Surveying the damage from the Drysdale default
To all appearances, it seemed pretty much business as usual in the Government securities trading rooms of Wall Street last week. But behind the scenes there was a mood of uncertainty in the once stodgy business of buying and selling U.S. Treasury bonds, bills and notes. For the brokers and dealers in the $700 billion market, the task at hand was to sort out the implications of the default two weeks ago by Drysdale Government Securities Inc. on more than $189 million worth of obligations to Chase Manhattan Bank and other major banks. Meanwhile in Washington, probes of the Drysdale affair were opened by both the Securities and Exchange Commission and a Senate subcommittee.
For Chase Manhattan, the impact of the default was plain enough. After an impressive five-year string of earnings gains, the third largest commercial bank in the U.S. was confronting the biggest single loss in its history. Still unable to explain fully how the bank's bond trading department had stumbled into its costly involvement with the little-known Drysdale in the first place, Chase had no choice but to swallow hard and announce a onetime write-off of perhaps $135 million after taxes, or more than what the bank had expected to earn in the second quarter. Another big commercial lender, Manufacturers Hanover Trust, was also hit, though its initial announcement of a likely $29 million write-off was later pared back to only about $9 million after taxes.
Bankers and brokers spent much of last week trying to nail down how Drysdale pulled off its caper. Though the nearly four-month-old company employed about 30 securities traders and operated with little more than $20 million in capital of its own, it had managed to put together a $6.5 billion portfolio of U.S. Government bonds, bills and notes. More than $4 billion of that was borrowed. Said a top Wall Street bond trader of the bewilderingly complex financial structure of the upstart firm's activities: "It was the most astonishingly leveraged operation that I have ever seen."
Basically, Drysdale's traders, headed by President Richard Taaffe and Chairman David Heuwetter, used an accounting quirk in the way Treasury securities are valued in so-called repurchase deals. These are short-term transactions in which a bank or brokerage house raises cash by selling a Treasury security to another dealer on a promise to buy it back when the deal expires. Since typical repos last for only a few days, traders normally do not take account of the accrued interest on a bond, bill or note when valuing it in the transaction. Instead, when the interest is paid by the Treasury to the current holder, the money is automatically passed back to the original owner of the security.