There has always been a philosophical tug and pull regarding the proper amount of regulation for U.S. financial markets. At one end are the minimalists, who believe that bankers will naturally act in a responsible manner in service of their best long-term interests—what Alexis de Tocqueville called “self-interest rightly understood” in his nineteenth-century classic Democracy in America. The conventional wisdom of the holders of the minimalist outlook tells us that Wall Street will behave if left alone and, what’s more, its ability to operate unfettered by intrusive and costly regulation will ultimately promote the greater good for Main Street.
At the other end are the realists, such as Nobel laureate Joseph Stiglitz, who hold no illusions that financiers act in accordance with their better angels but argue rather that they tend to look out for their short-term best interests with scant attention to the long-term benefits for the public weal. For that reason, according to Stiglitz and like-minded realists, self-regulation is “preposterous,” and it’s a national illusion that “markets are self-adjusting or that the role of government should be minimal.”1
From the time of the publication of de Tocqueville’s Democracy in America in 1840 through J. Pierpont Morgan’s death in 1913—a time coinciding with America’s emergence as a world industrial and financial power—regulatory minimalism was the state of affairs on Wall Street, and Morgan himself treated the prospect of government regulation in a cavalier manner. When he learned in February 1902 that Teddy Roosevelt’s attorney general planned to file suit to break up the Northern Securities Company, a railroad trust he had organized, Morgan called Roosevelt for a conference to discuss the matter. His suggestion for the president was simple: “If we have done anything wrong, send your man to my man and they can fix it up.”2
Although Roosevelt was not inclined to treat the private banker as an equal and ultimately forced the breakup of the Northern Securities Company under the Sherman Antitrust Act, Morgan’s presumptions were revealing. He believed that government and business could operate independently but cooperatively, and he further believed that the general public would ultimately benefit if he and other financiers of the day were unencumbered by government interference and guided largely by their own enlightened self-interest.
And while such beliefs warrant a healthy dose of skepticism, there is reason to believe that Morgan was sincere in his convictions about the efficacy of self-regulated capitalism. After all, by acting as an honest broker he attracted large pools of European money into a capital-starved American economy. The trusts he formed, those Roosevelt seemed intent on dismantling, were meant to preserve the stability of that economy by preventing “ruinous competition” in the New World’s industrial sector. In the past he had certainly acted to maintain a steady economy through his outsized role in taming the U.S. business and financial cycles. Not long after his run-in with Roosevelt, he quelled the panic of 1907, just as he had played the leading role in stemming the earlier financial panics of the Gilded Age. His actions, arguably heroic, worked to the mutual benefit of the House of Morgan and the national economy.
Yet however self-enlightened Morgan’s actions might have been, the panic of 1907 served as a wake-up call to Washington, and Nelson Aldrich, the Republican chairman of the Senate Finance Committee at the time, pointed out that Morgan was now an elderly man and could not be counted on to engineer a solution for the next banking crisis.3 And what had to be done was to establish an institutional lender of last resort in the form of a central bank to provide liquidity in times of financial crisis and also to regulate the supply of money circulating in the economy and serve as the nation’s chief bank examiner. The ultimate role of a central bank is to keep a country’s economy stable, and as late as 1913, the year of Pierpont’s death, the United States didn’t have one.
Chapters 2 and 3 tell the story of how two unlikely allies, Paul Warburg and Carter Glass, combined to create an American-style central bank by effecting the passage of the Federal Reserve Act of 1913. The two men could not have been more different. Warburg, an intellectual, was a member of a prominent German banking family and had immigrated to the United States to join the powerful Wall Street firm of Kuhn, Loeb & Company; Congressman Glass was a combative, self-educated Democrat from Lynchburg, Virginia, who referred to big city bankers as “money devils.” While they rarely admitted to cooperating with each other, in a two-step process they created the 1913 Federal Reserve Act and the country’s first enduring central bank.
Much as the panic of 1907 ultimately served to create “the Fed” in 1913, the great stock market crash of 1929 spurred Congress to establish, in 1934, the second pillar of U.S. financial regulation: the Securities and Exchange Commission. Prior to the sweeping new securities regulation that came in as part of Franklin Roosevelt’s New Deal legislation—the Glass-Steagall Act of 1933 that separated investment banking from commercial banking; the Truth in Securities Act of 1933 that mandated full disclosure in securities offerings; and the Securities Exchange Act of 1934 that created the SEC—the investment business was largely self-regulated.
Before the SEC, the New York Stock Exchange was Wall Street’s self-appointed watchdog. It monitored the business practices of its members—the investment firms that conducted their business at the exchange—and it required the companies whose stock traded on the exchange to conform to a modicum of business disclosure and rules of fair practice. From all appearances and declarations, the exchange was governed by men of probity who were intent on keeping players in the stock market honest and making sure the executives of its listed companies were forthright about their business. A minimalist if there ever was one, the NYSE’s president, Richard Whitney, famously declared in 1934 that “the Exchange is a perfect institution.”4
Would that were so! Chapter 4 introduces Ferdinand Pecora, the no-nonsense realist who, during sixteen months between 1933 and 1934, directed congressional hearings into the speculative excesses on Wall Street during the Roaring Twenties. The fiery former prosecutor undermined any notion that self-regulation had been effective during those years and, through withering testimony, exposed the culpability and venality of a shocking number of men at the top of Wall Street’s best-known institutions. The hearings captured front-page interest as one high-profile financier after another—from J. P. Morgan Jr. to the NYSE’s own Richard Whitney—laid out sordid instances of their own self-dealing and investor abuse. Their disclosures stoked a firestorm of indignation among a public beaten down by the Great Depression, resulting in changes in the financial world far beyond anyone’s expectations. As a direct outcome of Pecora’s tenacity, the House of Morgan and other financial giants of the day were dismantled and, more importantly, the manner in which stocks and bonds were bought and sold underwent fundamental and constructive changes.
The two mainstays in the regulation of American financial institutions and markets have been the Federal Reserve System and the Securities and Exchange Commission. Without those two institutions, and the confidence they instill, the United States would not have become the world’s financial center. And without the fortuitous emergence of Warburg, Glass, and Pecora, it is difficult to imagine how the United States would have put the necessary reforms in place to create the Fed and the SEC and thereby achieve its global financial stature.