Salomon Brothers: History of the Investment Bank

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Salomon Brothers was a Wall Street investment bank founded in 1910 that became one of the most powerful bond-trading houses in the world before disappearing into Citigroup. Its history runs from a small money-brokerage partnership, to the dominant dealer in U.S. government and mortgage bonds in the 1980s, to a Treasury auction scandal in 1991, a takeover by Travelers in 1997, and the retirement of the Salomon name in 2003. Few firms were more influential in modern fixed-income markets, and few produced as many alumni who went on to shape, and sometimes shake, the financial system.

From partnership to bulge bracket

The three Salomon brothers set up the firm in New York in 1910. For most of its first six decades it was a private partnership that worked as a broker and dealer in money-market instruments and bonds rather than a prestige advisor to corporations. That background mattered: while older firms built their names on stock underwriting and corporate relationships, Salomon built its business on trading desks, inventory and the willingness to commit its own capital to buy and sell large blocks of debt.

As the U.S. government bond market expanded after World War II and interest rates became more volatile in the 1970s, a firm that could price and carry large bond positions had a clear advantage. Salomon became a primary dealer in Treasury securities, meaning it bought directly from the government at auction and redistributed the bonds to investors. By the early 1980s it was among the most profitable firms on Wall Street and was counted in the bulge bracket alongside the largest underwriters.

The partnership era ended in 1981, when Salomon was acquired by Phibro Corp., a commodities trading company. The combined business was known as Phibro-Salomon. The deal turned the partners’ stakes into shares of a public company, and within a few years the trading side had become the dominant part of the group; the parent was renamed Salomon Inc in 1986. John Gutfreund, who had led the firm through this period, became the face of Salomon in the 1980s.

How Salomon made its name in bonds

Fixed-income trading

Salomon’s core strength was its fixed-income department. The firm made markets in Treasuries, corporate bonds and other debt, and its traders took large positions on the relationship between different bonds, a practice known as bond arbitrage. In a simple version of the idea, a trader buys a bond that looks cheap relative to a similar one and sells the expensive one, profiting if the price gap narrows. The risk is that the gap widens instead, and because the spreads are small, these trades are usually run with heavy leverage to make the returns meaningful.

Salomon’s bond arbitrage group, led by John Meriwether, became one of the most profitable units on Wall Street in the 1980s. The academic economist Myron Scholes, later a Nobel laureate, also worked with the firm before joining Meriwether’s next venture. Along with Drexel Burnham Lambert in high-yield bonds, Salomon helped turn bond trading from a sleepy back-office business into the center of Wall Street profits.

Mortgage-backed securities

The firm is also credited with building the private market for mortgage-backed securities. Salomon’s mortgage department, closely associated with trader Lewis Ranieri, packaged home loans into bonds whose interest and principal payments came from borrowers’ monthly mortgage payments. Salomon developed some of the first privately issued MBS, as opposed to those backed by government agencies, and then made markets in them.

Securitization let banks and savings institutions sell loans rather than hold them to maturity, freeing capital for new lending. The technique later spread far beyond prime mortgages, and the market it helped create sat at the center of the 2008 financial crisis.

Bond indexes

Salomon also built bond benchmarks used by institutional investors to measure portfolio performance, including the Salomon Broad Investment-Grade Bond Index and the World Government Bond Index. After the Citigroup years these indexes carried the Citigroup name and were later taken over by FTSE Russell, which is why references to a “Salomon bond index” still appear in older fund documents.

The culture behind Liar’s Poker

Salomon was famous for a trading-floor culture that paid enormous bonuses for profitable risk and pushed out people who lost money. Michael Lewis, who worked as a bond salesman at the firm, described it in his 1989 book Liar’s Poker. The title refers to a betting game played with the serial numbers on dollar bills, which traders used as a test of nerve and bluffing.

The book’s portrait of a loud, aggressive, money-driven trading floor became one of the defining images of 1980s Wall Street and is still the main reason many readers know the Salomon name.

The 1991 Treasury auction scandal

The episode that nearly ended the firm came in 1991. Treasury rules limited any single bidder to 35% of the securities offered in an auction. A Salomon trader, Paul Mozer, submitted bids in the names of customers who had not authorized them, allowing Salomon to obtain far more of certain issues than the cap permitted. Control of a large share of a Treasury issue let a dealer squeeze other firms that needed those bonds.

Salomon disclosed the violations in August 1991. Senior management had learned of at least one false bid months earlier and had not promptly reported it to regulators, which turned a rogue-trader problem into a crisis of leadership. Gutfreund resigned, and Meriwether, who supervised the government bond desk, also left.

Warren Buffett, whose Berkshire Hathaway had bought a large block of Salomon preferred stock in 1987, stepped in as interim chairman. His task was to keep the firm alive: the Treasury briefly moved to bar Salomon from bidding at auctions, a decision that was soon softened, and the firm faced possible criminal charges that could have cut off its funding. Buffett replaced management, cooperated with investigators and told Congress that he would forgive the firm for losing money but would be ruthless about any loss of reputation. In 1992 Salomon settled with the Securities and Exchange Commission and the Justice Department for $290 million. Mozer later served a short prison sentence.

Mergers and the end of the Salomon name

Buffett stepped back once the firm was stable, and the culture he tried to reform soon reasserted itself. In 1997 Travelers Group, led by Sandy Weill, acquired Salomon and merged it with its brokerage, Smith Barney, creating Salomon Smith Barney. A year later Travelers merged with Citicorp to form Citigroup, and Salomon Smith Barney became the new group’s investment banking and brokerage arm. Berkshire exited its Salomon investment through the Travelers deal.

In 2003 Citigroup dropped the Salomon name as part of streamlining its many brands. The investment bank became Citigroup Global Markets, while the Smith Barney name stayed with the retail brokerage for several more years.

Long-Term Capital Management

After leaving Salomon, Meriwether founded Long-Term Capital Management (LTCM) in 1994 with several former colleagues from the bond arbitrage group, plus Myron Scholes and Robert Merton. The hedge fund applied the Salomon arbitrage approach on a larger scale, using borrowed money to bet that price gaps between related bonds would converge.

In 1998, after Russia defaulted on its debt, investors fled to the safest assets and those gaps widened sharply instead of narrowing. LTCM’s arbitrage positions had a notional value of more than $1 trillion, so its failure threatened the banks on the other side of its trades. The Federal Reserve Bank of New York organized a rescue in which major banks recapitalized the fund and wound down its positions. A wider crisis was avoided. The same year, Salomon Smith Barney closed its own U.S. bond arbitrage desk after heavy losses.

Legacy inside Citigroup and beyond

The structures and people inherited from Salomon helped push Citigroup deeply into mortgage-backed securities in the 2000s. When that market collapsed, Citigroup took large losses and many former Salomon executives and traders left. In 2009 The Wall Street Journal reported that then-CEO Vikram Pandit was dismantling what remained of Salomon inside the bank to reduce that type of risk.

Salomon’s influence outlasted the firm itself. It trained a generation of traders, quants and executives who went on to run banks and hedge funds, and its story shows how a pay system built around short-term trading profits can encourage risk-taking and rule-bending. In 2022, a group of former Salomon employees and executives announced plans to revive the name as a full-service investment bank.

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The Bottom Line

Salomon Brothers matters to anyone studying how modern bond markets, mortgage securitization and Wall Street pay culture took shape. The firm's trading strength made it hugely profitable, but the 1991 auction scandal and the LTCM collapse showed how leverage and rewards for short-term profit can turn into serious risk. Its name disappeared inside Citigroup in 2003, while its indexes, alumni and methods remained part of the financial system.