The Bank of America’s Clausen: When a Golden Boy Lost His Gleam

“They’ve wrecked that bank,” says Claire Giannini Hoffman. “It’s pathetic.”

The bank she is talking about is, of course, the Bank of America, founded by her father, A.P. Giannini, 83 years ago. Ten years ago it was the largest--and hailed as the best-managed--bank in the world. Today, it doesn’t make the top 15.

There was a time when the Bank of America was California. The bank lured the infant film industry from New Jersey to Hollywood. California’s most distinctive landmarks, from Disneyland to the Golden Gate Bridge, owed their finance to the credit, and sometimes faith, of Giannini, the unconventional people’s capitalist.

The real strength of the Bank of America--and pride of its founder--were in relationships with ordinary Californians. Bank employees fanned out across the state encouraging school children to open savings accounts with nickels and dimes. The bank pioneered in small business loans, middle-income mortgages and consumer loans when most banks turned up their noses at such business.

What happened? The answer lies in the career of A.W. (Tom) Clausen, head of the bank from 1970 to 1981 and again since October, 1986. Clausen was a product of the old Bank of America. Joining the firm in 1949, he worked his way up through the ranks. More than that, he was seen as the best of his class: imaginative, daring, loyal to company and customers.

He came to the top when the environment in which the Bank of America had prospered was beginning to change. The postwar years had been easy for U.S. banks. Federal regulations limited competition. Interest rates were stable; economic growth was a constant. It seemed that U.S. banks would go on making money forever on car loans, fixed-rate mortgages, farm and industrial loans.

But cold winds were blowing. The Vietnam War had spawned an inflation that threatened to send the U.S. economy and its banks into turmoil. Bank of America’s special niche in the market was the one most directly threatened. Its millions of small depositors had low-rate passbook savings accounts; as the rate of inflation rose past the interest rates on savings accounts, consumers looked for higher rates. The rising rates of the 1970s created major financial problems for banks that, like Bank of America, had many mortgage loans outstanding. These loans--yielding 5% or 6%, once seemed the safest and most profitable of investments. Now they were a terrible drag on earnings. Companies, too, looked for ways of getting around the banks. They discovered they could raise money directly on the unregulated Eurodollar markets and pay lower rates than their American bankers could offer.

Clausen saw that Bank of America would have to change to survive. It would need to offer consumers more products at market rates of interest; to keep its corporate clients, it would have to become a worldwide financial institution, offering services in every country where its clients had operations. The bank would have to become more entrepreneurial and more daring. It needed high-interest loans to offset the effect of those low-rate mortgages and, as all bankers know, high-interest loans carry high risks.

Clausen decided to harness the forces that threatened the bank. If world capital markets were disrupting the stability of the bank’s relationships with its corporate clients, then the bank would learn to play those capital markets. If inflation was changing the rules, Clausen would use inflation to strengthen the bank.

Oil, for example, was said to be going to $100 a barrel. This meant a boom for oil-drilling equipment makers other companies whose fortunes rose or fell with the business. It meant Mexico would have the revenue to service any conceivable level of debt. It meant housing and commercial real estate markets would boom in U.S. oil-producing regions. Bank of America moved aggressively into these markets.

By the end of the decade Clausen was regarded as a financial wizard. Bank of America appeared to have outstripped its Eastern archrival, Walter Wriston’s Citicorp. It was hailed as the bank of the future.

In 1979, Clausen could have had any job he wanted. No banker had ever made so much money for his company or presided over such dramatic growth. Jimmy Carter offered him chairmanship of the Federal Reserve, but Clausen turned him down. In 1980, Carter offered him another of the world’s most prestigious jobs: World Bank president. He accepted. He would employ the talents that had done so much for Bank of America to benefit the world’s neediest countries. He turned Bank of America over to his protege, Michael H. Armacost, and went off to solve the Third World debt problem.

Almost immediately, Bank of America began to unravel. One by one the decisions Clausen made came back to haunt his successor in a crush of cataclysms that may yet topple the institution. It turned out that Clausen’s two basic assumptions--inflation was here to stay and international expansion was the best path to growth--were spectacularly wrong.

Commodity prices began a collapse that ultimately would take oil below $9 a barrel and bring farm prices to levels not seen since the Depression. Energy-related and agricultural borrowers fell behind on loans; when the bank went to foreclose, it discovered it had overestimated the value of its collateral. A million-dollar oil well at $30 a barrel might be worth $100,000 at $15 a barrel. Farm land lost half its value--and Bank of America was the nation’s largest private farm lender.

As problems mounted, so did criticism. Clausen had looted the bank, charged his former employees. Everything had been sacrificed to show good short-term results. He used aggressive (a code word for dubious) accounting techniques to overstate profits. He booked income as profit that should have been invested in technology. While other banks were using automatic teller machines and sophisticated check-processing equipment, Bank of America relied on expensive human tellers and slow hand-sorting of checks.

The international arena turned out to be a mine field for the bank. There had always been skeptics. “Putting Tom Clausen in charge of the World Bank is like putting Mrs. O’Leary’s cow in charge of the Chicago fire department,” said one. Although America’s bank executives were unanimous in 1980 that their loans to the Third World were safe and prudent, insiders knew that Bank of America had the weakest portfolio of all. “We picked up the crumbs the other institutions weren’t interested in,” Clausen admitted later.

By 1986, federal banking regulators had lost all patience with the bank’s management and board of directors; 20,000 employees had lost their jobs; the bank had posted record losses. Claire Hoffman had resigned in disgust from the board of her father’s bank, advising stock holders to sell. The market agreed; stock that once sold for $30 a share was selling--in a bull market--for $12. A hostile takeover was attracting a dangerous amount of interest.

Under immense pressure from the government, the board of directors dismissed Armacost and, presumably after a nationwide search, reappointed Clausen. Outsiders and insiders were stunned.

Yet how unique is Clausen? None of the nation’s money-center banks held back from the orgy of Third World lending--and how many CEO’s have resigned? Automobile and steel companies have suffered years of abysmal earnings--and their executives are all doing well. If incompetents manage their companies into the ground, they escape with golden parachutes. There are no penalties for failure at the top of the corporate world.

A.P. Giannini never accepted more than $50,000 a year to build the Bank of America, less than a month’s pay for some who helped wreck it. The United States has the best-paid managers and some of the worst-managed corporations in the world. Hoffman is right: pathetic.