Wall Street brokers and at least one major bank are facing $160 million in losses following the collapse of a tiny securities firm's multibillion-dollar government bond trading business.
The Federal Reserve Board immediately stepped in and offered to make loans if needed to prevent repercussions on Wall Street from the plight of Drysdale Government Securities Inc., a firm that bought and sold government securities.
Wall Street sources said Chase Manhattan Bank and several big brokers stand to lose $160 million as a result of their dealings with Drysdale, which has assets of less than $30 million.
The banks and brokers yesterday were fighting about who would have to bear the loss. Chase Manhattan Bank, Drysdale's chief lender, said it expects to be sued by the brokers, who include such top Wall Street firms as Merrill Lynch, Pierce Fenner & Smith, Drexel Burnham Lambert and Goldman Sachs & Co.
Drysdale on Monday collected $160 million in interest on government securities, and was supposed to pass the interest payment on later in the day to a group of brokers who own the billions of dollars worth of government bonds and notes. Drysdale had borrowed the government securities in a complex set of transactions. The brokers never got their money. Chase Manhattan and the brokers said they don't know what happened to the $160 million.
The telephone in Drysdale's New York office was not answered yesterday afternoon. Drysdale President Richard Taffe told Dow Jones News Service yesterday morning, "I have heard the rumors and I understand we had a problem last night, but I don't know what the details are and I don't know what the extent of the problem is. I can't comment any further."
The brokers say Chase is responsible for making good the $160 million they are due. They say they lent the government bonds and notes to Chase, not Drysdale. Chase, they say, without their knowledge, re-lent the securities to Drysdale.
Chase, the nation's third biggest bank, says it merely acted as an agent in the transactions, and insists that the brokers will have to get their money from Drysdale.
Nevertheless, it was Chase Chairman Willard C. Butcher, not Drysdale executives, who called a meeting of the brokers involved Monday night at the Federal Reserve Bank of New York.
Butcher told the brokers that Drysdale would not be able to pay them the interest the government paid Drysdale Monday. Butcher said Chase had no liability in the matter. A Chase spokesman said Butcher called the meeting to ensure that there was no panic in the $500 billion market for government securities.
The government securities markets continued to operate normally yesterday, but Wall Street was swept by rumors about the Drysdale affair.
Drysdale's business is buying and selling government securities: U.S. Treasury bonds, notes and bills.
Wall Street sources said Drysdale probably got into trouble because it sold government securities it did not own, a time-honored Wall Street practice known as "short-selling."
Like all government securities dealers, Drysdale sometimes borrowed government bonds from brokers and then sold them to investors. Its aim was to make a profit when it came time to repay the brokers.
The transaction is profitable if the price of the security declines, because the firm can repay the loan with securities purchased at a lower price. Government securities prices fall when interest rates rise and rise when rates decline.
The company that lends the securities still owns them and is entitled to the interest the government pays. Because the borrower, in this case Drysdale, has possession of the securities, it collects the interest and is supposed to pass it on immediately to the owners: the Wall Street brokerage houses.
While Drysdale's short-selling problems came to light yesterday, Wall Street executives said the firm probably was involved in other complex transactions that contributed to its difficulties.
Although there was no panic in the normally skittish government securities market yesterday, the Federal Reserve called dealers to calm them and remind them that the central bank stood ready as "lender of last resort" in case any "unusual credit demands" resulted because of the Drysdale failure.
Several Wall Street bankers said they did not see how Drysdale could continue operations, but one securities executive said he heard that the firm was trying to negotiate its way out of trouble.
Government securities dealers routinely borrow huge amounts of cash and securities, often many times as much as the firm is worth.
Drysdale Government Securities had less than $30 million in capital, but apparently took positions in government notes and bonds totaling between $2 billion and $3 billion. Bankers and brokers said, however, that the risks Drysdale appears to have taken were far too big for the firm's resources to bear.
Though it had been in business less than a year, Drysdale had applied to become one of the elite 35 or so firms that are allowed to deal directly with the Federal Reserve, which buys and sells securities as part of its monetary policy operations.