Back in Prehistory, 400 Firms Lost To One With A Computer. They Got The Idea.
Thirty years ago this past summer, one man shook the municipal bond market to its very core - and he wasn't even a congressman.
The industry witnessed a seminal moment: the clash of the prehistoric with a harbinger of the future.
With the aid of a homemade computer, William S. Morris stunned municipal bond dealers when his five-man firm of William S. Morris & Co. took on a 400-member underwriting syndicate, headed by the powerful Bank of America, and snared two large California competitive bond deals totaling $200 million.
While his competitors were hunched over desks with pencil and paper, Mr. Morris's computer determined the scale and net interest cost of his winning bid.
And he scored big, earning a total of about $2 million on the deals.
The precision of his calculations and the ability to incorporate market conditions into the scale gave him the edge.
He made a big impression on dealers, an impression that would come back to haunt him less than two years later.
But in August and September of 1961, the name of William S. Morris was the talk of the nation's bond traders.
His winning bids were considered brazen and unorthodox because at that time in the municipal bond industry nobody bid alone and challenged the powers that be. And nobody used computers.
Mr. Morris added spice to a sometimes sleepy and inefficient market. Perhaps most importantly, he introduced the use of computers to an industry still making do with Stone Age tools: Monroe calculators - not the bond calculator - and basis books.
Taking immediate notice of Mr. Morris's victory, The Bond Buyer led its Aug. 18, 1961, edition with a two column headline that described the winning bid as "A Brilliant Coup" and spoke of "Serious Industry Implications Seen In Surprise Bid for California Bonds."
On Sept. 14, one day after Mr. Morris did it again, The Bond Buyer led the paper with this headline: "Morris Underscores First Upset; Beats Syndicate of 400."
The next Monday, The Bond Buyer ran an editorial with a headline asking "Is Municipal Underwriting Out-Of-Date?"
The editorial began, "The one-two punch administered to the municipal bond fraternity by William S. Morris, who successfully bid for and distributed $200 million State of California bonds in less than a month, has spurred agonizing reappraisal of municipal underwriting syndicate practices."
And to this day Mr. Morris is remembered by many a veteran of that era.
"He was truly one of the maverick geniuses of Wall Street," said Preston V. Pumphrey, a former colleague of Mr. Morris and now head of Pumphrey Securities in Syosset, N.Y.
Richard S. Locke, former head of E.F. Hutton & Co.'s municipal securities department and a longtime veteran of the industry, put it like this: "I think most people thought [Mr. Morris] was off the wall."
"He was a guy just ahead of his time," Mr. Locke said, adding that Mr. Morris's big splash in the market marked the "birth of all these small gurus in the technology area."
Lloyd Bush said Mr. Morris "served notice that there was a role for computers. There was money to be made by using computers." Mr. Bush should know: In 1971 he founded Lloyd Bush Inc., which went on to develop programs for competitive underwriting.
A Different Sort of Mind
Now 75 years old, retired from Wall Street, and living in Palo Alto, Calif., with his wife Jeanne, Mr. Morris said in a recent phone interview that he is "still playing around with computers."
He said he is also deeply involved with the Sierra Club, actively lobbying Congress to protect the California coastline. In a book heralding its 100th anniversary, the Sierra Club describes the Morrises as "a one-family Coast Guard."
Recalling the summer of 1961 and why he dared to take on the staid municipal bond community, Mr. Morris said, "I have a mind that tends to see different ways of doing things."
His unorthodox mind was trained in mathematics at Princeton University, where he graduated in 1937.
"I got interested in computers while I was there, but there weren't any to work with until later," he said. In 1938, he took a job with Equitable Life Insurance's accrual department. He then moved to Detroit and got a job analyzing engine test results. Drafted for World War II, he joined officer candidate school and served in the Pacific Theater.
After the war, he became interested in the investment part of life insurance. He landed a job with First Boston Corp., moved into municipal bonds when he joined W.H. Morton & Co., and then went to Hirsch & Co.
In 1950, he joined Talmedge & Co., where he ran the municipal bond department. It was during his tenure at Talmedge that Mr. Morris began to study the application of the computer to competitive bidding.
In 1958, he and his wife purchased a Heath kit - a do-it-yourself assembly pack for homemade electric devices such as radios and computers - and assembled its bits and pieces into an analog computer. That computer would help him calculate the winning bid on the California deal.
He also began to tinker with what was then considered state-of-the-art computer ware. In those days, he recalled, the program was punched into the card. He would hunt down an IBM 650 ("We had to go to a service bureau or rent time on a computer or go to brokers") and put the cards into a stacking machine.
The program cards would go in first, followed by the data cards. The data cards would show a maturity in each year and then another card would show limitations, such as the maximum and minimum coupons, and how many coupons you could have.
In 1959, Mr. Morris ventured out on his own and opened William S. Morris & Co. in New York.
As an underwriter, his firm frequently joined syndicates. But it also went out on its own, engaging in "splinter bidding," the underwriting practice of bidding on small deals that were a part of large bonding programs. For Mr. Morris, this type of underwriting came about when federal housing authority bonds were reorganized and bond offerings would total a "couple of hundred million" and consist of several issues.
"Groups were formed around the theory of all or none, bidding for the whole package," Mr. Morris said. "So it was the easiest thing in the world, to buy one of the issues in the total offering - the bigger syndicate took the bulk of the bonds."
Splinter bidding, Mr. Pumphrey said, had a marketing advantage: A dealer bidding for and winning the small deals could offer bonds to customers with immediate confirmation, rather than wait for a large syndicate to go through the time-consuming task of reviewing orders.
Challenging the Syndicate
In 1961, Mr. Morris became restless. He was a member of the syndicate that assembled about four times a year to bid on California's competitive bond offerings. It was the only syndicate, a temporary amalgamation of firms from all over the country created to digest the large offerings.
Mr. Morris wanted to get more bonds and so he asked Bank of America, the head of the syndicate. Up until then, William S. Morris & Co. and many of the other firms in the syndicate were awarded about 50 bonds a deal. That small slice of the underwriting action was doled out to these firms in the syndicate's lower tiers "to keep them quiet," Mr. Morris said.
Bank of America never responded to his queries. Mr. Morris decided to drop out of the syndicate and began laying plans for what would prove to be one of the underwriting feats of the decade.
"Nobody knew he was bidding on the first one," said Mr. Locke. On a profit margin basis, the California deal was extremely important to underwriters, Mr. Locke added.
There were usually four California bond deals a year of $100 million apiece and four large public housing administration bond sales. "There was enough juice in those eight deals - and making money in the aftermarket - that you paid your department's overhead for the year," he said.
In those days it was considered "heretical" to think of using computers, Mr. Pumphrey said.
Mr. Locke said, "We used to figure all of our bonds on a Monroe calculator and use basis books. One guy would figure the scale and then another guy would check them over. It would take hours, sometimes days."
The key to Mr. Morris's success with the computer was his ability to "optimize the couponing of the debt," Mr. Bush said. Bids were offered on net interest cost basis by putting high coupons on the short end and lower ones on the long end, he said.
"Morris did the reverse: He estimated where the net interest cost would be and then he would work the coupons to optimize the couponing of the debt," Mr. Bush said.
Mr. Morris also got a boost from the state, which had lowered the amount of cash needed on a good faith check deposit to $100,000 from the traditional check totaling 2% to 3% of the bond offering.
On Aug. 17, Bert Betts, the state treasurer, opened bids on the state's largest ever bond issue: an offering of $225 million school, veterans, and construction bonds.
There was the traditional bid from Bank of America and its syndicate for the entire issue, but there was a lone bid for the $100 million of school bonds from State Street Securities Corp., a subsidiary of William S. Morris & Co.
The bid was submitted in person by one of Mr. Morris's colleagues, Thomas C. Plowden-Wardlaw, who also slipped the treasurer a letter from Mr. Morris begging then-Gov. Pat Brown and Mr. Betts to award his firm the bonds if he won. According to Mr. Morris, the gist of the letter went something like this: "If you let me live, I'll come back and bid again next time and I'll keep bidding until you get more than one bid and I'll restore competition to your market."
The Morris bid was for a net interest cost of 3.7544%, as compared to 3.860% offered by Bank of America. The state's finance committee, after a long metting, accepted Mr. Morris's bid for the $100 million of school bonds and threw out the Bank of America bid for the other two issues: a $100 million veterans issue and a $25 million state construction deal, which carried net interest costs of 3.8948% and 3.8338%, respectively.
Because the two offerings had net interest rates higher than the net interest rate on the school bonds, state officials were pulled from the market and slated for sale at a later date. State officials reasoned that it would behoove them to have the citizens of California pay high interest rates when the potential existed for lower rates.
After Mr. Morris's bid was accepted, Mr. Betts said in a statement that "We are glad to see the competition and the acceptance of this lower bid."
"On the day of the auction, I knew that I was bidding high," Mr. Morris recalled. He had originally planned to bid for only $25 million of the bonds, but changed his mind just before the auction. If he won, he reasoned, "one of the advantages was that I would have the market to myself with the $100 million. I tried to do that and did."
Mr. Morris could not rest on his laurels yet. "When you have $100 million, you need lots of salesmen," he said.
Taking another innovative step, he said he called Drake & Co., a broker's broker. Utilizing the facilities of a broker to accept orders from dealers and dealer banks was an unusual arrangement, but it proved an effective one.
After negotiations, Drake agreed - for a commission totaling $125,000 - to act as sales agent for placement of the bonds to dealer firms, but not investors.
"He came into our office and we didn't see anything wrong with deal," said Charles W. Murray, a former official and partner of Drake. "But there were repercussions for us afterwards," he noted. "A few of the dealers on the Street did not talk to us for years."
Selling the bonds back to the dealers "took out a little of the sting" of the day's events and a lot of the dealers were placing big orders, Mr. Morris said. He remembered that the demand overloaded the phone lines at Drake.
The issue was sold out in 24 hours at prices to yield from 2% in 1963 to 3.90 for 3.50% coupon bonds in 1987. The Bank of America scale ranged from a yield of 1.70% in 1962 to a dollar price of 100.50 for 4s due in 1987.
Add it all up, and that day's deal made Mr. Morris over $1 million.
While the computer played an important role in winning the bonds, common sense also had a hand. Because there had been only one syndicate that traditionally bid on the bonds, Mr. Locke said, nobody expected competition - "a blind man could have pulled them off."
Even Mr. Morris admitted, "The other syndicate was putting in one bid and they were making a somewhat relaxed bid - it doesn't take a computer to figure out what to do."
Nevertheless, he was the richer for his daring. His firm invested some of the profits in an IBM 1440 computer.
Less than a month later, California came to market with a $100 million competitive offering of veterans bonds.
The large Bank of America syndicate apparently had not learned its lesson from the last time. It never saw the punch coming.
Once again, Mr. Morris stepped to the plate, this time with a winning bid of 3.7596%. The Bond Buyer reported that the issue was sold down to $25 million within the first half hour of sales and less than $500,000 remained at mid-afternoon and at 5 p.m., the issue was sold out. The Bank of America syndicate had submitted a bid of 3.787%.
Over the next 20 months, Mr. Morris used the profits from the California deals, this deal, and the last deal to multiply his firm's staff from five to 40 and expand to another floor.
But during that time, Mr. Morris said, his firm never won deals with the size and scope of the California offerings. That is, not until the Washington Public Power Supply System offered competitively $122 million of revenue bonds for the Handford Electric Project on the Columbia River.
Four groups bid for the bonds on May 8, 1963. William S. Morris & Co. submitted the winning bid of 3.2601%. Halsey, Stuart & Co. followed with 3.313%; Smith Barney & Co. came in third with 3.332384%; and John Nuveen & Co. followed with a bid with 3.34456%.
An official with WPPSS described the winning bid as "simply remarkable."
It was also Mr. Morris's undoing.
Mr. Locke, who was in one of the bidding syndicates as an employee of Kidder Peabody & Co., recalled, "His computer came up with wacky numbers."
And, like old elephants, municipal dealers remembered the California deals. Now they saw an opportunity for revenge. Mr. Locke said. "The Street wanted to stiff him anyway and when he bought this issue they said to him: ~This is for you.'"
Drake was once again called in to serve as marketing agent. "I think if he went one-eight higher, I think he might have been okay," Mr. Murray said.
"But there was nothing for us to do on that one," he recalled. "People went in and bid them down." After one day, Mr. Morris had $106 million of bonds to sell.
"We sold the bonds, but took a $3 million beating," Mr. Morris recalled. The failure, he said, could be attributed to a number of things. "The computer is best when you are dealing with something that is marketed beforehand, and in an established market. If you have to guess with a startup project which involved nuclear power, the guess work neutralizes the database of the computer." His firm closed in September, and after a stint at another firm, he left Wall Street forever in 1969.