Trading & Options · Profile from Trading and Options Research Companion

Salomon Brothers Arbitrage Group

In the 1980s Salomon Brothers' domestic fixed-income arbitrage group was the most profitable trading desk on Wall Street (Finance KB). John Meriwether built it, and it was staffed with finance PhDs who bought cheap bonds, sold expensive near-identical ones and waited for the gap to close, using Salomon's balance sheet. Its trades were Treasury relative value, the cash–futures basis, swap spreads and mortgage spreads, which this knowledge base catalogues as On the Run / Off the Run and the Treasury cash–futures basis trade. The group's pay deal reportedly gave it a share of its own profits. One member, Lawrence Hilibrand, was reported (Newsweek, Jan 1991) to have been paid $23m for a single year, which set off a bonus revolt elsewhere in the firm (secondary, verify). The group's end came from a neighbouring desk. Paul Mozer, head of government bond trading, reported to Meriwether. He submitted unauthorised customer bids in five Treasury auctions between Dec 1990 and May 1991 to get round the Treasury's 35% rule (Joint Report on the Government Securities Market, Jan 1992, Appendix C). By the settlement date of the 22 May 1991 two-year note auction, Salomon's position was "almost 94 percent" of the issue (Joint Report), and a squeeze followed. Senior management learned of one false bid in April 1991 and did not report it for months. When the firm disclosed this in August 1991, Gutfreund, Strauss and Meriwether resigned and Warren Buffett became interim chairman (18 Aug 1991; Finance KB). Salomon settled for $290m on 20 May 1992. Meriwether took most of his team to found Long-Term Capital Management in Feb 1994. Inside Travelers, the desk's US arm was restructured in July 1998 and lost $120m in July–August 1998 (Salomon Smith Barney 8-Ks). In the edge equation, the group is a case where the edge was real and the survival depended on a bank's balance sheet. The bank's culture and controls, not the trades, ended the group.

At a glance

Founded: The group formed under Meriwether in the early 1980s: Meriwether was head of domestic fixed-income arbitrage "in the early 1980s" (NYT 2009, via Wikipedia), and one account dates the group to 1980. The A0 blueprint row gives 1977 (from memory, verify)
Headquarters: Salomon Brothers Inc, New York (One New York Plaza; later 7 World Trade Center — from memory, verify)
Ownership / structure: A desk inside Salomon Brothers Inc, the broker-dealer of Salomon Inc (public after the 1981 Phibro merger; Wikipedia). Berkshire Hathaway held $700m of 9% convertible preferred from 1987 (Finance KB). Travelers Group bought Salomon for ~$9bn in stock in 1997 and merged it with Smith Barney (Finance KB); it then became part of Citigroup (1998), and the Salomon name was dropped on 7 Apr 2003 (Wikipedia)
Type: Bank trading desk (proprietary relative-value arbitrage); this profile has seven moves
Head: John W. Meriwether, head of the group from the early 1980s; vice-chairman of Salomon from 1988 (NYT, via Wikipedia); resigned Aug 1991
Core members (to LTCM): Eric Rosenfeld, Lawrence Hilibrand, Victor Haghani, Gregory Hawkins, William Krasker (Finance KB)
Scale (dated): The group's profit is not disclosed in any filing seen. Secondary accounts give ~$400m for a year around 1990 (verify); Salomon Inc's balance sheet was ~$150bn, funded largely short term (Finance KB, verify)
Regulators: SEC (broker-dealer), Federal Reserve Bank of New York (primary dealers), US Treasury (auction rules), Justice Department (antitrust and criminal)
Signature moves (incl. failures): Building the arbitrage group (early 1980s); Berkshire's preferred and the balance sheet behind the desk (1987); the profit-share pay deal and the Hilibrand bonus (1990); false bids in Treasury auctions (Dec 1990–May 1991); the May 1991 two-year note squeeze; disclosure, resignations and the $290m settlement (Aug 1991–1993); Travelers and the 1998 restructuring of the desk

7 strategic moves analysed

Each one gets a full strategy file in the companion: context, the decision, the financing, what happened, and the lesson.

1980
Building the Fixed Income Arbitrage Group
Founding or new strategy
1987
Berkshire Preferred and the Balance Sheet
Capital raise
1990
False Bids in Treasury Auctions
Rogue trade or control failure
1990
Profit Share Pay and the Hilibrand Bonus
Fee change (internal pay structure)
1991
Disclosure Resignations and the 290m Settlement
Regulatory, enforcement or legal action; hiring, spin-out or partner departure
1991
May Two Year Note Squeeze
Large trade or position; market-structure abuse
1998
Travelers and the Arbitrage Desk Restructuring
Closing a strategy; loss response

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