ON MONEY AND MARKETSA Wall Street Memoir
By Henry Kaufman
McGraw-Hill 388pp $24.95
Paul A. Volcker, former Federal Reserve Board chairman and close friend of Henry Kaufman since their days together at the Federal Reserve Bank of New York, once told BUSINESS WEEK: "Henry gets wiser and wiser as he ages." After reading Kaufman's On Money and Markets: A Wall Street Memoir, you will understand what Volcker meant.
If your recollection of Kaufman and his career doesn't go much beyond his highly visible role as partner and head of research at Salomon Brothers in the 1970s and '80s--along with his reputation as a Cassandra with the moniker Dr. Doom--then you have a lot to learn about the man and his message.
Kaufman gives us an analysis of the financial markets that is impressive in its depth and breadth. Yet his memoir is also very personal. He writes with an objectivity and a rare clarity that can come only from experience and a thorough understanding of his subject. More than that, Kaufman gives us multiple perspectives on the past, present, and future of the financial markets. He is at different times historian, teacher, philosopher, and visionary.
Kaufman's early background and accompanying hardships speak volumes about his analytical perspective and his character. Born in 1927 in the German farming village of Wenings, the son of a butcher and cattle trader in a close-knit Jewish family, he remembers vivid stories recounted to him about the devastation of German hyperinflation. These would shape his anti-inflation views.
At age 4, Kaufman contracted polio, and by the age of 9, he had witnessed the growth of anti-Semitism, including the terrifying crash of his own door being smashed in, followed by "the sickening thud of footsteps on the stairs," while he and other family members huddled in a bedroom. Unexpectedly, the Nazi marauders bypassed the room. The next day, on Jan. 31, 1937, he left Wenings with his family, and by December, Kaufman was in New York City.
These events and the sacrifices of his family galvanized Kaufman's sense of purpose and achievement. His family pushed him toward a career in medicine, but he was more fond of history and literature, and he developed a special interest in economics. Early on, Kaufman was impressed by Friedrich A. Hayek's 1944 book, The Road to Serfdom, a defense of free markets that held special significance for many like him who had seen how central economic planning could lead to totalitarian regimes and the loss of freedom.
Kaufman earned a bachelor's degree in economics at New York University in 2 1/2 years, taking the maximum course load. In one year's time, he got a master's degree from Columbia University, and during his first job as a credit analyst, he toiled at night toward his PhD in banking and finance from New York University's Graduate School of Business Administration.
There, legendary academic figures in business and finance such as Peter Drucker and Marcus Nadler further shaped Kaufman's philosophies. In particular, Kaufman credits Nadler with two beliefs that resonate throughout his book: that "no school of economic thought has a monopoly on wisdom," and that "financial institutions must balance entrepreneurial drive with fiduciary responsibility." One thing that comes across most clearly about Kaufman is his commitment to intellectual honesty.
As financial markets changed radically in the 1970s and '80s--a time of explosive growth that would increasingly put profits ahead of public responsibility--Kaufman maintained these beliefs, sometimes at the cost of derision from top executives in banking and finance. Whether sparring with former Citicorp Chairman Walter Wriston over the soundness of Third World loans or tussling with Reagan-era congressional leaders about the worrisome ballooning of the budget deficit, Kaufman never let business or political biases cloud his judgment--even at his own firm.
Kaufman joined Salomon Brothers & Hutzler in 1962, after completing a four-year stint in the research department of the Federal Reserve Bank of New York, a key post that prepared him for his unique contribution to Wall Street. Charles Simon, a senior partner at Salomon, offered Kaufman the opportunity to assist Sidney Homer in setting up a comprehensive money- and bond-market research unit, the first of its kind. It would analyze Federal Reserve and U.S. Treasury borrowings and build on Homer's work on projecting credit flows and interest rates. Kaufman built the operation into Wall Street's largest and most influential research effort, ultimately employing some 450 highly trained analysts.
At Solly, Kaufman's contributions to the rise of economic and financial forecasting made him a Wall Street "guru" who could--and often did--move markets, especially when interest rates were at issue. Like most intrepid forecasters, Kaufman has had plenty of misses. But because of his many hits, beginning with his call of the 1966 credit crunch, he became one of the most powerful people on Wall Street. Kaufman always tempered his forecasts with intuition and good judgment, believing that elegant econometric models too often depend on historical data that miss key aspects in the evolution of finance.
The most far-reaching aspect of this evolution, says Kaufman, is the securitization of credit--the conversion of nonmarketable assets, such as credit-card receivables or mortgage obligations, into marketable assets that can be priced to market and traded. The trend has created a bewildering array of derivative instruments that have fueled what Kaufman believes to be a dangerous explosion of credit. He says that economic conditions have favored the growth of these derivatives but that no one knows how they will perform in an economic downturn or what their broader economic consequences will be.
Because of this credit explosion, which Kaufman analyzes in exhaustive detail, he devotes considerable thought to the urgent need for regulatory and supervisory reform at home and abroad, as financial innovation and global integration outpace an already obsolete regulatory structure. He exposes shortcomings of the Federal Reserve and offers proposals for reforming international regulation, including the reorganization of the International Monetary Fund and the World Bank into a "Board of Overseers of Major Institutions and Markets." Whether you agree with the plan or not, it is strongly argued.
Kaufman also tackles the world of finance in the 21st century and discusses his near-term uneasiness about the U.S. economy. And he devotes a key chapter to 17 "neglected financial lessons," an opportunity for any student of finance to step back from the day-to-day grind and reflect on the future through the eyes of a master.
Ironically, the evolution of finance in recent decades also tracks the changes at Salomon that led to Kaufman's disagreement over the company's direction---and to his resignation. It all came down to balancing the entrepreneurial drive of Salomon CEO John Gutfreund with the fiduciary responsibility that, in his opinion, Kaufman felt was lacking. Amid Salomon's push toward high risk and high leverage, in pursuit of high returns, Kaufman claims that "Gutfreund practiced a permissive style of leadership that allowed too many abuses to go unchecked." In 1988, Kaufman started his own money management firm, Henry Kaufman & Co. In 1991, Gutfreund left in the wake of scandal.
Throughout Kaufman's career, he would often tell clients, institutions, and politicians, who tend to be heavily biased against bad news, things that they didn't want to hear. But he was just being honest with himself and true to his philosophies. "I have always thought that truth and accuracy are preferable to political expediency and wishful thinking," he says. Wall Street could use more people like Henry Kaufman.