Cultures Clash at Salomon Smith Barney
Richard Bookstaber was Salomon Brothers’ chief risk officer in 1997 when the firm was bought by Travelers and merged with Smith Barney, Travelers’ retail brokerage. He describes the resulting clash of cultures.
I joined Salomon Brothers in 1994 as chief risk officer, which meant I was in charge of assessing the firm’s market-related risk. I oversaw market risk at Salomon’s customer desks, which bought and sold securities to institutional investors. There were about 50 such desks around the world, such as the New York corporate bond desk, the London government bond desk, and the Tokyo equities desk, among many others.
I also oversaw market risk at Salomon’s proprietary trading desks. These hedge-fund-like entities put on long and short positions, often in huge quantity, and often holding onto positions for weeks or months. These desks operated in New York, London, and Tokyo. Salomon was famous for the scope and profitability of its proprietary trading operations.
One part of my job was to put in place a system to aggregate the market risks to which individual desks were exposed, for example, their profit and loss sensitivity to changes in interest rates, credit spreads, or exchange rates. When I arrived at Salomon, each desk managed its risk independently and Salomon had no system in place to measure and manage market risk on a firm-wide basis.
I put in place a structure where each desk calculated and reported their sensitivity to different market risks in a format where I could aggregate results. We could then see where the firm as a whole was building up risk exposures through the independent actions of autonomous desks. Then we could take steps to cut positions or hedge these risks.
Another aspect of my job was assessing the desks’ risk management. Even though each desk was responsible for managing its own risk, it made sense to have an independent and objective party, someone not affected by the desk’s profit and loss, take a look and give senior management a second opinion. We called this process risk audits, although it was a collegial and joint effort to make sure things were right.
I was able to put my risk system in place and evaluate desks’ risk management with a very small group; six or seven people at our peak. Salomon was the largest trading firm in the world at the time, so the idea that you could do risk management with a small team like that might seem crazy. But if you receive high quality information and lever technology, you don’t need an army to get this stuff done.
And we did get the job done. The year I joined, 1994, was a horrible year for Salomon, with the firm losing money in three of four quarters and losing $399 million over the year. After our firm-wide risk management system was in place, we never lost money in any quarter, from mid-1995 onwards. Earnings fluctuated in a much smaller range and never fell below $112 million in any quarter.
Salomon’s Culture
I had an ideal position to understand Salomon’s business and witness Salomon’s culture as it existed 1994 through 1998. The first aspect of Salomon that impressed me was its intellectual foundation, which translated into practical research and innovative financial products. Henry Kaufman and Marty Leibowitz were pre-eminent in market economics and fixed income research and in developing that foundation. In the years before I joined, Salomon had invented or played a huge role in the development of mortgage-backed securities, interest rate swaps, third-party repo, and triple-A-rated derivative product companies.
Marty was the one who recruited me. In the years before I joined, Marty and I would have lunch together periodically, and he would suggest open positions at Salomon for which he thought I was suited. The one that made the most sense was the risk role -- which I did at Morgan Stanley before I made the switch.
Salomon’s intellectual focus fostered dispassionate analysis where a collegial atmosphere prevailed. I interacted daily with the heads of the trading desks individually. I also witnessed their interactions when they and I met each month with CEO Deryck Maughan and chairman Bob Denham to go through the firm’s risk exposures. There was always mutual respect, all of us trying to understand what everyone was doing and figure out what the risks were.
One example of collegiality at Salomon was the way people respected each other’s ideas. If someone made a proposal and it wasn’t quite right, if something was missing, others would try to help fill out the idea. There was a sense of everyone working together. That was distinct from most other firms I’ve worked at where, if you made a proposal that wasn’t bulletproof, people would just shoot the idea down. In fact, at some firms, people seemed to live to shoot down other people’s ideas.
But collegiality was part of Salomon’s culture. The firm had been a partnership only 13 years previous and throughout its history Salomon was an outsider among security firms. It had come into its own via the competitive world of fixed income trading, not the clubby world of equity underwriting. People at Salomon had an us-versus-them attitude, a feeling of being alone together in a lifeboat in the middle of the ocean. If you find yourself together in a lifeboat, you rely on each other and you work together to survive.
The intellectual and collegial attitude limited infighting. The best example I can think of comes from one of the meetings of the senior risk management group. We were talking about a trading strategy being done on both the customer interest rate swap desk and on the New York proprietary trading desk. The two desks sometimes traded against each other because one hand didn’t know what the other hand was doing. There was a wall between the prop and customer businesses. Rob Stavis, the head of the New York prop desk, explained why the strategy fit better on his desk. People in the risk management committee said, “Yeah, that makes sense. We should consolidate it on the prop desk.”
After the meeting was over, I was walking back to the trading floor and Stavis was a little ahead of me. He walked over to Rick Stuckey who ran the swap desk and said, “We just had a risk management meeting, and I was saying that this part of your business makes more sense in prop trading.” Stucky said, “Yeah, I get that. Why don’t we talk about it after the close?”
In most firms, the situation wouldn’t play out this way. Instead, the person in Stavis’ place might not give Stucky a heads up at all or, if he did say something, it would be along the lines of “Hey, while you weren’t there, I argued to take away some of your business and, ha-ha, you weren’t there to defend yourself, so too bad.” And the person in Stuckey’s position would yell and scream and threaten retaliation. But at Salomon it was “this is what we discussed” and “let’s see if it makes sense.” This is a good example of how things operated.
Intellectualism and collegiality manifested itself in other ways, too. Offices at Salomon were spartan, with two or three trading desk heads sharing rooms located around the perimeter of the trading floor. No space for mahogany butler’s tray tables or plush couches. What every office did have, though, was a white board. Throughout Salomon, I’d often see two or three people working out a problem at a white board and handing the marker back and forth to each other. Another thing I noticed was how junior employees acted and were treated at Salomon. In meetings, junior members of the team gave their opinions and made suggestions. Their suggestions were considered as seriously as anyone else’s. Many times, I saw a working group adopt a junior employee’s idea.
So, we had this intellectually driven, collegial, all-of-us-in-the-life-raft-together culture. Then things changed.
Travelers Buys Salomon and Cultures Clash
Travelers’ purchase of Salomon was announced in September 1997 and in November Salomon was merged with Smith Barney, Travelers’ retail broker subsidiary. Why Salomon sold itself was a subject of speculation among Salomon employees. In the 12 months preceding the merger announcement, Salomon had made $827 million. True, the rating agencies still had us at triple-B, down from our single-A rating prior to our disastrous 1994. But the agencies are slow to change ratings and an upgrade was only a matter of time so long as we extended our nine-quarter record of relatively stable earnings. Seven months later, when Travelers merged with Citibank, our incorporation into Travelers seemed like only an intermediate step in forming an insurance-trading-retail brokerage-commercial-banking behemoth.
An early meeting between Salomon and Smith Barney gave Salomon executives an idea of the tight leash under which Smith Barney operated. At Smith Barney’s offices, a Salomon exec reached for a phone to call his London office to get information relevant to the discussion. He couldn’t get the call through. When the Smith Barney hosts realized the Salomon exec was trying to call London, they explained that overseas calls were disabled on conference room phones. So where could he make the call? There’s a secretary who has the key to the room containing a phone capable of calling overseas. One just has to catch her at her desk, log out the key, and go to the room with the phone.
The individual trader and the trading floor stood at the center of Salomon culture. After the near-death experience of the 1991 Treasury auction scandal, Warren Buffet, Bob Denham, and Deryck Maughan had made progress in asserting greater senior management control. But to a large extent, traders and trading desks still operated autonomously, and how much money a trader or desk made dictated status and power in the firm. Meanwhile, it seemed to Salomon execs that what mattered most at Travelers was proximity to and friendship with Travelers chairman and CEO Sandy Weill.
Although the scope of Salomon’s business dwarfed that of Smith Barney, key control positions went to Smith Barney personnel. The head of audit, the treasurer, and chief financial officer came from Smith Barney. I was the only Salomon control officer who stayed in his position because Travelers recognized that they didn’t have anyone who could deal with the varied market risks in which Salomon engaged.
A few months after the merger, Travelers management realized they also needed the expertise of Salomon’s credit risk department and tried to reverse their previous decision to give credit risk management to Smith Barney personnel. But by then it was too late. Salomon’s chief credit officer had already left the firm and the next most senior person in Salomon’s credit risk department had lined up a job at another firm and couldn’t be persuaded to stay.
When I came to Salomon, the lessons learned from its Treasury auction scandal three years previous were still fresh in the minds of its executives. Salomon had survived the scandal for two reasons. The first was its balance sheet management. Well before the scandal, CFO Don Howard had reduced Salomon’s dependence on short-term unsecured debt, terming out our liabilities with medium- and long-term debt. Salomon had also become expert at maximizing secured funding sources. During the scandal, John Macfarlane, our Treasurer, raised the internal working capital rate, the cost charged desks to finance security positions, to force desks to shed assets.
The second reason Salomon survived the Treasury auction scandal was Warren Buffett’s perceived rectitude and his full cooperation with regulatory and law enforcement authorities. Salomon would not have retained its primary dealership status, whose loss might have been fatal to the firm, except that Buffett assumed Salomon’s chairmanship. Under Buffett, Salomon’s cooperation extended to waiving attorney-client privilege and sharing the results of its internal investigations. This openness helped resolve the matter with seven law enforcement and regulatory entities in a relatively quick nine months.
Travelers and Smith Barney had never gone through a trial like Salomon’s Treasury auction scandal and did not appreciate these lessons. Members of Salomon’s interest rate swap desk became alarmed when Smith Barney executives did not see the need to trade with other swap dealers on a fully collateralized basis. Such collateral agreements could be an important source of funding for the desk. A Traveler’s exec, Heidi Miller, dismissed the traders’ concern saying, “I understand how your history makes you so concerned about liquidity. But now you are part of a much larger and much better run organization, and you don’t have to worry about liquidity so much.”
Similarly, when a Salomon accountant discovered that a subsidiary had been supplying incorrect capital calculations to the credit rating agencies for months, he argued that the rating agencies must be informed. But Smith Barney personnel didn’t see the need to fess up.
Smith Barney’s lack of sophistication regarding working capital charges led to an almost-humorous situation when Travelers merged with Citibank in 1998. Traders found that they could profit by arbitraging the difference in the lower amount Citibank charged for working capital and the higher amount Smith Barney paid for working capital. They extracted working capital from Citi and supplied it to Salomon Smith Barney, earning the difference.
Jamie Dimon Ends Salomon’s Proprietary Trading
One positive aspect of the Travelers merger was Jamie Dimon’s influence. Unique among Travelers executives, Jamie had broad expertise in Salomon’s businesses and stayed on top of details. I worked with him a lot.
Jamie tried to smooth over the culture clash between Salomon and Smith Barney, once even calling to apologize to a mid-level Salomon exec for the words of a much higher-ranking Smith Barney exec. The Smith Barney executive, in rejecting a course of action advocated by the Salomon exec, had made a lot of the fact that he, the Smith Barney exec, owned many more shares of Travelers than did the Salomon exec.
In early 1998, Jamie began focusing on the proprietary trading desk’s’ Russian exposure. This was months before Russia’s default in August. Everybody knew that Russia risked falling off a cliff and the game was how long you could pick up very high returns and still pull out before Russia crashed. Jamie didn’t go along with this idea, he wanted our Russian exposure reduced, and it wasn’t happening.
Finally, in June 1998, we had a meeting and Jamie looked at the risk reports from proprietary trading. He saw that our Russian exposure was not dropping as fast as he wanted and he said to everyone, “By our next meeting, I want this down to zero.” He then turned to me, made a zero with his index finger and thumb, and reiterated, “To zero.” Enough said.
By 1998, opportunities in convergence trading, the type of trading Salomon’s proprietary desks engaged in, were disappearing. Sandy had an antipathy towards the proprietary trading, both philosophically and because the unit operated independently of the main customer and client businesses of the firm. With that pressure from Sandy and Jamie’s own concern about convergence trading’s continued viability, Jamie disbanded Salomon’s proprietary trading over the 1998 July fourth weekend.
Salomon’s prop trading was viewed as it’s crown jewel, and to the customer-side’s annoyance, Deryck would occasionally remind us in firm meetings of the “highly talented” traders in the unit. Firing Salomon’s proprietary desk was a shock to Salomon personnel. If the proprietary traders could be shown the door, no Salomon desk, no Salomon business, was exempt from Travelers’ interference. But it’s hard to say Jamie’s action wasn’t the right move. By pulling out of Russia and proprietary trading, we avoided losses from the market disruptions of Russia’s August default and Long-Term Capital Management’s September insolvency. We still held some positions we had not closed out, but our losses were nothing like what would have occurred if our proprietary desk had been going full steam ahead.
Risk Monitoring Instead of Risk Assessment
In spite of saving Salomon Smith Barney from catastrophic losses, Jamie was fired a couple months after the Russia and LTCM debacles, in November 1998. The rumor was that it was because Jamie had failed to promote Sandy Weill’s daughter. I don’t think anyone except Sandy knows whether this rumor is true, but it supported the view around Salomon that what mattered at Travelers was not expertise and performance, but your relationship with Sandy.
With the loss of both the prop desks and Jamie, my job became more risk monitoring than risk assessment. I got the message at a risk management meeting soon after Jamie was gone. In the aftermath of LTCM, Treasury prices were crazy because firms had to liquidate positions to raise cash and few entities were on hand to purchase securities. We had on a convergence trade between 19-and-a-half-year and 20-year Treasuries. Its rationale was that the wide difference in yields that existed between the two securities was the result of short-term liquidity pressures and was not sustainable. But from the time the trade had been put on, the yield difference had increased and the trade was down a hundred million dollars.
I looked at the report and knew the increased spread was clearly there because of the lack of liquidity. There’s was no way the yield difference would persist. Once Treasuries finally sold off, the spread was bound to collapse and we would reap the profit. So I said, “We should be adding to this trade.” Charlie Scharf, Salomon Smith Barney’s CFO, looked at me like I was crazy and said, “What sort of risk manager are you?”
That signaled the end of my being a Salomon-style risk manager where if you could assess the risk, you could take the opportunity. Now my job was simply mechanical risk monitoring for purposes of reporting and control.
Back when Salomon merged with Smith Barney, I had inherited a risk management group from Smith Barney that was five times the size of mine. I didn’t know what they all did and I really never figured out what to do with all of them. I also inherited a fair bit of political intrigue. Heidi Miller, the woman who had pooh-poohed the swap traders’ liquidity concerns, became my boss, even though she had no trading experience. It was clear she preferred one of her own in my position.
Travelers seemed to run on personal allegiances and on political jostling to earn that allegiance. With Jamie gone there was no one who might say “this guy should stay in his position because he does a good job.” Not being adept at office politics, I was pushed more and more to the side. I lasted at Salomon Smith Barney a year after Jamie was let go before being fired myself. Which, considering the quality of other people who were fired or who left the firm, I wear as a badge of honor.
The risk function was eventually taken over by Dave Bushnell, who had run Salomon’s money market desk. Within a year, risk management grew to over 200 people, twenty times the number when I was in charge at Salomon. Yet, as Citi’s results in the 2007-08 crisis showed, the risk management group didn’t do its job. Dave, along with Citi’s CEO, Chuck Prince, was shown the door.
In the ten years after leaving Salomon, Rick worked at some of the largest and most successful hedge funds. After the 2007-08 financial crisis, he joined the Obama administration. In government for six years, he worked at Treasury with the Financial Stability Oversight Council and the Office of Financial Research, and at the Securities and Exchange Commission on the Volcker Rule and other regulations. Rick is currently co-founder and head of risk at Fabric, providing financial advisors with insight into market risk that deepens the advisor/client relationship.
He is the author of two books on market risk, A Demon of Our Own Design and The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction.
To comment on a story or offer a story of your own, email Doug.Lucas@Stories.Finance
Copyright © 2022 Richard Bookstaber. All rights reserved. Used here by permission. Short excerpts may be republished if Stories.Finance is credited or linked.
Comment by Michael LoBosco
Michael worked at Smith Barney and succeeding firms 1984-2003, holding various risk management positions overseeing brokerage, banking, and capital markets activities globally.
I will comment on three parts of the January 25 story, titled “Cultures Clash at Salomon Smith Barney.”
1. The characterization of Smith Barney as simply a “retail brokerage”
2. Less than flattering depiction of Smith Barney management
3. Mischaracterization of the Credit Risk function
My comments are as follows:
1. The first thing that got my claws up was the description in the first paragraph of the article simply describing Smith Barney as “Travelers’ retail brokerage.” In addition to being the US’ second-largest retail brokerage, Smith Barney was the world’s most prominent futures commission merchant, had assets under management of $156 billion and a capital markets presence which included being #1 in Munis (where Salomon had no existence). Smith Barney also had a much larger Equities division, typically placing between 5th-8th in equity underwriting. We were also formidable in M&A.
Salomon was world-class in Fixed Income, had a more profound derivatives business, and an international presence, among other things. The 1998 combination made Salomon Smith Barney (“SSB”) robust across most major lines, and one with the largest capital base in the industry.
2. In order to run such a firm, it was recognized from the outset that a strong (risk) management culture would be required. One example of our thinking was the appointment of Heidi Miller to be the Chief Risk Officer. The characterization of Heidi by the author is condescending and completely off-base. It was clear by all involved then that she was an excellent CRO, as well as the right one to build out the risk framework for a larger organization.
Since I did not run market risk, I will not weigh-in on the author’s specific assertions about that area.
Author’s Quote: “It seemed to Salomon execs that what mattered most at Travelers was proximity to and friendship with Travelers chairman and CEO Sandy Weill.”
Comment: I refute that completely based on the prestigious appointments Sandy gave to former Salomon business execs. It’s more than clear in the record.
Author’s Quote, speaking of the former Salomon: “To a large extent, traders and trading desks still operated autonomously, and how much money a trader or desk made dictated status and power in the firm.”
Comment: This is EXACTLY what we wanted to change. We were all in favor of paying the producers, but there would be strict and independent minded controls around the activity.
3. In this section, the author talks about appointments to the control function.
Author’s Quote: “Although the scope of Salomon’s business dwarfed that of Smith Barney, key control positions went to Smith Barney personnel.”
Comment: Correction; it was specifically the risks Salomon presented that dwarfed Smith Barney’s. As far as the key control positions, the author is correct. For example, the firm chose me to be responsible for all credit and operational risks for the combined firm. The author also had something to say about that.
Author’s Quote:“A few months after the merger, Travelers management realized they also needed the expertise of Salomon’s credit risk department and tried to reverse their previous decision to give credit risk management to Smith Barney personnel. But by then it was too late. Salomon’s chief credit officer had already left the firm and the next most senior person in Salomon’s credit risk department had lined up a job at another firm and couldn’t be persuaded to stay.”
Comment: Yes, there were some in management who had a reservation about me, but thankfully not all. Things were changing and it would take time for everyone to get the memo. Here are two stories that straight away illustrated a departure from previous credit risk practices at Salomon. This caused friction, but it eventually died down when the results from this new type of control, standard at Smith Barney, became obvious.
A. Tom Maheras was the head of Fixed Income and one of the most influential people at SSB. I turned down a repo transaction with an existing client because I felt the level of our participation was too large. Tim Douglas, who co-ran the finance desk, disagreed. He then conferenced Tom into our telephone call. At Salomon, Tom could overturn a credit decision by simply making a “business decision.” After hearing both sides, Tom said he appreciated my efforts but would allow the transaction based on his comfort with the client. I stood firm and said, “no, you can’t.” Under the new procedure, I advised Tom that he’d have to appeal to Jamie Dimon. Tom later decided instead to save his powder.
B. In early 1998, Salomon was LTCM’s second-largest counterparty. At Smith Barney before the SSB merger, I placed high collateral requirements on LTCM. In turn, Smith Barney did little business because other firms were more comfortable and hence less stringent. As the heads of LTCM were former Salomon, there was a close relationship. Nevertheless, I decided to set up basically the same collateral requirements for SSB that I had previously mandated at Smith Barney. I argued lower collateral requirements could cause untoward leverage and potential credit losses for us. The desks hated my decision. LTCM then began reducing its business with us. Because of the transactions we inherited from Salomon, which included long-term transactions of a year or more in term, significant reduction would take some time. I could not legally break the trades. When LTCM blew up in September 1998, we had dropped to their sixth-largest counterparty, greatly reducing our credit risk. Had LTCM stayed in business another 3-4 months, SSB’s credit risk would have been close to zero.
Strict and independent control, commonplace at Smith Barney, goes to the heart of proper risk management. Done right, it doesn’t always make the Chief Credit Officer (“CCO”) a popular person. Because of the unique realities in the SSB merger, I felt the pressure big time. Nevertheless, there were three people who kept me in my CCO position. They were Jamie Dimon, Heidi Miller, and Tom Maheras. Over time, Tom and I built a respectful relationship around the management of credit risks. As an enormous shareholder of the firm, Tom came to appreciate rather early on as to what I was doing.
An article like this about events from 25 years ago certainly tests the memory circuits. However, since 1998 was such a significant one for our markets and our firm, I actually remember a decent amount. I left the firm in 2003.
I’m aware that a lot happened at our firm in the years after 2003 as different people took the helm of important control functions.
Prepared By: Michael LoBosco Date: February 12, 2023