Project Financing and Options Trading

Effective nationwide distribution, particularly access to large numbers of individual buyers, proved itself in July 1975 when Kidder, Peabody, together with Salomon Brothers, Merrill Lynch, and three of New York City's largest commercial banks (Morgan Guaranty Trust, Chase Manhattan, and First National City), served as senior co-managers of the huge bond issue brought out by the Municipal Assistance Corporation for the City of New York, better known as "Big Mac." The $1 billion offering, the first of three designed to provide New York City with enough cash to pay its bills and avoid default, proved difficult to sell. Investors both large and small had little confidence in the city's ability to manage its affairs, and Kidder, Peabody's salespeople not only had to stress price and yield but, more importantly, had to persuade clients that the bonds appeared to be a safe investment because of their strong prior claim to city revenues. Most of the firm's initial sales, upwards of $26.1 million, went to clients in the Northeast with the next largest number going to buyers in Atlanta and Dallas. Kidder, Peabody's leadership in selling "Big Mac" bonds for a hard pressed city continued through most of that year. In August it distributed an additional $3.5 million; the next month, together with the First National City Bank, the firm jointly placed some $80 million with various institutions; and in November Kidder, Peabody sold another $5 million. By the end of 1975 Kidder, Peabody alone was responsible for distributing some $34.7 million of Big Mac bonds.

"We have a large machine," Gordon once said, "and we find a great many securities have to be fed through it if we want to break even." That statement, made some twenty years earlier during the antitrust trial, applied with even more force in the 1970s when competition from commercial banks and other financial intermediaries moved into areas once considered exclusively the domain of investment houses. To hold on to its old clients and win new ones while serving them both efficiently, as well as to guard against possible steeper declines in brokerage income, the most vulnerable source of an investment firm's earnings, Kidder, Peabody strengthened its traditional services and added new ones, two of the most important being project financing and trading in options. Between 1970 and 1975 the firm's lease financings of plant and equipment totaled $502.3 million and the volume of its options transactions also grew substantially, particularly after April 1973 when the Chicago Board of Options opened for business.

Option trading-a contract to buy or sell a specified number of shares of a certain stock at a determined price within a defined period-was an old business, the instruments themselves dating back to antiquity. Options regained popularity in the early 1970s because, in the words of the Chicago Board of Options, they offered investors opportunities for a "potentially large profit from a relatively small investment with a known and predetermined risk," provided the buyer made the right decision (some preferred the word bet) on a stock's future movement and acted on it in time. Options, like other investments, also carried the risk of losses. But whether the option buyer made or lost money the brokers dealing in these instruments earned handsome commissions, sometimes as many as three or four in a single operation.



‘Options trading’ was a profitable business. Dealers in these securities, said SEC chairman Roderick M. Hills, "make more money from options than they foresee making from new stock issues." Hills was concerned the option business would siphon off seed money from new enterprises. "I'd like to get some of the horse-betting money on stocks," he said in July 1976 when he announced plans to have the SEC study the economic effects of option trading. Kidder, Peabody not only traded in options-these operations helped offset some 50 percent of the firm's decline in commission earnings-but also included the instruments in its portfolio management service. Gary L. Gastineau, the manager of Kidder, Peabody's options portfolio service, was an experienced security analyst and portfolio manager whose book The Stock Options Manual (McGraw-Hill, 1975) analyzed the various techniques for evaluating option contracts, with special reference to the computerized model he developed with Professor Albert Madansky of the University of Chicago's Graduate School of Business Administration.

Investment management and advisory functions provided still other opportunities to expand Kidder, Peabody's income-producing services. Although investment management was a highly competitive business with several types of financial intermediaries seeking to serve a relatively small clientele of individuals and institutions, it allowed Kidder, Peabody to employ more fully and effectively its resources and expertise. The decision to expand this area of its operations was strengthened by the acquisition of Clark, Dodge & Co., which had a substantial and well-staffed management service. Five of its top managers joined Kidder, Peabody and together with its own advisory group provided the firm with a large experienced staff. In January, 1976, Kidder, Peabody reorganized and consolidated all its investment management and advisory services, assigning them to a new and separate subsidiary called the Webster Management Corporation. The new corporate entity, named after Edwin S. Webster, Jr., Kidder, Peabody's senior partner from 1931 until his death in November 1957, was designed to provide the benefits of outside investment research and in the words of the corporation's officers, assure its fourteen senior and five associate portfolio managers the required "autonomy and independence in decision making." At the time of its organization Webster Management took over accounts valued in excess of $460 million, some 50 percent of which belonged to individuals with the rest almost equally divided between tax exempt funds and those of corporations and other institutions.