Tectonic Shifts in Financial Markets

Frontmatter

1. How It Began at Salomon Brothers

Abstract

On the eve of the 1960s, even the most astute observers of financial markets had little inkling of what would follow over the next generation. The 1950s had unfolded with moderation. The economy returned to a sound postwar footing, while the financial sector remained stable and conservative—thanks in large part to the constraints placed on financial intermediaries during the 1930s. There was a mild business recession in the early 1960s, but nothing of the sort that foreshadowed what was to follow.

Henry Kaufman

2. The Art and Science of Forecasting

Abstract

Today, forecasting is all the rage. A small army of economists and analysts scrutinizes every bit of new information and speedily attempts to predict its implications.

Henry Kaufman

3. Presidents versus Fed Chairmen

Abstract

Just as the political system in the United States is based on the separation of powers, our federal economic bureaucracy possesses some components under direct executive control, and others that are supposed to operate independently. Among the latter, none is more prominent than the Federal Reserve System. The Fed is officially charged with maintaining stable economic growth through monetary policy. This is a goal any president should embrace, yet since its founding in 1913 the Fed often has found itself at odds with one or another presidential administration.

Henry Kaufman

4. Paul Volcker, Perennial Public Servant

Abstract

Very soon after I joined the Federal Reserve Bank of New York as an economist in 1957, I encountered a very tall man. I was walking down the ninth-floor corridor of the Research Department. Coming toward me was a man chewing on a cigar, about six and a half feet tall, deeply engrossed in writing notes on a yellow pad as he walked. I greeted him and said, “I am Henry Kaufman.” “Well,” he responded, “I’m Paul Volcker. You’re the new fellow in Financial and Trade” (a division of the Research Department). With a “Good luck” sort of “Good bye,” he rambled on.

Henry Kaufman

5. The Fed and Financial Markets: Greenspan, Bernanke, and Yellen

Abstract

In recent decades, two Fed chairmen have garnered more attention than arguably any previous central bankers in U.S. history. Alan Greenspan became the second-longest serving Fed Chairman after heading the bank from 1987 to 2006. He presided over a period of economic expansion, but became controversial in his final term and beyond, after the financial crisis hit in 2007. His successor, Benjamin Bernanke was by necessity a central figure by virtue of grappling with the crisis. Both men were appointed by Republican presidents, inflation hawks, neoliberal monetarists willing to infuse massive amounts of liquidity into the system during times of emergency, and unlikely celebrities. And both, for all their accomplishments, remained rather tone deaf to structural changes in financial markets and how those affected monetary policy.

Henry Kaufman

6. Charles Sanford and the Rise of Quantitative Risk Management

Abstract

Charles “Charlie” Sanford, Jr., was one of the most innovative, entrepreneurial, and philosophical commercial bankers in the post-World War II era. Although little remembered today, he was a pivotal figure in recent financial history who was central to bringing about a tectonic shift in modern commercial banking. He did this by transforming Bankers Trust Company from a commercial bank into a merchant-investment bank. More broadly, he put in place innovative quantitative risk management techniques as the principal tool for assessing risks—tools that became widespread throughout the industry. But his career was checkered. During his tenure at Bankers Trust, the bank’s balance sheet was restructured and profits rose sharply. Yet by the time Sanford retired in 1997, profits were declining and the bank was embroiled in litigation.

Henry Kaufman

7. The Dominance of Walter Wriston

Abstract

During the Second World War and for several more years, financial managers adjusted to the new rules and regulations put into place during the New Deal and began to finance the private sector again. But over time the legacy of financial excess in the 1920s faded. By the 1960s, managers and owners who had dominated during the Great Depression were retired or fired, giving way to a new generation of financial leaders. Within that generation, the most dominant banker was Walter Wriston of Citibank. More than any other figure, Wriston—as CEO of one of the world’s largest financial institutions from 1967 to 1984—pushed the boundaries of American banking. No one, thus far, has been his equal.

Henry Kaufman

8. The Bigness Crisis

Abstract

While Wall Street, policymakers, and the nation as a whole watched the drama of the 2008 crisis unfold, fearful of systemic collapse, another drama was unfolding on the same stage. The institutions that intermediate between lenders and borrowers were collapsing and concentrating into a small number of super-dominant players. The process, in fact, was aided and abetted during the crisis by official policymakers. By then it was abundantly clear that the largest institutions were “too-big-to-fail.” In an effort to minimize insolvency and market disruptions, Fed and other officials actually encouraged financial institutions to consolidate. They also required large institutions to accept an equity injection by the government itself. It was another way—one largely overlooked amid the crisis atmosphere—that the most severe financial crisis since the Great Depression damaged not only the financial system but also the larger economy.

Henry Kaufman

9. A Meeting with Margaret Thatcher

Abstract

U.S. presidents and other heads of state too often sideline economic affairs when their attention is demanded elsewhere. Diplomacy, wars, and scandals are typical reasons. More than that, some leaders don’t value high-level economic advice. President Herbert Hoover considered himself an economist of sorts, and spurned the counsel of leading experts. President Ronald Reagan was so confident in the wisdom of supply-side theory that he considered shutting down the Council of Economic Advisers and rarely conferred with his treasury secretary, Donald Regan.

Henry Kaufman

10. Michael Milken: Moving Junk Bonds to Prominence

Abstract

Michael Milken was a pivotal figure in late-twentieth-century bond markets. He unearthed a slumbering junk bond market and catapulted it to the forefront of the credit markets. In the process, he encouraged many bond market participants to embrace higher risk. The debt instruments he packaged and sold through Drexel Burnham Lambert helped fuel a wave of leveraged buyouts and other corporate takeover gambits, including several major deals put together by Kohlberg Kravis Roberts in the late 1980s. KKR found that negotiation with a “highly confident” letter from Drexel in hand—in which Milken offered strong assurances he would underwrite a deal—was a powerful bargaining chip. Milken’s below-investment-grade bonds also were embraced by many small and medium sized firms hungry for growth capital as well as by stalwart institutional investors. Mr. Milken and Drexel made billions of dollars in profits before the wunderkind investor was indicted and sent to prison.

Henry Kaufman

11. Financial Crises and Regulatory Reform

Abstract

In the United States, meaningful financial reform has tended to be crisis-driven. That is an unfortunate fact, for several reasons. It means that our regulatory system has been defined and redefined under extreme rather than normal conditions. It means that financial regulation is more reactive than proactive. And it means that we must endure serious dysfunction, if not a major calamity, before fixing problems—financial excesses that typically have been recognized and acknowledged long before the crisis hits.

Henry Kaufman

12. The Present Value of Financial History

Abstract

In one sense, we all rely on history every day in almost everything we do—because we employ knowledge of the near- , medium-, or long-term past to understand and decide our actions. History is memory, and memory is much of what makes us human. But there is a big difference between informally recalling what has happened and systematically studying and analyzing it. It is no coincidence that dictators devote a lot of effort to destroying (think of George Orwell’s novel 1984 or the Mao’s “Red Guard”) or completely rewriting the history of their dominions.

Henry Kaufman

13. The Politicizing of the Fed

Abstract

The U.S. Federal Reserve’s record since the end of World War II has been checkered at best. Along with some significant accomplishments have come considerable shortcomings. The central bank’s greatest achievements are these: First, under Paul Volcker’s leadership (see Chap. 4 ), the Fed broke the back of the virulent inflation that had plagued the economy for a decade and a half beginning in 1965. Had prices continued their upward spiral for much longer, our economy, and possibly our very social structure, could have suffered dire consequences. Second, under Ben Bernanke, the Fed—albeit belatedly—helped ameliorate the macroeconomic impact of the 2008 financial crisis. While it is true that Greenspan’s Fed policies contributed to the credit binge at the heart of the crisis, his successor acted innovatively to help ward off what likely could have morphed into a great depression. Indeed, monetary policymakers deserve considerable credit for the fact that the U.S. hasn’t suffered a major depression since the 1930s.

Henry Kaufman

14. Tectonic Shifts

Abstract

One of the great assets of the present day, it is often argued, is the new information revolution. The World Wide Web is only twenty years old, yet investors now have access to geometrically more information than a generation ago, as well as sophisticated new tools for modeling that information. Even so, our heavy reliance on statistics carries considerable risks, especially on the policy side. The data are rich and accessible, but how accurate and valid are they? Consider a few illustrations.

Henry Kaufman

15. You Can’t Go Home Again

Abstract

Nostalgia has a powerful draw. Sometimes we desire to return to the magic of a youthful romance, the triumph of a winning sports play, the excitement and camaraderie of college life, or even the hardships and struggles that ultimately brought success. But as Thomas Wolfe portrayed vividly in his aptly named 1940 novel about small town life, “You Can’t Go Home Again.” The home you leave is never the home you find upon return.

Henry Kaufman

Backmatter