Unravelling the Myth

Introduction

Seven years ago, today's guest, Mr. Peter Foster, wrote these words: The Reichmanns have become victims of their own success in a uniquely Canadian way; they have been encouraged by a financial and political system that loves size and indulges those with talent and chutzpah to the point of folly. It is the Canadian corporate equivalent of the Peter Principle. It might even be called the Paul Principle. As corporate executives tend to be promoted to the level of their incompetence, so Canadian companies in a prevailing climate of mega-loans and economic nationalism tend to expand to the point of self-destruction.

It remains to be seen if they proceed, like Dome Petroleum, to the point of a financial trauma so great that it threatens to bring down the banking system. With perhaps twice Dome's overall debt load, they certainly have the potential.

As a banker, why is it that I so suddenly feel the need of a sword to fall on?

Perhaps it is because Mr. Foster is a relative newcomer to Canada, having emigrated here from England in 1976, that he seems to have had insights into the Reichmann family that others--notably some of us in the banking industry--lacked. But having garnered more than a dozen writing awards since beginning his career here with The Financial Post, it is clear that his insights are not limited to the Reichmanns alone.

His first book, The Blue-eyed Sheiks, has been called the most readable account of Calgary's wildcatters and energy barons yet written. Mckapitalism, his story about Moscow's McDonald's, which appeared in Canadian Business, recently won the 1992 Canadian National Magazine Award for best business article.

But it is his newest work, a revised and updated version of the Reichmann saga entitled Towers of Debt, that brings him here today. Depending on what he says in the next few minutes, I'll either rush out to buy a copy when it hits the book stores this Saturday, or start considering early retirement.

In the introduction to The Master Builders, his first book about the Reichmanns published in 1986, Mr. Foster asked:

Had growth led to a change in-indeed forced a change on-the way the Reichmanns did business? Had Paul Reichmann perhaps become the victim of his own success? Or was it, perhaps, that the Reichmanns had never been equal to the mythology that had grown around them?

I'm sure we'll all enjoy hearing him answer those questions today. Please join me in welcoming our distinguished guest.

Peter Foster

Almost exactly a year ago, Olympia and York was forced out of the commercial paper market when investors--spooked by rumours of default--refused to roll their paper over. When a small company runs out of money, it goes bankrupt. When a large company does so, it has a restructuring. Everybody attempts to keep the music playing and resist the urge to dive for one of the too few remaining chairs.

The question I shall address today is how and why--in the broadest sense--did this happen?

In one way, the answer is simple. Real estate has witnessed a devastating collapse. Olympia and York was the world's largest private real estate developer. It was engaged in one of the world's most ambitious projects, at Canary Wharf in London. It was borrowed up to the hilt. Having risen so high, it inevitably had the farthest to fall.

But the question is: How did it rise so high? It is here that we begin to deal with the most fascinating aspect of this sad story. The Reichmann Myth. It Is here that we have to examine an extraordinary man and his extraordinary relationship, both with his bankers and the media.

It was traditionally a matter of family loyalty to speak of the Reichmann brothers--Ralph, Albert and Paul--as equal partners in O and Y. In fact, Ralph, the youngest brother, remained primarily involved with their original tile business, while Albert, the eldest, although acknowledged as a fine developer, was essentially a sounding board and perhaps a moderating influence on the real mastermind and driving force behind O and Y's rise and fall: Paul Reichmann.

I say at the beginning of my book that Paul Reichmann was always easier to describe than fathom. A tall, stooped, sombre figure, always dressed in dark suits, he reminded me of an undertaker. His courtesy and modesty were certainly appealing traits.

He once expressed apparent surprise that the media should be interested in him. After all, he and his brothers were just your regular old single-generation multibillionaires.

Paul always spoke softly, with an almost labyrinthine speech pattern which reflected the complexity of his thinking. Some of his own employees used to carry tape recorders into meetings so that they could, afterwards, bend with knitted brows to decipher their master's voice.

When we write of corporate moguls, we often concentrate on the superficial aspects of their characters, and on their so-called lifestyles. But the Reichmanns did not live anything in which Robin Leech would be interested.

They reputedly relaxed on the Sabbath with the Talmud. They didn't buy yachts or hockey teams; they didn't get involved in messy divorces. The only thing that raised Paul Reichmann's pulse, reputedly, was walking.

What Conrad Black called Paul Reichmann's "rabbinical inaccessibility" seemed all the more astonishing when set against his business achievements. If there was a Reichmann Myth, it was certainly based on solid ground.

The Reichmanns came to Toronto in the mid to late 1950s from the more exotic locale of Tangier, fleeing, as they had done throughout their lives, political unrest. They had a small tile importing business and stumbled into real estate development when they decided to build a new warehouse for themselves.

From there they expanded their operations until, in the early 1970s, they undertook First Canadian Place. The project put them both on the map and into The Guinness Book of Records.

But it was the purchase, in 1977, of eight New York skyscrapers for $320 million (U.S) that led to the transition from mere reputation to mystique.

New York City had been facing commercial default. There was widespread fear that it might go up in flames. Literally. The Reichmanns made their purchase at what turned out to be the bottom of the market. Henceforth, the multiplication in value of those buildings provided not merely the collateral base against which O and Y could expand, it led to a belief that the Reichmanns were magic men, who somewhere within their modest baggage carried a corporate crystal ball.

The reputation was further burnished when, in the early 1980s, Paul Reichmann, in the face of considerable scepticism, pulled off the development of the huge World Financial Centre in lower Manhattan. The project drew both rave reviews from architectural critics, and lots of high-profile tenants, such as American Express and Merrill Lynch.

O and Y appeared to weather the 1981-82 recession as if it wasn't there. Or at least they successfully created that impression. As a result, to the crystal ball was added another mythical attribute: deep pockets. The question was what would Paul Reichmann do next?

I first became intrigued by the Reichmann mythology in 1985--when the brothers took over Gulf Canada. Because of a tax break--picturesquely known as the "little Egypt bump," which was worth more than $500 million and the fact that Petrocan, where empire building had always taken precedence over value for money, bought $1 billion worth of assets that the Reichmanns didn't want, Canadian taxpayers wound up paying as much for the Reichmanns to take over Gulf as the Reichmanns did.

The Gulf takeover could hardly have been worse timed. Early in 1986, the price of oil collapsed. And yet, instead of regrouping, almost immediately Gulf was pushed by Paul Reichmann into staging an assault on Hiram Walker resources. I studied these takeovers closely and decided that there were some problems with the Reichmann mythology.

Both deals showed that Paul Reichmann and his lieutenants were obsessively tough negotiators who never left a dime on the table. Paul Reichmann had claimed he would never carry out a hostile takeover, and disliked using lawyers. In fact, Hiram Walker turned out to be both hostile and extremely litigious.

I wrote an earlier book on the Reichmanns, entitled The Masterbuilders, in which I expressed these concerns. I noted that getting to the heart of the Reichmann Empire was a little like reaching the end of the yellow brick road. When you drew back the curtain, there was just one man pulling the levers. This was both intriguing and frightening.

The final chapter of my book was entitled The Paul Principle. I put forward the proposition that Paul Reichmann was in danger of being elevated by an enthusiastic banking system to the point of self-destruction. No bankers, it seems, read the book.

One of the reasons for concern was that I had written a previous book on the debacle of Dome Petroleum, when Jack Gallagher and Bill Richards, having been deemed by bankers to have the magic touch, were henceforth given enough financial rope with which to hang themselves.

At the time, there was a great deal of talk and writing about the somewhat vague supposed dangers of corporate concentration. In fact, the dangers of concentration and conglomeration relate not to those of excessive corporate power--whatever that may be--but to lack of competence. And yet the Reichmann Myth remained intact. Indeed, perhaps its height was reached when Paul Reichmann was announced to have had himself appointed to a special exploration committee of the board of Gulf Canada. The crystal ball, presumably, was assumed to have a seismic device attached.

People seemed to imagine that Paul Reichmann would go to the map and mark the spot where oil might be found. The mystique was certainly a key factor in peddling more than $500 million of Gulf equity in 1987. But it wasn't just the essentially more gullible equity market that clamoured to put up cash.

J. P. Morgan once said that the most important consideration in providing credit is the character of the borrower. It stood to reason that anybody regarded not only as more upright than mere mortals but also financially superhuman should have the vaults opened to him.

Paul Reichmann once confided to one of his bankers that he had unlimited funds available to him. This message was designed both to impress and frighten the banker. Bankers like to lend primarily to people who don't need money, so lending to Paul Reichmann was the banker's dream. But then again, anybody with unlimited credit might choose not to borrow from your particular bank--the banker's nightmare.

Paul Reichmann was as skilful at dealing with bankers as he was at dealing with the press. If a banker was too inquisitive about the precise depth of the pockets, he might return to his office to find that Paul Reichmann had taken terrible action: he had repaid his loan! For Paul Reichmann to repay a loan was, at one time, a mark of abject failure on the part of a banker.

It would be a parody to suggest that the banks merely handed out money to O and Y willy-nilly, but the financial structuring of the Reichmann's empire was such that money was often raised against particular assets, with a guarantee given by the mother company. To ask to look into the mother company's pockets would, of course, have been impolite.

In the end, Paul Reichmann's character--in the J. P. Morgan sense--became a self-feeding phenomenon. He had to be the dream credit. Otherwise why were they all lending so much money to a man who wouldn't show them his books? And if they were content with less than full disclosure, that was hardly Paul Reichmann's fault.

The media played a critical part in perpetuating the mythology. Back in 1982, when things were surely very tight, Paul Reichmann "came clean," revealing that O and Y's net worth was $5 billion. Fortune obligingly printed the figure. As late as 1991, the Reichmanns were prominent in both the Forbes and Fortune lists of billionaires. The most monstrous misreading of their fortune came in May, 1992, when, at the end of a week in which Paul Reichmann had been fighting for his financial life at Canary Wharf, The Sunday Times declared the Reichmanns to be worth $15.6 billion.

Where can they have come up with these figures? We can only assume that they were being released from sources within O and Y, whose view of reality was, to say the least, optimistic.

How did things go so terribly wrong? The answer lay partly in Paul Reichmann's desire for ever-bigger challenges. Canary Wharf seemed to more than fit the bill.

The Reichmanns had once before undertaken development in London in the early 1970s. They'd put up a small building in Kensington. Such were the frustrations of the stratified and sclerotic British mode of construction, that the project took the same time to put up as First Canadian Place. The Reichmanns decided they wanted no part of the British Disease.

However, by the mid-1980s, Maggie Thatcher appeared to be in the process of changing all that with her "enterprise culture." In 1981, she'd created the London Docklands Development Corporation to revitalize the derelict stretches of land downstream from the city. In 1985, some American bankers came up with the idea of building a new financial centre at Canary Wharf, a plot of land set within a bend of the Thames known--now somewhat ironically--as the Isle of Dogs, about 2-1/2 miles east of the Tower of London.

Paul Reichmann took over this already ambitious plan, to build a British Wall Street on the Water, and made it even more ambitious, to build the heart of a whole new third business district in London which would do nothing less than shift the city's gravitational centre.

The deal was not based simply on ego. At the time, following the so-called Big Bang of financial deregulation in 1986, the arteries of the City of London were clogged. Its buildings were badly out of date. Just as he had with the World Financial Centre in New York, Paul Reichmann hoped to create an address by offering top-quality, sophisticated buildings at lower than city rents.

It's easy, with hindsight, to see his miscalculations. First there was a traditional reluctance on the part of financiers to move from the square mile. Second, Paul Reichmann didn't see the implications of a counterattack by the city, which had in fact taken place even before he took over Canary Wharf.

In 1986, the city had relaxed its planning regulations. Although this led to no project as large or spectacular as Canary Wharf, it led to a surge of construction that helped kill the property market when the deep recession--,a third factor-hit. Paul Reichmann, like the rest of the world, also failed to foresee the fall of the Berlin Wall and the shift this meant in Europe's financial focus.

The reluctance of business to move to Canary Wharf wasn't just a matter of the Brits being stick-in-the-muds, for the final, and perhaps most devastating, problem with Canary Wharf was its lack of transport infrastructure.

Not only was Paul Reichmann flying in the face of location, location, location, he was engaged in a back-to-front process. He was putting in the buildings before you could get there, presumably believing that, if you built a better building, then the world would beat a subway to your door.

The first phase of Canary Wharf wound up costing more than $3.5 billion. The borrowed element of this money had to be serviced from North American cash flows that from 1990 onwards were being squeezed both by recession and the hefty debt loads they were already carrying.

One might say that Paul Reichmann showed extraordinary skill in keeping all the plates spinning for so long. I believe that he was experiencing considerable pressure for at least a year before the commercial paper problems hit early in 1992.

In retrospect, I think we can trace the beginning of the end back more than three years, to Paul Reichmann's involvement with Robert Campeau. Robert Campeau was another business genius whose personal foibles and insecurities were, nevertheless, hardly a secret. Campeau's takeovers of Allied and Federated stores in the U.S., for a total tab of over $10 billion (U.S) must surely rank as two of the more bizarre episodes of the 1980s.

Paul Reichmami became involved with Campeau by buying half of Scotia Plaza, then investing more and more, and then way too much, in Campeau's wild ambitions.

When Campeau ran out of cash in the fall of 1989, the bankers raised Hallelujahs when Paul Reichmann stepped in to help with the restructuring. In fact, his involvement was predicated on trying to salvage a disastrous investment. He inevitably failed. His involvement with Campeau not only cost O and Y some $600 million, it angered bankers, who had expected the magic man to pull something out of the hat.

Throughout 1990, Canary Wharf lost momentum. By the time of the Gulf War, it had ground to a halt. From examining documents that have emerged during the negotiations of the past year, it is obvious that O and Y was having trouble with its loans in the fall of 1990 when the Reichmanns put 20 per cent of their U.S. holdings on the market. The problem was: Who would want to buy if the Reichmanns were selling?

I believe that an increasing number of banks, individually, began to express concern throughout 1991. But, of course, when you see your loans to an entity like O and Y going sour, you don t mention it to your banking colleagues. You try to get your money back or increase your collateral.

I find it astonishing, however, that O and Y's true situation should, according to recent press reports, only have become apparent to the majority of its bankers--including its lead Canadian backer--in the spring of last year.

The restructuring seems to have been marked by a comprehensive misreading by Paul Reichmann of his relative power in the affair, a toughness which was all too typical but which, in the end, has led to the family being ousted from the running of O and Y, which is now being kept on life support primarily for its tax losses.

It is perhaps worth mentioning that the Canadian banks were, at the end, far less exposed in relative terms to O and Y than they had been to Dome Petroleum. I'm not sure if this had much to do with learning lessons, however, since one of the fallouts from the near Dome disaster was that restrictions were placed on lending to individual clients.

However, when Paul Reichmann ran out of Canadian bankers, he had no problem in lining up foreign bankers who were consumed both with the Reichmann Myth and real estate fever. Not surprisingly, Japanese banks are more deeply and embarrassingly in hock to the Reichmann Myth than any other national group.

Some posturing continues but the story seems essentially to be over. What's left of the Reichmann Empire apart from a lot more litigation and lawyers fees?

Well, for a start, the assets haven't gone away. The brothers--and here we must drag Albert back into the picture--will remain among the world's great property developers. First Canadian Place, the World Financial Center and even Canary Wharf are embellishments to the cities where they stand.

O and Y's non-real-estate operations, however, have not thrived under Reichmann ownership. The myth of the Reichmanns as patient investors was among the most mythical aspects of their makeup. In fact, as time went on, it appeared that there had never been more impatient investors. The need to squeeze cash from their holdings to meet the demands of Canary Wharf led to myriad complex moves that helped neither corporate morale nor balance sheets.

During the promotion of my book, the media almost always ask: What's next? What will he do now? Will he come back? The questions seem almost symptomatic of the mindset that helped create this problem in the first place: A desire always to be rushing onto the "what's next" without reflecting sufficiently on the past.

Paul Reichmann can obviously never be what he was because, for a start, the environment is no longer conducive. As important, he has not just lost his fortune, he has lost his credit, that nebulous but all-powerful attribute that, as J. P. Morgan said, is ultimately based in perception of character.

What lessons are to be drawn from all this? Nothing that the bankers didn't know already. How could they prevent themselves from doing this again? The answer is that they probably can't. However, I think it might be a good idea to make a thorough grounding in financial history and psychology a prerequisite of every banker's training.

It would be immodest to suggest that my own little tomes should appear on young bankers' reading lists. However, I think that a very old book--written in the 1860s and called Extraordinary Popular Delusions and the Madness of Crowds should be compulsory.

The problem in the end is that experience tends to be the best tutor and the real estate mania which was one of the roots of the O and Y debacle is unlikely to return in such virulent form for many years, perhaps even in our lifetimes.

People often ask what this means for Canadians, how much more we'll have to pay in bank fees or whatever to make up for the losses on O and Y. The answer is that, of course, there will be a cost. I've noticed that on phone-in shows that I have been on recently, some people choose the fall of the Reichmanns as yet another opportunity to berate the whole notion of free enterprise and capitalism, which is where I come to my other recent book, which was about Petro-Canada, entitled Self-Serve, and subtitled How Petro-Canada Pumped Canadians Dry.

I calculated in that book that if we assume that the government of Canada had borrowed the $6 billion which it pumped into our state oil company, and had to pay an average of 10 per cent on its money, then the amount of national debt now associated with Petro-Can is more than $15 billion, which happens to be around what the Reichmanns, or rather O and Y, wound up owing.

More important, Petro-Can's present worth in the market is less than $2 billion. O and Y, however great the disaster, is worth a great deal more than that. What I am saying is that, in terms of costs to Canada, Petro-Canada is a far bigger disaster than Olympia and York. The difference is that, since its cost is buried in the national debt, we hardly seem to have noticed. The consequences, nevertheless, are creeping up on us.

I make this point to emphasize that, whatever the failings of the so-called free-enterprise capitalist system, they inevitably pale into insignificance beside the shortcomings of public ownership. Moreover, where there are always more unpublicized successes than trumpeted disasters under a free-enterprise system, or what might be more appropriately described in Canada and elsewhere as "fettered capitalism," I can think of no successes of public ownership.

To return finally to the story at a personal level, Paul Reichmann is a tragic figure. Tragic figures in traditional drama are great men with fatal flaws. He was an undoubted business genius but he was, after all, just a man. In his case, the gods destroyed him by giving him, in both the mythological and banking sense, too much credit.

The appreciation of the meeting was expressed by Monty Larkin, Director, The Toronto Arts Council, and a Director, The Empire Club of Canada.