Until seven months ago, Drysdale Securities Corp. was a small, old-line brokerage firm that had not made many waves on Wall Street.
Then, in an abrupt change of personality, the firm began buying huge amounts of U.S. Treasury bonds, thrusting itself into one of the biggest and most volatile of the financial markets. Some of its neighbors began to take notice.
Late last year, the New York Stock Exchange called in officials of the 93-year-old firm to caution that heavy trading in government securities was a high-risk, big stakes business that might not be appropriate for a company of Drysdale's size. To protect brokerage customers, the exchange tries to make sure member firms have enough assets to conduct business safely.
Exchange officials suggested that Drysdale should establish a separate trading firm to deal in government securities. Drysdale did.
The new company, Drysdale Government Securities Inc., was formed in February, with a half-dozen traders and a score of other employes occupying offices in the New York State Chamber of Commerce building, up the street from the headquarters of Chase Manhattan Bank.
Last week, its name was all over Wall Street.
On Tuesday, Drysdale Government Securities and Chase Manhattan, its chief trading agent, staggered the financial community with disclosure that Drysdale, with debts of $250 million after four months of operation, had failed to pay nearly $200 million in interest due the brokerage firms whose securities Drysdale borrowed and then traded. The default threatened solvency of several of the 30 securities firms involved, Wall Street officials said last week.
After a brief, intense debate Tuesday over who would bear the responsibility, Chase on Wednesday assumed Drysdale's debts as well as responsibility for the securities Drysdale still held. In all likelihood, after paying debts and selling the securities (many at a loss) Chase will have no profits for the April-June period.
In a few days the debris was discreetly swept up; business in the government securities markets continued, although without Drysdale. Several government agencies, a congressional subcommittee and Chase are trying to figure out how the debacle occurred.
But the Drysdale Government Securities saga appears to be a vivid demonstration of the allure, and dangers, inherent in speculative trading in the rapidly growing, highly volatile financial markets.
How could such a tiny firm grow in four months to a size where its debts threatened the health of several bigger brokerage firms?
In part, it was because Drysdale used the interest it was supposed to pass along to the brokers last week to finance its trading. But without its relationship to Chase, Drysdale's growth would have been severely limited, brokers said.
One top securities trader who had seen Drysdale's financial statement said, "It was clear they didn't have the capital to support their trading positions." All the brokerage firms echoed Merrill Lynch Pierce Fenner & Smith's statement that "we were dealing with Chase, not Drysdale." Edwin Kantor, president of Drexel Burnham Lambert Inc.'s government securities trading subsidiary, said Drysdale wanted to do business and "we turned them down."
Drysdale Government Securities was formed by two men who have spent their working lives in the brokerage business, Richard Taaffe, 43, the president, and David Heuwetter, 41, the treasurer.
Taaffe was with the corporate bond department at Kidder, Peabody & Co. when he said he was recruited by Heuwetter for the new venture. In a telephone interview last week, he said that only Heuwetter, the chief trader and owner of most of its voting stock, knew what had gone wrong.
By all accounts, Heuwetter called the signals at Drysdale Government Securities. He had been a consultant to the older firm, Drysdale Securities, and some Wall Street sources say he was responsible for its brief plunge into government securities trading before the new firm was formed.
Heuwetter did not answer telephone calls last week. Michael Savage, a Washington lawyer who has known him four or five years, describes Heuwetter as a prototypical trader.
Heuwetter is "a very bright guy, a real workaholic," said Savage, counsel to the law firm of Gersten, Scherer, Kaplowitz & Brown, which is representing Drysdale Government Securities. "He loves government securities. He loves trading . . . . He was happy doing it, even though he never made a lot of money. Of course, he would have liked to have made $280 million, but the fact that he didn't never bothered him."
Drysdale Government Securities, in the words of one employe, "was adventuresome and aggressive," wheeling and dealing scores of securities trades each day, trying to make money by gambling on changes in the prices of Treasury bonds and notes.
The potential profit on any individual trade was relatively small, but the cumulative profits on hundreds or thousands of trades could have been enormous. But potential losses were equally great.
"When I heard the numbers, I couldn't comprehend them," said Kantor of Drexel Burnham, who cut short a European trip Tuesday to return to New York. Drexel was owed $19 million.
Drysdale was reported to have traded $6 billion in securities a day at one point, a volume "that's got to be larger than Salomon Brothers," Kantor said. Salomon Brothers Inc., long the most important government securities firm in the nation, has capital of about $400 million. Drysdale has $20 million.
Drysdale Securities put up $5 million to launch its namesake, Drysdale Government Securities, acquiring all of the non-voting preferred stock. But in an interview, Peter J. Wasserman, president of Drysdale Securities, took pains to draw a line between the two companies. "We have no involvement in the operations and management of the firm . . . . It was an investment." Drysdale Securities wrote off that investment last week.
Wasserman would not discuss the founding of the government securities firm.
Taaffe, Drysdale's president, said he did not know until last Monday that his new company was in difficulty. Heuwetter "ran that book," Taaffe said.
But at dinner on May 12, Heuwetter confided to Savage that Drysdale was having trouble, the lawyer said. The next day, Heuwetter informed Chase. His first instinct was to keep dealing. "David said he thought he might be able to trade his way out of it," Savage said.
"David and the bankers were deciding whether the interest would be paid. They were all trying not to imagine the unimaginable," the lawyer said. On Thursday Heuwetter hoped so save the firm. By Friday he and Chase knew it could not be salvaged, the lawyer said.
The tension was high on Wall Street on Tuesday when Chase was claiming the $160 million interest Drysdale owed brokers on securities traded through Chase was not the bank's liability.
"Most of that 24 hours was spent by David Heuwetter trying to explain to Chase where we were," said Savage, his attorney. "We were all trying to figure out who owed what."
If Chase is lucky, some of the roughly $4 billion of securities transactions still on Drysdale's books will end up profitable. The bank has begun to sell off the Drysdale portfolio.
Chase has paid $160 million to cover the interest Drysdale owed brokers who had loaned it securities and Chase will have to pay brokers a smaller sum May 30 to cover interest due on other securities on loan.
Chase has said that after taxes the bank expects the cost to it will be $135 million, more than the $116 million it earned in the first three months of the year. Manufacturers Hanover Trust Co., which had smaller dealings with Drysdale Government, paid out $29 million to brokers Wednesday, and U.S. Trust Co. paid out a smaller, undisclosed amount.
Chase continues to deny liability for the $160 million, arguing it acted only as agent and that brokers knew the securities loaned were destined for someone other than Chase. The bank said it paid Drysdale's debts to prevent repercussions in the nation's financial markets, as well as to keep some brokerage firms from financial difficulties.
A government regulator in contact with both Chase and Drysdale said he is astonished that Chase's securities division could have let Drysdale do that much business with it. "Could you imagine what Chase's lending division would say to a company with $20 million in assets that wanted to borrow $250 million? They'd be told to 'get lost,' " he said.