Money and Power (21 page)

According to
Charles Ellis in his book about the firm, by the end of the 1930s, Levy had already made his first million dollars. “
Despite a distinctive lisp that complicated the bayou drawl,” Ellis wrote, Levy used his “aptitude for math, extraordinary memory, ability to connect with many, many people, and capacity for long hours of highly concentrated hard work” to get ahead at the firm in the
years after the Trading Corporation scandal. With the advent of
World War II in Western Europe “
and the opportunities in arbitraging of foreign bonds diminished,” the
Times
wrote, “Mr. Levy became active in arbitraging of railroad reorganization securities and of convertible debentures.”

While largely profitable, Levy’s focus on trading in risky railroad and utility bonds was not a business with which Sidney Weinberg, or Goldman Sachs for that matter, had much familiarity or interest. Levy “
had collected a group of rough-and-tumble entrepreneurial clients that Weinberg thought of as ragtag,” according to former partner
Roy Smith. Levy’s bets also required capital—and tied it
up for potentially long periods of time—unlike an equity or debt underwriting, which generally used capital only sparingly (during the short period between purchasing the securities from an issuer and then selling them to investors), or advising on a merger or an acquisition, which required no capital whatsoever. Since Goldman’s capital at the time was modest—around $9 million in the early 1950s—and it came from the partners’ wallets, there
was necessarily plenty of caution about how and when it was used and for what purposes. This led to a natural tension between Weinberg, the ultimate investment banker, and Levy, the younger, equally ambitious and hardworking trader and arbitrageur. For instance, in an interview Weinberg gave in 1967, he noted that the $100,000 in capital he invested when he became a Goldman partner in early 1927 came from the money he had earned as a banker. “
None
of it was from trading,” he said. “I never traded.” He then proudly reiterated that he was an “investment banker.”

Sandy Lewis—a onetime Wall Street arbitrageur and the son of Salim L. “Cy” Lewis, a longtime senior partner at Bear Stearns & Co.—knew Gus Levy from the time he was a child growing up in Park Avenue splendor. Gus Levy and Cy Lewis were very close friends, in large part because they shared many of the same interests, whether playing golf or bridge, supporting Jewish philanthropic causes around New York City, or making money through
arbitrage.

Cy Lewis’s big break at Bear Stearns came after the bombing of
Pearl Harbor, when the United States decided the time had come to enter World War II. “
The war came and Roosevelt needed to arm the nation and deliver whatever he needed to the factories and then take the product to the ports and get it out of here,” Sandy Lewis said. “He was trying to produce airplanes, tanks, trucks, millions of things.
They had to seize the
railroads and force traffic over the railroads and make sure that the railroads were working just for the government to move product. You had to make sure you got it when you needed it. This was war. They broke the railroads. They put credit controls on. You couldn’t borrow money.” Cy Lewis noticed that before Roosevelt commandeered the railroads for the war effort,
railroad bonds were trading at par because
interest payments were still being made. “But, all of a sudden, they can’t pay the coupon,” Sandy Lewis said. “So they start trading what is called ‘flat.’ You can buy and sell a rail bond any way you please, but the coupon’s not accruing. It’s dead.… If you buy it, you can call it a future and maybe it’ll be worth something someday.” With these railroad bonds no longer paying interest, they were trading as
low as five cents on the dollar. Lewis started to think about whether to buy the bonds at these severely depressed prices. He figured either Armageddon was imminent—in which case nothing much would matter—or the United States would end up winning the war and the country would desperately need its railroads back to rebuild and supply the victorious nation. In the latter instance, railroad bonds bought at a steep discount during the war would be worth a fortune.

Cy Lewis had a great influence on Gus Levy. He encouraged Levy to trade in distressed railroad bonds and in other forms of arbitrage, including so-called
block trading—the buying and selling of large blocks of stock, ideally at a profit—and in so-called
merger arbitrage, which as Rohatyn described was the trading in the stocks of companies involved in corporate mergers, generally after the
mergers had been announced publicly.

Many institutional shareholders that owned the shares of companies involved in mergers often chose to sell those shares into the market—shares would trade up to near the offer price after a merger had been announced—since the time and risk involved in waiting often many months for a merger to close to get slightly more cash or stock was not generally worth doing. Merger arbs were willing to buy the stock being sold quite simply because they hoped to make
an attractive return on the money invested. They were willing to take the chance a deal might not close, or the financial consideration might change unfavorably, in the hope of making money on their bet. There were risks, of course—if they
bought the stock of a company being taken over and then the deal failed to close, such a mistake could be devastating financially. But such mishaps were rare, and experts in the art of merger arbitrage did their best to
avoid them.

Why Cy Lewis would give away one valuable trading idea after another to a competitor—albeit someone who was also a friend—may never be known for sure. Perhaps it was just friendship, perhaps it helped create a market for the products Lewis was selling.

In 1941, with the United States on the verge of entering
World War II, Levy was anxious to see action. He did not have to go to war because by then he had two children. But he was determined to do it. “I’m goin’ in,” he reportedly told his wife, and then he arranged to become a mission observer in the
Civil Air Patrol. Levy was a pilot who used to fly his own Stinson Voyager single-engine plane. He
hoped that experience would get him a gig flying fighter planes during the war. But it was not sufficient. “
I didn’t have enough experience to qualify as a pilot,” he once told the
New York Times,
“and at thirty-two, I was too old for training. I ended up as a lieutenant colonel in the ground office of the Air Force in Europe.” He was in the war for twenty-six months.

While Levy was off at war, his colleague in the arbitrage department, Baruc, remained behind at Goldman to try to keep whatever meager business the firm had moving along. When Levy returned to Goldman after the war, in November 1945, he and Baruc resumed their work together in the firm’s arbitrage department and, according to
Walter Sachs, “
built one of the most active over-the-counter trading departments on Wall
Street.” Levy became a Goldman partner on January 1, 1946.
Al Feld, who started working at Goldman as an office boy in July 1933, recalled how skillful Levy was at making money from trading
railroad and
utility bonds. “
Gus was very smart, and an innovator,” he told Ellis. “He built a good business because he recognized the opportunity in all the
when-issued paper that came out on the big railroad and public utility financings of the 1940s. And he built a reputation for making good markets—in size. And if he had to take a loss, he took it.”

Among Levy’s best clients when he returned to Goldman after the war were two Dallas, Texas, brothers, the Murchisons—John D. and Clint W. Jr.—heirs to a Texas oil fortune established by their father, Clint W. Murchison Sr. Levy and Goldman’s involvement with the Murchison brothers had its origins in the March 1933 bankruptcy filing of the
Missouri Pacific Railroad.

The Missouri Pacific bankruptcy went on for twenty-three years, making it one of the longest running on record. During that time,
investors could buy and sell its debt or buy and hold it, with an eye toward getting control of the company when Missouri Pacific emerged from bankruptcy in the hands of its former creditors. Sometime after the war, the Murchison brothers became the principal owners of the general mortgage bonds of Missouri Pacific. They
were recommended to Levy and Goldman Sachs since they “
were seeking the assistance of a Wall Street arbitrageur …,” the
Times
reported, “and Mr. Levy … is generally regarded as tops in the field.” The article then explained that “an arbitrageur is one who deals in equivalents of currencies, securities and the like. He stands between the two parties in transactions involving
equivalents and guesses”—guesses!—“how the opinions that each man has of what the other man wants will vary. If he guesses right he can make a great deal of money. If he guesses wrong he doesn’t stay in the arbitrage business very long because the sums involved generally are too large.” The paper noted that Levy had been an arbitrageur since he joined Goldman in 1933 and “by guessing right he has made a great deal of money.”

The
Times
observed that during the long pendency of the Missouri Pacific bankruptcy, there “were plenty of opportunities for arbitrage transactions in the securities” since the railroad’s bonds “were to be exchangeable for other securities of the to-be reorganized company. Because of the uncertainty that the reorganization would be effected as proposed[,] the bankrupt railroad’s bonds often sold at a variance from” what
the financial experts involved with the bankruptcy predicted they might be worth when, and if, the company ever emerged from bankruptcy. “The Murchisons and other investors all the through the years were quick to take advantage of the price differences … whenever it appeared to be to their advantage.” Levy helped the Murchisons with their buying and selling and with their analysis—guessing—about the value of the railroad’s
bonds.

As would be expected from a good client, after their success trading the Missouri Pacific bonds, the Murchison brothers stayed in touch with Levy and Goldman Sachs. Soon, they had teamed up again in the quest of a bigger prize: the Murchisons wanted to get control of
Allegheny Corporation, and they asked Levy to help them pull it off. There was nothing the slightest bit friendly about the Murchisons’ proxy battle for control of Allegheny, and
Levy and Goldman were right in the middle of it. (A decade or so later, in the early 1970s, Goldman would often proclaim that it would never get involved in a hostile takeover. “
We’ve got a policy that we don’t participate in unfriendly takeovers, as either a manager or as a consultant,” Levy told
Institutional Investor
in November 1973, as if the Allegheny battle had never happened. Or as if Levy had
never been
elected to the board of Hunt Foods in August 1963 and then advised its chairman,
Norton Simon, on his 1964 unfriendly effort to get a seat for Levy on the board of
ABC, the television network, after Simon bought one hundred thousand shares of ABC stock.)

Allegheny was owned by two financiers,
Robert R. Young and
Allan P. Kirby, who wrested control of the company from the
Ball family in 1942. The
Times
described Allegheny as “
a heap of du——, with a jewel or two hidden in the debris.”

Young and Kirby had used proceeds from asset sales to diversify Allegheny’s holdings, including buying control of the
New York Central Railroad, the nation’s second largest, and
Investors Diversified Services, Inc. (IDS), the Minneapolis-based mutual fund business. Allegheny also owned 51 percent of Missouri Pacific’s Class B stock—postreorganization—and had a $20 million investment in
Webb & Knapp, Inc., a real-estate company. “
The Murchison-Kirby relationship,” the
Times
noted, “began on a note of hearty common interest” during Kirby’s proxy battle, in 1954, against the Vanderbilt family for control of the New York Central Railroad. Young and Kirby asked Clint Murchison Sr. and his longtime partner,
Sid Richardson, to buy eight hundred thousand
shares of New York Central and vote them in favor of the Young and Kirby takeover. Murchison and Richardson complied. In return for their support, or so it seemed, in 1955 the two Murchison brothers “obtained control” of IDS through a stock deal with Allegheny engineered by Young and Kirby.

But in
January 1958, using a 20-gauge shotgun in the billiard room of his twenty-five-room oceanfront Palm Beach mansion, the “flamboyant” Young committed suicide. He was sixty years old and said to be suffering from “melancholy and depression” brought on by the
recession of 1957, which had hurt Allegheny’s businesses. Holding the shotgun with his knees, he had fired both barrels at his head
at around 10:00 a.m., two hours after eating his normal breakfast. The mansion’s staff, which had not heard any shots fired, became concerned about Young’s whereabouts after he failed to show up for an appointment. Five days later, Kirby took control of Allegheny. In 1959, Allegheny’s public shareholders filed suit, arguing that control of IDS had been given to the Murchison brothers “for the favors rendered by their father to Mr. Young and Mr.
Kirby.”

To settle the lawsuit, the Murchisons agreed to return control—through a 47.5 percent stake—of IDS to Allegheny. The Murchisons retained a 17 percent stake in IDS. The Murchisons, Kirby, and the Young estate paid another $3 million together to Allegheny. But, after the settlement, the Murchisons found themselves suddenly “frozen out” of
the affairs of IDS, and they were not pleased. In an effort to strengthen their
hand, the Murchisons paid Young’s widow $10.2 million for the estate’s stake in Allegheny. The Murchisons thought owning a large stake in Allegheny would get them more influence on IDS. But Kirby, resentful of the Murchisons’ hostile act, started an investigation into the way they had managed IDS and asked for their cooperation in the investigation. When the Murchisons refused to help, Kirby kicked them off the IDS board.

Incensed, the Murchisons with Levy’s help began a hugely public and hostile proxy fight in September 1960 to seize control of Allegheny from Kirby. According to the
Times
’s account of the nine-month proxy battle, Levy was the Murchisons’ “principal banker-adviser” and played a “
quiet, powerful role” in the fight. In the end, despite the Murchisons’ owning only 2 million of the
9.8 million Allegheny shares outstanding—and Kirby owning 3 million shares—the Murchisons were able to get other shareholders, including no doubt Goldman Sachs, to vote in their favor in sufficient numbers to get an 855,000-vote majority. In May 1961, the Murchisons took control of Allegheny after getting five shareholder votes for every four votes received by Kirby and his supporters. The fight was believed to be one of the largest and most contentious to have occurred
to that time.