Not that long ago, there were no U.S. financial institutions deemed too big to fail. Commercial banks were not allowed to grow beyond well-defined geographic limits and investment banks were constricted by their limited access to capital—and neither was allowed into the other’s business.
By state and national law, commercial banks were not permitted to branch very far, if at all, from their headquarters, and as a result banking was a localized business. Each city was home to a number of single-office banks, the oldest and largest usually holding the title of First National in front of the name of the city it served. A fair number of banks had grown their assets beyond the billion-dollar mark toward the end of the twentieth century, especially in the cities with one of the twelve Federal Reserve Banks. Until recently, however, few would have imagined that America would be home to trillion-dollar banks.
At the same time, the reach and scope of investment banks were limited by the strict capital rules of the New York Stock Exchange. Due to concerns about interference by anyone outside “the club,” the ownership of the member firms of the exchange was limited to individuals active in the management of those firms, and as late as the 1980s even Morgan Stanley and Goldman Sachs operated as partnerships. Investment bankers viewed themselves as little more than the handmaidens of business—certainly not as the managers of future mega-firms.
The change on the commercial banking front came slowly but surely as the bankers and their lobbyists convinced state and national legislatures to remove the walls that blocked expansion. Soon “unit banks” were allowed to have branches, then to expand statewide, and inevitably nationwide. J. P. Morgan was perhaps most emblematic of the movement, growing in a matter of a few decades from a single location at 23 Wall Street to tens of thousands of offices around the world.
The changes in the investment business were equally dramatic, beginning with the Securities and Exchange Commission–mandated abolition in 1975 of the New York Stock Exchange’s system of fixed commissions. With the exchange’s requirement that its member firms—at that time representing virtually the entire securities industry—adhere to a schedule of commissions when doing business with the public, the investment business was run as a very profitable cartel. The exchange and the partners of its member firms considered themselves at the very heart of free-market capitalism, yet they prospered mightily from a system that forbade competition.
Immediately after investment firms lost the protection of fixed commissions, their numbers dropped quickly. Newly formed discount brokerage firms grew like spring flowers to lure investors away, and most of the old-line firms either went out of business or were acquired by other firms that were smart and nimble enough to survive in the world of open competition. The smartest and most nimble of those firms was an upstart house formed in the early 1960s called Cogan, Berlind, Weill, & Leavitt—the Weill being Sanford Weill, a brash and tough Brooklyn native who knew the nuts and bolts of the business and knew especially how to make acquisitions and cut costs. Under his leadership, CBWL grew by making ever more sizable deals, usually changing the name of the firm to reflect the latest and largest prey. By the time Weill had finished, CBWL had become Smith Barney and was second only to Merrill Lynch in terms of brokers. Although Weill eventually left the firm that Smith Barney became, he had made a name for himself and surged back onto the financial scene years later to create the financial behemoth Citigroup—a feat that required nothing less than a successful campaign for the full repeal of the Glass-Steagall Act.
One of Weill’s contemporaries, William Donaldson, was simultaneously changing the ways of Wall Street by challenging the exchange’s strictures on the use of outside capital. He and two of his Harvard Business School classmates formed Donaldson, Lufkin & Jenrette to provide research and trading services to institutional investors, but their business plan required much more capital than the three of them could assemble privately. Disregarding the NYSE rules and its threatened sanctions, DLJ barged ahead with the first-ever public offering for a member firm. The firm’s 1970 initial public offering broke the capital logjam and before long every other Wall Street firm of any size became a public company.
Both Donaldson and Weill were clearly interested in building financial empires, and both were tenacious and daring in their approach to obstacles. But the results of these men’s efforts were very different. While DLJ was eventually sold to Credit Suisse for $13 billion, Citigroup was a mess of a financial institution from its formation in 1998 and remained that way until it was largely dismantled—but not before it received $45 billion in emergency infusions of capital from U.S. taxpayers in 2008 to become the largest bank bailout in history. The personalities of Donaldson and Weill were as different as the plights of the institutions they built, but no two individuals were more responsible for enlarging the size and scope of today’s Wall Street than they.