The Last Days of the Club by Chris Welles

Chris Welles died a month ago at 72. Welles was one of the pioneering journalists of what might be called the "new" Wall Street, writing for Life magazine in the '60s, Institutional Investor in the '70s, then, after a stint running Columbia University's Bagehot program for midcareer journalists and teaching at the university's graduate school of journalism, reporting and editing for BusinessWeek. For all of that, much of his work -- notably powerful magazine pieces like his magisterial dissection of how tiny Drysdale Government Securities Inc. almost brought down David Rockefeller's Chase Manhattan Bank in 1981 in Institutional Investor -- have been mostly forgotten. That also applies to his most important book, "The Last Days of the Club," published in 1975, which may qualify as the most detailed description of how Wall Street really works ever written.

Given our own era of crisis and reform, "The Last Days of the Club" bears a serious second look. The book, long out of print, is a challenging read about a seemingly distant era before Michael Milken, hostile raiders, derivatives, securitization, Gordon Gekko or a globe-girdling Goldman, Sachs & Co. The book itself is long, dense, often preachy, with a tendency toward redundancy; he apparently cobbled it together from a dozen long II articles and published it only months after the key event, the demise of fixed commissions, on May 1, 1975, so-called May Day. It shows. Welles loved to dig deeply, then reveal everything, then repeat the lesson; his case study of the collapse of a retail brokerage called McDonnell & Co. sprawls over nearly 40 closely packed pages, many of which detail how utterly feckless the firm's CEO, Murray McDonnell, was. Then he offers two more cases on the same theme.

Structurally, the book swings back and forth in time. Welles lays out the slow breakdown of the old fixed-commission structure. Most of "Wall Street," meaning New York Stock Exchange members, made nice livings collecting a steady stream of brokerage commissions, culminating in the appropriately ambiguous May Day. Then he turns around and covers the same years, this time focused on the collapse of NYSE-member companies under back-office problems. Then he does it again as he tackles the development of what he views as the new, even more powerful club: institutional investors. And in there also lurks the tale of the advent of electronic exchanges.

Welles calls this period the Great Crisis and, in fact, the events of the early '70s, notably May Day, did shatter the monopolistic power of the NYSE "Club," and did launch the transformation of Wall Street from a mass of poorly capitalized, often family partnerships to a small number of large, diverse, capital-rich public companies -- or banks -- we know today. For all the talk of how ambitious our bout of financial reform is, it remains to be seen whether fundamental change will occur. Welles' era was a true watershed between post-Depression Wall Street and the current global system. At the center of the "old" Wall Street, like an institution out of "Alice in Wonderland," sat the NYSE, which controlled a tightly ordered, if competition-lite, system. Since the '30s, Wall Street had been a backwater, with business, both at the exchange and at the brokerages, dominated by individual investors trading stock. It was an insider's world -- "inside" denoted by membership in the NYSE. By the '60s, however, pressures were mounting. The primary challenge: institutional investors, led by mutual funds and their cult of performance, which were growing fast and chafing at Wall Street's hidebound, expensive, priviliged ways. The NYSE and its members, both individuals and firms, not only resisted institutional pressure for efficiency and competition, they fought nearly anything remotely innovative.

Welles is persuasive on the centrality of fixed commissions to the cartel -- commissions that were high enough to dampen volumes (nonmembers found competing difficult) and steady enough to resemble an annuity. Much of his early narrative involves the various schemes developed to retain monopoly pricing, which gave the appearance of adjusting to mounting pressures from Congress, regulators, outsiders and from new technology, notably computers. But for all the ways of offering discounts while pretending not to, for all the give-ups, soft dollars and reciprocity agreements, the fixed system was crumbling, particularly as the '60s bull turned into the '70s bear, and as firm after firm collapsed under the hammer blows of, first, back-office implosions, then shrinking volumes, then competition.

"The Last Days of the Club" is a tonic for anyone prone to nostalgia, or anyone who believes contemporary Wall Street has a corner on venality, self-interest, greed or ineptitude. Welles is withering on a Street that resists innovation and competition, that was allowed to slip into cushy, entitled somnolence. Feel that we should return to an era of partnerships, when finance was modest and too-little-to-care? Welles ruthlessly exposes the weaknesses of the partnership structure, with its nepotism, shaky capital bases and shallow wells of talent. Feel that we have lived through a unique period of regulatory capture? Welles outlines how the Securities and Exchange Commission since the '30s allowed the NYSE to self-regulate and build a closed, self-aggrandizing system (there was a major element of social exclusion here as well: The Club had a WASP and Irish flavor, though the real key to getting in was longevity on Wall Street). The SEC sat by and watched the NYSE keep firms in business that had long since failed capital tests and tolerated anticompetitive practices, like fixed commissions, in the belief that it (primarily the well-heeled, well-populated floor of the exchange) was a necessary, "perfect" utility, not unlike our own government-sponsored enterprises, with their private profits and implicit public support. Believe we have an exclusive hold on lobbying? The NYSE and its allies were well connected and entrenched, and, like today, forecast utter disaster if the cartel was broken.

The irony, of course, is that the shattering of the Club spawned the large, highly leveraged, high-volume firms of today. The revolution of May Day was a key event, a storming of the Bastille, in a process that eventually eroded relationship banking, empowered M&A and fueled the transactionally dominant system often decried today. Firms merged, diversified, brought in new state-of-the-art technology, developed new products, produced vast profits and paid each other vast sums. The new Wall Street was a ruthlessly competitive meritocracy -- and that competition morphed into recklessness and disaster. Vestiges of the cartel-like system persist, in underwriting syndicates and initial public offerings. But the predominant themes of the next three decades were the very antithesis of the Club. The old Wall Street was about scarcity, control and guaranteed return; the new Wall Street stressed liquidity, creativity and risk.

Welles was concerned that the winners of the game in the '70s, the institutions, would use their dominance to re-create a new Club more powerfully stifling than the old. That didn't occur, though it is fascinating to watch him sift the evidence. Welles believed institutions were consolidating and growing more activist, particularly in terms of corporate control. He argued that that concentration was predominantly occurring within bank trust departments and that the new age would be dominated by those banks. What he couldn't see in 1975 was the complex effects of affluence and innovation. The institutions remained relatively passive, frustrating the ascendant corporate governance crowd, though a new class of corporate raiders, shadowed by hedge funds and buyout shops, emerged and flourished. Deregulation became orthodoxy. Market order and control became the efficient-market hypothesis. Shareholders became king. And banks saw much of their dominance through trust departments disintermediated away by, among others, institutional money managers and Wall Street. In defense they consolidated, geographically and functionally. Wall Street firms did as well, beginning with the back-office crisis that led to an enormous culling of firms. The result: a sector accustomed to chasing the newest windfall, steeled to competition and risk. The new Club became the markets themselves, which proved to be uncontrollable.

Remarkably, the NYSE survived and even prospered (Welles was convinced that the electronic Nasdaq, or some successor, would sweep it away), although it gradually lost its place at the heart of finance. In the new century, the exchange underwent its own transformation into a globally competitive player, embracing technology, engaging in M&A (merging with Archipelago, among others) and finally going public. The hold of the floor was broken, though it took decades and dramas like the Dick Grasso pay flap to re-create the place. Today the floor of an expansionist, efficient NYSE is as much a television studio as the location where best price is magically arrived at.

What can we take from all this? First, the obvious: how hard it is to truly see the future by even a deep understanding of the past and present. This applies to Welles, to reform-minded politicians and regulators, and to the media and punditocracy. Second, how glib are notions that we simply return to a past that appears glorious mostly because we can't recall it. Does anyone -- on Wall Street or Main Street -- really want to go back to an era of small firms resistant to change, in which relationships implied a kind of suffocation? It was certainly a "safer" Wall Street, if an afterthought, like the post office (and it also implied a corporate structure skewed to size and self-funding, which isn't ours). Third, we tend to search for a single cause -- an original sin -- to a crisis. Clearly, the genesis of the new Wall Street was May Day, which represented the triumph of competition over monopoly, and released pent-up creativity. As Welles argues so convincingly, May Day was not only an unalloyed good, but necessary. Many of the evolutionary changes that occurred since resulted from innovations or policy changes that seemed like similarly good ideas at the time.

"The Last Days of the Club" can be an extremely tendentious book. Welles is not afraid to offer opinions. But, with the perspective of time, the book paradoxically suggests that there is no rigid formula for structuring finance or regulation; the great sin is always excess, either of the Club's smothering control or the freewheeling mania of the 2000s. Regulation is about balance, fundamental values and vigilance. The Club escaped the competitive drives built into the New Deal's disclosure regime. The giant overleveraged firms, with their opaque instruments and complex market operations, did as well in our era. On the other hand, structure is not destiny. The stuffy partnerships of Welles' day are not determinative of all partnerships; and universal banks, with their tendency to conflict and dysfunction, are similarly not necessarily failures. The bonus system is like the nepotism of the Club: poisonous only in an already toxic environment. Competition can be good; competition, in excess, can be very bad. Someone must judge every day and still understand how contingent every judgment may be.

For all its flaws, "The Last Days of the Club" is a remarkable dissection of a complex social and economic system. Welles himself is weakest when he indulges in theory and generalization. Like most good journalists, he was at heart an empiricist. He is best at building an argument up from the bottom, from understanding how nasty little kickback schemes worked or how firms actually fail. Welles made great demands on his readers; it makes you wonder if this book could be published today, or the original articles reported and written. He explains how things work, and they are rarely simple, but you must hang in there with him; he is not a popularizer who can articulate the reality of finance with a sweeping metaphor or single dramatic scene. He was a very serious man, and "In the Last Days of the Club," it shows.