see Salomon.

Salomon Brothers was a Wall Street investment bank. Founded in 1910, it remained a partnership until the early 1980s, when it was acquired by the commodity trading firm then known as Phibro Corporation. This proved a "wag the dog" type merger as the parent company became first Phibro-Salomon and then Salomon Inc.[1] and the commodity operations were sold. Eventually Salomon (NYSE:SB) was acquired by Travelers Group in 1998, and following the latter's merger with Citicorp that same year, Salomon became part of Citigroup.

Period of Innovation

John Gutfreund became managing partner in 1978 and took the company public, staying on as CEO. During its time of greatest prominence in the 1980s, Salomon became noted for its innovation in the bond market, selling the first mortgage-backed security, a hitherto obscure species of financial instrument created by Ginnie Mae. Shortly thereafter, Salomon purchased home mortgages from thrifts throughout the United States and packaged them into mortgage-backed securities, which it sold to local and international investors. Later, it moved away from traditional investment banking (helping companies raise funds in the capital market and negotiating mergers and acquisitions) to almost exclusively proprietary trading (the buying and selling of stocks, bonds, options, etc. for the profit of the company).

Salomon had an expertise in fixed income trading, betting large amounts of money on certain swings in the bond market on a daily basis. The top bond traders called themselves "Big Swinging Dicks", and were the inspiration for the books The Bonfire of the Vanities and Liar's Poker (see below).

During this period however the performance of the firm was not to the satisfaction of its upper management. The amount of money being made relative to the amount being invested was small, and the company's traders were paid in a flawed way which was disconnected from their true profitability (fully accounting for both the amount of money they used and the risk they took). There were debates as to which direction the firm should head in, whether it should prune down its activities to focus on certain areas. For example, the commercial paper business (providing short term day to day financing for large companies), was apparently unprofitable, although some in the firm argued that it was a good activity because it kept the company in constant contact with other businesses' key financial personnel. It was decided that the firm should try to imitate Drexel Burnham Lambert, using its investment bankers and its own money to urge companies to restructure or engage in leveraged buyouts which would result in financing business for Salomon Brothers. The first moves in this direction were for the firm to compete on the leveraged buyout of RJR Nabisco, followed by the leveraged buyout of Revco stores (which ended in failure).

Treasury Bond Scandal

In 1991, Salomon trader Paul Mozer was caught submitting false bids to the U.S. Treasury by Deputy Assistant Secretary Mike Basham, in an attempt to purchase more Treasury bonds than permitted by one buyer between December 1990 and May 1991. Salomon was fined $290 million, the largest fine ever levied on an investment bank at the time, weakening it and eventually leading to its acquisition by Travelers Group. CEO Gutfreund left the company in August 1991; a SEC settlement resulted in a fine of $100,000 and his being barred from serving as a chief executive of a brokerage firm.[2] The scandal is covered extensively in the 1993 book Nightmare on Wall Street.

After the acquisition, the parent company (Travelers Group, and later Citigroup) proved culturally averse to the volatile profits and losses caused by proprietary trading, instead preferring slower and more steady growth. Salomon suffered a $100 million loss when it incorrectly bet that MCI Communications would merge with Sprint instead of Worldcom. Subsequently, most of its proprietary trading business was disbanded.

For some time after the mergers the combined investment banking operations were known as Salomon Smith Barney, but reorganization has renamed this entity as Citigroup Global Markets Inc. The Salomon Brothers name, like the Smith Barney name, is now a division and service mark of Citigroup Global Markets.

Liar's Poker

Salomon Brothers' success and then decline in the 1980s is documented in Michael Lewis' 1989 book, Liar's Poker. Lewis went through Salomon's training program and then became a bond salesman at Salomon Brothers in London. In the work, Lewis portrays the 1980s as an era where government deregulation allowed less-than-scrupulous people on Wall Street to take advantage of others' ignorance, and thus grow extremely wealthy.

He traces the rise of Salomon Brothers through mortgage trading, when deregulation by the U.S. Congress suddenly allowed Savings and Loans managers to start selling mortgages as bonds. Lewis Ranieri, a Salomon Brothers' employee, had created the only viable mortgage trading section, so when the law passed, it became a windfall for the firm. However, Lewis believed that Salomon Brothers became too complacent in their new-found wealth and took to unwise expansion and massive displays of conspicuous consumption. When the rest of Wall Street wised up to the market, the firm lost its advantage.

Likewise, Lewis argued that Salomon Brothers improperly tried to "professionalize" itself. As he notes, Ranieri and his fellow traders lacked college degrees; one of the traders only had an eighth-grade education. Despite this lack of credentials, the group was extremely successful financially. However, the firm, in order to improve its "image," began to hire graduates of prestigious business and economics programs (a group which included Lewis himself). Because of his uncouth manners, Ranieri (along with many of his Italian colleagues) was eventually fired. By relying more on diplomas than on raw trading skill, Lewis argued that Salomon crumbled.

After mortgage bonds, Lewis examined junk bonds and how Michael Milken built junk bonds from nothing to a multi-trillion-dollar market. Because the demand for junk bonds was higher than its supply, Lewis argues that corporate raiders began to attack otherwise sound companies in order to create more junk bonds.

Lewis remarked in his conclusion that the 1980s marked a time where anyone could make millions, provided they were at the right place at the right time, as exemplified by Ranieri's success.

Long Term Capital Management

Salomon Brothers' bond arbitrage group was also the breeding ground for the core group of founders and traders (led by, among others, John Meriwether and Myron Scholes) for Long Term Capital Management, the hedge fund that notoriously blew up in 1998.[3]

Notes

  1. ^ Michael Lewis. Liar's Poker. New York, pg 228 http://books.google.com/books?id=Ujl3ngrhduUC&pg=PA228&dq=partnership+salomon+inc+liar%27s+poker&client=safari
  2. ^ Ex-Salomon Chief's Costly Battle, The New York Times, August 19, 1994
  3. ^ When Genius Failed: The Rise and Fall of Long-Term Capital Management

References

  • Sobel, Robert (1986). Salomon Brothers, 1910–1985: Advancing to Leadership. New York: Salomon Brothers.
  • Lewis, Michael (1989). Liar's Poker: Rising through the Wreckage on Wall Street. New York: W.W. Norton. ISBN 0-393-02750-3.
  • Lowenstein, Roger (2000). When Genius Failed: The Rise and Fall of Long-Term Capital Management. Random House. ISBN 0-375-50317-X.
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