Sunshine Charlie Misses the Point
Just as with the Mississippi Company, South Sea Company, and railway bubbles, the anatomy of the 1929 crash involved the “four ps”: the promoters, the public, the press, and the politicians.
In the early twentieth century, Samuel Insull inherited the mantle of John Law and George Hudson by creating an industrial goliath; in his case, one that powered the nation’s great factories and illuminated the homes of millions.
Born in 1859 to a ne’er-do-well London lay preacher and a temperance hotel keeper, Insull toiled through his teenage years as a clerk and stenographer. As did many ambitious young men in that era, he idolized Thomas Edison, and after losing his job in a London auctioneer’s office, he was thrilled to come across a help-wanted ad for one of Edison’s British phone companies, where he secured employment.
His superiors quickly recognized that he had arrived with office skills that extended well beyond shorthand transcription and bookkeeping. A few years later, when offered employment at the company’s head office in the United States, he replied, “I’ll go if I can be secretary to Edison himself.” He grew sideburns so as to look older than his tender twenty-one years, and in early 1881 crossed the Atlantic to work at the great man’s side, where he stayed for eleven years and gradually rose through the company’s ranks.
Increasingly, Insull’s fortunes were bound up not only with Edison’s, but with those of J. P. Morgan, who was a supporter of the great inventor. By that point, Morgan was reaching the apex of his influence and technological acumen, and as an early electricity enthusiast, he had outfitted his home at 219 Madison Avenue with Edison’s first incandescent bulbs. In the absence of an electrical grid, this was no small feat, a deficiency he later remedied by bankrolling Manhattan’s first large-scale generating plant and transmission lines.
Unfortunately for Edison General Electric, because its low-voltage DC system was ill-suited to long-distance transmission, it began to lose market share to the AC high-voltage grid constructed by Thomson-Houston, a competing company founded in 1882 by electrical engineers Elihu Thomson and Edwin Houston. The beginning of the end for Edison General Electric came in 1883 with the issuance of an English patent for a transformer that “stepped down” the high-voltage current in long-distance AC transmission wires for residential use. It was quickly licensed by American George Westinghouse, who deployed it in Thomson-Houston’s system.
Morgan, in a master stroke of investment banking, staved off Edison General Electric’s demise by merging it in 1892 with Thomson-Houston to form General Electric. Edison himself never accepted the superiority of AC transmission; he sold his GE shares in a fit of pique, and when reminded later how much they would have been worth, remarked, “Well, it’s all gone, but we had a hell of a good time spending it.”398
Insull proved to be a genius at running electrical utilities, and in the decade before the merger, he had gradually swallowed up Edison’s rivals to achieve monopoly status in the Chicago area.399 Insull wound up running the company’s Chicago organization, which had been cut adrift by the 1892 merger, and so left him at loose ends. The next year he struck out on his own by taking over Edison’s now orphaned operations in Chicago, where he proceeded to adroitly acquire, manage, and combine smaller utility companies into larger organizations. By 1905 he had expanded his operations well beyond Chicago into the Midwest; he operated his companies competently and, for the era, in the public interest. The industry’s growing scale allowed him to gradually reduce rates and introduce low off-peak pricing. Insull welcomed statutory regulation of the increasingly essential electrical service, and on one occasion he even suggested that if his companies could not properly service their customers, then the government should do so.400
Had he limited his horizons to merely powering industries and lighting cities, he would still be well remembered. Sadly, his scrupulous regard for his companies’ electrical customers did not extend to his companies’ shareholders. Typical of Insull’s early financial machinations was his 1912 floatation of the Middle West Utilities Company, whose primary purpose was not to produce electricity, but rather to raise capital for his other operations. At the heart of his complex financial machinations was his personal purchase from Middle West Utilities of all of its preferred and common shares for $3.6 million. Then, he turned around and sold all of the preferred shares, but only one-sixth of the common shares, to the public for the same $3.6 million, effectively acquiring for himself five-sixths of the company for nothing.
Like Hudson, Insull was public spirited and worked like a Trojan. Also like Hudson, he gave generously to civic projects and the arts, including Chicago’s Civic Opera House, known to locals as “Insull’s Throne.” He built a 4,445-acre estate in Libertyville, north of Chicago, where inhabitants “built homes on Insull real estate, sent to an Insull school children born in an Insull hospital, used Insull lights, cooked with Insull gas, traveled on an Insull road, saved in an Insull bank, and played golf on an Insull golf course.”401 The town represented in microcosm his vast empire, which at its height constituted scores of companies that employed seventy-two thousand workers in power plants that served ten million customers. He sat on or chaired the boards of sixty-five companies and was president of eleven.402
As early as 1898, Insull had intuited that oversight by state agencies was preferable to competition from city-run utilities, and by the First World War, largely as a result of Insull’s personal leadership of the industry, the utilities companies were solidly under the thumb of government regulation.403 This limited their profits, but Insull, like Hudson before him, grasped that the biggest money lay not with providing goods and services, but in financing them.
The complexity of Insull’s holding companies outran the ability of most observers, and perhaps even of Insull himself, to understand. He stacked hundreds of companies into layers, with the bottom layers sometimes owning pieces of those at the top of the structure. Historian and journalist Frederick Lewis Allen described one small corner of Insull’s Rube Goldberg apparatus as follows:
The little Androscoggin Electric Company in Maine was controlled by the Androscoggin Corporation, which was controlled by the Central Maine Power Company, which was controlled by the New England Public Service Company, which was controlled by the National Electric Power Company, which was controlled by Middle West Utilities.404
The common shares of Middle West Utilities, which conferred ownership and control, were by that point held by Insull’s personal vehicle, Insull Utility Investments, Inc.—seven layers in all. The leverage described above was thus multiplied many times, not just the skimming of cream, but, in Allen’s words, of “superrich cream” and “super-superrich cream” that came from stacking multiple organizational levels.405 By 1928, Insull’s byzantine agglomeration was hardly the exception, but rather the rule. In that year, of the 573 entities listed on the New York Stock Exchange, 92 were purely holding companies, 395 were both holding and operating companies, and only 86 were pure operating companies.406
Selling the shares of these stacked companies to the public at inflated prices required the illusion of profitability. Insull did so with an arsenal of financial legerdemain worthy of Blunt and Hudson, most notoriously by having his companies buy assets from each other at escalating prices and then booking each operation as a profit. It was as if a husband sold to his wife for $1,500 the Chevrolet he had previously bought for $1,000, and the wife sold him her Ford in the same fashion, each claiming a $500 gain.
As with Blunt and Hudson before him, and as with the internet moguls after him, both the public and press worshipped Insull. His august image graced the cover of Time twice in the 1920s, and to be glimpsed with him in front of the Continental Bank was said to be worth a million dollars.407
Insull salesmen propelled the final act in this leveraged farce. In early 1929, this specially trained corps began selling to the public, for the first time, shares in his top-level company, Insull Utility Investments, initially at prices that were ten times what he had paid for its assets, and later at more than thirty times as the popular enthusiasm surrounding it grew. These were structures, like the Goldman Sachs trusts, designed for boom times. Any bump in the economy that impaired the ability of his electrical companies to pay off the interest and dividends on their bonds and preferred stock (which had first claim on their revenues) would savage the dividends and prices of their common shares. The net worth of the common share holders, who often owned them on margin, would also suffer. This process accelerated with each step up Insull’s holding company pyramid.
This is precisely what happened to him and most of his six hundred thousand shareholders after 1929. Like Hudson, he sincerely believed in his scheme to the end and borrowed millions in a vain attempt to keep aloft company share prices in his many-layered contraption as it collapsed in slow motion during the long, grinding 1929–1932 bear market. In April 1932, just three short months before the stock market itself finally bottomed, his bankers summoned him to a New York office and informed him that they would not support him further. “Does this mean receivership?” he asked. “Yes, Mr. Insull, I’m afraid it does.”408 The damage to the investing public was immense; one accounting estimated that by 1946, when the prolonged legal wrangling surrounding the bankruptcy of Middle West Securities was finally completed, it amounted to $638 million.409 By that year, the stock market had largely recovered; the losses sustained immediately after the 1932 collapse, near the market’s nadir, must have run into the billions.
Insull’s final act was no less convoluted than the layers of his holding companies and echoed Hudson’s downfall. Indicted for mail fraud connected to sales of utility company stock a few months after his bankruptcy, he fled to France, and when the government tried to bring him back for trial, he decamped for Greece, which had not yet inked a pending extradition treaty with the United States. Authorities in Athens ignored that nicety and packed him off home via Turkey anyway.410 Back in the United States, he appeared again on the cover of Time, this time with his hat shielding his face. Stripped of most of his wealth, he could still mount a high-powered legal defense that eventually beat the multiple counts against him. He returned to France an embittered and frail seventy-eight-year-old shadow of his former self. On July 16, 1938, he descended into a Paris Metro station, extended his hand to the ticket taker, and dropped dead with a few francs in his pocket. His wife had repeatedly warned him to avoid the subway because of his bad heart.411
Insull’s holding companies were only a relatively small piece of a much larger debt pie. The major effect of the late-1920s mania, as with the Mississippi, South Sea, and railway episodes, was to infect the population and business community with an extreme optimism, which led them to borrow excessively against the future.412 Between 1922 and 1929, the nation’s total debt increased by 68 percent, but its total assets increased by only 20 percent, and its income by only 29 percent.413 Debt can grow faster than the rest of the economy for only so long before they implode. This is particularly true of private debt; individuals and corporations, unlike governments, cannot tax or print money, and since individuals and corporations were the main engines of debt in the 1920s, their obligations proved especially explosive when the music finally stopped.
Another major promoter of the 1920s bubble was the stock pool, which typically consisted of an ad-hoc group of brokers and financiers who manipulated the share price of a particular company by buying and selling shares to each other in a carefully choreographed sequence. The procedure was designed to catch the attention of small investors who, clustered in front of the tickers and chalk boards in brokerage galleries, concluded that a stock had been “taken in hand,” and jumped in themselves, driving the price up yet further.
The key player in such a pool was the stock exchange floor “specialist” in the target company’s shares: the broker who bought and sold them on the exchange floor for the public, and who kept a precious “order book” of customer buy and sell orders that predicted future share direction. When the order book’s list of public buy orders grew fat enough, the participants would sell their shares to investors aroused by the steep price rise and reap millions in profits.
The most notorious pools of all centered on Radio, as RCA was known, and its participants read like a who’s who of American politics and business: John J. Raskob, the treasurer of DuPont and General Motors; U.S. Steel chief Charles Schwab; Walter Chrysler; Percy Rockefeller; and Joseph Tumulty, a former aide to Woodrow Wilson. To the modern reader attuned to insider trading, an act that was not illegal in the 1920s, another name sticks out: Mrs. David Sarnoff, the wife of Radio’s president and founder.
The greatest stock pool impresario of all time, though, was Joseph P. Kennedy, Sr. Popular mythology associates the Kennedy family fortune with bootlegging. No credible evidence supports this, and in any case the illicit manufacture of spirits would hardly have been a rational career choice for a Harvard economics graduate, a pedigree far better suited to Wall Street, where his legendary pool operations amassed a fortune that he later expanded into, among other venues, Hollywood and real estate.
Just as George Hudson’s Ponzi-like financing of his railroads—initially paying dividends to existing shareholders out of capital from new ones—was acceptable and legal in the 1840s, so too was the pools’ behavior in the 1920s, and such blatant manipulation of stock prices would not be prohibited until the passage of the Securities Acts of 1933 and 1934.
The third and fourth anatomical components of financial manias, the politicians and press, were both neatly encapsulated in John J. Raskob. When his father, a middling cigar manufacturer, died in 1898, he had the same good fortune as Insull when he became the personal secretary to a titan of industry, Pierre S. du Pont, eventually rising to treasurer of the giant chemical firm. When du Pont rescued troubled General Motors in 1920, Raskob took over the automaker’s finances as well. As the 1920s wore on, Raskob became a stock enthusiast and participated in some of the most successful stock pools.414 In 1928, the Democratic Party appointed him the chairman of its national committee.
Raskob is best remembered, though, for an infamous interview, entitled “Everybody Ought to Be Rich,” given in Ladies’ Home Journal, which by that point had more than two million subscribers. It was published in the August 1929 issue, the most infamous passage from which explains the thrust of the title:
Suppose a man marries at the age of twenty-three and begins a regular savings of fifteen dollars a month—and almost anyone who is employed can do that if he tries. If he invests in good common stocks and allows the dividends and rights to accumulate, he will at the end of twenty years have at least eighty thousand dollars and an income from investments of around four hundred dollars a month. He will be rich. And because anyone can do that, I am firm in my belief that anyone not only can be rich but ought to be rich.415
A classic bubble-era media paean to effortless wealth, this quote neatly illustrates the heuristic shortcuts taken by even the chief financial officer of two great corporations. Today only modest competence with a spreadsheet or financial calculator is needed to determine that turning savings of fifteen dollars each month over twenty years into $80,000 requires earning an average annual return of 25 percent. In 1929, that estimation was more difficult, and while it’s possible that Raskob got out his pencil, paper, and compound interest tables, the fact that he didn’t mention the implied long-term investment return (ludicrously high even for 1929) makes it more likely that he simply pulled his numbers out of thin air.
The role during bubbles and crashes of politicians like Raskob is twofold. First, like everyone else, they become intoxicated by the pursuit of effortless wealth, as did King George I and the Duke of Orléans in 1719–1720, and much of Parliament during the railway bubble. In recent decades, modern political probity and legislation have tamped down such graft, at least in the developed West, leaving political leaders with a more priestly function, the unceasing incantation that the economy is fundamentally sound. On the way up, no mention of speculative excess is hinted at, and on the way down, a nation’s leaders steadily avoid any hint of fear or panic.
And so it was in the 1920s. In his 1928 acceptance speech at the Republican convention, Herbert Hoover solemnly intoned, “We in America today are nearer to the final triumph over poverty than ever before in the history of our land. The poorhouse is vanishing from among us.”416 After the crash, both Hoover and his Treasury secretary, Andrew Mellon, repeatedly reassured the public that the economy was “fundamentally sound.” Hoover also pioneered what would become the standard response of modern leaders around the world when faced with an economic crisis: what John Kenneth Galbraith labeled the “no-business meeting,” in which the nation’s political, financial, and industrial leaders are called to the White House “not because there is business to be done, but because it is necessary to create the impression that business is being done.”417
Is it possible to spot a bubble in real time?
One of the great advances in modern finance was the formulation of the Efficient Market Hypothesis (EMH) by the University of Chicago’s Eugene Fama, who in the 1960s realized that financial markets rapidly incorporated new information—that is, surprises—into prices. Since, by definition, it’s impossible to predict surprises, it’s also impossible to predict future price direction.
And, as the EMH posits that the current market price accurately reflects existing information, manias by definition should not occur. As Fama pungently remarked: “The word ‘bubble’ drives me nuts, frankly.”418
The antipathy of EMH enthusiasts toward the existence of bubbles is understandable; the heart of modern finance formulates and tests mathematical models of market behavior. While it’s easy to toss off Isaac Newton’s supposed lament that he could calculate the motions of the heavenly bodies but not the madness of men, it illuminates a deeper truth: Newton was one of the greatest mathematical modelers the world has ever seen, and if he couldn’t describe a bubble in mathematical terms, then perhaps no one ever could.
Robert Shiller of Yale University, who shared the 2013 Nobel Prize in Economics with Fama, suggests that bubbles occur when price rises become self-sustaining, in his words, “if the contagion of the fad occurs through price.”419 While true of all bubbles, this phenomenon alone does a poor job of identifying them, since investors everywhere and always chase assets with recent high returns. Large-scale bubbles, however, like the ones in 1719–1720, the 1840s, and 1920s are rare, and the mere existence of everyday self-sustaining price rises yields a high false-positive rate.
Supreme Court Justice Potter Stewart confronted the same problem in the case of Jacobellis v. Ohio, which involved a different arena, and his approach offers another way of considering bubbles:
Under the First and Fourteenth Amendments, criminal laws in this area are constitutionally limited to hard-core pornography. I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description, and perhaps I could never succeed in intelligibly doing so. But I know it when I see it. (italics added)420
Just as Newton could not model the madness of men, and just as Professor Fama pushes back against the very word “bubble,” Justice Stewart’s famous construct conveys that although he couldn’t linguistically model hard-core pornography, he knew what it looked like. Jacobellis v. Ohio applies equally well to finance: Even if we can’t model bubbles, we surely by now know what they look like qualitatively.
The financial manias covered thus far—the Mississippi Company, South Sea, English railway, and 1920s stock market—all exhibited four highly characteristic features. First, financial speculation becomes the primary topic of everyday conversation and social interaction, from the throngs in Rue Quincampoix and Exchange Alley to those in American brokerage galleries in the 1920s. Frederick Lewis Allen recalled that during the 1920s,
stories of fortunes made overnight were on everybody’s lips. One financial commentator reported that his doctor found patients talking about the market to the exclusion of everything else and that his barber was punctuating with the hot towel more than one account of the prospects of Montgomery Ward. Wives were asking their husbands why they were so slow, why they weren’t getting in on all this, only to hear that their husbands had bought a hundred shares of American Linseed that very morning.421
The second characteristic bubble feature is that a significant number of ordinarily competent and sane people abandon secure, well-paying professions for full-time financial speculation. Absent the financial excitement of their times, for example, both Blunt and Hudson would have remained modestly successful linen dealers. Allen described an actress who outfitted her Park Avenue residence as a small brokerage operation and “surrounded herself with charts, graphs, and financial reports, playing the market by telephone on an increasing scale and with increasing abandon,” while an artist “who had once been eloquent about only Gauguin laid aside his brushes to proclaim the merits of National Bellas Hess [a now-defunct mail-order house].”422
The third, and most constant, feature of any bubble is the vehemence that believers hurl at skeptics. If anyone had the pedigree and sense of history to express doubt and warn the public about the looming disaster during the late 1920s, it was Paul M. Warburg. Born in 1868 into a German-Jewish family with banking roots in medieval Venice, he rose meteorically through the European financial apparatus before becoming a naturalized U.S. citizen in 1911; in 1914 he was sworn in as an inaugural member of the Federal Reserve Board.
Warburg had seen this movie before he emigrated from Europe, and he knew how it ended. In March 1929, while serving as the head of the International Acceptance Bank, he noted the complete detachment of stock prices from any rational valuation measures and pointed out with alarm the burgeoning amount of loans that caused an “orgy of unrestrained speculation,” which would not only eventually savage the speculators but “would also bring about a general depression involving the entire country.”423
This stunningly accurate prognostication was met with a wall of public condemnation. The mildest label applied was “obsolete”; angrier observers accused Warburg of “sandbagging American prosperity,” foreshadowing nearly word for word the invective hurled at internet bubble skeptics two generations later.424
The same fate met the famous investment adviser Roger Babson when, on September 5, 1929, speaking at a well-attended business conference at Babson College, which he had founded a decade before, he said that “sooner or later a crash is coming, and it may be terrific.” Like Warburg, he predicted a significant depression. That day, the market fell sharply, the so-called Babson Break. If Warburg was easy to attack with nativism and dog-whistle anti-Semitism, Babson presented an even fatter target because he had proved himself a bit of a crackpot and had authored, among other works, a manifesto entitled Gravity—Our Enemy Number One, and established the Gravity Research Institute, whose major purpose was the invention of a protective shield against this deadly force.
In normal times, Babson’s prognostications would have been met with, at worst, good-humored skepticism. But these were not normal times. Newspapers sarcastically referred to him as “The Sage of Wellesley” and pointed out the inaccuracies of his previous prognostications. One investment house warned its clients, “We would not be stampeded into selling stocks because of a gratuitous forecast of a bad break in the market by a well-known statistician.”425
Minsky’s amnesia requirement usually reveals a generational divide during bubbles; only participants old enough to recall the last boom and bust are likely to be skeptical. Their younger and more enthusiastic colleagues will deride them as old fogies, out of touch with the new realities of the economy and the financial markets. Bubbles are, in short, the province of young people with short memories.
Whatever the mechanism, such vehemence is perfectly understandable as a manifestation of Fritz Heider’s theory of balanced and unbalanced states. Mirroring the expectations of end-times adherents, few beliefs are more agreeable than the promise of effortless and unbounded wealth, and its acolytes do not easily part with so comforting a notion. For the faithful, the path of least resistance runs through a balanced state of disagree/dislike, labeling skeptics dim bulbs who “don’t get it.”
The fourth, and final, symptom of a bubble is the appearance of extreme predictions, such as the South Sea forecasts of Spain miraculously ceding its New World trade monopoly to England, investments of £100 yielding hundreds in annual dividends, the railway’s impending “lordship over time and space,” or Raskob’s implicit projection of 25 percent annual market returns.
In 1929, the prediction to end all predictions, though, came from Yale’s Irving Fisher. Perhaps the greatest financial economist of his time, Fisher is today revered for developing much of the underpinning of modern mathematical finance. Alas, he is even better remembered for a remark made on October 15, 1929, to the Purchasing Agents Association in Manhattan, nine days before Black Thursday: “Stocks have reached what looks like a permanently high plateau.”426
No history of the 1929 crash is complete without the tale of “Sunshine Charlie” Mitchell. Insull and Hudson had at least endowed posterity with vital infrastructure, a bequest that mitigated their sins. Nothing, on the other hand, redeemed Charlie Mitchell, the great financial promoter—and predator—of the era.
Like Insull, Mitchell came from humble origins and became an assistant to a corporate titan, in his case Oakleigh Thorne, president of New York City–based Trust Company of America in 1907, just in time for the great panic of that year. Thorne led the large firm though the bank run at the storm’s epicenter, and throughout the crisis, Mitchell, his thirty-year-old aide, put in punishing hours and often slept on his boss’s office floor in lieu of returning home. Between 1911 and 1916 he ran his own brokerage firm, then was hired by the National City Bank (the predecessor of today’s Citibank, hereafter “the Bank”) to run its tiny stock-and-bond sales arm, the National City Company (hereafter, “the Company”).
The commercial banker performs three near-sacred functions central to any capitalist society: the safeguarding of other people’s money; the provision of working capital to businesses, without which the economy cannot function; and the creation of money. By contrast, the investment banker sells stocks and bonds to the public, a much riskier and morally more ambiguous activity.
Banking regulators had long understood this distinction, and in fact, prohibited commercial banks from owning investment banks. But that did not mean that a commercial bank could not control an investment bank without actually owning it, which is how Mitchell and the Bank’s lawyers managed to structure its relationship with the Company.427 Charlie Mitchell, in short, was a pirate disguised as an officer of the queen who sailed under the flag of the Bank. For substantial fees, the Company became an investment bank, whose main function was to generate capital for corporations by selling their newly issued stock shares and bonds to the public. Unfortunately, many of the stocks and bonds sold by the Company were dodgy, and it compounded the malfeasance by selling these securities to the Bank’s unsuspecting customers. Later, the Company and Bank would underwrite even dodgier bonds issued by foreign governments.
When Mitchell took over the Company in 1916, it occupied one room and housed just four employees in the Bank’s headquarters. Promoters need not only the public, their customers, but also the press, which during boom times provides an army of credulous recruits. The 1920s prototypical media shill was a magazine writer named Bruce Barton, the son of a preacher who once described Jesus as an “A-1 salesman.” In 1923, he wrote a puff piece on Mitchell entitled “Is There Anything Here that Other Men Couldn’t Do?” In an interview, Mitchell recounted for Barton how, when one of his young salesmen encountered a slump, he would take him to the top floor of the Bankers’ Club to survey the multitudes below. “Look down there. There are six million people with incomes that aggregate in the thousands of millions of dollars. They are just waiting for someone to come and tell them what to do with their savings. Take a good look, eat a good lunch, and then go down there and tell them.”428
Mitchell’s charisma, drive, glowing press, and the mania of the 1920s stock market swelled the Company’s operations; by 1929, it employed fourteen hundred sales and support personnel scattered among fifty-eight branch offices, all connected to its New York headquarters by eleven thousand miles of private wires (hence the modern pejorative for a full-service brokerage firm, “wirehouse”). Mitchell emitted a nearly constant stream of exhortation to his charges: “We do want to be absolutely sure that, with the exception of the cubs, we have no one in our sales force but producers.” The Company met this aspiration and more, issuing in excess of $1.5 billion annually during the 1920s in the stocks and bonds it had underwritten, more than any other investment bank.429
The Bank heavily marketed the Company’s investment banking “expertise” to its trusting customers. In place of traditional low-yielding but safe passbook accounts, they were advised to buy bonds with alluring fat coupons and stocks with even more alluring nosebleed-inducing price increases.
Mitchell probably didn’t invent the brokerage sales contest, but he refined it to a high art, offering prizes as large as $25,000 to the winning “producer” (an unlovely term still unselfconsciously used in the financial industry). So successful was Mitchell’s apparatus that it ran out of bonds to sell. Normally, companies and foreign governments court investment banks to issue their bonds, but the Company reversed this dynamic by actively encouraging companies to issue more of them. Even more egregiously, Mitchell’s salesmen fanned out to shaky Balkan and South American nations to offer cheap capital to their needy governments.
Despite the salesmen’s reports of ineptitude and mendacity among foreign governments such as Peru and the Brazilian state of Minas Gerais, and of the near-certainty of their default, Mitchell and the Company kept selling these foreign bonds to the Bank’s trusting customers.
In 1921, he ascended from the presidency of the Company to that of the Bank itself, removing the last major roadblock to his sales steamroller. Literary critic Edmund Wilson best captured Mitchell’s spirit, describing how he sent out his salesmen “knocking at the doors of rural houses like men with vacuum cleaners or Fuller brushes.” During the early- and mid-1920s, the Company mainly sold bonds; as the decade wore on and the bull market gained momentum, it shifted its focus from bond sales to stock sales, not only risky issues such as the indebted Anaconda Copper Company but even the Bank’s own stock, which would have been illegal but for the fig leaf of the legal separation of the Company and the Bank.430
In 1958, Wilson described how Mitchell
sold the American public, over the course of ten years, over fifteen billion dollars’ worth of securities. He sold them the stock of motor-car companies that were presently to dissolve into water; he sold them the bonds of South American republics on the verge of insolvency; he sold them on the stock of his own bank, which dropped in the course of three weeks, after October, 1929, from $572 to $220, and which was recently worth $20.431
Mitchell had made his customers ground zero for the crash, the popular image of which centers on the dramatic “black days” of October. Black Thursday, the 24th, saw a consortium led by the J. P. Morgan organization stage a dramatic rescue that broke the panic by midday. But by Black Monday and Black Tuesday, the 28th and 29th, the titans who had saved the day on the 24th—Mitchell, Thomas Lamont of Morgan, and Albert Wiggin of Chase National—had run out of both nerve and capital. On those two successive days, the market fell by 13.5 percent and 11.7 percent, respectively.432
By the close of business on October 29, the market had fallen by 39.6 percent from its September peak: bone-rattling, to be sure, but not as bad as the price falls seen in 1973–1974, 2000–2002, and 2007–2009. Further, by mid-April 1930, stocks had recouped more than two-fifths of that loss.433
During the 1907 crash, only a few percent of Americans owned equities, and even by 1929 that figure had risen to only about 10 percent, and so the initial 1929 fall had relatively little direct economic effect on the general population.434 But over the next several years, the rot spread to the beating heart of business activity, the banking system, and the economy entered a tailspin. By mid-1932, stock prices had plummeted by nearly 90 percent from their 1929 peak level. On December 11, 1931, still six months from the market’s ultimate bottom in mid-1932, a small investor named Benjamin Roth wrote of the impoverishment of investors in his diary,
A very conservative young married man with a large family to support tells me that during the past 10 years he succeeded in paying off the mortgage on his house. A few weeks ago, he placed a new mortgage on it for $5000 and invested the proceeds in good stocks for long-term investment. I think in two or three years he will show a handsome profit. It is generally believed that good stocks and bonds can now be bought at very attractive prices. The difficulty is that nobody has the cash to buy. (italics added)435
Figure 7-1. Dow Jones Industrial Average 1925–1935
A cashless public is an angry public and, as in 1720 and 1848, it wanted scalps. The financial humorist Fred Schwed put it most succinctly: “The burnt customer certainly prefers to believe that he has been robbed rather than that he has been a fool on the advice of fools.”436 By 1929, the Bank had 230,000 customers; it’s not known exactly how many of those established brokerage accounts at the Company, but the number ran at least well into the tens of thousands, and likely more.437 Unlike other brokers’ customers, who had willingly come in the front door to purchase securities, Mitchell’s had sought a safe place for their money in a commercial bank and instead stumbled into a bordello.
The fates afflicted Charlie Mitchell with a most unlikely avenging angel: a plainspoken Italian-American attorney named Ferdinand Pecora, whose education had been cut short when his father, a shoe factory worker, sustained a disabling industrial injury. Pecora dropped out of college as a teenager in the late 1890s to support his parents and siblings, and somehow managed to cram in a law degree. Subsequently, his career included a long stint as an assistant district attorney in New York City, where he successfully prosecuted a number of financial cases.
The crash and subsequent bear market prompted an investigation of the securities industry by the U.S. Senate’s Committee on Banking and Currency. It began its hearings in 1932 and questioned Mitchell, among many others. So ineffectual was the interrogation by the first two counsels that the committee fired them.
Pecora’s brilliance in cross examination had caught the eye of Bainbridge Colby, a distinguished attorney who had served as secretary of state under Woodrow Wilson, who recommended the young assistant DA to Peter Norbeck, the outgoing Republican chair of the Committee, who by this point was desperately looking for a replacement for his previous hires.438
Pecora began work as chief counsel on January 24, 1933; he had to hit the ground running and started out well behind the curve. During his first crack at the participants in the Insull trusts, just three weeks after he was hired, he landed nary a punch, so when the tall, imposing, tanned, and supremely self-confident Mitchell strode into the committee room on February 21, 1933, the new chief counsel seemed hopelessly overmatched.
But Pecora soon found his prosecutorial legs, so dominating the hearings and thoroughly destroying its targets that history remembers the proceedings as the “Pecora Commission.” Great wealth, as we’ve seen, confers upon its recipients great adulation. This, in turn, corrodes self-awareness, a fatal flaw when criminal behavior is involved. Further, criminal enterprises typically anesthetize participants to their organizations’ moral failings, who come to view their activities as normal, even laudable.
The same thing often happens with skullduggery at financial companies, where employees learn to rationalize their behavior as in their clients’ best interests. This phenomenon applies in spades to charismatic and successful corporate leaders; as the old saw goes, the fish rots from the head down. Pecora, a connoisseur of criminal behavior, quickly recognized that Mitchell, typical of such corporate thoroughbreds, saw nothing legally or ethically amiss with National City’s modus operandi, and that the most effective way to indict him would simply be to have him explain how he directed his salesmen. Over eight days of testimony, Pecora completely dismantled the haughty Mitchell by leading him methodically, in polite, understated fashion, through the moral swamp that was the National City sales apparatus.
How much did Mitchell have to pay his salesmen to induce them to sell their clients stocks and bonds? Not much, answered Mitchell, only about $25,000 per year—at a time when the average American worker earned $800 per year. How did National City pay its executives? According to the profits from selling securities, and not according to how those securities performed for the customers. How much did this system award Mitchell? Over one million dollars per year, an unheard of salary even for the highest executives in that era.
To make matters worse, Mitchell sold National City stock to his wife at a loss, then immediately bought it right back from her, and thus paid no income tax in 1929; engaged in a classic stock pool manipulation of the Bank’s shares; and made extravagant forgivable “loans” to high executives while simultaneously sandbagging his ordinary employees with mandatory purchases of Bank stock, journaled against their future paychecks at well above the market price. When his rank and file finally paid off their overpriced purchases, he fired them.439
As the shocking salaries and loans, tax shenanigans, and employee abuse filled the headlines, it slowly dawned on the initially confident Mitchell that he was in deep trouble. Pecora, though, aimed higher: He wanted to expose the twisted incentives that pushed securities salesmen in general, not just National City’s, to sell customers high volumes of risky securities with borrowed money, a prescription for bankrupting thousands of hardworking Americans. He began this task on the fourth day of the hearings and demonstrated how the Company, with full access to the list of ordinary Bank depositors, “ruthlessly,” as worded in a sales directive, sold them stocks and bonds.440
On the sixth day of the hearings, February 28, Pecora again shifted gears and focused on the damage done to individual investors. Prior to the hearings, the committee had received hundreds of letters from National City’s ruined customers. Their common thread involved prudent, thrifty people who had managed to acquire a comfortable cushion of government bonds, and whom National City salesmen then methodically reduced to penury through repeated leveraged purchases of risky stocks and bonds.
Pecora picked one of the most sympathetic and engaging of them, one Edgar D. Brown from Pottsville, Pennsylvania, to testify. Brown had recently sold a theater chain and desired to move to California for health reasons, and he decided that he needed the financial advice and logistical support from a national financial institution. He came across this advertisement in a national magazine:
Are you thinking of a lengthy trip? If you are, it will pay you to get in touch with our institution, because you will be leaving the advice of your local banker and we will be able to keep you closely guided as regards to your investment.441
Critically, the advertisement had been placed by National City Bank, but Brown was contacted by Fred Rummel of National City Company to help him invest his nest egg of $100,000, most in cash coming due from the sales of his theaters. One quarter of this sum was already in bonds, mainly U.S. government securities. Brown made only one request: He wanted to avoid stocks.
Rummel purchased a wide variety of domestic and foreign bonds for Brown, with his permission, well in excess of his $100,000 nest egg, which required that he take out loans from various banks, including National City, totaling $180,000 more. When his bond portfolio plummeted, even before the crash, Brown complained.
Brown: And [Rummel] said, “Well, that is your fault for insisting upon bonds. Why don’t you let me sell you some stock?” Well, the stock market had been continually moving up. So then I took hook, line and sinker and said, “Very well. Buy stock.”
Pecora: Did you tell him what stocks to buy?
Brown: Never.
Pecora: Did he buy stocks then for your account?
Brown: Might I answer that facetiously—Did he buy stocks?
To which the committee’s clerk dutifully recorded, “Great and prolonged laughter.”442
Brown then produced for the committee a record of stock purchases so voluminous that Pecora did not burden the clerk with their entry. Brown recounted how he traveled to the National City headquarters to complain that Rummel had so aggressively traded his account that despite the rising stock market, his portfolio’s value had declined. He was told that the Company would look into the matter and that he would hear back.
Brown did hear back from Mr. Rummel, who recommended the purchase of more stocks, including National City Bank; by October 4, 1929, the value of his portfolio had declined yet further. Brown marched into National City’s Los Angeles office and demanded the sale of all his positions, and recounted what happened next: “I was placed in the category of the man who seeks to put his own mother out of his house. I was surrounded at once by all of the salesmen in the place, and made to know that that was a very, very foolish thing to do.”
The Company finally did sell Brown’s stocks on October 29, Black Tuesday, when he had run out of margin, leaving him with nothing. Further, it had done so in the most mendacious way possible, purchasing Brown’s securities themselves at prices well below the going market price.
Brown, who two years prior had been worth $100,000, about $1.5 million in today’s money, was now a pauper. Amazingly, what Brown wanted most at this point was an additional loan of $25,000 so that he might speculate further in Anaconda stock. The Bank, of course, refused, on the grounds that Brown was unemployed and broke.443
Before 1929, successful businessmen attained near-cult status as the ultimate arbiters of what was good for the nation; for a time after 1933, the Pecora Commission made Wall Street public enemy number one. It also introduced the word “bankster” into the American vocabulary, two generations before it was resuscitated with a vengeance by the 2007–2009 global financial crisis.
The hearings wound down on March 2, just two days before the inauguration of Franklin Roosevelt, and amid massive bank failures that modern economic historians have attributed in no small part to FDR’s campaign rhetoric, particularly pertaining to his threat to devalue the dollar relative to gold, which he eventually carried out.444 The public thirsted for revenge, and within two months of the hearings, Mitchell found himself on trial for fraud. As with Blunt and Hudson, Mitchell had probably not done anything that violated the lax fraud and securities laws of that time, and he was acquitted on all charges, although he did later have to settle with the government for back taxes. Over the next two decades, he even regained some semblance of wealth and respectability; his last residence on Fifth Avenue now serves as the French consulate.
Just as happened after the South Sea debacle two centuries prior, the law belatedly changed. Within fifteen months of the hearings, Roosevelt would sign a panoply of securities legislation inspired by the Pecora Commission, including the Glass-Steagall Act, which rigorously separated investment banking and commercial banking; the Securities Acts of 1933 and 1934, which regulate, respectively, the issuance and trading of securities; and the Investment Company Act of 1940, which governs financial advisors and investment trusts, the progenitors of today’s mutual funds.
In one of finance’s greatest ironies, the first commissioner of the Securities and Exchange Commission, established by the 1934 act and charged with enforcing its provisions, was none other than pool operator par excellence Joseph P. Kennedy, Sr. When the incongruity of Kennedy’s appointment was pointed out to FDR, he quipped, “It takes a thief to catch a thief.”445
A contemporary perspective on the crash was offered by Fred Schwed, who, with his characteristic fey humor, explained it thusly:
In 1929 there was a luxurious club car which ran each week-day morning into the Pennsylvania Station. When the train stopped, the assorted millionaires who had been playing bridge, reading the paper, and comparing their fortunes, filed out of the front end of the car. Near the door there was placed a silver bowl with a quantity of nickels in it. Those who needed a nickel in change for the subway ride downtown took one. They were not expected to put anything back in exchange; this was not money—it was one of those minor conveniences like a quill toothpick for which nothing is charged. It was only five cents.
There have been many explanations of the sudden debacle of October, 1929. The explanation I prefer is that the eye of Jehovah, a wrathful god, happened to chance in October on that bowl. In sudden understandable annoyance, Jehovah kicked over the financial structure of the United States, and thus saw to it that the bowl of free nickels disappeared forever.446
A quote apocryphally attributed to Albert Einstein posits compound interest as the most powerful force in the universe. It is not. Amnesia is. Just two short years after the Pecora hearings, Frederick Lewis Allen presciently observed that
St. George attacks the dragon and is furiously applauded; but there comes a time when St. George is dead, when the audience has dispersed, and when St. George’s successor finds the dragon a very persuasive fellow and begins to wonder why such a to-do was ever made over dragon-slaying, whether times haven’t changed, and whether there is any need for subjecting the dragon to anything more than the mildest restraint.447
As the Pecora Commission faded into memory, Saint George fell not merely off his guard, but lay bleeding by the roadside, unable to protect a public with little recollection of Raskob, Insull, and Mitchell from their erstwhile late-twentieth-century successors.
398. Bernstein, The Birth of Plenty, 127–128.
399. The Bend [OR] Bulletin, July 16, 1938, 1, 5.
400. Allen, The Lords of Creation, 267–269.
401. Quoted in Allen, The Lords of Creation, 281–282.
402. Ibid., 266–286.
403. Virginia State Corporation Commission, “Staff Investigation on the Restructuring of the Electric Industry,” https://www.scc.virginia.gov/comm/reports/restrct3.pdf, accessed April 17, 2019.
404. Allen, The Lords of Creation, 279
405. Ibid.
406. Adolph A. Berle, Jr., and Gardiner C. Means, The Modern Corporation and Private Property (New York: The Macmillan Company, 1948), 205n18.
407. Allen, The Lords of Creation, 281.
408. Ibid., 286.
409. Arthur R. Taylor, “Losses to the Public in the Insull Collapse: 1932–1946,” The Business History Review Vol. 36, No. 2 (Summer 1962): 188.
410. “Former Ruler of Utilities Dies in France,” Berkeley Daily Gazette, July 16, 1938.
411. “Insull Drops Dead in a Paris Station,” The Montreal Gazette Vol. 167, No. 170 (July 18, 1938): 9.
412. Allen, The Lords of Creation, 353–354.
413. Evans Clark, Ed., The Internal Debts of the United States (New York: The Macmillan Company, 1933), 14.
414. See, for example, “Reveal Stock Pool Clears 5 Million in Week,” Chicago Tribune Vol. 91, No. 121 (May 20, 1932): 1.
415. Samuel Crowther, “Everybody Ought to Be Rich: An Interview with John J. Raskob,” Ladies’ Home Journal, August 19, 1929, reprinted in David M.P. Freund, The Modern American Metropolis (New York: Wiley-Blackwell, 2015), 157–159. Circulation estimate from Douglas B. Ward, “The Geography of the Ladies’ Home Journal: An Analysis of a Magazine’s Audience, 1911–55,” Journalism History Vol. 34, No. 1 (Spring, 2008): 2.
416. Yanek Mieczkowski, The Routledge Historical Atlas of Presidential Elections (New York: Routledge, 2001), 94.
417. Galbraith, The Great Crash 1929, 139.
418. David Kestenbaum, “What’s a Bubble?,” http://www.npr.org/sections/money/2013/11/15/245251539/whats-a-bubble, accessed August 1, 2016. For a sample of the academic literature on the nonpersistence of money manager performance, see Michael C. Jensen, “The Performance of Mutual Funds in the Period 1945–64,” Journal of Finance Vol. 23, No. 2 (May 1968): 389–416; John R. Graham and Campbell R. Harvey, “Grading the Performance of Market Timing Newsletters,” Financial Analysts Journal Vol. 53, No. 6 (November/December 1997): 54–66; and Mark M. Carhart, “On Persistence in Mutual Fund Performance,” Journal of Finance Vol. 52, No. 1 (March 1997): 57–82.
419. Robert Shiller, Market Volatility (Cambridge: MIT Press, 1992), 56.
420. Anonymous, “Jacobellis v. Ohio,” https://www.law.cornell.edu/supremecourt/text/378/184#ZC1-378_US_184fn2/2, accessed August 1, 2016.
421. Allen, Only Yesterday, 288.
422. Ibid., 273–274.
423. Chancellor, 210.
424. Alexander Dana Noyes, The Market Place (Boston: Little, Brown and Company, 1938), 323–324.
425. Galbraith, The Great Crash 1929, 84–85; and The Wall Street Journal September 6, 1929.
426. “Fisher Sees Stocks Permanently High,” New York Times, October 16, 1929, 8.
427. Michael Perino, The Hellhound of Wall Street (New York: The Penguin Press, 2010), 197.
428. Bruce Barton, “Is There Anything Here that Other Men Couldn’t Do?” American Magazine 95 (February 1923): 128, quoted in Susan Estabrook Kennedy, The Banking Crisis of 1933 (Lexington: The University Press of Kentucky, 1973), 113–114.
429. Quote in Allen, The Lords of Creation, 313; also see Edmund Wilson, The American Earthquake (Garden City, NY: Anchor Doubleday Books, 1958), 485.
430. Allen, The Lords of Creation, 313–319.
431. Edmund Wilson, 485.
432. As measured by the Dow Jones Industrial Average.
433. On October 19, 1987, the Dow Jones Industrial Average fell by 22.6 percent, which marked “only” a 36.1 percent price fall from its previous high eight weeks prior.
434. For longitudinal U.S. stock ownership, see https://www.fdic.gov/about/history/timeline/1920s.html.
435. Benjamin Roth, The Great Depression: A Diary (New York: Public Affairs, 2009), 44.
436. Fred Schwed, Where Are the Customers’ Yachts? (Hoboken, NJ: John Wiley & Sons Inc., 2006), 155.
437. Thomas F. Huertas and Joan L. Silverman, “Charles E. Mitchell: Scapegoat of the Crash?” The Business History Review Vol. 60, No. 1 (Spring 1986): 86.
438. Perino, 40–59.
439. Ibid., 135–155.
440. Ibid., 202.
441. “Hearings before a Subcommittee of the Committee on Banking and Currency of the United States Senate, Seventy-Second Congress on S. Res. 84 and S. Res. 239,” 2170, http://www.senate.gov/artandhistory/history/common/investigations/pdf/Pecora_EBrown_testimony.pdf, accessed August 17, 2016.
442. Ibid., 2176.
443. Ibid., 2168–2182.
444. Wigmore, The Crash and Its Aftermath, 446–447; Barrie A. Wigmore, “Was the Bank Holiday of 1933 Caused by a Run on the Dollar?,” Journal of Economic History Vol. 47, No. 3 (September 1987): 739–755.
445. William J. Bernstein, The Four Pillars of Investing (New York: McGraw-Hill Inc., 2002), 147.
446. Schwed, 54.
447. Allen, The Lords of Creation, 225.