Chase Manhattan Bank yesterday agreed to pay $160 million in interest payments owed by Drysdale Government Securities Inc. to about 30 brokerage firms, as Wall Street tried to figure out how the tiny, four-month-old securities firm had managed to trigger a financial crisis.
Chase officials said privately they took the action because they feared Drysdale's inability to pay its debts could force several brokerage firms out of business, causing unpredictable repercussions in the securities markets.
Executives of several brokerage firms said the Drysdale affair will cause brokers to reexamine their practices in the government securities markets and could lead to much closer government supervision of the almost totally unregulated market in U.S. Treasury bonds, bills and notes.
The Federal Reserve Bank of New York yesterday sent investigators to look at Drysdale's books in an attempt to sort out who is owed what.
Federal Reserve sources said that so far they have been unable to figure out how many government bonds and notes the firm had bought and sold during the four months of speculative trading that ended Monday, when Drysdale was unable to come up with more than $189 million owed to brokers.
The size of the losses continued to grow yesterday, as Manufacturers Hanover Trust Co. acknowledged that it, too, did business with Drysdale and said it will pay $29 million in interest owed to brokerages. The bank said it expects its losses to be less than that.
The total cost to Chase, the nation's third biggest bank, is expected to be about $250 million. Chase took over Drysdale's business yesterday and assumed responsibility for future debts. The bank had insisted on Tuesday that it was not responsible for Drysdale's debts, but yesterday agreed to pay $160 million in interest owed to the brokers. The bank did not offer a public explanation.
Chase said it expects to take a $135 million after-tax loss--more than the $116.2 million profit it made during the first three months of the year. Chase's stock has declined more than $5 in the last two days to $47.125 a share.
About 30 brokers were involved with Drysdale, including some of the nation's biggest: Merrill Lynch, Pierce Fenner & Smith; Paine Webber; and Drexel Burnham Lambert.
The chief unanswered question is how a securities firm that opened its doors in February with about $25 million in assets and 30 employes could grow so fast and get in so much trouble that by May its problems could threaten the solvency of brokerage houses.
The firm's president is Richard Taaffe, 43, who said he has spent 25 years in the securities business.
Reached at his Manhattan residence, Taaffe said he had been recruited to form the new firm by an official of Drysdale Securities Corp., a 92-year-old Wall Street brokerage firm. Taaffe was then an executive at Kidder Peabody & Co.
Although a Drysdale Securities spokesman said there is no corporate link between the two firms, Taaffe said Drysdale Securities "basically created" the new firm and hired him to run it. Many brokerage firms establish separate companies to trade unregulated government securities, thus avoiding Securities and Exchange Commission supervision.
Taaffe said he didn't learn of the company's crisis until Monday and said he doesn't know what went wrong. The company's treasurer, whom he identified as former Drysdale Securities official David Hewetter, was in charge of the operations that apparently got the company in trouble, said Taaffe. "I didn't run that book," he said.
Within four months of opening, the firm was trading government securities worth at least $2.5 billion and doing business with the biggest banks and brokers on Wall Street.
"Others besides Chase and Manufacturers had to be dealing with them directly," said a top official at one brokerage firm. "It's just that nobody's owning up to it."
Drysdale has not gone bankrupt but has halted trading. A bankruptcy would have prevented Chase from taking over and paying the bills and could have pushed several brokers to the brink of insolvency, government and securities industry officials said.
Most sources think Drysdale got in trouble primarily because of the practice of short-selling: Drysdale sold bonds it didn't own, then borrowed bonds to deliver to its customers. The firm borrowed the bonds from brokers using what are called reverse repurchase agreements, promising to repay the debt with other bonds of the same face value at a future date. Drysdale hoped for a decline in bond prices, so that when it had to buy bonds to repay the loans they would cost less.
Drysdale and other dealers often use middlemen in these transactions--in part to conceal their trading strategies. In this case, Chase and Manufacturers Hanover were the middlemen.
Drysdale, because it had possession of the securities, collected the interest paid on them by the government and was supposed to pass that interest directly back to the brokers.
Securities firm officials said Drysdale used funds owed to the brokers to finance further speculative activities that went bad, leaving it with too little cash to meet interest payments Monday.