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UNITED STATES

FINANCIAL HISTORY of the

UNITED STATES
Volume II
From J.P. Morgan to the Institutional Investor (1900 -1970)

FINANCIAL HISTORY of the

Jerry W. Markham
M.E.Sharpe
Armonk, New York London, England

Copyright 2002 by M. E. Sharpe, Inc. All rights reserved. No part of this book may be reproduced in any form without written permission from the publisher, M. E. Sharpe, Inc., 80 Business Park Drive, Armonk, New York 10504. Library of Congress Cataloging-in-Publication Data Markham, Jerry W. A financial history of the United States / Jerry W. Markham. p. cm. Includes bibliographical references and index. Contents: v. 1. From Christopher Columbus to the Robber Barons (14921900) v. 2. From J.P. Morgan to the institutional investor (19001970) v. 3. From the age of derivatives into the new millennium (19702001) ISBN 0-7656-0730-1 (alk. paper) 1. FinanceUnited StatesHistory. I. Title. HG181.M297 2001 332.0973dc21

00-054917

Printed in the United States of America The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences Permanence of Paper for Printed Library Materials, ANSI Z 39.48-1984.

BM (c)

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For my parents, John and Marie Markham

In every generation concern has arisen, sometimes to the boiling point. Fear has emerged that the United States might one day discover that a relatively small group of individuals, especially through banking institutions they headed, might become virtual masters of the economic destiny of the United States. Adolf A. Berle, February 1969

Contents

List of Illustrations Preface Acknowledgments Introduction Chapter 1. A New Century 1. The Twentieth Century Begins The NYSE 3 The Consolidated Stock Exchange 5 The Curb Market 6 Brokerage Firms 7 The West Coast 9 Speculators 10 The Securities Business 10 Mergers 12 The Great Northern Battle 13 2. Insurance, Banking, and Underwriting Insurance 17 The Armstrong Investigation 18 New Directions 20 New Entrants Into the Banking Business 21 Money Markets 21 Consumer Credit 22 The Big Banks 23 Investment Banking 25 Economic Consolidation 26 Securities Disclosures 27 3. The Panic of 1907 J.P. Morgan to the Rescue 31 Effects of the Panic 34 The Hughes Committee 35 Currency Issues 38 Trading Continues 39 Taxes 40 4. The Federal Reserve and the Money Trust The Duck Hunters 43 The Federal Reserve Is Created 45 State Banks 46 The Hunt for the Money Trust 47 The Pujo Committee Attacks the NYSE 50 The Pujo Committee Recommendations 53 5. Banking and Securities Before the War Changing of the Guard 55 Financial Institutions 56 Bank Affiliates 57 Blue-Sky Laws 58 Financial Markets 60 William Durant 63 Automobile Finance 64 International Finance 65

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29

42

55

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CONTENTS

Chapter 2. America Enters the War 1. World War I Prewar Finance 69 International Payments 70 American Financial Leadership 73 America Enters the War 75 The Liberty Loans 76 War Finance 78 2. War and the Stock Market The Money Committee 80 The Capital Issues Committee 82 Securities Trading 85 Financial Changes 88 Pension Plans 90 Disturbances 90 Accounting 91 3. The Futures Markets Regulatory Issues 94 The Cotton Futures Act 95 Wartime Trading 96 Postwar Problems 99 The FTC Study 100 Legislation 101 Abuses Remain 102 Additional Exchanges 104 Clearinghouses and Other Issues 105 4. Banking in the Twenties Consumer Finance 107 Money Markets and the Fed 108 Banking Operations 111 Branch Banking 113 International Banking 115 Bank Securities Affiliates 115 J.P. Morgan & Co. 118 Government Finance 118 Chapter 3. The Crash 1. The Stock Market Expands The NYSE 124 Other Markets 126 Information 128 Investments 129 Merrill Lynch and Other Giants 130 Syndicate Operations 131 William Durant 132 More Automobiles 133 Financial Troubles 134 2. The Market Surge and Investment Trusts Investment Trusts 137 The Big Investment Trusts 140 Investment Trust Abuses 142 Other Abuses 143 Preferred Lists 145 Real Estate 146 3. The Stock Market Crash of 1929 Speculative Orgies 148 Manipulations 149 Margin Concerns 150 The Crash 153 Aftermath 156 4. The Banking Crisis Bank Failures 160 The Reconstruction Finance Corporation 161 Government Programs 163 Bank Runs 164 The New Deal 165 The Investment Bankers Split 168 Further Reforms 171 5. Congress Investigates the Stock Market The Crisis Deepens 173 Congressional Investigations 177 Insider Trading 180 Margin Trading 182 Securities Legislation 184 173 160 148 137 123 107 93 80 69

CONTENTS

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Chapter 4. Regulating Finance 1. Monetary Policy and the Depression 189

Monetary Policy and International Finance 190 The Gold Standard Is Abandoned 191 The Silverites Return 194 Fort Knox 195 Government Intervention 195 The Bonus Army 197 NIRA 198 More Relief Agencies 199 Social Security 200 Taxes 201 2. The Federal Securities Laws Joseph Kennedy 202 SEC Regulations 202 Holding Companies 205 The Whitney Scandal 206 NYSE Reforms 207 SEC Efforts 208 The NASD 210 Accounting 211 Trust Indenture Act 212 3. Commodity Market Reforms Speculation 214 Farm Relief 214 Trading Concerns 215 President Hoover Becomes Alarmed 216 Commodity Prices Continue Their Plunge 217 Government Intervention 218 Congress Investigates 220 The Commodity Exchange Act 222 Margin 223 Commodity Markets 224 4. The Market Suffers Trading Continues 226 Government Securities 228 Financing Business 230 New Leaders 232 Market Ups and Downs 233 The Crisis Continues 235 5. Investment Companies and Insurance Regulation Abuses 238 Legislation 239 Market Activity 241 Government Investigations 244 TNEC and a New Money Trust 245 Insurance Industry Investigation 245 Industry Composition 246 Insurance Industry Investments 249 Industry Abuses 250 Chapter 5. War and the Rebuilding of Finance 1. World War II and Finance War Preparation 255 Effects of the War in Europe 257 Lend-Lease 258 Commodity Trading 259 Financial Effects of the War 260 Government Finance 261 War Loans 263 Wartime Taxes 263 Securities Markets 265 Banking Activity 266 Insurance Business 267 2. After the War Demobilization 269 Postwar Boom 270 Speculation Resumes 270 Trumans Attacks on Speculators 272 Expanded Trading 274 The IMF 275 GATT 277 The Marshall Plan 277 Banking Operations 278 Credit Cards 279 Insurance Companies 280 Financing Resumes 281 Government and Finance 283 Securities Trading and Information 284 269 255 237 226 214 202

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CONTENTS

3.

Korea and the War on the Investment Bankers Speculation 286 Insurance Programs 288 A New Money Trust Hunt 288 Underwritings 290 Stock Trading 292 New Issues 293 Securities Fraud 295 Boiler Rooms 296 Financial Changes 297

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4.

The Fed and the 1950s

299

The TreasuryFederal Reserve Accord 299 Fixed Income Securities 301 Small Businesses 303 Commercial Banks and Thrifts 303 Consumer Finance 305 Credit Card Growth 306 Banking Operations 307 Bank Holding Company Legislation 307 Banking Challenges 308 International Finance 309 Financial Concerns 310 Chapter 6. A New Era Begins 1. Institutional Investors Investment Standards 315 Insurance Business 316 Annuities 317 Pension Funds 318 Mutual Funds 320 Corporate Finance 320 Securities Markets 321 Financial Abuses 323 Commodity Markets 323 Increased Wealth 324 2. Banking, Gold, and Trading Gold Problems 326 Euro Dollars 328 Problems on the AMEX 329 Securities Trading 330 Salad Oil Swindle 331 Special Study of the Securities Markets 333 Insider Trading and Other Concerns 334 Government Finance 334 Banking Consolidation and Regulation 335 Crossing Regulatory Boundaries 336 Banking Finance 339 Government Securities 340 Commodity Markets 341 3. The Securities Markets Merrill Lynch 342 Underwriting 343 Stock Exchanges 344 Exchange Competition 346 Securities Information 346 Mergers and Acquisitions 347 Conglomerates 348 Securities Markets and Mutual Funds 351 IOS 353 4. Institutions and Paperwork Insurance Companies 356 Pension Plans and Other Institutional Investors 357 Hedge Funds 358 Institutional Membership 359 Block Trades 360 REITs 360 Securities Trading 361 Paperwork Crisis 362 Legislation 364 Stock Certificates 366 Conclusion Notes Selected Bibliography Name Index Subject Index 369 373 383 395 401 356 342 326 315

List of Illustrations

James R. Keene J.P. Morgan Nelson Aldrich William C. Durant Benjamin Strong Carter Glass Jesse Jones Joseph P. Kennedy Charles Merrill William McChesney Martin

11 32 35 63 151 153 162 203 243 301

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Preface

This is the second of three volumes in a history of finance in America. The first volume covered the period from the discovery of America to the end of the nineteenth century. This volume starts with the investment bankers who dominated finance at the beginning of the twentieth century. It then describes the Panic of 1907 and the resulting creation of the Federal Reserve Board (the Fed). The volume then traces finance through World War I, and it examines the events that led to the stock market crash of 1929 and the Great Depression. From there, it reviews the rebirth of finance after World War II and the growth of the institutional investor. The third and final volume of this history will focus on the growth of derivatives, the savings and loan crisis, the merger mania of the 1980s, the accompanying insider trading scandals, and the battle with inflation. That volume then reviews the market run-up in the 1990s and the revolution in finance that was strongly pushed by the Internet economy.

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Acknowledgments

The author would again like to express his appreciation for the assistance given by his many research assistants over the last several years.

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Introduction

By the beginning of the twentieth century, the robber barons had been replaced at the center of finance by the investment bankers. Of course, speculators still lurked on the fringes, and the financiers continued to arouse distrust. Trustbusters were in pursuit of the giant amalgamations formed at the turn of the century. The Federal Reserve Board would be created in the aftermath of the Panic of 1907 as a signal that the government would no longer depend on the investment bankers to handle financial panics. A money trust hunt began that continues even today. Yet finance continued its growth. America provided a massive amount of financing during World War I with seemingly little effort. The stock markets then began a surge that suggested a permanent prosperity, but it all collapsed in the maelstrom that struck Wall Street in October 1929. The American economy and finance would not recover until the outbreak of World War II. Despite being crippled by the Great Depression, America was still able to absorb much of the monetary costs incurred by the Allies during the war. Amazingly, American finance then provided the foundation for the reconstruction of Japan and Germany, its defeated enemies. World War II was also the backdrop for the Bretton Woods agreement, which established an international monetary system for currency exchange that was tied to gold at a fixed price. That system would crumble some twenty-five years later. The postwar period witnessed another miracle in the form of an expansion of the American economy that lasted over fifty years. The 1950s were quiet in terms of finance, but the commodity and stock markets were often roiled by manipulation and speculation. An underworld of financial criminals emerged to fleece the unsophisticated. More importantly, the Federal Reserve Board was able to gain its independence from the Treasury Department. It was not long before the Fed chairman was more prominent than the Secretary of the Treasury, at least in financial circles. In the 1960s, the war in Vietnam and government spending on social programs touched off an inflationary cycle in America that created much finanxix

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INTRODUCTION

cial uncertainty. That inflation undercut the carefully structured banking and thrift regulatory system, which depended on stable interest rates for what was then a rather unimaginative business of taking deposits and lending money. The securities markets also found themselves under attack, first from an overabundance of business that broker-dealers could not handle and then from a dismantling of the fixed commission structure that the industry had relied upon since the Buttonwood Agreement was signed in 1792. This change would allow the development of the discount brokers who competed with the larger firms on the basis of no-frills executions at much reduced commission charges. Those brokers would be well positioned in the 1990s for the introduction of the Internet to the securites market. Another revolution was under way in the form of derivatives. The creation of the Chicago Board Options Exchange and innovations in the futures industry would give rise to an era of financial engineering that would change the face of finance. Perhaps the most significant development in the postwar period was the arrival of the institutional investor, including insurance companies, pension funds, and mutual funds. These entities accumulated enormous amounts of assets that had to be invested. Those resources and the loosening of traditional restrictions on fiduciary investments would thrust the institutional investors into the center of finance. This would have far-reaching effects on the financial system. But let us begin with their predecessors, the financial titans that roamed the landscape at the beginning of the twentieth century.

THE TWENTIETH CENTURY BEGINS

Chapter 1 A New Century

1 The Twentieth Century Begins

The NYSE Two exchanges were dealing in securities in New York and seven in commodities at the beginning of the century. The commodity exchanges were incorporated, while the securities exchanges were not. The leading exchange in the city was the New York Stock Exchange (NYSE). Average daily trading volume grew from 1,500 shares in 1861 to over 500,000 by 1900. Annual trading volume increased from less than 80 million shares in 1897 to over 265 million in 1901. One million share trading days were occurring after the turn of the century, and 2 million shares were traded in a single day in January of 1901. That volume was not constant, however. Only some 329,851 shares were traded on July 3, 1901. Nevertheless, the overall picture was one of growth that required larger trading facilities. The NYSE entered temporary quarters at the Produce Exchange on Beaver Street in 1901 and in 1903 moved into a new building that cost $4 million. This was one of the first buildings in America to be air-conditioned. It contained 6 miles of pneumatic tubes, as well as almost 250 miles of wiring. The NYSE was open from 10 A.M. until 3 P.M. Members moved from post to post on the floor to trade in whatever stock appeared active. Some members specialized in odd-lot orders of less than 100 shares. As trading activity increased, specialists in particular stocks began making a continuous market in those securities. The specialists traded for their own accounts and acted as brokers in executing customer orders. The specialist system did not follow the English method of separating the functions of brokers and dealers. This raised concerns of a conflict of interest on the part of the specialist and led to some abuses. Nevertheless, the specialist system provided advantages in creating a continuous market in securities, which might otherwise have been illiquid at times. Some members of the NYSE acted as floor traders. These individuals traded only for their own account and did not execute customer orders. The floor traders added liquidity to the market, but they were often
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A NEW CENTURY

involved in abusive trading practices. Among other things, floor traders were accused of moving prices up and down on the basis of their inside connections with officials of corporations whose stock was being traded on the exchange. Floor traders enjoyed a time and place advantage on the floor that gave them an edge over individuals entering orders from outside the exchange. The outside operators were handicapped by their location off the floor, and they had to pay higher commission rates than those available to members. These nonmember traders often ended up suffering ruinous losses, as did many inexperienced persons who acted on tips and other questionable market advice that usually resulted in losses.1 Advertising by NYSE members at the turn of the century was restricted. Members were required to obtain approval before establishing telegraphic or telephone communications with nonmember firms. Bids or offers on the exchange were limited to variations of a minimum of one-eighth. Transactions on the NYSE could be settled by cash, which required delivery upon the day of the contract; regular way, where delivery was to be made on the following business day; at three days, where delivery was made on the third day following the sale; and at buyers or sellers option, which required settlement of not less than four days nor more than sixty days. Interest at less than the legal maximum rate had to be paid on buyer and seller options contracts. Although the NYSE prohibited the buying or selling of privileges to receive or deliver securities, it allowed margins of up to 10 percent, which provided plenty of leverage to speculators. Corporations were required to provide details of their financial condition in order to be listed on the NYSE. An unlisted department allowed trading in securities of corporations that refused to furnish any substantial information as to their business and which, therefore, could not be admitted to the regular list.2 The Amalgamated Copper Company and the American Sugar Refining Company were two such unlisted securities. Those companies were dealt in on the Exchange for many years without the public having any information regarding their affairs. 3 They were in effect conducted and maintained as blind pools. Those in control were thus enabled to more freely use their information for speculative purposes.4 Another form of pool was operating in the securities markets at the turn of the century. This device was simply an organized effort by a group of speculators to manipulate the price of a particular stock. The pool operators would drive up the price of the stock through various maneuvers and would then sell the stock to unsuspecting investors at the inflated price. In 1900, Whiskey Trust security prices were manipulated by a pool managed by James Keene for Moore & Schley, a brokerage firm. Other pool activities were regularly reported in the newspapers. The Chicago Tribune, for example, reported in 1901 that a pool was operating in the securities of the Western Union Telegraph Company. The Industrial Commission that was created in 1898 proposed federal legislation that would prohibit short selling. The use of fictitious trades de-

THE TWENTIETH CENTURY BEGINS

signed to give a false appearance of trading activity was another concern. The pools often used wash salesthat is, orders entered to buy and sell the same stock by the same personwhich created the artificial appearance of activity in the stock, attracting the interest of unsuspecting investors who then bought stock from the pool. The NYSE prohibited wash sales, but matched orders were permitted. Matched orders involved simultaneous buy and sell orders sent by the same person to different brokers for execution. The brokers would not know of the countervailing orders and would competitively execute the trades. Different brokers were used to avoid claims that the orders were wash sales and unenforceable. Nevertheless, the matched orders created an artificial appearance of activity and their manipulative effect was the same as a wash sale. Matched orders were used by underwriting syndicates in stabilizing transactions that were made during the distribution of the securities being underwritten. Such stabilizing transactions were needed to maintain the offering price until the market could absorb the new issue. Matched orders and orders given at increasing prices during the distribution were often used to manipulate the offering price upward in order to draw in the public at unrealistic prices. The NYSE maintained control of its price information through the New York Quotation Co., which supplied member firms with NYSE price reports. The NYSE sold its quotations to a subsidiary of Western Union for distribution through ticker services that broadcast information throughout the United States. As stock ownership increased, the public came to depend on that information for the value of the securities being traded. It provided a measure of their liquidity and encouraged trading. Listing on the New York Stock Exchange gives a security a wider market and a more definite current value, making it easier to sell and easier to borrow upon. In fact, securities are not generally available for collateral for stock-exchange loans unless they are listed.5 The NYSE refused to list a bond issued by New York City because its bond certificates had not been printed by the American Bank Note Company. The New York Bank Note Company had been allowed to do the printing by the city because of a lower bid. The largest shareholder at that time in the American Bank Note Company was J.P. Morgan. The Consolidated Stock Exchange The NYSE continued its bitter war against the Consolidated Stock Exchange, which was trading in odd lots on NYSE-listed stocks. Prices on the NYSE were posted on a board at the Consolidated. Odd lots or small fractional lots were then traded at a premium or a discount over those prices. The Consolidated Exchanges volume would reach about 45 million shares by 1909, when it had 1,200 members. The Consolidateds trading volume was about 25 percent of that of the NYSE. The Consolidated Stock Exchange did little to provide capital for businesses. Rather, it affords facilities for the most injurious

A NEW CENTURY

form of speculationthat which attracts persons of small means.6 The NYSE continued the ban on its members dealing with members of the Consolidated Stock Exchange. Like the Chicago Board of Trade, which was also facing competition from the Consolidated, the NYSE tried to drive the Consolidated Stock Exchange out of business by preventing it from having access to the ticker tape and quotations. That effort was frustrated because the courts were slow, at least initially, in enjoining such activity. Bucket shops, which were often linked to the Consolidated Exchange, remained a problem after the turn of the century. Some sixty bucket shops in Pittsburgh were using NYSE quotations for their betting operations in 1905. Later, in 1908, New York State enacted legislation that made the operation of a bucket shop a felony. The Curb Market The DuPont Company was an amalgamation of several companies that were the largest makers of gunpowder and dynamite. This consolidation was completed around 1903. The company was not allowed to list its stock on the NYSE because the Du Pont family held so much of the companys stock. Pierre Du Pont then proceeded to have the stock traded as an unlisted security by investment banking firms in New York. Du Pont himself made a market in the shares of the powder company by placing standard orders at 100 to 102 for the companys common stock and 92.25 for bonds and 89 for preferred stock. A growing market for securities in New York was the curb market on Broad Street. This over-the-counter market was an unorganized affair blocked off from the roadway by a rope, but trading often spilled out into the street and obstructed traffic. Some 150 traders were conducting business on the curb each day at the turn of the century. Their clerks and messengers swelled the crowd even further. Quotations on curb-traded securities were being printed in the newspapers. Some traders acted as specialists in particular securities on the curb market. The curb market mostly traded stocks that were not listed on the NYSE, and members of the NYSE were allowed to engage in curb transactions as long as the securities were not listed on the exchange. The curb market had grown on the basis of a loophole in a NYSE rule that prohibited its members from engaging in transactions on any other securities exchange in New York. The curb market was not an organized exchange and therefore did not fall within this prohibition. The curb market was open during the trading hours of the NYSE because a great deal of the business on the curb exchange was the execution of orders from NYSE members. Other exchanges were also operating in New York at the turn of the century. They included the Coal and Iron Exchange, the Coffee Exchange, the Cotton Exchange, the Maritime Exchange, the Metal Exchange, the New York Insurance Exchange, the New York Produce Exchange, and the Leaf Tobacco Board of Trade of the City of New York. The latter entity sold tobacco to manufacturers of tobacco products. Commodity exchanges were growing in Chicago,

THE TWENTIETH CENTURY BEGINS

and regional stock exchanges were providing alternative markets for securities in Chicago, Boston, Detroit, Cincinnati, Philadelphia, Pittsburgh, Baltimore, and Los Angeles. The regional exchanges initially traded in stocks of local corporations. For example, the Cincinnati Stock Exchange, which traces its origins to 1887, had specialized in trading stocks of corporations headquartered in southwestern Ohio and Kentucky. Later, the regional exchanges began trading on a more national basis. Brokerage Firms More brokerage and investment banking firms were appearing. In 1901, Ennis & Stoppani had lists of desirable stocks and bonds that could be obtained upon application. The firm additionally sold cotton and wheat. E.H. Rollins & Sons in Boston had a list of high grade municipal and corporate bonds for public investors. Farson, Leach & Co. offered guaranteed 4 percent Russian bonds that would mature in 1957. These bonds were payable in United States gold coin and were not taxable by the Russian government. In 1901, Vermilye & Co. and Hallgarten & Co. conducted an $8 million bond refunding for the Seaboard Air Line Railway for collateral trust, 5 percent, ten-year bonds. Both principal and interest were payable in gold coins of the United States, free of all taxes. Subscription lines were opened to take orders. Blair & Co. offered letters of credit in pounds sterling or francs. Robert Goodbody & Co. sold investment securities and executed orders on the London and Dublin stock exchanges. Mallette & Wyckoff solicited customers by mail. It published a monthly pamphlet called Practical Investing. Edward C. Jones & Co. specialized in bonds. Dominick & Dominick sold investment securities, as did Spencer Trask & Co. Later, Spencer Trask & Co. offered railroad bonds that it arranged into four groups based on investment objectives and customers. One group was for persons dependent upon income and another for those seeking semispeculative bonds. Henry Clews & Co. executed orders for investment or on margin. Edward B. Smith & Co. dealt in guaranteed stocks. Jacob, Berry & Co. provided investors information with a Glimpse at Wall Street and Its Markets, as well as Monthly Fluctuation Sheets, Daily and Weekly Reports. Fred H. Smith gave attention to curb securities. William G. Gallagher was another firm that sold curb securities: Correspondence solicited on all matters pertaining to all active copper and unlisted stocks. Blair & Co. advertised its services as a domestic and foreign banker for investment securities. F.S. Moseley & Co. offered short time notes. Francke, Thompson & Robb specialized in Cuban securities. In 1902, Joseph Cowan & Co., a member of the Consolidated Stock Exchange, published a daily market letter and supplied investors with Cowans new book, Reveries of a Trader. J.L. McLean & Co. provided market letters to customers upon application; the firm allowed interest on deposits subject to check. Kissel, Kinnicutt & Co. and

A NEW CENTURY

Rudolph Kleybolte & Co. paid interest on monies on deposit that were awaiting investment. The Real Estate Trust Co. of New York allowed interest on deposits. Adolph J. Lichstern & Co. dealt strictly on a commission basis in stocks, grain, and cotton. Securities were still being sold by auction in New York. Adrian H. Muller & Son auctioned stocks and bonds of an estate in 1902 at the New York Real Estate Sales Room on Broadway. Speyer & Co. had been an international investment banking firm even before the Civil War. By the 1890s, Speyer & Co. was one of the three or four most influential international banking firms in the country.7 The firm continued its growth after the turn of the century. Among other things, Speyer & Co. acted as underwriter for financing of securities for the London underground railway in 1902. The firm financed Philippine railway construction in 1906 and acted as underwriter for $35 million of credit for the Republic of Cuba, as well as for Mexican bonds issued in the American market. Speyer & Co. was the first investment banker in New York to create a pension fund for employees. Investment bankers such as J.P. Morgan & Co., William A. Read & Co., and Kuhn, Loeb & Co. were handling large amounts of securities underwritings, but they limited their participations essentially to the New York market. Although there were about 1,000 other investment banking firms in the United States at the turn of the century, only about five of those firms had a national distribution system. They were Lee, Higginson & Co., N.W. Harris & Co., N.W. Halsey & Co., Kidder, Peabody & Co., and William Salomon & Co. Wire houses were developing on Wall Street. These were essentially retail brokerage firms that handled the orders of small customers and were the predecessors to our modern broker-dealers. They acquired the name wire houses because of their telegraph and telephone connections with branch offices around the country. These firms maintained separate offices for their women customers. J.S. Bache & Co., which was formed in 1892 after succeeding to the business of Cahn & Co., conducted an investment banking business. Bache had several offices, including its head office at 47 Exchange Place in New York. The firm accepted deposits subject to check at sight. Bache dealt in stocks and bonds, and it had extensive dealings in cotton and grain. The firms correspondent in Chicago for commodity futures trading was Lamson Brothers & Co. A.G. Edwards & Sons in Missouri sold City of St. Louis bonds. The Lyon Investment Company in Joplin, Missouri, sold Hanover Zinc Company stock at fifty cents a share. The firm claimed that an assay demonstrated that the mine would pay 3 to 5 percent monthly. Peabody, Houghteling & Co. in Chicago offered real estate bonds and mortgages that netted 4 to 6 percent. Bartlett, Frazier & Co. dealt in cotton, grain, and provisions, as well as stocks and bonds. Granger, Farwell & Co. acted as bankers and brokers in Chicago. The Chicago-Beaumont Oil Company offered stock for a 10 percent cash down payment, the balance to be paid when the company struck oil. There

THE TWENTIETH CENTURY BEGINS

seemed to be little doubt of that occurring because the advertisement stated that a gusher was guaranteed within three weeks. The oil well was being drilled at Spindle Top, which had started producing the year before.8 Foreman Brothers Banking Co. in Chicago was seeking the accounts of corporations, firms, and individuals in 1900. Those accounts would be received upon the most favorable terms consistent with conservative banking.9 N.W. Harris & Co. acted as bankers in Chicago. The firm bought and sold government, railroad, gas, and electric company bonds and issued letters of credit and drafts on the Bank of Scotland and the Crdit Lyonnais in Paris. Interest was allowed on deposits. N.W. Harris & Co. dealt exclusively in municipal, railroad, and other bonds that were appropriate for trust funds and savings. The firm operated the largest and most highly developed distributing organization of any private investment house before World War I.10 N.W. Harris used sales agents who called upon customers. It became the Harris Trust and Savings Bank in 1907. The firms New York operations became known as Harris, Forbes & Co., which handled underwritings for many of the electric utility companies. The Harris firm was soon facing competition from N.W. Halsey & Co., which had been dealing in railroad bonds selected for the investment of Trust Funds.11 This firm was created in New York in 1901 by Noah W. Halsey. In 1903, he hired Harold L. Stuart to open a Chicago office, and the firm began to specialize in underwriting public utility securities through its offices in New York, Chicago, and Philadelphia. The West Coast San Francisco had become a center for finance and securities trading on the West Coast by the turn of the century. The San Francisco Chronicle quoted local stocks and bonds on the San Francisco Stock and Exchange Board, as well as commodity futures prices from London and Paris. The California Stock and Oil Exchange and the Goldfield Consolidated Mining Stock Exchange were operating in San Francisco. Zadig & Co., which had a direct wire to Nevada, offered Comstock, Tonopah, Goldfield, Bullfrog, Manhattan, and Rawhide stocks, which were very active in San Francisco during the first decade of the twentieth century. By 1905, Dorr & Ray in San Francisco was executing orders within five minutes after their receipt through private wires to the New York Stock Exchange, the New York Cotton Exchange, and the Chicago Board of Trade. A few years later, Nat Boas, a banker and broker in San Francisco, had a private wire that provided him with direct communications to the Boston Copper Market. Arkell, Hicks & Co. was offering two cents per share for ninety-day calls on 500 shares of Tonopah stock at thirty cents per share in 1905. Sutro & Co. provided a circular with descriptions of several stocks it was recommending. The firm acted as brokers in high-grade investment securities as well as coins and currency in San Francisco. E.H. Rollins & Sons

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A NEW CENTURY

sold municipal, railroad, and corporate bonds nationwide through offices in San Francisco, Boston, Chicago, and Denver. E.F. Hutton & Co., bankers and brokers, had offices in San Francisco and New York. E.F. Huttons New York phone number was Broad 4209. Its partners were members of the NYSE, the New York Cotton Exchange, the New York Coffee Exchange, and the Chicago Board of Trade. Lazard Frres was another firm with California connections. It was founded by three French brothers whose dry goods business in San Francisco had prospered with the discovery of gold in the 1850s. The brothers soon became involved in gold sales and foreign exchange. They opened offices in Paris, London, and New York and began shipping gold to and from Europe, as well as dealing in commercial bills. The brothers initially called their operation the American Bank, Ltd., which was sold in 1908 and became the Crocker National Bank. This left the Lazard investment banking offices in New York, Paris, and London, which would be operated as separate businesses until 1999. Speculators A number of daring speculators were still presiding in New York after the turn of the century. Bernard Baruch, Diamond Jim Brady, John Bet-a-Million Gates, James R. Keene, and Thomas W. Lawson frequently congregated at the Waldorf-Astoria, where they planned their market forays. Although these rapacious gamblers were being gradually shunted aside by the more staid investment bankers, Keene and his ilk would continue to disrupt the markets. Bernard Baruch would build a large fortune from his speculations before he became a statesman. John Gates lost large sums in the stock markets and decided to give up his bear raids. Gates then concentrated on oil and other investments. He helped form the Texas Company, which became Texaco. In another transaction, Gates joined with J.P. Morgan to buy the Tennessee Coal & Iron Co. The Securities Business Charles Dow died in 1902, nine months after Dow Jones & Co. was sold to Clarence Barron for $130,000. Its index of security prices was rising. Transportation stocks were particularly popular. Their prices rose from an average of $77 in 1896 to over $210 in 1901 and to $250 by 1902. Interest in other securities was growing. The Commercial Chronicle and the Bond Buyer were reporting transactions in municipal securities. The American Hide & Leather Company offered first mortgage, 6 percent, sinking fund, twenty-year gold bonds. So-called baby bondsthat is, small denomination bondswere being sold to small investors. Previously, bonds had been offered in $500 and $1,000 increments, which was out of the reach of most small investors. The Pearsons-Taft Land Credit Co. was advising small investors to begin with

THE TWENTIETH CENTURY BEGINS

11

$10 and through such small savings become a bond holder.12 Inscribed securities were being sold in England at the turn of the century. These securities were simply book entries. No certificates were issued as evidence of ownership. This would presage the use of book entry securities by the United States government in future years. Government finance in America depended largely on tax revenues and long-term borrowings that included $2.5 million in 4 percent bonds for Philippine public works and improvements in 1905. Another $400 million was spent on the Panama Canal between 1904 and 1916. About a third of that amount was borrowed. Despite these offerings, only a few firms specialized in United States government secuJames R. Keene. Keene was a turn-of-therities at the beginning of the century. century speculator who was in the midst of In 1901, the National City Bank ar- many market battles. (Courtesy of Archive ranged for a customer to buy Photos.) $10,000 in federal bonds. This was considered radical.13 Even by the outbreak of World War I, there would still be only two government securities dealers in the United States. Foreign countries were increasingly seeking to raise capital in the United States after the turn of the century. Germany placed 80 million marks in Treasury bonds in Washington in 1900. The National Railroad Company of Mexico engaged in underwritings in 1903 and 1905. The Nicaraguan, Guatemalan, and Costa Rican governments sought funds in America during that period. A Manila syndicate was formed in 1903 to raise funds for public works in the Philippines. Kuhn, Loeb arranged some $200 million in financing for Japan to finance its war with Russia in 1904 and 1905. Japanese 6 percent bonds were sold in the United States by Sig. H. Rosenblatt & Co. John D. Rockefeller bought big chunks of those loans, and he purchased participations in Chinese loans in 1911. J.P. Morgan & Co. and others floated a $1 billion loan in 1903 for the Russian government in the United States. The czar presented the NYSE with a Faberg urn as an expression of his gratitude. Unfortunately for investors, the bond issue was repudiated after the communist revolution of 1917. Trading in these bonds on the NYSE was not suspended until 1921. Abuses in the securities markets included the sale of worthless securities

12

A NEW CENTURY

conducted through alluring circulars and advertisements in the newspapers and by vicious tipsters cards.14 Directors and officers of corporations used their positions to manipulate stock prices. They could increase prices by declaring larger-than-expected dividends or decrease prices by reducing dividends. Stock was watered and other actions were taken to affect stock prices. Investors were deceived by schemes in which prominent individuals were elected as directors of companies in order to lend their name and prestige to the sale of the companys securities. Investors depended upon the good name of those individuals, but the directors often did not have full knowledge of the operations of the companies they were supposed to be directing. The Industrial Commission rendered a report in 1901 that supported the use of futures trading, but speculation and manipulation continued to disrupt the commodity markets. In one assault on the wheat market in 1902, James A. Patten made some $2 million in profits. Patten drove wheat prices up some thirty-four cents a bushel. Harpers Weekly claimed that Patten was the Man Who Raised the Price of Bread.15 An oat corner in 1902 led to numerous lawsuits.16 The New York Cotton Exchange saw extensive speculative activity. In 1904, a bull clique of New Orleans traders drove cotton to 17.5 cents a pound, its highest price in a decade and four times the price of just six years earlier.17 John Gates led an operation that cornered the wheat market in 1905. This corner was conducted by Wall Streeters in New York, rather than Chicago. Mergers In 1904, a third of the manufacturing in America was being conducted by 318 firms. A tidal wave of mergers occurred around the turn of the century. Some 2,600 firms merged between 1898 and 1902. Those mergers were valued at over $6 billion. One large combination involved the McCormick Reaper Company, which accounted for 35 percent of the market share in farm machinery in 1902. Cyrus McCormick Jr. met with J.P. Morgan & Co. in order to develop a trust that would reduce competition even further. This meeting resulted in the formation of the International Harvester Company, which was a combination of McCormick Reaper and three other farm implement companies. The new combination had an 85 percent market share in farm machinery. The largest of the combinations at the turn of the century resulted in the creation of the United States Steel Co. That entity was capitalized at $1.4 billion, which was almost three times the annual revenues of the national government. The merger was the culmination of an attack by Andrew Carnegie on the Rockefeller and Morgan interests, which were competing with Carnegie in the steel industry. Carnegie wanted to retire, and he pushed Morgan into buying him out by threatening ruinous competition. Charles M. Schwab helped Carnegie in this effort. To avoid the battle, Morgan agreed to pay more than $450 million for Carnegies steel operations in the greatest sale in the history of the world.18

THE TWENTIETH CENTURY BEGINS

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Following the purchase from Carnegie, Morgan began an effort to consolidate the other steel groups in the country. His efforts were successful, and he formed United States Steel from over 200 smaller companies. Upon its creation, United States Steel controlled some 70 percent of the American iron and steel industries. It was the first billion-dollar company in America and the greatest amalgamation of capital up to that time in any industry. J.P. Morgan used a syndicate of 300 underwriters to float a sale of an issue of United States Steel stock to the public. The underwriting syndicate was paid 1.3 million shares of that stock, as well as commissions that totaled over $60 million, of which J.P. Morgan and Co. received over $12 million. James R. Keene, the market manipulator, was employed by Morgan to make sure that the underwriting received a warm reception by pushing up its price. After the underwriting, that support was dropped. Charles Schwab became the president of United States Steel with a rumored salary of $1 million, but this did not make him subservient. Schwab resigned from United States Steel after a squabble with the board. He then took over the Bethlehem Steel Company and made it into one of the nations largest steel producers. Although John D. Rockefeller claimed that he did not need a J.P. Morgan to build his empire, Rockefeller made $200 million on the United States Steel consolidation. In 1902, John D. Rockefellers income was $58 million. One newspaper claimed that Rockefeller was making $1.90 each second. Morgan formed other large combinations, including the International Mercantile Marine Company, which controlled a large portion of the shipping business, but was not profitable until after World War I. Among those losing from Morgans difficulties with International Mercantile Marine was John D. Rockefeller, an investor in that enterprise. J.P. Morgan & Co. was heavily involved in the financing of the General Electric Company, but the prime securities continued to be railroad bonds. Railroad and public utility financing was handled by a small number of firms. The railroad financing was done to a considerable extent by Kuhn, Loeb & Co., J.P. Morgan & Co., Vermilye & Co., and August Belmont.19 In 1902, J.P. Morgan announced in the New York Times that the holders of Southern Railway Company trust certificates had agreed to the extension of their voting trust agreement. An incentive had been provided to induce holders to agree to that extension. Stock trust certificates that agreed to the extension were to be listed on the New York Stock Exchange. This provided liquidity for their investment. The Great Northern Battle Kuhn, Loeb placed $50 million of Pennsylvania Railroad bonds in France. The bonds were repurchased after the outbreak of World War I. Jacob Schiff of Kuhn, Loeb reorganized the Union Pacific Railroad for Edward H. Harriman. This operation commenced in 1897 and took some fifteen years to complete. From 1898 to 1909, E.H. Harriman controlled the Union Pacific, the South-

14

A NEW CENTURY

ern Pacific, and the Chicago & Alton railroads. Harriman had other interests. He was a principal in the Illinois Central Railroad, and he kept the Erie Railroad out of receivership in 1908. A great railroad battle fought in the markets early in 1901 pitted Harriman against two titans of financeJames J. Hill and J.P. Morgan. Hill had acquired a large interest in the Chase National Bank, and he controlled the Great Northern Railroad. Its competitor was the Northern Pacific Railroad, which Hill obtained control over with the help of J.P. Morgan. The Great Northern and the Northern Pacific then became commonly known as the Hill Lines. The Hill Lines competed with Harrimans Union Pacific Railroad, and war broke out between the two in 1901. Hill sought to expand his railroads by acquiring the Chicago, Burlington & Quincy Railroad, which Harriman was also seeking. Hill, with the assistance of J.P. Morgan & Co., sought to frustrate Harriman by having the Great Northern Railroad and the Northern Pacific Railroad each purchase a half interest in the Burlington & Quincy. Harriman then enlisted Jacob Schiff at Kuhn, Loeb to conduct an early version of aggressive gambits that would be employed in later takeover battles. Although Hill and Morgan had operating control over the Northern Pacific, they did not own a majority of its stock. Harriman perceived this as a weakness and began secretly purchasing Northern Pacific securities in 1901 in order to obtain majority control that could be used to block Morgan and Hills control over the Burlington. This attack caught Hill and Morgan unprepared, but Hill learned of the plan just before Harriman acquired majority control. Harriman had given an order to Schiff to purchase the 40,000 additional shares needed by Harriman for majority control. Schiff thought the purchase was unnecessary, and he failed to execute the order before the Morgan firm ordered the purchase of 150,000 shares. Hill and Morgan used James R. Keene to carry out that purchase. Battle was joined, and both sides claimed control of the Northern Pacific, but they were actually in a standoff. A corner in the stock had occurred because more shares had been sold than were in existence. On one day, in one hour, the stock price jumped from $350 to $1,000 a share. The price of the stock had begun at $114. The New York Times, reporting on the event, stated that a corner more complete and more disastrous in its result than any Wall Street has ever before known came to its culmination yesterday. The Times noted that this corner was one radically different from any of the others that Wall Street had experienced: it was neither planned or desired.20 Northern Pacific stock was being brought to New York by speculators using every available means, including mail ships from England. When the Northern Pacific stock price reached $500 per share, Samuel Hessberg, a resident partner of J.S. Bache & Co. in Albany, New York, sold his customers stock and chartered a special train to take their shares to New York. The train was met by a charter motor vehicle. The corner touched off a wave of speculation in Northern Pacific stock. A police raid on a bucket shop in New York found 500 people gambling on stock prices. A panic occurred as the Northern Pacific corner reached its

THE TWENTIETH CENTURY BEGINS

15

culmination. The tape quote fell some ten minutes behind. Call money rose to 60 percent, causing prices of other securities to drop sharply. The value of United States Steel common stock fell by $100 million, and its preferred stock dropped by another $133 million. Nothing like it had ever before been seen in Wall Street.21 One victim, Samuel Bolton Jr. of Troy, New York, was found drowned in a vat of hot beer at his brewery. He had lost heavily in the market, and his death was an apparent suicide. Bernard Baruch made substantial profits by buying securities at low prices as short sellers in the market sold stocks in order to cover their losses when the market collapsed. To relieve the corner, J.P. Morgan & Co. and Kuhn, Loeb & Co. advised their brokers that they would not demand the delivery of the stock they had bought. After a court order, the parties met and agreed upon a price of a mere $150 per share for the shorts to settle their obligations. Thereafter, a compromise was reached between the Harriman and Morgan and Hill interests that involved the formation of a holding company for the securities of the Great Northern, Northern Pacific, and Burlington Railroads. This new entity, the Northern Securities Company, had a capitalization of $400 million. Harriman was given representation on the Northern Pacific board of directors, as well as a substantial ownership position in the company. The dmarche between Hill and Harriman was short-lived. The Supreme Court required the Northern Securities Company to be broken up in 1904 because its operations were deemed anticompetitive and in violation of the Sherman Act. Thereafter, war broke out once again between Harriman and Hill over railroad right-of-ways in Oregon. Although the Northern Pacific corner has been described as the last railroad war, still another bruising fight occurred not long afterward over the Louisville and Nashville Railroad. J.P. Morgan was pitted against Bernard Baruch, John Gates, and Edwin Hawley in that battle. Baruch made over $1 million in this operation after Morgan bought the Louisville and Nashville railroad from the speculators. The Northern Pacific corner was not the only event that caused the stock market to fall. Prices plunged in September of 1901 after the assassination of President William McKinley. Another sharp drop occurred in December of 1902. During both of those events, the Treasury Department purchased bonds in order to provide liquidity by injecting funds into the market. Between 1900 and 1907, as a result of dangerous perturbations in the money market, the Secretary of the Treasury was called upon to adopt the very questionable policy of making large deposits of public money in banks to relieve threatening situations.22 This signaled a further effort by the Treasury to use its resources to control the money market and to assume some central bank functions. Transportation stocks fell from an average of $250 in 1902 to just over $200 in 1903. This caused great financial stress in the country. The Secretary of the Treasury allowed bonds to be deposited as reserves in the national banks as a means to provide liquidity. Insurance companies then loaned their bonds to the banks for use as reserves. This event was followed by the Rich

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A NEW CENTURY

Mans Panic in 1903, which was caused by the distress sales of securities by underwriters and syndicates after the banks began calling in loans. The syndicates had been experiencing difficulty in selling securities because of an oversupply of offerings. There were simply too few buyers and too many corporations issuing new stocks. Speculation in watered stock further drove prices up to levels that could not be supported. The Rich Mans Panic caused J.P. Morgan considerable concern, and he stepped in to stop the slide in securities prices. Morgan put together a reserve of $50 million for the banks during this panic. Morgan had other problems. The United Steel Corporation failed to pay dividends in 1903, and its stock price dropped sharply. The stock recovered, however, when the companys fortunes improved. The stock market also recovered. The Dow Jones index doubled between 1904 and 1906. One speculator, Harry Content, who was nearly destroyed in the Northern Pacific corner, regained his feet and obtained control of the National Lead Company in a single trading session on the New York Stock Exchange in 1905. In that year, New York adopted a tax of two cents on each $100 of par value of shares transferred. This would prove a boon to state revenues as trading volumes increased.

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2 Insurance, Banking, and Underwriting

Insurance The amount of per capita life insurance more than quadrupled between 1885 and 1910. The three big insurance companies at the turn of the century were called the Racers. They were the Equitable, Mutual Life, and the New York Life Insurance Company. The fourth largest insurance company, the Prudential, had decided to abandon sickness insurance. Its growth was due largely to industrial policy sales. The North Carolina Mutual Life Insurance Company was founded in Durham, North Carolina, in 1898 by John Merrick, an ex-slave. It would become the largest black-owned and -operated business in the United States. Floridas first insurance company was the Afro-American Life Insurance Company, founded in 1901. Woodrow Wilson paid $290 for his life insurance policy premium in March of 1902 to the Mutual Life Insurance Company of New York (MLIC). More complicated policies were being developed to meet the rising demand for savings programs to build up individual estates. MLIC offered a twenty-year gold bond policy in 1896 that paid benefits in coupon bonds of the company. The bonds were redeemable in gold coin at the end of twenty years and paid 5 percent interest in gold. Another policy provided for benefits to be paid in the form of guaranteed, compound interest, gold bonds. The company annually credited to the policy 3 percent of all premiums previously paid. Those credits could be used to pay future premiums and were payable in gold coin. One insurance contract offered after the turn of the century was the yearly bond contract that paid a face amount of $20,000 and had a term of twenty years. The insured could elect benefits to be paid in the form of a $1,000 bond annually. The growing reserves of the insurance companies provided them with a great deal of economic power that was engendering criticism. Louis D. Brandeis, a future Supreme Court justice, stated in 1905 that the insurance companies were the greatest economic menace of today and that as creditors of great industries they were using their power selfishly, dishonestly
17

18

A NEW CENTURY

and inefficiently.23 Brandeiss concern would be given credence by events that were unfolding at the Equitable Life Insurance Company. The founder of that company, Henry B. Hyde, had died in 1891. He left the majority of the stock to his son James Hyde, who was then twenty-three. James was given to ostentatious displays of his wealth that marked him as a less than serious businessman. A debutante party given by Hyde for his niece at Sherrys, a New York restaurant, was claimed to have cost $100,000. The extravagance of that affair engendered so much criticism that it encouraged a group of directors within the Equitable Life Insurance Company to seek Hydes removal from control of the Equitable. That group was led by James W. Alexander, the Equitables president. Alexander wanted to have the company mutualized, which would allow the policyholders to elect directors. Although the Equitable was not converted to a mutual company for some time, Hyde was forced to sell his stock for $2.5 million to Thomas Ryan, who controlled much of New Yorks public transportation system, including the subway. Control of the stock was then given to three trustees, among them ex-President Grover Cleveland. The Armstrong Investigation An investigation was initiated by the New York Superintendent of Insurance as a result of Hydes excesses, and after questions were raised as to how Hyde could sell his stock for $2.5 million when it was yielding only $3,514 in dividends annually. Critics were concerned that the purchase price reflected a control premium that would allow the holder of Hydes stock to loot the insurance company. Claims were made that corporate assets were being wasted, and it was charged that the management of the Equitable Insurance Company was using improper accounting procedures. Some of those allegations were made by Henry Frick, the erstwhile partner of Andrew Carnegie. The charges led to scandal and eventually to the appointment by the New York legislature of its own investigating committee headed by Senator William W. Armstrong. The Armstrong Committee decided to conduct a broad review of the activities of all New York insurance companies, not just the Equitable. President Theodore Roosevelt also urged Congress in 1904 to consider whether the Bureau of Corporations should have jurisdiction over insurance. That effort was unsuccessful, but the Armstrong Committees investigation in New York would have long-lasting effects. Charles Evans Hughes acted as the Armstrong Committees counsel, a role that would place him in the spotlight and help make him governor of New York. From there, Hughes would launch an investigation of the securities industry in 1909. He would later serve as the chief justice of the Supreme Court. The Armstrong Committee rendered a ten-volume report on the insurance industry that, among other things, reviewed the organization of life insurance companies, their investments, political contributions, lobbying, and use of rebates. The Armstrong Committees investi-

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19

gation revealed a number of abuses by members of the insurance industry, including parking transactions that were designed to conceal losses on securities investments. In one such scheme, the New York Life Insurance Company sold bonds to J.P. Morgan & Co. at par on December 31, 1903, with an agreement to repurchase them immediately after the first of the year at the same price ($800,000). This arrangement allowed New York Life to keep the diminished value of these bonds off its records for reporting purposes at yearend. George W. Perkins, a senior official at the New York Life Insurance Company and a partner in J.P. Morgan & Co., was indicted after the Armstrong investigation for forgery in connection with another parking scheme. The indictment involved an effort by Perkins to disguise a transaction for the fictitious sale of some railroad securities. Ostensibly, Perkins had sold the railroad securities to the New York Security and Trust Company. In fact, the trust company carried the transaction as a loan on its own books and had accepted the stock only as collateral for the loan. The indictment against Perkins was dismissed in 1907. The Armstrong Committee concluded that the insurance companies were part of the trend toward the accumulation of great capital by a few individuals and enterprises. Echoing the concerns raised by Louis Brandeis, the committee stated that [n]o tendency in modern financial conditions has created more widespread apprehension than the tendency to vast combinations of capital and assets.24 The committee was also troubled by the fact that the large reserves held by the insurance companies were increasingly being invested in the stock market. The insurance companies were particularly fond of railroad, public utility, and bank securities. The Armstrong Committee recommended that investments in stocks by insurance companies should be prohibited because the insurance companies could incur liabilities as shareholders. In such event, an insurance company would assume the responsibilities of proprietorship and must contribute from the accumulations provided by the policyholders in order to sustain the enterprise.25 This would endanger the reserves held by the insurance companies to cover policyholder claims. The Armstrong Committee sought to prohibit insurance companies from underwriting securities. The Armstrong Committee also sought standardized insurance forms that would clarify the obligations of insurance companies and the rights of policyholders in the event of a claim. The committee further recommended that restrictions be placed on agents, particularly on their sales incentives, in order to stop abuses in the sale of insurance to unsophisticated customers. New York enacted legislation that adopted several of the Armstrong Committees recommendations. Tontine schemes were prohibited, and cash reserve requirements were adopted. In order to limit the economic power of insurance companies, the legislature prohibited any one company from writing more than $150 million in new insurance if it had $1 billion of insurance in force. That limitation on size was later eased, but the legislature restricted

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A NEW CENTURY

the ability of insurance companies to invest in real estate and common stock. Another provision required insurance companies to divest themselves of bank stocks. Insurance companies were prohibited from acting as underwriters for securities or engaging in securities syndications. This legislation forced Equitable Life Assurance Company to sell off its subsidiary, the Equitable Trust Company, which was purchased by John D. Rockefeller, George Gould, and Kuhn, Loeb. It would merge with the Chase National Bank after the stock market crash of 1929. The restrictions imposed by New York and other states on insurance company investments shut off a large source of funds for Wall Street. In 1906, insurance companies held over 6 percent of their assets in stocks. That percentage dropped to 1 percent by 1922. The effects from those sales were not all bad for the financiers. The insurance companies sold their trust company stocks to the investment bankers that controlled many of the insurance companies. It was charged that this was simply moving the securities from one pocket to another and that those pockets belonged to the same small group of investment bankers. New Directions Louis Brandeis was the advocate of a proposal to sell life insurance through mutual savings banks in Massachusetts. That proposal followed revelations of the Armstrong investigation that insurance companies were maintaining scandalously high premiums and commissions and low policy values and retention rates.26 Massachusetts enacted legislation in 1907 that allowed mutual savings banks to provide life insurance and annuity policies. New York and Connecticut adopted similar legislation in later years. Those laws limited the amount of insurance that the savings banks could write. Even so, by 1998, insurance policies written under those laws covered some one million people and the insurance was valued at $50 billion. The insurance companies initially engaged in some agitation for federal regulation in order to avoid multiple state regulation. The industry soon took the view, however, that state regulation was preferable to federal regulation. The industry then contended that its business was not a part of interstate commerce that could be regulated by Congress and was not subject to the antitrust laws. The result was that federal legislation was avoided, and the industry resumed its growth. In particular, the carnage that would be wreaked by the automobile would spur the growth of casualty insurance in the twentieth century. The Travelers Insurance Company issued the first automobile policy in 1897 to Gilbert Loomis in Westfield, Massachusetts. The company paid its first such claim in 1900. That claim involved the death of Hieronymous Mueller in Decatur, Illinois, who was killed in the act of filling up his gas tank while smoking a cigar. Travelers was the strongest casualty insurance company at the turn of the century but was dependent on life insurance for most of its revenues. The earthquake that occurred in San Francisco in 1906 was a disas-

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21

ter for the fire and casualty business, an event that saw fourteen looters killed while attacking the United States Mint. On another front, Theodore Roosevelt had promoted workmens compensation programs as a form of industrial insurance for workers injuries. It established the no-fault concept for casualty insurance. The trade-off was that compensation was capped and often meager. By 1919, thirty-seven states had adopted such programs. New Entrants Into the Banking Business The banking sector continued to expand in the early years of the twentieth century. Between 1896 and 1907, the number of state banks increased by almost 6,000. The Chicago Clearinghouse Association required periodic examinations of its member banks. New York adopted similar procedures. Many of the state banks were still operating without adequate reserves and posed a danger to the banking system. Other banking institutions were growing. Between 1896 and 1907, the number of trust companies increased from about 250 to almost 1,500. By the turn of the century there were also over 5,300 thrift institutions in the United States with assets of some $570 million. Credit unions were appearing, but they had been slow to reach America. These institutions trace their origins back to the Rochdale Cooperative Store created in 1844 in England. A Peoples Bank, established in France in 1848, was a precursor of the modern credit union. A credit union was founded in Belgium in 1848, and Raiffeisen societies, founded by Friedrich Wilhelm Raiffeisen, the former mayor of Heddesdorf, were operating in Germany in 1849 and were a form of an agricultural credit union. Credit unions are cooperative institutions owned by their member-customers, both borrowers and savers. They differ from the commercial banks, which are owned by the stockholders and from the mutual thrift intermediaries, which are owned by the savers alone.27 Credit unions accepted passbook savings and made consumer loans. The first credit union in the United States was created by St. Maries Parish in New Hampshire in 1909. Its foundation followed a letter-writing campaign in 1908 by President William Howard Taft, who had sent letters to the governors of all the states urging them to adopt laws that would allow the creation of credit unions. But only four states adopted such legislation by 1921. The Massachusetts Credit Union Law was adopted in 1909. It was designed to provide factory workers with an alternative to the usurious moneylenders. Money Markets Secretary of the Treasury Leslie M. Shaw believed in active intervention in the money markets. He was injecting money into the financial system in 1906 in order to assure the continuance of prosperity. Shaw stated that the Treasury Department had $100 million available for use in stabilizing the markets through deposits and withdrawals from the national banks. Shaw believed

22

A NEW CENTURY

that such techniques would assure that no panic could threaten the United States. He announced that it was the duty of the government to protect the people against financial panics, which, in this country, have caused more mental and more physical suffering than all the plagues known to man.28 The Treasury had some selfish motives in its money market operations. The secretary began reducing deposits of government funds with the banks unless they were secured by United States bonds. At the same time, deposits were increased at banks that secured those funds with government bonds. The secretarys plan was to make government bonds scarce and increase the price of a planned sale of Panama bonds being issued by the government. It was virtually an attempt to corner the market for existing United States bonds in order to get a higher price for the new debt.29 The Secretary of the Treasury was criticized for other monetary arrangements. He showed favoritism when he agreed to deposit government funds in banks against pledges of gold imports. The deposits were to be returned when the gold arrived in the United States. The National City Bank in New York was allowed to receive such deposits two weeks before the Treasurys action was publicly announced. There was much criticism of the advantage that this gave the National City Bank over other banks. One critic charged that the manipulation of the money market by the Treasury has gone so far that the Secretary seems in large amounts to exercise guardianship over the money market, not only in times of crises, but other times. He feels that he must relieve the money market by depositing the publics money in the banks in the fall to meet the Autumnal grain from the interior, and taking it out after that grain has passed. The Treasury was responding to the fact that the New York banks continued to hold large amounts of deposits from interior or country banks.30 Those deposits were loaned into the call market, but there were seasonal variations in money supplies when the country banks needed funds to meet the demands of the farming cycle. At times, those fluctuations resulted in excess funds in New York City. Such excesses resulted in low interest rates for call loans, and this induced speculation. Then a step-up in business activity would occur and cash demands would further increase when crops were being harvested, causing money to be tight in New York. This would result in margin loans being called, and the market would then be driven downward, sometimes violently, as sale orders were entered in order to raise the necessary funds. Consumer Credit Numerous small loan companies were operating at the turn of the century. D.H. Tolman had loan offices in sixty-three cities. Tolman used wage assignments as security for his loans. He claimed that his offices were salary buyers. Women employed by these small loan offices were charged with the responsibility of acting as a bawler outthat is, they located delinquent borrowers and berated them in front of their families and coworkers in order

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23

to embarrass them into paying.31 Consumer installment credit, long a staple of Yankee peddlers, was growing. The New York State usury law exempted loans of more than $5,000 that were payable on demand and secured by collateral such as stock. This permitted the call market to operate with a flexibility denied to other credit operations. A practice known as pyramiding involved the obtaining of increased amounts of credit on stock as it appreciated in value. The additional credit was then used to buy more stock on margin. This leveraged the investors profits as the market was going up, but it compounded losses when the market declined. Branch banking was still limited after the turn of the century. In 1901, there were forty-seven banks with a total of eighty-five branches in the United States. Thirteen of those banks were in New York. Because national banks were not allowed to open branch offices, the number of banks in the United States expanded into the thousands. Most of those banks were small in size, but the failure of even small banks could have serious effects, particularly in a money center such as New York. Chain banks were being established in states where branch banking was prohibited. These banks had their own charters but were all owned by one central group or company. Some of these chains would eventually control over 100 banks. Peter Giannini, a California businessman, expanded his operations in California after branch banking restrictions were eased by the legislature in that state. Giannini had started the Bank of Italy in a converted saloon in 1904. It later evolved into the Bank of America. Giannini went door-to-door soliciting customers for his bank. He often made small loans, as little as $25, and he advertised for clients in the newspapers. Giannini kept his bank operating right through the San Francisco earthquake. Giannini opened his first branch office in 1907 in San Francisco. The California legislature allowed statewide branch banking two years later. Giannini then opened a branch in San Jose by buying a bank and making it a branch of his Bank of Italy. He later made several such acquisitions. Wells Fargo separated its banking and express business in 1905. At that point, Wells Fargo was under the control of Edward H. Harriman. The Big Banks The largest national bank after the turn of the century was the National City Bank, which was controlled by the Rockefellers, J.P. Morgan, and Jacob Schiff of Kuhn, Loeb. The National City Bank had expanded considerably after its merger with the Third National Bank in 1897. In 1902, the Comptroller of the Currency ordered the national banks to restrict their underwriting activities or to leave the investment banking business entirely. In order to avoid that ruling, the First Trust and Savings Bank of Chicago was formed in 1903 as an affiliate of the First National Bank. The First Trust was to conduct securities activities for the banks customers. The United States Bankers Corporation was formed in 1902 for the purpose of establishing trust companies in forty or

24

A NEW CENTURY

more cities in the United States. The company stated that thoughtful students of finance predict that trust companies will have ultimate supremacy over all other banking institutions.32 National banks were still not allowed to act under trust powers. James B. Forgan at the First National Bank created the Chicago Plan in 1903, in which national banks acquired trust companies so that they could indirectly provide fiduciary services, which was then prohibited by the national banking law. Under this plan, the shareholders of both the bank and the trust company were the same. The Bankers Trust Company was organized by Henry Davison to handle the trust business for commercial banks, who were prohibited from engaging in such activity. The Bankers Trust proclaimed that, unlike other trust companies, it would not compete with the banks for their deposit business. At the time he founded the Bankers Trust Company, Henry Davison was a vice president of the First National Bank. Bankers Trust was managed by three trustees, all of whom were allied with J.P. Morgan & Co. These and other relationships led most people to view this trust company as a Morgan entity, but the initial board of directors of the Bankers Trust Company represented several large commercial banks in New York, Chicago, and other cities, as well as Blair & Co. and Kidder, Peabody & Co. Another financial giant, the Manufacturers Trust Company, was created in 1905. It was one of over 1,000 trust companies that were in existence by 1910. Trust companies were publishing statements of their condition in the papers. The North American Trust Company claimed assets of over $19 million at the turn of the century. The Trust Company of America, which acted as a trustee, receiver, committee, executor, guardian, administrator, assignee, registrar, transfer, and fiscal agent, had some $22 million in assets in 1901. It allowed interest on deposits and acted as a depository for the cotton, coffee, and produce exchanges in New York on contract. Its directors included Frank Jay Gould, son of the infamous speculator Jay Gould. President Theodore Roosevelt was writing checks on the Astor Trust Company, including one to the American Express Company for $31. First Chicago National Bank, which had begun business on July 1, 1863, merged with the Union National Bank in 1900 and with the Metropolitan National Bank in 1902. It opened the First Trust and Savings Bank to serve retail customers in 1904. The Royal Trust Company in Chicago told subscribers to the Chicago Tribune that they should not be ashamed to open a savings account with a dollar. Three percent interest was paid on such small accounts. The Commercial Trust Company of New Jersey provided [a]ll the facilities of a New York City Bank, including interest on deposits and [s]pecial terms for collecting out-of-town checks.33 Although most bank clearinghouses did not provide for collection of out-of-town checks, they required their members to charge set fees for the collection of those items. The New York Clearing House required all trust companies that cleared through its members to be subject to reserve requirements. Some of the trust companies then gave up

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their clearinghouse privileges. This avoided the problem for a while, but the State of New York imposed reserve requirements on trust companies in 1906, and it raised those requirements in 1907. They would prove to be inadequate. Investment Banking Before the turn of the century, corporations generally bore the risks of the success of their securities issues. Investment bankers were often asked to serve on the issuers boards of directors in order to interest them in the securities of the company. Investment bankers in turn approached their wealthy friends and other moneyed individuals, who were willing to take the risks involved, and ask them to participate in offerings. Commercial banks took participations in substantial amounts.34 This haphazard financing was gradually replaced by the firm commitment underwriting method. Goldman Sachs & Co. had become a joint-stock association under New York law, but then reverted to a partnership. It was still a commercial paper firm, but had expanded its business to include high-grade bonds. The firm became involved in the underwriting business in 1906. Its first underwriting was for the United Cigar Manufacturers, which later became the General Cigar Company. Goldman did not have the resources to conduct the United Cigar underwriting on its own, so Henry Goldman asked Philip Lehman at Lehman Brothers to assist. Lehman Brothers was then dealing in investment securities, as well as commodity transactions on the cotton, coffee, and produce exchanges in New York. In 1906, Goldman Sachs & Co. had another opportunity for underwriting for Sears, Roebuck & Co. and again joined with Lehman Brothers. This was a $10 million offering of preferred and common stock. The preferred stock was sold to the public and the underwriters retained the common stock shares. Goldman Sachs and Lehman Brothers continued to work closely together as underwriters until the 1930s, managing over 100 offerings, including underwritings for B.F. Goodrich, May Department Stores Company, and F.W. Woolworth Co. Goldman Sachs also participated in underwritings with Kleinwort, Sons & Co., investment bankers in London. Goldman Sachs employed firm commitments for the purchase price from the issuer in these underwritings. Under this approach, an investment banking firm agrees to purchase an issue of securities from the issuer at a specified price. The investment banking firm that purchased the entire issue was known as the originating banker or house of issue. The originating banker formed a purchase syndicate and divided up the securities among the investment bankers in the purchase syndicate at an increased price. The originating banker would manage the purchase syndicate, which would sell the securities. Sometimes an even larger syndicate (a banking syndicate) would be formed. The purchasing syndicate would sell its securities to the banking syndicate at an increased price over that paid to the originating banker. The syndicates sought to main-

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tain a fixed price, which was called the public offering price, for the security during the offering. The syndicate members engaged in market transactions to maintain that price, and they coordinated their sales operations. Corporations were borrowing large amounts. Among the new bond issues in 1906 was an underwriting conducted by Harvey Fisk & Sons for $12 million of Bethlehem Steel Company first extension mortgage, 5 percent gold bonds, due in January of 1926. Commercial credit bills were in use. These were two- or three-month bills that were drawn on a bank as a commercial credit to the customer. The bank did not actually have to advance any cash because the customer would pay for the bills before they were presented for payment. The banks guarantee or acceptance allowed the customer to sell the bill at a discount and obtain cash for use in business. These commercial bills circulated among banks and commercial firms. A new form of instrument called the finance bill was in use by 1906. These bills were issued in anticipation of shipments and not against an actual lot of merchandise. Many of these finance bills were drawn from the United States on London, draining gold from London. These finance bills, which were simply a form of commercial paper or bankers acceptance, outstripped the commercial bills by 1913. Economic Consolidation The British investment trusts made large investments in American securities at the turn of the century. Two trusts organized in 1906 and 1907 by the directors of a large bank in Bern, Switzerland, presaged some future abuses. They were used as a dumping ground for undesirable investments. The Alexander Fund was a Philadelphia company formed in 1907 to take public subscriptions for funds that would be invested through a common pool. It would be followed by other investment companies, but the growth of this investment device would not skyrocket until the 1920s. Great wealth was still accumulating, inventions were appearing, and the world was changing. One million miles of telephone wire had been strung by 1900. The turn of the century saw the introduction of the radio. The motion picture business was another growth industry. By 1910, some 10,000 movie theaters were in operation in the United States. Other empires were growing. The Weyerhauser family owned some 60,000 square miles of timber at the turn of the century. Marshall Field & Co., the Chicago department store, conducted $50 million in business in 1906. Marshall Field sold goods on credit but required cash at thirty and sixty days. Payments were required to be prompt. The oil industry continued its growth as new discoveries flowed. Oil would create a slew of millionaires who would vie for the title of being the richest man in the world. The gasoline-powered automobile that was receiving acceptance in America shortly after the turn of the century was another source of wealth. The number of automobiles in the United States increased from 800 in 1898 to 8,000 in 1900. The automobile would soon replace the railroad as the center of transportation and finance, forming the basis for a massive

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industrial expansion in the United States. That product would demand great sums of capital over the next century and broaden the foundation of consumer credit in the United States. Despite the Sherman Antitrust Act, over 300 trusts were created in the United States after the turn of the century. However, a new force was entering the scene. Theodore Roosevelt was an enemy of big business. An Antitrust Division was created in the Department of Justice in 1903. Its budget was only $100,000 per year and the average number of attorneys used by the government to bring antitrust cases was only five during Roosevelts administration. Nevertheless, the Northern Securities case, which made Roosevelts reputation as a trustbuster, signaled a more aggressive posture on the part of the federal government against large business combinations. Before that action was brought, J.P. Morgan visited Theodore Roosevelt at the presidents office to seek to convince him not to file suit. Morgan told the president that if we have done anything wrong, send your man to my man and they can fix it up. Roosevelt declined that offer. One large industry consolidation involved the American Tobacco Company, which was formed in 1904. It controlled most of the tobacco industry. Bernard Baruch had made large profits from his trading during these tobacco mergers. Antitrust suits were brought against the tobacco companies, as well as the steel trusts, the harvester trust, and others. In 1906, Standard Oil of New Jersey was indicted on over 500 counts of illegal rebates and fined $29 million. Another victory for the trustbusters was a Supreme Court decision35 that required the meat packers to stop their illegal rebating practices under the Hepburn Act of 1906, which authorized the Interstate Commerce Commission to set maximum freight rates. Other lawsuits were brought to break up interlocking directorates among the railroads. A Bureau of Corporations was created within the Department of Commerce and Labor. This was an effort by Theodore Roosevelt to supplement the governments antitrust efforts by collecting information and imposing controls on large corporations. The bureau was headed by James R. Garfield, the son of the former president. The bureau concluded, however, that it did not have jurisdiction over businesses that were not operating in interstate commerce. This sharply circumscribed its role. Among the businesses that the bureau did investigate was Standard Oil. Although the bureau asserted that the face value of the securities (over $1 billion) issued to create the United States Steel Corporation was about half water, it had no power to do anything about such abuses. The bureau sought to adopt a federal charter requirement for corporations, but that effort was not successful. The bureau was merged with the Federal Trade Commission in 1914. Securities Disclosures Little information was available concerning the securities that were sold to the public at the turn of the century. Prospectuses were little more than no-

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tices.36 The Industrial Commission recommended in 1902 that corporations be required to publish reports of their activities and to provide annual financial reports to shareholders. That commission had been created in 1898 by Congress to consider the need for regulation of industries. The commission, which consisted of nine industry representatives and ten members of Congress, recommended that misleading prospectuses be subject to legal liability. Those recommendations fell on deaf ears. The NYSE gradually began to require more disclosures from listed companies. For example, the NYSE required Sears, Roebuck & Co. in 1906 to publish its financial results annually, and the company had to agree not to speculate in its own stock. Information on individual companies was gathered by other sources. In 1900, John Moody began operating a bureau of statistics that collected and published information on securities. Moodys Manuals were an effort to provide information on companies that could be used for some credit and investment decisions.37 Moodys would later be acquired by Dunn & Bradstreet.

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3 The Panic of 1907

The Dow Jones Industrial Average doubled between 1904 and 1906. Speculation mounted on Wall Street as stock prices soared. Jacob H. Schiff of Kuhn, Loeb & Co. advocated changes in the American monetary system. He warned that, without reform, another panic would result compared with which the three that have preceded would be only childs play. There were reasons for his concern as violent speculation began driving up prices. A mining stock craze arose, and it seemed as if the whole country was buying worthless gold and silver mining shares.38 At the end of 1905, call money rates were 25 percent and higher, rising to 60 percent in the following year. The Dow Jones Industrial Average reached 100 for the first time on January 12, 1906. Securities prices then started dropping. A March Panic in 1907 knocked $2 billion off stock market values. Union Pacific stock dropped $25 in a single day. That panic was curbed by the intervention of the Secretary of the Treasury, but problems continued. New York City tried to float a 4 percent bond issue in June of 1907 for $29 million. Only $2 million of that offering was subscribed for by potential purchasers. It failed because the 4 percent rate was too low. The market rallied when United States Steel Corporation announced the resumption of dividends in July of 1906. In the following month, the Union Pacific dividend was increased from 6 to 10 percent. This added fuel to what appeared to be another speculative binge. In August of 1907, the Secretary of the Treasury announced that he would be depositing $28 million in banks across the United States in order to relieve the expected stringency in the money supply that would occur in the fall, a perennial problem. That was good news, but more storm clouds were appearing. The City of San Francisco could not place a loan in New York, and the Egyptian Stock Exchange crashed, as did the Tokyo Exchange. France was having difficulties. Westinghouse and Boston had trouble underwriting bond issues. The United States Steel Corporation had another setback and announced a drop in earnings. A shipping combination failed. These events were followed by a copper speculation that came apart. A group of speculators had
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been using the National City Bank and several other New York Banks to gain control of the copper market. At the center of these speculators was Frederick A. Heinze, the president of the Mercantile National Bank and its majority stockholder. Heinze had obtained his wealth through highly speculative transactions in Montana copper properties. He used the assets of the Mercantile Bank to engage in further copper speculations. Heinze thought that he had cornered the stock of United Copper, until he was hit with a flood of stock from short sellers as copper prices started dropping in October of 1907. The price of the shares of United Copper dropped thirty-five-points in two hours. The shares of Amalgamated Copper, which owned Anaconda Copper, suffered severe losses, dropping some $70 in value. Heinzes brokerage firm failed, touching off a run by depositors on the Mercantile National Bank. Charges were made that Standard Oil had wrecked Heinzes copper scheme because Standard Oil had been hurt earlier in one of his operations. Runs began on other banks involved in the copper speculation. The New York Clearing House provided assistance to save the Mercantile National Bank, but only after Heinze and the entire board of directors agreed to resign. One of those directors was C.F. Morris, whose activities in the industrial and banking world had been of an extreme character, even when judged by American speculative standards. Among other schemes, Morris had promoted the American Ice Company that had acquired a monopoly on ice sales in New York City by bribing the mayor with $500,000 in its stock and causing great scandal when revealed. The company was the fifth largest corporation in America before its demise. Morris controlled a chain of banks in New York by using shares of one bank as collateral to obtain loans to purchase shares in other banks. His banks came under attack after the Mercantile National Bank ran into trouble. The clearinghouse refused to offer assistance to the Morris banks unless he retired altogether from banking in New York. Also excluded by the clearinghouse were E.R. and O.F. Thomas, who owned the Mechanics and Traders Bank and the Consolidated Bank.39 John D. Rockefeller tried to stabilize the market by depositing bonds in New York banks in September of 1907. That aid was offset by Judge Kenesaw Mountain Landis, who levied a fine of over $29 million against Standard Oil Company in the fall of 1907. This caused Standard Oils shares to drop to $421 from $500. More bad news arrived. The trust companies were proving to be a danger. They had engaged in operations far beyond the limit of conservative practice, and in particular did not protect their deposits by adequate reserves.40 The New York Clearing House had required the trust companies to keep 10 percent of deposits on reserve in 1903. The trust companies then began resigning from the clearinghouse in order to avoid that requirement. They began clearing through the National Bank of Commerce, which was considered to be a Morgan bank. In October of 1907, the National Bank of Commerce announced that it would discontinue clearing for the Knickerbocker Trust Company, the third largest trust company in New York, with deposits in

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excess of $60 million. Without a clearing agent, a bank or trust company could not survive. The Knickerbocker paid out $8 million in three hours when a run began on its deposits. The Knickerbocker was then forced to suspend, and it closed its doors on October 22, 1907. The Knickerbockers problems were the result of speculations by its president, Charles T. Barney, who was assisting Frederick Heinze in trying to corner the stock of the United Copper Company. Barney shot himself after the Knickerbockers failure. Yet so improbable was the bullets angle of entrythrough the bankers abdomen that the coroner had never, in a dozen years, seen another suicide just like it.41 Barneys death was said to have produced a wave of suicides among the banks depositors.42 J.P. Morgan to the Rescue The failure of the Knickerbocker Trust Company touched off the Panic of 1907, which was one of the worst panics in the history of the United States. Long lines formed outside of banks overnight as depositors sought to obtain funds. Many failures followed, including the National Bank of America. A run by depositors began on the Trust Company of America on October 23, 1907, and lasted for two weeks. During that period $34 million was paid out to depositors. Another run began on the Lincoln Trust Company. Both of these trust companies had engaged in reckless practices. Their methods of attracting business, absurdly high interest on deposits and the collection of out-oftown checks without charges were generally regarded as unsafe and even piratical. The situation worsened when the country banks started demanding their funds from the New York banks.43 This caused a scarcity of money, and the rate on call loans rose to 125 percent. This placed further pressure on the securities market as brokers began demanding margin that customers could meet only by selling their securities. The Pittsburgh Stock Exchange suspended operations, and losses mounted as the panic spread. Some 2,000 firms failed in the wake of the panic. Over 100 state banks failed, as did some 30 national banks. The Panic of 1907 resulted in the suspension of convertibility of bank deposits into currency by money center banks. The savings banks sought to stave off runs on their reserves by requiring notices of withdrawal of sixty to ninety days. Hoarding of money was widespread. It was estimated that almost $300 million was removed from circulation during the panic. Clearinghouse certificates and other emergency currency were issued by the clearinghouse banks and by individual manufacturers and corporations. The New York banks were furnished with $36 million in small bills by the Treasury in order to meet currency demands. The New York Clearing House delayed its issuance of certificates, which was thought to have exacerbated the panic. The clearinghouse refused assistance to the trust companies that were in trouble because they were not members. In particular, assistance to the

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Knickerbocker Trust Company was denied because it was not a member and was not a bank. Blocked from access to clearinghouse certificates, the trust companies began paying depositors with certified checks drawn on clearing house banks. This strategy was designed to stem the loss of their cash reserves. A congressional committee later noted that clearinghouse loan certificates were issued without authority of law.44 This did not discourage their use. Loan certificates were used by other clearinghouses in cities across the country. In total, over $250 million in clearinghouse certificates was issued during the Panic of 1907 in order to J.P. Morgan. A one-man Federal Reserve durprovide liquidity to the monetary sys- ing the Panic of 1907, Morgan often found tem. Still there was a money short- himself the subject of suspicion and criticism age. Money was being sold at a as the center of a money trust. (Portrait by premium of as much as 4 percent for Adrian Lamb, courtesy of National Portrait Gallery, Smithsonian Institution. Gift of H.S. some two months after the panic. Morgan.) Some banks started printing scrip. San Francisco banks used clearinghouse scrip that was issued by the San Francisco Clearing House Association. The Bank of Italy continued to pay its depositors in gold or legal tender, which greatly enhanced that banks reputation in San Francisco. In other towns and cities across the country, the shortage of cash required the use of cashiers checks, paychecks from manufacturing companies, and other devices. The federal government appeared helpless in dealing with the crisis. Instead, a single individual emerged as the countrys savior. He was an unlikely, unappreciated, and well-paid hero. That individual, J.P. Morgan, acted as a oneman Federal Reserve Bank in stopping the panic.45 On October 20, 1907, Morgan met with James Keene, E.H. Harriman, James Stillman, George F. Baker, and others. They agreed to assist Morgan in a rescue of the banking system. William Sherer, the manager of the New York Clearing House, agreed to support this effort. In order to save the Trust Company of America, J.P. Morgan was given $3 million by George F. Baker of the First National Bank and James Stillman of the National City Bank. Some of these funds were drawn on the Rockefeller deposits at the National City Bank. The shares of the Lincoln Trust Company and the Trust Company of America were placed under the control of a committee of trust company presidents, which called itself the Associated Trust Companies. This group loaned the Trust Company of America $25 million, and the Lincoln Trust Company was

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provided with $5 million in clearinghouse certificates. Morgan arranged a further $1 million loan for the Trust Company of America. Both of these trust companies would survive and repay their loans, but the panic continued. Ransom H. Thomas, president of the NYSE, advised Morgan that $25 million was needed to save some sixty brokerage firms in danger. Thomas told Morgan that the money had to be obtained immediately or the exchange would have to close early. Knowing that this would further demoralize the market, Morgan raised the money within minutes. He announced that call money would be loaned at 10 percent. Morgan had the banks and trust companies raise additional funds in order to bail out other trust companies experiencing runs. Morgan wanted the Secretary of the Treasury to deposit government funds in trust companies, but the secretary could deposit funds only in national banks. Morgan had him deposit $25 million in those banks, which then loaned the money to the trust companies. That was not enough and more was added. Between October 21 and October 31, 1907, the Treasury put over $36 million into the national banks in New York City. The banks then advanced those funds to trust companies in order to meet demands by depositors. Still, the panic continued. On Saturday, November 2, 1907, J.P. Morgan called a group of more than fifty New York bankers and trust company presidents to his home on Fifth Avenue. Morgan locked the financiers in his library until they agreed to provide even more funds to stop the panic. Morgan told the trust company presidents that they had to raise $25 million. They finally agreed to this demand. But for the powerful influence of Mr. J.P. Morgan it is probable that no united action would ever have been taken. It is certainly an element of weakness in our central money market that influential credit institutions should have to be dragooned into doing what is after all in their own interests as well as to the general advantage.46 Among other things, Morgan used the money gathered from the bankers as a fund for supplying call money on the floor of the NYSE, and it was also used to save the Lincoln Trust. John D. Rockefeller stated that he would give half of his securities if it would stop the Panic of 1907. Rockefeller appeared ready to abide by that pledge. He deposited $10 million with the National City Bank and contributed to the $25 million fund that J.P. Morgan put together to keep the stock market going. In order to give the announcements of relief to the call market the most dramatic effect, and thereby restore confidence, it was decided that the public would be informed that J.P. Morgan was arranging the delivery of these funds. Stillman had sought the honor for the National City Bank, but the other clearinghouse members thought that this would be too much of a free advertisement for the bank. As planned, this announcement stemmed the tide and kept the NYSE open. Another pool of funds was gathered, but it proved unnecessary. Only an additional $2 million was needed in call money funds. To further assist the market, J.P. Morgan put out the word that short sellers would be properly attended to. This served to discourage such activities.47 Morgan sought more substantial relief in the form of inducements to bring

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more gold into the United States. That effort resulted in an inflow of $100 million of gold. Among other things, Morgan was buying bills of exchange in order to force gold shipments from Europe. He obtained from the Bank of England $10 million in gold that arrived on the Lusitania. Several appeals were made to the Secretary of the Treasury during the crisis to make more money available by repaying outstanding loans of the government or by issuing additional currency against gold deposits. The secretary refused on the ground that he was not permitted by existing law to take such steps to relieve the monetary stringency. As noted, in order to assist Morgan and to provide some liquidity, the secretary did deposit funds with the New York banks, but that was as far as he was willing to go. President Theodore Roosevelt, at the urging of southern bankers, put another $50 million of federal deposits into their banks to help them through the liquidity crisis. Still, the governments efforts had proved woefully inadequate in meeting the crisis. J.P. Morgan was plugging holes in other dikes. The New York City funding crisis worsened in the middle of the Panic of 1907. On October 28, 1907, the mayor of New York advised Morgan, Baker, and Stillman that New York City was short of funds and needed $30 million to meet the payroll and other obligations. Call money rates were reaching 150 percent, and the city was facing bankruptcy. The three financiers raised that sum through municipal revenue bonds that paid 6 percent. Another large problem encountered during the panic involved Moore & Schley, an investment banking firm that promoted industrial mergers. It was second in prominence only to J.P. Morgan & Co. and was the largest brokerage firm on Wall Street. Moore & Schley had a speculative pool operation in the Tennessee Coal, Iron and Railroad Company but could not pay the loans that had been secured with the Tennessee Coal securities. If Moore & Schley failed, many other firms would follow. In order to save the firm, Morgan arranged to have United States Steel buy the stock of the Tennessee Coal, Iron and Railroad Company from Moore & Schley. Theodore Roosevelt granted antitrust immunity for this transaction. This stopped the panic. It also gave Morgan a lucrative prize, but the takeover of the Tennessee Coal by United States Steel later became the subject of much concern. Theodore Roosevelt was harshly criticized for approving that merger. Those and other charges resulted in Theodore Roosevelt forming his own party to make another effort to become president in 1912. Effects of the Panic The nation was left shaken and stunned by the suddenness and force of the Panic of 1907. Senator Nelson Aldrich later noted that the country escaped by the narrowest possible margin from a total collapse of all credit and a wholesale destruction of all values. He asserted that
to the great majority of the people of the country the blow came without a warning. Most of our banking institutions were in excellent condition, business of every kind

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was prosperous, labor was fully employed at satisfactory wages, industries of every kind were flourishing. Our people were full of hope and confidence for the future. Suddenly the banks of the country suspended payment, and acknowledged their inability to meet their current obligations on demand. The results of this suspension were felt at once; it became impossible in many cases to secure funds or credit to move crops or to carry on ordinary business operations; a complete disruption of domestic exchanges took place; disorganization and financial embarrassment affected seriously every industry; thousands of men were thrown out of employment, and the wages of the employed were reduced.48

Of course, there were those who profited from the Panic of 1907. Jesse Livermore, the Boy Plunger, was able to make a profit of $250,000 from speculative operations. The Westinghouse Electric Company had had troubles during the Panic of 1893, but it encountered even more difficulties during the Panic of 1907. The company was highly leveraged in its borrowings. It had $15 million in convertible sinking fund 5 percent bonds; $6 million in three year, 5 percent collateral trust notes; $2.5 million of 5 percent debenture certificates; $8 million in bank loans; $2 million of trade credit debt; and $4 million in preferred stock. In 1907, Westinghouse sold an additional $3.5 million in convertible sinking fund bonds and $2.7 million of two-year collateral notes payable in francs or sterling. Westinghouse was unable to meet its obligations as a result of the Panic of 1907 and was placed in receivership. Westinghouse would recover, as would others who were damaged by the panic. Among those suffering was John Moody, who had to sell his Moody Manual Company to Roger W. Babson, which began rating railroad bonds in 1909. Moody later regained control of Moodys Manual and began Moodys Bond Ratings. Roger Babson began publishing Babsons Reports.
Nelson Aldrich. A senator with close connections to the Rockefeller family, Aldrich was the father of the modern Federal Reserve. (Portrait by Anders Leonard Zorn, courtesy of National Portrait Gallery, Smithsonian Institution. Gift of Stephanie Edgell in memory of Elsie Aldrich Campbell.)

The Hughes Committee The Panic of 1907 occasioned another large-scale investigation in New York. The Governors Committee on Speculation in Securities and Commodities rendered its report on June 7, 1909, to Charles E. Hughes, who had become the governor of New York after the Armstrong Committees investigation.

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Interestingly, claims have been made that the Armstrong Committee, for which Hughes acted as counsel, had precipitated the Panic of 1907 by causing the insurance companies to pull their reserves out of Wall Street. That action exacerbated liquidity problems and prevented Morgan from gaining access to the reserves of the life insurance companies to support the market. The Hughes Committee found that, while the securities markets served useful purposes, speculation was playing a large role in the markets. The committee concluded that it is unquestionable that only a small part of the transactions upon the Exchange is of an investment character; a substantial part may be characterized as virtually gambling. The Hughes Committee stated that [s]peculation consists in forecasting changes of value and buying or selling in order to take advantage of them; it may be wholly legitimate, pure gambling, or something partaking of the qualities of both. By the beginning of the century, the courts had held that speculation was gambling where there was no intent to actually own the property that was being sold, whether it was commodities or securities. Purchasing a stock to be held by a broker for resale was not considered to be gambling, as long as there was an intent to actually purchase and sell the stock. If the intent was to simply pay for price changes in the price of a stock, then the transaction was illegal gambling. Those same rules applied to commodities transactions. Technical delivery provisions on the commodity exchanges allowed speculators to avoid the gambling restrictions even though offsetting and ring settlements allowed speculators to bet on price changes. Despite its concerns with gambling, the Hughes Committee found that speculation had its uses. Speculation permitted hedging of commodity prices. Speculation could steady securities and commodities prices. In the absence of speculation, merchants and manufacturing would be required to carry the risks of price changes. The committee noted that it would be very difficult to separate destructive gambling from useful trading in the markets. The Hughes Committee, however, decried the fact that numerous unsophisticated customers with small means had been induced to speculate in the futures and securities markets. The committee noted that these small speculators usually lost their investments. Consequently, a continual influx of new customers was required to maintain the sales operations of the brokerage firms. The Hughes Committee rejected recommendations that margin trading should be prohibited because it encouraged gambling. The committee did suggest an increase in the customary margins to a level of at least 20 percent. Another concern was the rehypothecation of customer securities for the brokers own use without the customers consent. The Hughes Committee sought legislation that would make it a crime for a broker to receive securities or cash from a customer when the broker was insolvent or to sell customer securities after they had been paid for by the customer. The Hughes Committee found that branch offices of brokerage firms were being used to sell securities in a speculative manner. Those offices were of-

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ten luxuriously furnished and sometimes equipped with lunchrooms, cards and liquor. The tendency of many of them is to increase the lure of the ticker by the temptation of creature comforts, appealing thus to many who would not otherwise speculate.49 The Hughes Committee thought that customers should be allowed to obtain treble damages for losses caused by fictitious sales. Short selling was another much-criticized practice on the exchanges. A manipulation in the stock of the American Ice Company drew particular attention and criticism from the Hughes Committee. Although New York had prohibited short sales in 1812, that legislation was repealed in 1858. Short sales, thereafter, became a common feature in the market and were often the subject of abuse. Short sellers frequently conducted bear raids that sought to drive prices down so that the short sales could be covered at lower prices, resulting in a profit to the short seller. Manipulation of prices were a common practice during the bear raids. The Hughes Committee was critical of the NYSE. The NYSE clearinghouse was found to have facilitated transactions that were manipulative or gambling in nature. The exchange often failed to take sufficient measures to prevent wrongdoing, which may have been due to a spirit of comradeship among brokers that led them to overlook improper activities on the part of their fellow members. The NYSE was severe in its punishments of firms when it discovered they were insolvent. Unfortunately, such action was often taken too late to prevent losses to customers. Brokerage firm failures were exacerbated by the fact that the firms continued to conduct business even after they were insolvent. There was no requirement for examinations of the books and records of the brokerage firms. The Hughes Committee recommended that such examinations be conducted by the NYSE, rather than by a governmental body, because of the confidential nature of customer securities transactions. The Hughes Committee further recommended that the NYSE require financial reports for all of the securities listed on the exchange. These statements would include balance sheets, income and expense statements, and the committee thought that these statements should be made public. The Hughes Committee urged the NYSE to upgrade listing requirements and recommended that the NYSEs unlisted trading department be abolished. The committee made other recommendations that would presage the current federal securities laws. It thought that criminal liability should be imposed against persons making advertisements for securities that they knew to be false or for which they had no reasonable grounds for believing true. The Board of Trade in London had already opined that an official investigation should be made into the soundness, good faith, and prospects of companies. The Hughes Committee noted that companies issuing securities in England were required to register with a public authority and to identify their promoters. This allowed their prosecution in the event of fraud. Direct liability was imposed on directors in England. The Hughes Committee noted that it would be difficult to establish effective state regulation to impose such requirements, unless all states adopted such provisions.

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The Hughes Committees recommendations were largely ignored. The NYSE did prohibit brokers from offering large blocks of securities on an all or none basis, and the unlisted department was abolished in 1910. Most of the unlisted securities were simply added to the listed securities, but the NYSE thereafter restricted its listings to high grade stocks. The curb traders picked up the market for the securities of smaller, more speculative companies. Currency Issues Efforts on the federal level to achieve market reforms met resistance. President Theodore Roosevelt had been warned before the Panic of 1907 that reckless speculation could stop the prosperity in the country. Jacob Schiff had advised the president that the failure to revise the banking laws and provide for a more elastic currency would cause a terrible panic. J.P. Morgan had also warned President Roosevelt of the effect on the financial markets of tight money before the Panic of 1907. Roosevelt ignored those warnings, and it was widely believed that his animosity toward big business was actually a cause of the panic. The presidents speech at the Gridiron Club in which he had attacked the malefactors of great wealth was thought to have undermined confidence in the business community. Roosevelts attacks on big business under the antitrust laws added further uncertainty to the market. Among his targets were the Du Pont powder company and the Gunpowder Trade Association, which were charged with violating the Sherman Antitrust Act, and a court later upheld that claim. Roosevelt remained unrepentant. He sent a special message to Congress in 1908 in which he demanded regulation of speculators in the stock market. Roosevelt sought legislation that would stop the grosser forms of gambling in securities and commodities, such as making large sales of what men do not possess and cornering the market. The president informed Congress that complete control over the issue of securities was needed. Roosevelt sought the creation of a federal commission to regulate the securities market, and he wanted to require corporations to be federally licensed. Roosevelts proposals were not adopted. Instead, Congress focused on the inelastic money supply as a prime culprit of the Panic of 1907. That concern led to the enactment of the Aldrich-Vreeland Act of 1908, which established National Currency Associations. These associations were to provide emergency liquidity by allowing banks to issue credit notes against deposits of commercial paper, as well as government bonds. The thrust of the Aldrich-Vreeland Act was to provide for the issuance of a substitute currency in the event of an emergency. This act sought to alleviate currency shortages by allowing the issuance of emergency certificates by the banks without awaiting action by the bank clearinghouses. The Aldrich-Vreeland legislation did not prove to be of much immediate use. The government, nevertheless, continued its quest for a cure for the periodic panics that devastated the economy. Congress conducted an intensive,

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prolonged examination of the financial markets over the next several years. From those inquiries would eventually emerge the Federal Reserve System. Another less fruitful search was begun for a bogeyman on whom to blame the countrys economic troubles. Although a cure for the panics would remain elusive, the scapegoat became the financiers who it was claimed had formed a money trust. It would be charged that J.P. Morgan & Co. was in command of that money trust. Despite his warnings to the president of the danger of a panic and his heroics in curbing the panic that followed that warning, J.P. Morgan would be vilified for his dominant position in finance. Morgan had become too strong a force in America. The federal government was simply unable to permit such competition with its central authority in times of crisis. The government was also institutionally incapable of being dependent on such a private force. The American public had begun to distrust the amalgamation of wealth that was occurring among the financiers and industrialists. Trading Continues This criticism did not stop Morgans dominance in finance. His firm acquired control of the Guaranty Trust Company from E.H. Harrimans estate. Harrimans death had caused the NYSE to fly its flag at half mast. Along with the Bankers Trust, this acquisition gave Morgan control of the first and second largest trust companies in the country. The total resources of the banks and trust companies controlled by Morgan soon were in excess of $700 million. Morgan obtained control of the Mutual Life Insurance Company and the Equitable Life Assurance Company. Some of the Equitable stock was bought from the Harriman estate and the rest from Thomas Fortune Ryan. Morgan then grabbed the New York Life Insurance Company. These were the big three of insurance companies in New York. Morgan was not always successful, however. The United States Shipbuilding Company and the International Mercantile Marine that he organized never performed very well. He was said to have lost some $400 million in his effort to reorganize railroads in New England. There was also some financial chicanery involved in those reorganizations. The stock market increased by over 45 percent in 1908. Over $100 million in stocks and bonds was traded on the curb exchange in 1908 as speculation was renewed. Some $40 million of the shares traded on the curb were speculative mining stocks. The curb market often traded in small companies whose stocks were easily manipulated. Other abuses occurred in the curb market, including frequent wash sales, thus facilitating swindling enterprises.50 Brokers in the curb market were acting as bookies for horse races, fights, and other events. Efforts to prosecute curb exchange abuses under the mail fraud statutes had proved unsuccessful. The New York Curb Agency was formed in 1908 to give some structure to the over-the-counter trade. It was shortly replaced by the New York Curb Market Association. Members, clerks, and messengers were given badges to identify themselves as Curb Market Asso-

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ciation participants. By 1909, over 300 brokers had joined the Curb Market. It was still dwarfed by the NYSE, and the volume of transactions on the NYSE was making it probably the most important financial institution in the world.51 Memberships on the New York Stock Exchange were selling for $80,000. The commodity markets were another source of speculation. Herman Sielcken, informally crowned the nations Coffee King after the turn of the century, frequently manipulated the coffee market up and down. He was not shy about his abilities: I can put coffee down again just as easily as I put it down once before.52 Jesse Livermore was a heavy hitter in the commodity markets. Livermore honed his skills in the bucket shops before he began trading in the regular market. Livermore attempted a corner of the cotton market in 1908 by buying 120,000 bales of cotton futures. Livermore placed an article on the front page of a New York newspaper announcing his corner. This caused prices to rise even further. Livermores effort ultimately failed, and he lost almost $1 million. Livermore had sold short during the Panic of 1907 in the stock market, however, and made some $3 million. In 1909, James A. Patten cornered the wheat market on the Chicago Board of Trade. His earlier corner in the oat market in 1902 had prompted several bills in Congress to outlaw short selling and other speculative practices.53 In 1909 Patten drove the price of wheat up to $1.34 from about ninety cents per bushel. It was thought that he made more than $1 million in that foray. Patten was blamed for the rising cost of wheat, of flour, of bread.54 There was concern that price increases caused by the Patten corner might result in bread riots in Chicago neighborhoods. The Supreme Court held that the Patten corner was illegal. Undeterred, Patten tried to corner the corn market in 1913. The Du Pont Company was issuing ninety-day sight notes on Brown Brothers to purchase raw materials. This allowed Du Pont to finance the acquisition of needed supplies cheaply by using Brown Brothers credit. During the Panic of 1907, however, Brown Brothers demanded $2 million in collateral for those notes. Although that demand caused Du Pont problems, it was able to deal with that crisis. In 1909, the Du Pont company obtained a revolving line of credit of $2 million from the National City Bank to be made available to English banks, where the funds would be disbursed for payments in shillings. Taxes Corporations, and wealth in general, were facing a new threat. The PayneAldrich Tariff of 1909 established a corporate excise tax. It was, in fact, a corporate income tax equal to 1 percent of corporate net income over $5,000. The Supreme Court upheld this tax. An effort in 1909 to impose an individual income tax was deferred only by a compromise in which the corporate excise tax was adopted. It was agreed that a sixteenth amendment to the Constitution would be added to authorize an income tax on individuals without restriction by the apportionment requirements in the Constitution. That amendment was

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not passed until 1913. The Income Tax Act of 1913 then imposed a personal income tax on incomes in excess of $3,000 ($4,000 for married couples). A tax of 1 percent was imposed on incomes above those levels, and a surtax of 1 percent was assessed on incomes of $20,000 to $50,000. The level rose to 6 percent for incomes in excess of $500,000. The Income Tax Act of 1913 consisted of fourteen pages. As simple as it was, the establishment of the income tax led to an increased demand for accountants. The income tax also proved a boon to sellers of municipal bonds, who advertised their tax-free status in the New York Times and other newspapers. Although a shareholder of the Union Pacific Railroad Company challenged the decision of that company to pay income tax, the Supreme Court upheld the act.55 In the first three years of operation, the income tax produced less than $140 million. Massachusetts trusts were in use as a tax shelter after adoption of the federal income tax on corporations because that tax could be avoided through this form of organization. That gap was later closed by Congress, and its popularity waned.

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4 The Federal Reserve and the Money Trust

Before the Panic of 1907, President Theodore Roosevelt had advocated the creation of a Government Banking Reserve that would operate through the post office. No action was taken on that proposal, but Congress created a Monetary Commission in 1908 to examine the causes of the Panic of 1907 and to propose measures to prevent the occurrence of such an event in the future. The commission was chaired by Senator Nelson Aldrich of Rhode Island. Aldrich was not a humble public servant. It was charged that he had made millions from his position in the Senate. Whatever the truth of those claims, they did not stop Aldrich from conducting an extensive investigation that lasted almost four years. The commissions proceedings would have continued even longer, but Congress finally demanded a report by a fixed date. The commission then published some fifty volumes of reports and investigative materials. The commissions reports included a number of monographs on banking methods in the United States and several foreign countries. The Monetary Commission concluded that a central banking authority was needed to provide liquidity in times of stress. As was pointed out in one commission report, the responsibility for the Panic of 1907 lies at the door of our currency system. No other adequate cause can be found. We do business by the modern system of bank credits, but we have failed to supplement this machinery with a means for readily converting bank credits into cash.56 Unlike many other countries, the United States had no central bank to provide liquidity and stability during times of crisis. Andrew Jackson had destroyed that institution in his war against the Bank of the United States. Central banks did exist in Europe, and their operations were examined by the Monetary Commission. The use of such an institution was thought to offer a means to alleviate monetary problems in the United States. The Bank of England was one model, but Senator Aldrich noted that the Crdit Lyonnaise in France was in certain respects the greatest commercial bank in the world.57 Aldrich cited the example of the Baring Brothers Panic in 1890 as demonstrating the important role that central banks could play in a financial crisis.
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In that instance, the prompt action of the Bank of England, working with the Banque de France and the Bank of Russia, prevented a broader panic. The Banque de France had prevented another general crisis in 1882 after the failure of the Union Gnrale, one of the largest joint-stock banks in Paris. The Banque de France played a similar role in 1889, after the failures of a copper syndicate and a large French joint-stock bank, the Comptoir dEscompte. Germanys central bank, the Reichsbank, had intervened after the failure of the Leipziger Bank in 1901 and prevented the spread of financial problems to other parts of the economy. The Duck Hunters Senator Aldrich introduced legislation in 1912 that proposed the creation of a central banking authority in the United States. Ostensibly the result of the Monetary Commissions study, the bill had actually been written in a secret meeting at a gentlemans club on Jekyll Island, Georgia. That club was founded by John D. Rockefeller, J.P. Morgan, William K. Vanderbilt, and Silas McCormick. Disguised as a group of wealthy duck hunters, the Aldrich party arrived in a private railcar. Their number included Paul M. Warburg, a partner in Kuhn, Loeb & Co.; Henry Davison, the founder of the Bankers Trust Company and a partner of J.P. Morgan; Frank A. Vanderlip, an executive at the National City Bank; Benjamin Strong, the vice president of Bankers Trust; and Walter A. Piatt Andrews, an Assistant Secretary of the Treasury. Led by Warburg, who had been studying the concept of a central bank and acting as an adviser to Senator Aldrichs Monetary Commission, the duck hunters concluded that a federal banking system was needed to provide liquidity to the private banks in times of stress. The group eschewed a central bank that would be controlled by the government. Instead, they opted for a more decentralized system that would be controlled by private bankers such as themselves. The Aldrich bill that resulted from the Jekyll Island meeting proposed a Reserve Association of the United States that was to be chartered by the federal government to act as the governments fiscal agent, to hold government deposits, and to conduct operations in foreign exchange. It was to be a bankers bank that would set discount rates and issue notes backed with gold reserves and commercial paper. The proposed Reserve Association would rediscount commercial paper, purchase bankers acceptances for member banks, and otherwise act as a central banking authority in maintaining liquidity in the money markets. Reflecting the bankers concern over control, the Aldrich bill proposed the creation of a group of district banks located in large cities across the United States. Each district bank would be owned and controlled by private banks in that district. The Aldrich bill met opposition, however, because control of the system would be vested in the private banks. Senator Nelson Aldrichs sponsorship of the proposal raised further opposition because of his close connections with the Rockefeller family, whose for-

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tune was approaching a then astronomical $1 billion. That wealth, and the strong-arm tactics used by Standard Oil, made the Rockefeller family the target of reformists everywhere. The Standard Oil monopoly in particular was still attracting muckrakers. They were heartened when, on May 15, 1911, the Supreme Court announced the breakup of the Standard Oil monopoly. The Standard Oil empire was then divided into Standard Oil of New Jersey (Esso, later known as Exxon), Standard Oil of New York (Mobil), Standard Oil of Indiana (Amoco), Standard Oil of California (Chevron), Atlantic Refining (ARCO), and Continental Oil (Conoco). The members of this group would continue to dominate the oil industry, and they would be consolidating again as the century closed. In addition to their oil business activities, the Rockefellers were at the center of banking in New York. That role magnified the Rockefellers influence and aroused even more suspicion of the family. That distrust spread to persons associated with the Rockefellers, including Senator Aldrich, who had sponsored legislation that allowed the Rockefeller General Education Board to obtain a federal charter. The senators son, Winthrop, would become the leader of the Chase National Bank, which was a Rockefeller bank. The senators daughter, Abby, was married to John D. Rockefeller Jr., and they named one of their sons after the senator. That child, Nelson Aldrich Rockefeller, would become governor of New York and vice president of the United States. Unfortunately, Nelson did not inherit either of his grandfathers financial acumen. Nelson would create his own financial crisis in New York in future decades. In the meantime, animosity toward the Rockefeller family would be leavened only after John D. Rockefeller made himself a more human figure by giving away dimes to children and hundreds of millions of dollars to various charitable causes. Among those opposing the Aldrich bill were William Jennings Bryan and Theodore Roosevelt. The president, Woodrow Wilson, found himself in a difficult spot. He was a reformist who believed that big business was a danger. Being on record with those views, Wilson could not support the Aldrich bill, which seemed to favor big business. Nevertheless, the Panic of 1907 and the Monetary Commissions study provided evidence too compelling to ignore. Wilson had little choice but to support the creation of a central bank. Moreover, Wilson was not in favor of excessive government regulation of business: [W]hen once the government regulates the monopoly, the monopoly will have to see to it that it regulates the government. Furthermore, Wilson was afraid of a government of experts. To appease Aldrichs opponents and to satisfy his own reformist fervor, Wilson sponsored compromise legislation designed to create a central banking system that mixed government and private control. Representative Carter Glass of Virginia, who would later serve as Secretary of the Treasury and be elected to the Senate, took responsibility for shepherding that legislation through Congress. Glass did not really want a central bank even after the Panic of 1907, but he recognized that some action

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was necessary because failures in the banking system had threatened the economy of the country. The Glass bill modified the Aldrich proposal by creating a Federal Reserve Board composed of seven members that would be seated in Washington. Nevertheless, the Glass bill retained Aldrichs concept of creating a group of Federal Reserve banks in the larger cities. Each of twelve districts was to have a Federal Reserve Bank that would be owned by private banks. The Federal Reserve banks were to act as banks for banks and were not to engage in banking operations with private individuals. William Jennings Bryan and Wilsons Secretary of the Treasury, William McAdoo, remained opposed to the Glass bill. They wanted a Federal Reserve Board that would be controlled by government appointments, rather than by the banks. Changes were made in the Glass bill to impose that requirement. The Federal Reserve Is Created As enacted, the Federal Reserve Act of 1913 created a Federal Reserve Board composed of seven members. The Secretary of the Treasury and the Comptroller of the Currency were ex officio members; the rest were to be appointed by the president. All national banks were required to join the Federal Reserve System, and state institutions could, on the approval of the Federal Reserve Board, become members without giving up their state charters. The capital of the Federal Reserve banks was subscribed by banks in the districts. The majority of the board members of the Federal Reserve banks were elected by the local member banks. The Federal Reserve banks could hold deposits of the government, thereby creating the basis for a new and more efficient subtreasury system. The Federal Reserve legislation sought to cure the key problem that banks often encountered and that led to panics: a lack of liquid funds in time of stress. The banks would often have substantial commercial paper and other assets on hand, but those assets could not be used as a source of ready cash. The banks needed to be able to pledge those assets with a central bank in order to obtain money in times of panic. The Federal Reserve System permitted such pledges and thereby injected liquidity into the system. Assets that could be pledged for cash included bankers acceptances, bills of exchange, municipal security obligations of a short-term nature, and certain other items, such as gold coin or bullion. The Federal Reserve Act sought to have its banks establish an elastic currency by the issuance of Federal Reserve notes. Those notes were to become part of the general circulation of currency, today providing the basis for our paper currency. The Federal Reserve Act rescinded the power of national banks to issue notes that had circulated as currency. That authority was then restricted to Federal Reserve banks. Federal Reserve banks were allowed to issue Federal Reserve notes against deposits of commercial paper. The Federal Reserve banks could purchase and sell United States securities, securi-

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ties issued by state and county governments, and bills of exchange. They were further authorized to set rates of discount. There was no bankers acceptance market in the United States before the creation of the Federal Reserve System. A bankers acceptance is a time draft drawn on a bank. The bank accepts the draft, and the acceptance then circulates until its maturity date with the banks guarantee behind it. Bankers acceptances usually ran for three months. The National Monetary Commission had found that, while the National Bank Act did not specifically prohibit bankers acceptances, the courts had ruled that the banks did not have the authority to engage in such transactions. In contrast, an active bankers acceptance market in Europe provided the basis for a money market where funds could be easily obtained. In the United States, the call loan market was used. The call market was not as efficient as the European system, however, because the call market funds could be recalled at any time and could not be used for financing foreign trade or other transactions. The Federal Reserve Act sought to correct that situation by authorizing national banks to issue bankers acceptances in foreign trade. This authority was extended to domestic trade in 1916. Bankers acceptances that were endorsed by a member bank of the Federal Reserve were considered to have a higher-grade security than commercial paper bearing a similar endorsement. The bankers acceptance market created by the Federal Reserve did not correct the dangers posed by the call money market for brokers. The demand for such money was simply too great. The Federal Reserve legislation adopted the concept of open market operations in which the Federal Reserve banks bought and sold government securities and eligible private debt issues in order to influence the money supply. Through these techniques, the Federal Reserve Act provided further elasticity to the currency and established a more effective supply of funds for deposit credits. The Federal Reserve legislation sought to correct another flaw in the financial systemthat is, the lack of a clearance and collection system for checks outside major money market centers. The large cities had very efficient collection systems but at any time there was a large float of out-oftown checks that sometimes took weeks to collect. This fault was corrected when the Federal Reserve banks established themselves as agencies for clearing collected checks. The Federal Reserve Act also allowed national banks to act as trustees and executors and as registrars of stocks and bonds. This permitted them to compete with the trust companies in those areas. The Federal Reserve Act authorized national banks that were outside of Federal Reserve cities to make real estate loans for terms of up to five years. State Banks The Federal Reserve Act created a further division in bank regulation. In addition to state regulation, bank regulatory authority was split between the

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Treasury Department and the Federal Reserve Board. The Comptroller of the Currency at the Treasury retained responsibility for examining and regulating the national banks, while the Federal Reserve System managed monetary issues. Even on matters of monetary policy, however, the Treasury continued to seek a role in establishing and guiding policy. The result was that, almost immediately, the Federal Reserve Board began a struggle to become independent of the Treasury Department. That struggle would continue over the next several decades. The Federal Reserve Board would gain its independence on issues of monetary policy after World War II, but the bifurcation of regulatory authority in the banking system continues today. Several states took action after the Panic of 1907 to protect depositors against bank failures. Eight states established deposit guaranty funds for their banks, which were thought to give those banks an advantage over national banks as well as protect customers. The number of banks in those states did increase rapidly, but that increase was followed by several bank failures, which quickly exhausted those safety funds. The Hunt for the Money Trust The Panic of 1907 had effects that reached beyond the banking sector. Public hearings were held by a Railroad Securities Commission appointed by President Taft in 1910 on the issuance of stock and bonds by the railroads. That commission recommended legislation that would require publicity regarding stock and bond issues. The commission urged an approach of utilizing full disclosure of risks and other factors by the issuer rather than a process in which the government would approve bond issues. That suggestion was not adopted. Instead, Congress began an investigation of charges made in 1911 by Congressman Charles A. Lindbergh of Minnesota. Lindbergh, whose son would become a famous flier and marry the daughter of a J.P. Morgan partner, was given credit by Ida Tarbell, the muckraking author, for creating the money trust hunt. He claimed that a money trust was controlling American finance. Lindbergh asserted that J.P. Morgan, James J. Hill, George F. Baker, John D. and William Rockefeller, James A. Stillman, and Jacob H. Schiff controlled most of the finance and industry of the United States. Lindbergh was not the only one looking for such a cabal. Theodore Roosevelt had advocated the creation of a federal securities commission to control the financiers. Woodrow Wilson had long advocated legislation that would require large public companies to publish reports of directors meetings. While governor of New Jersey, Wilson claimed that the great monopoly in this country is the money monopoly. So long as it exists, our old variety of freedom and individual energy of development are out of the question. This search for a money trust became a part of Wilsons presidential campaign. His inaugural address called for a revision of the banking and currency situation. Wilson sought a federal commission that would regulate large business

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enterprises. The concern with the power of concentrated wealth was not entirely an American problem. In England, Winston Churchill had been concerned with the power of the Trusts at the turn of the century. He was afraid of the power that these merchant-princes held. An investigation was begun in 1912 by the House Committee on Banking and Currency to determine whether there was in fact a money trust in America. The committee uncovered some startling evidence as to just how centralized control was on Wall Street. The chairman of the Banking and Currency Committee was Arsene Pujo of Louisiana. Its counsel was Samuel Untermyer, a millionaire New York corporate lawyer who was an expert on mergers. Untermyer was not exactly new to the issue of whether there was a money trust. In 1911, he gave a speech that asked exactly that question: Is There a Money Trust? The Pujo Committee, as it was called, conducted extensive hearings and found that an inner group was controlling much of American finance and industry. The Big Three in this inner group were J.P. Morgan, George F. Baker at the First National Bank, and James Stillman, the president of the National City Bank. The committee published charts that showed J.P. Morgan & Co. at the center of a web controlling vast enterprises in the United States. When that web was connected to the enterprises of the other members of the inner group, it encompassed a great portion of the nations financial resources. J.P. Morgan & Co. controlled some of the largest insurance and trust companies. The firm owned significant amounts of stock of the First National Bank, the National City Bank, and the Chemical National Bank, as well as many other banks, trust companies, insurance companies, and savings banks. Morgan had control of numerous railroads, including the New York Central and Hudson River Railroad; the New York, New Haven & Hartford Railroad; the Northern Pacific Railway; the Southern Railway; the Reading Co.; the Erie Railroad; the Lehigh Valley Railroad; the Chicago Great Western Railroad; the Atchison, Topeka & Santa Fe Railway; and the Cincinnati, Hamilton & Dayton Railway. J.P. Morgan & Co. had obtained much of its prestige and authority from its role as an issuing housethat is, as an underwriter. The Morgan firm was the underwriter for almost $2 billion of securities between 1902 and 1912. It was the underwriter for many railways and dominated the underwriting and creation of United States Steel. International Harvester and General Electric were organized by J.P. Morgan & Co. The firm had affiliations with American Telephone & Telegraph, Western Union, and other communications firms. Other members of the inner group were Drexel & Co., George F. Baker, James Stillman, and the banks they controlledthe First National Bank, the National City Bank, the Chase National Bank, the Guaranty Trust Co., and the Bankers Trust Co. A trio composed of J.P. Morgan, Baker at the First National Bank, and Stillman at the City Bank had agreed that as originating houses for any original securities, they would take 50 percent and give 25

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percent to the other two. They then began underwriting issues for U.S. Steel, several railroads, and others. Between 1908 and 1912, those new issues totaled more than $500 million. The First National Bank had J.P. Morgan on its board of directors, and he was a major shareholder of the bank. The inner group had close relations with others who exercised vast control over corporate finance, including Lee, Higginson & Co. and Kidder, Peabody & Co. The Pujo Committee found other affiliations of this groupwith Kissel, Kinnicutt & Co., White, Weld & Co., and Harvey Fisk & Sonsthat further extended its power. Kuhn, Loeb & Co. was found to be qualifiedly allied with the inner group.58 Control by the inner group was exercised through a chain of interlocking corporate directorships. George F. Baker was found by the Pujo Committee to hold fifty-eight directorships. Collectively, J.P. Morgan & Co., the First National Bank, the National City Bank, and the Bankers and Guaranty trust companies held over 100 directors positions in 34 banks and trust companies, 30 directorships in 10 insurance companies, over 100 directorships in 32 transportation systems, 63 directorships in 24 producing and trading companies, and 25 directorships in 12 public utility corporations. In total, the inner group held over 300 directors positions in over 100 corporations, with aggregate capitalization of some $22 billion. The inner groups control of these large industrial groups allowed them to direct deposits from those corporations to their own financial institutions. The Pujo Committee charged that control, rather than investment, was the object of this web of directorships and holdings. The committee was especially struck by a transaction in which George Baker, president of the First National Bank, James Stillman, president of the National City Bank, and J.P. Morgan bought $3 million of the stock of the Equitable Life Assurance Company. This stock returned only a one-eighth percent dividend, but the position acquired by these financiers gave them control over the assets of the Equitable, which amounted to over $500 million. Morgan denied that the purchase was made for anything other than investment purposes, but that claim, as had been the case with James Hyde and the events that triggered the Armstrong investigation of the insurance industry, was met with widespread skepticism. Morgan received this rough handling despite his heroics during the Panic of 1907. His political connections provided even less shelter. Of course, he was a realist. When questioned about whether he expected politicians to show some gratitude to him after he made large campaign contributions, J.P. Morgan replied in congressional testimony, No. Gratitude has been rather scarce in my experience.59 Other targets for reform were revealed by the Panic of 1907. Many bank failures were due to loans to a banks own officers. Banks were exchanging loans for each others officers and directors. The Pujo Committee thought such practices should be stopped. The New York Clearing House was charged with being an illegal combination wielding autocratic power and exercising monstrous regulation over the banking business.60 The trust companies con-

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tinued to be of concern. In January of 1911, the Carnegie Trust Company was forced to close its doors. Its failure was caused by mismanagement. The Pujo Committee asserted that the states should restrict the activities of the trust companies so that they did not pose a competitive threat to the national banks. The national banks, in turn, should be prohibited from acting as promoters and underwriters of securities for corporations, particularly in firm commitment underwritings in which the bank would guarantee the sale of an issue of bonds. The Pujo Committee pointed out the danger of allowing national banks to create affiliated corporations that engaged in the securities business: The temptation would be great at times to use the banks funds to finance the speculative operations of the holding company.61 The Pujo Committee thought that private banks, such as J.P. Morgan & Co., should not be allowed to act as depositories for customer funds because the private banks were not subject to any governmental scrutiny. The assets and liabilities of the private investment banks were not published, the banks were not subject to reserve requirements, and they could use customer deposits in any way they wanted. Underwriting abuses were examined. The Pujo Committee investigated an underwriting involving the initial public offering of the California Petroleum Company. It issued over $30 million of preferred and common stock. The underwriters included William Salomon & Co. and Hallgarten & Co. The underwriting firms netted almost $2 million in profits. Also participating in the underwriting were banks in New York and a trust company, as well as bank officers. The stock had already been sold before many of the underwriters received their portion of the stock, thereby assuring the participants a large profit. Lewisohn Brothers began making a market in the stock by buying and selling orders that kept the price of the stock up and encouraged further public participation. The Pujo Committee tried to determine the identity of the bank officials who had profited from this arrangement, but the officer of William Salomon & Co. who had been called as a witness refused to supply that information. He was cited for contempt. The Pujo Committee Attacks the NYSE The NYSE did not escape the Pujo Committees scrutiny. At the time of the committees investigation, the NYSE was the primary market for securities in the United States, and as such is a vital part of the financial system. Quotations on its floor determine the current values of all securities there traded in, which means that the securities of all the greater corporations of the country. Its members maintain private wires to all principal cities of the United States and the transactions conducted by its members are for the account of customers from all parts of the country and from foreign countries. The NYSE was the marketplace of the entire country and of foreign countries for securities and the only public market in the United States where money is loaned and borrowed.62 The Pujo Committee found that the NYSE exercised vast

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control over corporate America in establishing listing requirements and in controlling the quotations of listed stock. The Pujo Committee concluded that the facilities of the NYSE, despite its lofty place in finance, were employed largely for transactions producing moral and economic waste and corruption. Only a small part of the trading on the New York Stock Exchange was for investment. A substantial part may be characterized as virtually gambling. Many small speculators were gambling in stocks, and a continuous influx of new customers were being fleeced. Gambling on the Exchange was fostered by the fact that there was often no delivery on securities transactions. Contracts to buy and sell were offset frequently. The offsetting may be done in a systematic way by clearinghouses or by ring settlements. The Pujo Committee found that obviously, this system of clearing promotes speculation beyond what it would be if delivery had to be made of certificates for the full number of shares bought and sold.63 The Pujo Committee studied the stocks of several corporations and found that most of the transactions in those securities were not for investment purposes. The Reading Co., for example, had its entire common stock issue sold at least twenty times over in 1906. That turnover rate more than doubled in the following year. In a single month, the entire stock of the company was sold six times over. The committee found that the number of shares transferred on the companys books averaged less than 10 percent of the shares that were outstanding during this period. These turnover figures evidenced to the committee that much of the trading on the NYSE reflected massive speculation that amounted to gambling. Other stocks listed on the NYSE evidenced similar trading velocities. Low margin requirements and the relative absence of stock deliveries, suggested to the Pujo Committee that the NYSE was operating in a fashion very similar to that of the futures exchanges, where actual delivery of contracts was rarely taken. The disparity in the number of transactions and the number of transfers may actually have been because the NYSEs clearinghouse was settling transactions on a net basis by 1912. The NYSE clearinghouse did not accept, receive, or deliver securities. Rather, it simply settled the transactions and issued orders for the delivery of securities by net settlement. If a broker sold 10,000 shares of the stock of company A and bought 12,000 shares of that stock on the same day, the member firm would receive only a net settlement of 2,000 shares from another member. Even where delivery was made, the stock was often borrowed to meet the delivery requirement. On one day in 1912, a survey of just thirty-two banks and trust companies in New York City who were members of the New York Clearing House Association showed that they had outstanding call loans in excess of $760 million. Customers were required to pay only 10 percent of the purchase price of securities as margin. An official of a large brokerage firm testified before the Pujo Committee that 90 percent of its business was conducted on that basis

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that is, 10 percent margin. The banks valued collateral securities at ten points below the quoted value on the New York Stock Exchange in 1912. The banks would then lend 80 percent of that valuation. This effectively meant a 70 percent loan value, but the brokers would lend on 10 percent margin. In a famous exchange, J.P. Morgan argued with the Pujo Committee over the basis for granting commercial credit. He asserted that it was not based upon the possession of money or property, but rather the first thing is character. He stated that in lending money, banks and other institutions look to more than just collateral. The Pujo Committee, however, noted that on the stock exchange loans were based simply on collateral. As a means of curbing speculation, the Pujo Committee recommended that margins on stocks be set at a minimum of 20 percent. The committee expressed concern that margin loans were diverting credit resources from places where they were needed, such as capital for industrial growth. Hypothecation of customer securities was being abused. Although the NYSE prohibited its members from pledging wholly paid customer securities for the brokers own loans, brokers often hypothecated customer margin securities. This presented a danger to those customers in the event the broker became insolvent. The margin customers could not obtain the securities by simply paying off their loans because the securities were combined with others and not separately identified. The result was that the customer could lose the equity in his margin securities in the event of a default by the broker. This practice was found to have encouraged short selling and excessive speculation. Scandalous practices were uncovered by the Pujo Committee that involved officers and directors who were speculating upon inside and advanced information as to the action of their corporations.64 Like the Hughes Committee, the Pujo Committee noted that the NYSE allowed matched orders where the buy and sell transactions were executed by different brokers and commissions were paid. Manipulation remained a common feature on the NYSE, often accompanied by wash sales that gave a false appearance of activity in order to encourage the public to speculate in the stock. One highly publicized case of manipulation involved the Columbus & Hocking Coal & Iron Co. This manipulation was conducted by a pool composed of ten stock exchange firms managed by James R. Keene. As the pool manager, he gave the orders to raise the price of the stock from $25 to over $90. The pool was broken, however, when large numbers of shares were offered for sale. Lathrop, Haskins & Co. and J.M. Fiske & Co. failed when the pool collapsed, as did the specialist for the stock on the NYSE. There was suspicion that a member of the pool had turned on his fellow pool operators and sold the stock. It may have been Keene. The Pujo Committee recommended that wash sales and manipulation be prohibited. The NYSE set brokerage commissions based on a fraction of each $100 par value of securities being sold. The purpose of the minimum commission rule was to prevent competition among members for business. Breaches of

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the minimum commission rule were considered among the most infamous crimes that a member of the exchange could commit. Despite their anticompetitive effect, the Pujo Committee did not advocate the unfixing of broker commissions. The committee was concerned that rate competition could lower service and threaten the financial responsibility of exchange members. Further, low commission rates would encourage speculation and could destroy the value of exchange membership. Those same arguments would keep commissions fixed until the 1970s. The Pujo Committee did advocate regulation of the NYSE by requiring it to incorporate. The committee thought that the states could impose charter provisions that would require the exchanges to avoid speculative operations and restrict abuses. The committee wanted the Interstate Commerce Commission to supervise interstate offerings of railroad securities. The committee recommended that interstate offerings of other securities be conducted by public or private competitive bids, rather than by private investment bankers such as J.P. Morgan & Co. The Pujo Committee also saw a need for a regulation of stock trading by a federal commission, a proposal that tracked the views expressed by Theodore Roosevelt, who advocated the creation of a federal securities commission in 1912 while running for president. Another suggested reform was that, as a condition for having their stock listed on an exchange, corporations should be required to provide periodic public statements about their assets and liabilities, income and expenses, and a description of payments made to brokers, promoters, and others who were issuing or underwriting stock. The Pujo Committee sought to require stock exchange members to keep accurate records concerning customer transactions. The Pujo Committee also examined corporate control issues. It found that public shareholders in the United States were largely powerless and took little initiative to control or influence management policies. The committee was unable to find a single instance in the history of the United States where public stockholders had overthrown existing management in any large corporation. The result was that management was self-perpetuating. The Pujo Committees concerns with corporate governance would be renewed in the 1930s by Adolf Berle and Gardiner Means in their treatise entitled The Modern Corporation and Private Property. The Pujo Committee Recommendations The recommendations of the Pujo Committees were, for the most part, ignored by Congress. Senator Owen, chairman of the Senate Banking and Currency Committee, sought to have the stock exchanges regulated by the Postmaster General in 1914. That legislation was not passed. Some reform was attempted through the Federal Trade Commission Act of 1914, which created the Federal Trade Commission. That agency was authorized to inves-

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tigate and stop noncompetitive practices. Another reform effort was the Clayton Act, which was passed in 1914. It sought to strengthen the prohibitions in the Sherman antitrust law by prohibiting interlocking directorships that limited competition. Legislation was proposed in New York that would have required the NYSE to incorporate, but that effort was opposed by the NYSE, and the legislation was not passed. The NYSE would not incorporate for several more decades, and it was not receptive to other suggestions of reform. The NYSE contended that its only role was to supply a meeting place for its members to deal in securities. Although the legislative response was limited, the money trust continued to be a focus of public concern after the Pujo Committee exposures. Louis Brandeis fueled this concern with a series of articles in Harpers Weekly that were later turned into a book offering further criticism of the money trust. Brandeis charged that the dominant element in our financial oligarchy is the investment banker.65 Brandeis proposed a remedy and set the stage for future regulation. He asserted that publicity is justly commended as a remedy for social and industrial diseases. Sun light is said to be the best of disinfectants; electric light the most efficient policeman. This prescription of full disclosure as the most effective means of regulating the securities markets would become the formula for the federal securities laws that govern our markets today. Those reforms would have to await another even more devastating panic to force their adoption.

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5 Banking and Securities Before the War

Changing of the Guard The partners at J.P. Morgan & Co. resigned from a large number of their corporate directorships in 1914. The reason given was that they did not have time to attend so many board meetings, but undoubtedly that action was taken to deflect the Pujo Committees criticism of J.P. Morgans influence. Their sacrifice was anticlimactic. J.P. Morgan was gone. That pillar of finance died on April 1, 1913, in Europe. His body was returned to America, and the New York Stock Exchange closed in his honor. J.P. Morgans estate was valued at $80 million. That was a lot of money, but not nearly as great as the fortune of John D. Rockefeller, whose estate was generating over $50 million just in income each year. After hearing the value placed on Morgans estate, Rockefeller was said to have remarked, [A]nd to think he wasnt even a rich man.66 J.P. Morgan was not the only one dying during a European vacation. The Titanic had earlier taken several wealthy individuals to their graves, including Colonel John Jacob Astor IV, whose estate was worth $85 million. The Titanic was operated by the White Star Line, which was owned by the International Mercantile Marine (IMM), a Morgan company. The president of IMM, J. Bruce Ismay, was harshly criticized for jumping into a lifeboat and saving himself while women and children were left to perish. J.P. Morgan Jr. (Jack) took over the reins of the Morgan firm when his father died. From that position, he assumed the leadership of the money trust in America and, like his father, was vilified by reformers. Jack had some more violent critics as well. On July 3, 1915, a German instructor at Cornell University who had just bombed the capital in Washington tried to kill Morgan. The would-be assassin was carrying two revolvers and dynamite. He and Morgan fought. Morgan was shot twice, but he prevailed in the struggle and quickly recovered from his wounds. This would not be the last attempt on his life.
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Financial Institutions The number of state banks tripled between 1900 and 1914. Despite their setbacks during the Panic of 1907, more than 1,800 trust companies were in operation in 1913, and some 2,000 savings banks were accepting deposits. By World War I, there were, in total, 30,000 banks and trust companies operating in the United States, serviced by over 240 clearinghouse associations. Some new financial institutions were appearing on the scene. The Morris plan banking concept was started in 1910 by Arthur Morris at the Fidelity Loan & Trust Company in Norfolk, Virginia. Under the Morris plan, workers were able to take out small, one-year loans that were paid back in monthly or weekly installments. The borrower had to have two cosigners and prove he was creditworthy before a loan would be granted. Interest was deducted in advance from the loan proceeds. The interest rate was supposed to be 6 percent, but with the advance deduction and the weekly or monthly payments, rates could run over 11 percent. The Morris plan was a success. Within ten years, these Morris plan banks, as they were called, were operating in thirty-seven states. Congress established a Postal Savings Bank system in 1910. These banks provided small depositors with a safe place for their savings. The Postal Savings Banks were allowed to keep 5 percent of their deposits as a reserve fund in the Treasury of the United States. They could invest up to 30 percent in government securities, but the president could require these banks to invest even higher percentages. These provisions had the effect of expanding the market for government bonds. In 1911, postal savers were offered the opportunity of exchanging their savings accounts for 2.5 percent, twenty-year government bonds. The bonds dropped almost immediately in price as interest rates rose. Even so, by 1916, there were some $80 million of deposits in the Postal Savings Banks. In another effort to improve consumer financing, Congress amended the National Bank Act in 1916 to allow national banks located in towns with a population of less than 5,000 to act as insurance agents. Those policies had to be written by unaffiliated insurance companies. Farmers and homeowners were receiving attention from legislators. Wisconsin authorized the creation of land mortgage associations in 1913. A Land Bank of the State of New York was organized in 1914. It issued bonds on the security of farm mortgages. Several states authorized investment of school funds in farm mortgages. In 1916, the Federal Farm Loan Act established Federal Land Banks for lending money on farm mortgages in each of twelve farm loan districts across the country. These government banks were to provide loans to farmers at low rates. A Federal Loan Board was created to administer the twelve district Federal Land Banks. The banks were owned by local residents, who could subscribe to shares and borrow from their bank. These institutions could loan up to $50,000. Shareholders in the joint-stock land banks were subject to double liability in the event of the banks failure. This was the same for the national banks. The Federal Land Banks were said

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to be a form of investment trust in that they were issuing bonds to buy mortgages. Loans could be made for up to $25,000 on farmland, and the proceeds could be used to buy land, livestock, or equipment. But subscriptions to the new Federal Land Banks proved less than enthusiastic. Only 24,000 shares were subscribed. The result was that the Secretary of the Treasury had to purchase almost the entire amount of the $9 million capital of the twelve banks that were created. A syndicate was formed in July of 1917 to market bonds for the Federal Land Banks. The syndicate was composed of Alexander Brown & Sons, Brown Brothers & Co., Harris, Forbes & Co., and Lee, Higginson & Co. Frank A. Vanderlip became president of the National City Bank in 1909. That bank was using Howard Fiske & Co. to execute transactions in government bonds for its out-of-town correspondent banks. After observing the number of commissions being paid to that broker for executing the National City Banks customer orders, Vanderlip decided to capture that revenue for the bank. Vanderlip put the bond business into an affiliate organized for that purpose. Vanderlip thereafter formed a holding company that held the National City Bank stock and that of sixteen other banks and trust companies, including Riggs National Bank of Washington, D.C. This was essentially a chain banking network used as an alternative to branch banking. Bank Affiliates After the Comptroller of the Currency ruled in 1902 that a national bank could not act as an investment bank in underwriting securities, the larger national banks began forming affiliates to act as securities dealers. The First Trust and Savings Bank, established in 1903, was owned by the shareholders of the First National Bank of Chicago. The use of such affiliates would be copied by several other banks, including the First National Bank, which established the First Security Corporation in 1908. Although technically designated as affiliates, there was little separation between the banks and their securities affiliates. In fact, they were bound together and made inseparable by couplingthat is, the printing of the bank and the affiliate stock on the reverse side of the same certificate so that the two securities could not be sold separately.67 In order to avoid the comptrollers restrictions, the officers and shareholders of the National City Bank were listed as shareholders of the banks securities affiliate, rather than the bank itself. Under this arrangement, technically, the affiliate was not owned by the bank. This affiliate, the National City Co., was funded by a special 40 percent dividend of $10 million that was to be used by the banks shareholders to pay for the stock of the affiliate. Spoiling the picture of corporate separation was the fact that shareholders of the National City Co. could not transfer their shares unless they transferred their stock in the bank. In addition, through a trust arrangement, the banking affiliate was controlled by the officers and directors of the bank.

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The investment banking affiliate of the Chase National Bank, the Chase Securities Corporation, was organized in a fashion similar to that of the National City Co. On November 6, 1911, Frederick W. Lehman, the solicitor general of the United States, rendered an opinion to the attorney general that the creation of the National City Co. violated banking laws because the company was not independently organized. The opinion not only attacked the creation of the National City Co. upon a legal basis, but almost prophetically pointed out the abuses and danger that would arise from the interrelationship of investment affiliates with large commercial banks.68 The National City Bank ignored that ruling. The attorney general then adopted the solicitors opinion and was prepared to mount a formal challenge to the subsidiary as being in violation of the national banking laws. The Secretary of the Treasury, however, took the opposite position. President William H. Taft then requested that the matter be sent to him for resolution. Taft decided to sit on the issue and nothing was done. The Pujo Committees investigation renewed the criticism of the bank securities affiliates after Woodrow Wilson took office in 1913. The committee saw the affiliates as simply a means for the national banks to evade restrictions on their securities activities. Despite these concerns, no action was taken to halt the use of affiliates by national banks to conduct a securities business, and the National City Co. soon became a major force on Wall Street. The Pujo Committee investigation similarly failed in its effort to enact federal legislation that would regulate the offer and sale of securities. Blue-Sky Laws Legislation to regulate corporations at the state level was also encountering difficulties. Just before leaving the New Jersey governors office to become president, Woodrow Wilson had signed seven statutes, called the seven sisters, that sought to curb the financiers by, among other things, banning the incorporation of holding companies in New Jersey. This progressive experiment was less than successful. New Jersey almost immediately suffered a drastic decline in revenue as the corporations rechartered in more welcoming jurisdictions. After Wilson became president, however, New Jersey reversed course and began easing its laws to stem the corporate defections. That action came too late. The states were fiercely bidding against each other to attract corporate charters by increasing the laxity of their administration and regulation. One state in particular, Delaware, determined to win this race to the bottom, took the lead as the friend of business and the preferred state of incorporation. The state would not relinquish that position. By the 1920s, it had become the home for most large corporations. At one point, some 10,000 corporations maintained their technical headquarters on a single floor of a building in Wilmington.

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The states were not entirely unwilling to regulate finance. Several states created commissions to supervise their corporations. Connecticut, in 1903, required mining and oil companies to file a certificate with the Secretary of State showing their financial condition and information about their drilling or mining activities. Georgia adopted a statute in 1904 that restricted the conditions under which companies could sell their stock on an installment plan. In 1909, Nevada required mining companies to file semiannual reports. In the following year, Rhode Island required issuers and sellers of securities to file financial reports with the Secretary of State. These reports were required for corporations located outside the state. Kansas is given credit for adopting the first blue-sky securities law. This was a derisive reference to promoters selling stock in companies whose only assets were blue sky. The Kansas statute was the first effort to adopt a comprehensive regulatory program for the sale of securities. Enacted in 1911, the law required companies selling securities in Kansas (both investment bankers and brokerage firms) to register with the states bank commissioner in order to obtain a license. Under the Kansas blue-sky law, issuers had to provide detailed information about their securities issues. In 1914, Kansas amended its law to provide for the registration of the sale of securities, rather than registration of companies issuing securities. This became the model for blue-sky legislation in other states. Over twenty states adopted some form of blue-sky law shortly after the enactment of the Kansas legislation. Some states, such as Pennsylvania,69 required broker-dealers to register. Some required permits before new securities could be issued. Many of the state statutes were simply antifraud provisions. New York prohibited brokers from hypothecating customer securities without their consent, except to the extent that the securities were being posted on margin. Brokers were required to provide their customers with confirmation of the execution of their orders on the customers request. New York prohibited false or misleading rumors, statements, or advertisements in connection with the sale of securities, and brokers were prohibited from receiving customer monies after the broker was insolvent. New York additionally prohibited bucket shops, manipulation, and fictitious transactions. Although a federal court in 1914 held that the Michigan and Iowa bluesky laws were unconstitutional because they unduly interfered with interstate commerce, the Supreme Court would rule in 1917 that the blue-sky laws were a proper method of state regulation.70 By then, twenty-seven states had such statutes. More would follow. Between 1910 and 1933, blue-sky laws were adopted in all of the states except Nevada. Nevertheless, those laws proved ineffective because they could not overcome the traditional legal rule of caveat emptor, let the buyer beware. Moreover, the states could only regulate sales within their borders, which allowed interstate dealers to avoid most regulation.

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Financial Markets The so-called Dow theory was an early effort at financial analysis. That theory was named after Charles Dow, a founder of the Dow-Jones Co. and inventor of its industrial average, but William Peter Hamilton, an editor of the Wall Street Journal, was actually responsible for its development. Hamilton espoused its use in editorials in the Wall Street Journal between 1902 and 1929. The Dow theory was based on a belief that investors should seek a return of 12 percent per year instead of the 50 percent weekly sought by greedy speculators. This was a trend-following system based on the Dow Jones industrial and transportation averages. The theory posited that both of these averages must proceed in the same direction before a trend would be established. Economists were beginning to dissect the economy on a grander scale. Irving Fisher at Yale was at the forefront of this dismal science. He was using indexing to measure inflation through a cost-of-living index. The economy was changing even as the economists tried to fathom its mysteries. By 1910, the number of industrial companies listed on the New York Stock Exchange was fast outstripping the number of railroad companies. The market continued to experience difficulties. The Dow Jones Industrial Average fell 18 percent in 1910, then drifted lower for the next several years.71 Trading volume on the NYSE had grown to over 200 million in 1909, but then volume gradually declined as prices fell. By 1912, volume had fallen to less than 130 million shares. In the following year, volume was only 83 million shares as the effects of a worldwide recession reached America. The NYSE responded to criticism of its failure to regulate the conduct of members by prohibiting them from making purchases on the floor for their own account unless the price was one-eighth of a dollar higher than the highest bid of the customers. Sales could not be made for the members own account except at a price of one-eighth of a dollar lower than the lowest offer of their customers. The NYSE adopted a rule in 1913 that required proper and adequate margins, but this did not stop the growth of the call money market. Most margin loans were obtained by the brokers from banks or other brokers. Call money could also be obtained from a stand on the floor of the NYSE where loans were negotiated. The chief lenders on the floor of the NYSE were the National City Bank, the National Bank of Commerce, the Chase National Bank, the Hanover National Bank, J.P. Morgan & Co., and Kuhn, Loeb & Co. Loans made on the floor were payable on demand and could be collateralized by listed securities. The pink sheets began in 1911. These were quotations for over-the-counter market stocks that were printed on a distinctive pink paper. This publication would become the prime source for price information on over-the-counter securities until the creation of the NASDAQ market some sixty years later. The New York Curb Market Association replaced the New York Curb Market Agency in 1911. The New York Curb Markets rules prohibited trading or

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quoting securities listed on the NYSE. In addition, members were required to obey police regulations by not trading outside roped areas on the street. [S]idewalks and streets must be kept clear at all times for traffic; skylarking, disorderly conduct, and unnecessary noise forbidden.72 Curb market rules provided for cash transactions on which delivery was to be made upon the day of the contract or regular way, which required delivery on the business day following the contract. Buyers or sellers options were allowed for not less than four days or not more than sixty days. Time contracts of more than three days had to be made in writing. The curb market was trading in when, as, and if issued contracts. The curb market required periodic and complete financial statements as to the condition of all corporations quoted on the market. The bond market was growing. Over $1.5 billion of bonds were underwritten in 1912. A number of bond houses were specializing in such underwritings. These firms acted as wholesalers, allocating the issues to retail brokerage firms for sale to the public. In England, many debentures issued by British companies were made being perpetual or irredeemablethat is, these bonds would be paid only in the event that the company was dissolved or in the event of a default. This seems to have been the case well into the twentieth century. Prior to World War I, investment banking firms in the United States used foreign firms to distribute American securities abroad. Goldman Sachs & Co. and Lehman Brothers used Kleinwort Sons & Co., Albert, Wagg & Russell, and S. Japatt & Co. in London and Labouchere, Oyens & Co. in Amsterdam. The investment bankers handling equity underwritings in America traded in the stock being issued in order to stabilize its price during the underwriting. These stabilizing activities continued to encourage manipulation that sought to drive the price of the stock up and induce investors to purchase at increasingly higher prices. Such practices would become a focus of future regulation. Between 1912 and 1915, there were only some 250 securities dealers operating in the United States, chiefly concentrated in the eastern part of the country. It was not until the time of the launching of the Liberty loans in the year 1917 that we find a large number of independent dealers engaged in the business of distributing securities throughout the country.73 In November of 1910, an arbitrageur was advertising his services in stocks and bonds in the New York Times. This individual claimed that he was engaged in strict arbitrage. No speculating. Estabrook & Co. was acting as bankers in investment securities in New York and Boston before the outbreak of World War I. Salomon Brothers & Hutzler was founded in 1910. There were three Salomon brothers in the firmArthur, Percy, and Herbert. They had worked for their father, who was a money broker. Morton Hutzler joined the firm not long after it was formed, and it kept the name of Salomon Brothers & Hutzler until 1970. Salomon Brothers originally operated as a discount house that bought and sold notes and bonds, both corporate and government. Arthur Salomon designed exotic futures contracts for bankers acceptances.74

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Before World War I, N.W. Halsey & Co., a banking firm in Philadelphia, Chicago, and San Francisco, was selling bond issues that had been Approved by Our Engineering, Legal and Accounting Experts. These bonds presented an unusual opportunity.75 John Muir & Co., Specialists In Odd Lots published the Odd Lot Review. It discussed weighty matters such as whether there was any sound foundation for the twenty-year cycle theory. White, Weld & Co. sold investment securities in Chicago, New York, and Boston. John P. Marsh & Co. offered 5 percent mortgages in Chicago in 1912 to trustees, banks, insurance companies, and other institutions. Wheat farm bonds on Canadian lands were sold in Chicago. Those bonds paid 7 percent per annum. Spitzer, Rorick & Co. offered municipal bonds that netted from 4.25 to 5.75 percent. Seney, Rogers & Co. sold real estate gold bonds and mortgages on Chicago property. Investments from $100 to $50,000 were sought. These investments were said to be safe-secure-dependable.76 John Nuveen & Co. offered municipal bonds. W.M. Sheridan & Co. provided a free market letter on automobile industry securities to its Chicago customers. Those issues included Willys-Overland, Packard, Ree, Hupp, Maxwell, Firestone Tire, Chalmers, Studebaker, Ford of Canada, General Motors, and Paige-Detroit. Jones & Baker touted McIntyre Mines as an investment, proclaiming monthly net earnings of about $35,000. Blair & Co. offered investment securities and travelers letters of credit. In 1912, William Salomon & Co. and Hallgarten & Co. created the Agricultural Credit Company, which was to purchase notes given for agricultural implements. Brokerage firms were selling partial payment plans that allowed small investors to make stock purchases on installment payments. These plans usually required a 25 percent down payment and monthly payments of 5 to 10 percent of the cost of the securities. S.W. Straus & Co., mortgage and bond banker, is credited with having created the first mortgage real estate bond in 1909. It was a security with a senior claim on a building constructed for investment. This project was followed by others that often included the skyscrapers that were increasingly forming the skyline. These bonds yielded 6 percent. S.W. Straus offered to investors a guide to Safe and Profitable investment. The firm stated that it would provide investments of a most conservative character that yielded 5.5 to 6 percent.77 S.W. Straus proclaimed in 1912 that in thirty-one years of business no customer had lost a dollar of principal or interest on any investment purchased of us. The firm dealt in the highest class of first mortgage loans and bonds on income-producing property.78 E.H. Rollins & Sons sold investment bonds. The firm stated that its customers were more than just thatthey were clients: The word client conveys a relation that is based on thorough trust on the one hand and conscious responsibility on the other, and carries a clear meaning that the interests of the adviser and of the client are identical.79 Russell, Brewster & Co. sold 6 percent cumulative stock of the United Light & Railways Co. at a discount. The actual average investment yield on the security was said to be 7.33 percent.

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The Michigan Land & Live Stock Co. sold $100,000 of 7 percent preferred stock in 1914. It claimed that a 10 percent annual increase in land values of the company was assured. Charles R. Blyth and Dean Witter organized Blyth, Witter & Co., in San Francisco in 1914 for the purpose of conducting a general investment banking business. Blyth was president and Witter was vice president. The firm specialized in the electric power and light industries on the West Coast. The firm opened a Los Angeles office in 1916 and a New York office in 1919. Blyth, Witter would open offices elsewhere in California and on the West Coast as well as in New Orleans. William Durant
William C. Durant. Speculator and automo-

Automobile manufacturing was de- bile magnate, Durant would lose a vast fortune in the securities markets. (Courtesy of manding large amounts of capital and Archive Photos.) was attracting speculative interest. The Detroit Stock Exchange was created in 1907 as a result of the rapid growth of the automobile industry. The Ford Motor Company had been incorporated in 1903, the same year that the Wright Brothers first flew, and its sales had grown quickly. William Crapo Durant, a market speculator who founded a carriage company, had taken over the Buick Motor Company in 1904. By 1908, Durant was selling 8,000 automobiles from his plant, outstripping the production of the still young Ford Motor Company. But Durant would make his share of mistakes. One big one was his decision to back out of an agreement to buy the Ford Motor operations in 1909 for $8 million. Durants bankers did not think Ford was worth that much. Durant incorporated the General Motors Corporation by adding Cadillac and Oldsmobile to his Buick operation, as well as other firms and truck companies. General Motors soon became the nations largest automobile manufacturer. John D. Rockefeller loaned General Motors $6 million and was paid off in General Motors shares that increased in price from $200 to $1,500. Like many financiers, Durant was a genius at organizing an empire, but a disaster when it came to administration. General Motors was soon mired in debt, and Durant is credited with creating the junk bond in 1910 as a part of his effort to keep General Motors afloat. Durants borrowings included $15 million from Lee Higginson & Co. of Bos-

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ton and other investment bankers, including J. and W. Seligman and Co. Unable to repay that debt, Durant was forced to retire from active management. The investment bankers were given control through a voting trust, and Charles Nash and Walter Chrysler were hired to manage the company. After exiting General Motors, Durant joined with Louis Chevrolet, a race car driver, and began building the Chevrolet company, which quickly became successful. Durant and his associates began buying up the General Motors trust certificates. Assisting him was the Chatham & Phenix Bank in New York. After the voting trust expired in 1915, control was split between the investment bankers and Durant. To break the deadlock, Pierre Du Pont and his appointees were elected to the board of directors to act as neutral directors. Durant sought to regain control of General Motors in 1915 with the help of John Jacob Raskob, an executive at the Du Pont chemical firm. Durant succeeded in that effort by offering five Chevrolet shares for each GM share. Durant then bought the Fisher Body Corporation, Delco, and other enterprises into the General Motors fold. This made General Motors an industrial giant. Competition in the automobile industry was intense. By 1910, some 200,000 automobiles were being produced annually in the United States. Henry Ford had begun selling his cars for just over $800. Even though Ford was selling all the cars he could make, he started reducing his prices. By 1914, Ford was selling models for as low as $490. At that time, the Ford Motor Company established wages at a generous $5 per day and implemented an eight-hour working day. By 1916, over 1 million automobiles were being sold each year. Henry Ford then sought to cut the Ford Motor Company dividends so that he could sell his cars at ever lower prices. Some price relief was needed. Prices in general had risen some 50 percent between 1897 and 1914. Although Ford knew that he could charge more for his cars and make more money, he believed that he had already made enough money, a philosophy with which the companys other stockholders disagreed. They sued Henry Ford, and the court ordered a dividend. The judges pointedly reminded Henry Ford that a corporation was to be operated for the benefit of shareholders and not for charitable purposes or simply for the publics benefit. Automobile Finance The first finance company to discount consumer installment paper was organized in 1908. It paved the way for the first automobile finance company, which was created in 1913. The Commercial Credit Company began specializing in automobile finance loans in 1915. It bought installment purchase agreements from the dealers and also financed dealer inventories. In the following year, the Commercial Investment Trust Company was formed for the same purpose. In 1919, General Motors created its own finance subsidiary, the General Motors Acceptance Corporation. This was the real beginning of consumer finance in America. An automobile liability policy was issued in 1912 by James S. Kemper,

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who founded the Lumbermens Mutual Casualty Company and the Kemper group of insurance companies. Kempers rates for automobiles were twice those charged for horses. Another form of insurance had arrived in 1911 with the creation of the first group life insurance program for employees. Employee pension plans continued their development. In 1908, the International Harvester Company established a pension plan for employees that offered a minimum of $18 a month to employees with twenty years of service. The maximum amount that could be earned in this plan was $100 a month; the average benefit was about $32 a month. Payments started when the employee reached seventy. International Finance The price of American eagles was up in England before World War I. A transfer tax on stocks was enacted by the federal government in 1914, but federal finance was taking second place to the states before the outbreak of World War I. The debt of the state and local governments, particularly local governments, grew greatly after the turn of the century. State and municipal debt was four times that of the federal government in 1913. Nevertheless, the federal government was flexing its financial muscle abroad through dollar diplomacy. That policy was applied to encourage American banking groups to invest in China so that the development of that country would not be financed entirely by the Europeans. Several banking groups agreed to participate: J.P. Morgan & Co., Kuhn, Loeb & Co., the First National Bank, and the National City Bank of New York. The same four institutions were called upon in 1910 to provide a rescue of Liberia through a loan of $1.7 million. President Theodore Roosevelt also used dollar diplomacy in Latin America and the Caribbean by encouraging those countries to borrow in the United States and, in some cases, taking over the operation of their finances. A Pan American financial conference was authorized by Congress in 1914. Many private bankers attended, as did President Wilson. London was still vying for the title of the center of world finance at the outbreak of World War I. The British pound sterling was the dominant international currency, and London was at the center of the gold standard in the years before World War I. During this gold standard era, exchange rates were remarkedly stable. Lloyd George, the English chancellor of the Exchequer, noted that in 1914 bills of exchange drawn on London were being used to finance cotton movements from the southern United States. Silk and tea bought in China by Americans were being financed through London. Lloyd George claimed that London was transacting far more than the whole of our own business; we were transacting half the business of the world as well by means of these paper transactions. What is also important to establish is this: that the paper which was issued from London has become part of the currency of commerce throughout the world.80 This was not idle boasting, but the United States was growing in financial importance, as witnessed by the fact that its gross national product in 1913 was seven times the gross national product in 1860.

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Chapter 2 America Enters the War

1 World War I

Prewar Finance A recession was under way in the summer of 1913. It was followed by a drop in the stock market as tensions mounted in Europe. A selling wave that originated in Europe after the assassination of Archduke Francis Ferdinand drove prices down even further. The stock market broke in the last week of July 1914. Trading was suspended on the NYSE because of the concern that demands on the call money market would result in another panic. Trading was not resumed until November 28, 1914. Even then, the NYSE imposed price limits on the securities being traded. Those limits were not removed until April 1, 1915. The New York Curb Market and the Consolidated Stock Exchange also closed when the war began in Europe. Trading reopened on the New York Curb Market on November 12, 1914. After trading resumed in the markets, a great speculative furor arose. Stock prices whirled upward with startling rapidity, driven by speculators who believed that American industry would benefit from war production.1 Stock market prices increased by over 50 percent in 1915. A series of manipulations in so-called war stocks followed in the wake of the war fever. These were stocks in companies that were likely to receive large profits from contracts for war materials. There seemed to be no limit to the gullibility of the public and under the influence of these reports supported by purchasing orders of great volume, enormous advances in prices were often established over night.2 The stock of the Crucible Steel Co. was among those manipulated. Although the company could not even pay its preferred dividend arrearages, it was expected to become profitable from European war sales. There was actually some validity to some of those claims. Among the many orders placed by the British government during World War I was a $550,000 purchase of farm wagons from Studebaker and $1 million for the purchase of nitroglycerin. The United States Steel Company had reduced its dividends in 1914 and suspended dividends in 1915. At the end of 1915, how69

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ever, the company was highly profitable as a result of the war, declaring the largest earnings in its history. Those earnings would be exceeded in 1916. When war broke out in Europe, 80,000 Americans were stranded abroad. The international credit exchange system was suspended, and Americans had difficulty in cashing their letters of credit. An American Committee was set up in London, with its headquarters at the Savoy Hotel, to cash letters of credit for travelers.3 The outbreak of war in Europe posed an even greater threat to the money markets in America. Fortuitously, the Aldrich-Vreeland Act of 1908 had been extended by the Federal Reserve Act of 1913. This allowed the banks to issue notes in large quantities in order to meet the monetary crisis brought on by the war. The banks used those notes to pay debts and were able to avoid suspending payments to depositors. The AldrichVreeland notes increased the currency supply by over $380 million. The clearinghouses added to the money supply by issuing certificates that aggregated over $200 million. Supplementing these resources, the Fed issued over $75 million in emergency currency to southern banks and gave banks permission to issue currency on the basis of notes secured by cotton.4 To assist the cotton planters, the Secretary of the Treasury deposited funds in three Federal Reserve banks in Richmond, Atlanta, and Dallas. The Fed then allowed special rates for the rediscount of commodity paper, which was intended to include notes secured by warehouse receipts for cotton. International Payments International payments posed another set of problems. A group of New York banks began forming a $150 million gold pool in September of 1914 for the purpose of meeting American obligations abroad. The gold in the pool was to be held in Canada for drawing checks on London. The banks contributed some $50 million for the gold pool. At the same time, the Fed and the Secretary of the Treasury were supervising the banks in raising another $100 million for the pool, which proved to be unnecessary. In the end, only $25 million in gold was needed because J.P. Morgan & Co. stepped in once again to steady the situation. The most significant part of the international obligations of concern was $80 million in bonds issued by New York City in London and Paris. Those bonds matured in January of 1915 and were required to be paid in gold. Payment was demanded by France and England, both of which were desperate for specie to fund their war efforts. Unfortunately, New York City did not have the gold to make payment. City officials asked J.P. Morgan & Co. to lead an underwriting of $100 million in gold notes in the United States. The proceeds of that loan were to be used to cover the European and other obligations of the city. J.P. Morgan & Co. recruited Kuhn, Loeb & Co. Together, they formed a syndicate of over 125 banks to conduct the New York City underwriting. The banks agreed to buy $100 million of bonds from the city. Of that amount, $80 million in gold was to be shipped to Europe to pay off the New York City bonds. The

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issue was oversubscribed, and this reduced most of the need for a gold pool. J.P. Morgan & Co. refused compensation for its services. England was forced off the gold standard during World War I, and gold was soon flowing back to America. Between the outbreak of the war and April of 1917, over $1 billion in gold was sent to the United States by the Allied powers for war purchases. America then became a source of finance for the governments involved in the war in Europe. Much of that financing would be supplied through the private investment bankers. One unique and creative structured financing effort presaged the asset-backed securities that bloomed at the end of the twentieth century. At the opening of World War I, British investors held some $4 billion in American securities. In December of 1915, Great Britain announced a stock loan scheme whereby American securities held in Great Britain by British investors would be bought or borrowed by the British government and used as collateral to obtain loans in the United States. In instances where the securities were borrowed, the owners were to receive 0.5 percent interest from the British government, in addition to the income from the securities. An investor who loaned securities to the British Treasury could request that they be sold and the proceeds credited to the investor. Such sales were advantageous to American purchasers because the war was pumping up the value of the securities that were being sold. The British stock loan scheme required some additional incentives to obtain securities from English investors. One such measure was a special tax imposed on American securities that were not sold or loaned to the British government. Even so, the British Exchequers effort to require its citizens to give up their American securities failed to bring in adequate amounts. As a result, the British government, in 1917, began requisitioning foreign securities held by British citizens. The British government further prohibited the sale of foreign securities held by its citizens outside the United Kingdom. Through such measures, the British government was able to obtain almost $3 billion in American securities from its citizens in order to fund its loan operations in the United States. Among those selling American securities was the Carnegie Trust in Great Britain. In December of 1915, it sold $25 million of fifty-year, 5 percent bonds of United States Steel so that the proceeds could be reinvested in English securities. In February of 1916, J.P. Morgan & Co. sold almost $23 million of United States Steel 5 percent, first mortgage bonds for the Carnegie Foundation in Scotland. The British investment trusts sold a large portion of their American investments. One British investment trust lost heavily because it had specialized in Russian securities. The British Treasury sold Exchequer notes during World War I to obtain funds. In September of 1916, for example, three-year Exchequer notes were sold that paid 6 percent. Principal and interest were exempted from British taxes if the notes were held by persons domiciled outside the United Kingdom. This was an inducement for foreigners to purchase those notes. In November of 1916, the British and French governments announced through J.P.

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Morgan & Co. that they would be issuing short-term Treasury securities in the New York market that would have maturity dates ranging from thirty days to six months. The Federal Reserve objected to this offering and warned the New York banks against making such purchases. As a result of those objections, the British Exchequer announced that it was withdrawing the proposal. Nevertheless, J.P. Morgan & Co. and other American banks made demand loans for the British government secured by gold and American securities. Those loans totaled some $400 million at one stage. The securities securing the loan were valued at more than $700 million. J.P. Morgan & Co. acted as the British and French governments purchasing and financing agent for war materials in America during World War I. In August of 1915, J.P. Morgan & Co. received some $30 million of securities and $20 million in gold from the British government. The shipment was sent from England to Halifax by British battleship and from there by special train. A similar amount was brought over by British cruiser. These consignments were used as collateral for loans to pay for Great Britains purchases. J.P. Morgan & Co. received another consignment of about $50 million of gold and securities from Great Britain in September of 1915. Still another cargo of gold arrived from Great Britain in October of 1915. This shipment included English coins valued at $25 million. In April of 1915, J.P. Morgan & Co. underwrote a French Republic oneyear loan in the United States for $30 million. In June, a $40 million loan was placed in the United States for the French government. This de Rothschild Frres loan was secured by United States railroad securities that had been turned in by French nationals in exchange for French bonds. J.P. Morgan & Co. was representing the Rothschilds in obtaining French financing in the United States. J.P. Morgan & Co., with the assistance of Kuhn, Loeb & Co., sold a large number of a Pennsylvania companys 3.75 percent bonds that were held by the Rothschilds. Brown Brothers & Co. was assisting on a smaller scale. It arranged the extension of a $25 million commercial credit to France. The French government asked American investment bankers to arrange for the American railroads to pay off their French franc bonds by dollar payments at profitable exchange rates for the railroads. Large amounts of that debt were then paid off through bond issues in America. In 1917, J.P. Morgan & Co. negotiated another asset-backed loan for the French in the United States in the amount of $100 million. This operation was carried out through a specialpurpose vehicle called the American Foreign Securities Co., which was organized to effect this loan. The American Foreign Securities Co. offered $94 million of three-year, 5 percent, convertible gold notes to investors in the United States. The proceeds were then loaned to the French. The French government secured their loan with securities borrowed from their French owners that were valued at $120 million. This loan program was oversubscribed. An Anglo-French loan for $500 million in 5 percent, five-year bonds was completed in October of 1915. The Anglo-French loan was a joint obligation

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of the British and French governments and was obtained through the sale of bonds in the United States that paid 5 percent and matured in five years. The bonds were convertible into British-French bonds that paid 4.5 percent with a longer maturity. J.P. Morgan & Co. was the lead underwriter. This loan was oversubscribed. Six individuals, including Charles M. Schwab of the Bethlehem Steel Company and members of the Du Pont family, subscribed to $100 million of this loan. In December of 1915, some $300 million of another Anglo-French loan was placed for investment. When the syndicate began to dissolve, however, the bonds dropped sharply in price. Sales on sellers fifteenday and thirty-day options were clearing at several points below the syndicate price of 98. In August of 1916, the United Kingdom borrowed another $250 million in the United States through the issuance of two-year, 5 percent, secured gold notes. The lead underwriter was again J.P. Morgan & Co. The notes were secured by collateral worth $300 million, including $100 million of United States securities that had been taken from British citizens. The entire offering was sold to investors in the United States. These notes were a direct obligation of the British government. Another loan was effected by J.P. Morgan & Co. in October of 1916 for $300 million of British and Irish 5.5 percent gold notes. The notes were secured by $360 million of stocks, bonds, and securities. Principal and interest was payable in United States gold coin at the offices of J.P. Morgan & Co. Alternatively, at the option of the holder, payment could be received in London in sterling at the fixed rate of 4.865 dollars to the pound, without any deduction for British taxes. The English pound was otherwise pegged at $4.27 during World War I. American Financial Leadership The Federal Reserve noted in 1916 that the United States is fast becoming the banker of foreign countries in all parts of the world.5 This was no exaggeration. Bond sales and loan participations were being conducted through some 1,500 banking institutions in the United States. J.P. Morgan & Co. would lead the underwriting of some $1.5 billion in loans for the British and French during the Great War. Kuhn, Loeb & Co. often supported J.P. Morgan & Co. in the larger underwritings, but also had other business. In September of 1916, Kuhn, Loeb & Co. underwrote a loan of $50 million for the City of Paris. The loan involved the use of five-year notes that paid over 6 percent interest. The principal and interest on the bonds were made payable at the option of the holder either in New York in gold or in Paris at the fixed rate of 5.50 francs per dollar. This gave to the holder the prospect of a very substantial profit in exchange inasmuch as the normal rate of exchange before the war was about 5.18 francs per dollar. The loan was heavily oversubscribed. It looked like something of a replay of the Erlanger loan used by the Confederacy during the Civil War, except that it did not involve cotton. In November of 1916, Kuhn, Loeb led syndicates that sought to place loans

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of $20 million each for the City of Bordeaux, the City of Lyon, and the City of Marseilles. The loans were made through 6 percent, three-year gold notes that were sold to investors in the United States. These offerings were not completely successful because the Federal Reserve warned against tying up funds in foreign Treasury notes, which might have to be renewed. In the event, another $50 million of loans were made to French industrial firms by the Guaranty Trust Company, the Bankers Trust Company, and William P. Bonbright & Co. Other countries were also seeking financing from America. Early in 1915, $15 million in 6 percent gold notes was sold for the Republic of Argentina. In June of 1916, a $50 million loan was arranged by American bankers for the Russian government. The credit was to last three years. To secure the loan, the Russian government established in Petrograd a credit of 150 million rubles in favor of the American banks at a fixed ratio of three rubles to a dollar. The American banks were given an option to purchase 5.5 percent, five-year imperial Russian bonds at 94.75 less a commission of 4.5 percent. These bonds could be purchased with the ruble credit. This gave the bankers a possible play on exchange rates. Later, in November of 1916, a syndicate composed of J.P. Morgan & Co., the National City Bank, the Guaranty Trust Co., Lee, Higginson & Co., and Harris, Forbes & Co. conducted an offering for $50 million of Russian government 5.5 percent, five-year bonds. The bonds sold at a discount, which netted the purchasers a return of about 6.75 percent. This offering did not prove entirely successful. Only about $30 million in bonds were sold. In June of 1917, the Equitable Trust Company of New York, Chandler & Co., and others announced that they had purchased an issue of 6 percent bonds of the Republic of Bolivia for $2.4 million. The National City Co., the securities affiliate of the First National City Bank, acted as underwriter for $4 million of 4 percent, ten- to thirty-year gold bonds of the Philippine Islands. Lee, Higginson & Co. acted as the head of an American syndicate for underwriting $25 million of 6 percent, one-year Italian government gold notes that were sold in the United States in October of 1915. Norway obtained a loan of $5 million at 6 percent for seven years from banks in the United States in December of 1915. On March 24, 1916, J.P. Morgan & Co. underwrote a $75 million, 5 percent gold loan for the government of Canada. In November of 1916, $5 million in 6 percent, three-year Treasury notes of the Republic of China were being offered in the United States. Another offering of $5.5 million of 6 percent serial bonds of the City of Sao Paulo were sold to American investors. The pace of American financing quickened as the United States came closer to joining the war. In January of 1917, J.P. Morgan & Co. acted as underwriter for $250 million of secured convertible gold notes for the United Kingdom. Those notes paid 5.5 percent interest and were to mature in one to two years. The notes were convertible at the option of the holder into twenty-year, 5.5 percent bonds, if not previously redeemed. The notes in this offering were

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payable either in New York in gold coins of the United States or, at the option of the holder, in London at a fixed rate of exchange of 4.865 dollars to the pound. The notes were secured by American, Canadian, and other securities worth $300 million. If the securities dropped in value by more than 20 percent, the British government agreed to deposit additional collateral to maintain 120 percent security to loan value. Later, in March of 1917, J.P. Morgan & Co. was the head of a syndicate that underwrote $100 million of 5.5 percent, secured, convertible, two-year gold notes for the French government. Like the earlier City of Paris offering, these notes were payable in New York City in United States gold coin. The holder, however, could collect both the principal and the interest in francs at a rate of exchange of 5.75 francs to the dollar, which was a favorable exchange rate. The loan was backed by securities valued at $120 million. The French and British governments paid for gunpowder and other purchases in the United States during World War I by issuing notes. The Du Pont Company took $55 million in notes for goods delivered. The Du Pont Company used those notes to declare a dividend. It could not otherwise dispose of the bonds because a sale would have depressed the market. The foreign securities of Britain and France that were not paid out to shareholders as dividends by Du Pont were discounted with banks. American railroad securities continued to be actively traded in Germany during World War I. Germany also placed several note issues in the United States between 1914 and 1916. One issue handled by Chandler & Co. in 1916 was for $10 million. The imperial German government issued another $10 million in Treasury notes in the United States in 1917. The notes, which paid 6 percent interest, were used to establish commercial credits in the United States for the German government. The declaration of war against Germany by the United States in April of 1917 stopped that activity. America Enters the War The Treasury Department had been gearing up for increased demands on the money supply even before Americas entry into the war. In January of 1917, the Treasury announced that it would begin issuing one- and two-dollar United States Treasury notes. The bills were needed because the Treasury could not issue enough silver certificates in those denominations. In April of 1917, over $250 million of Treasury certificates was issued. These certificates were a little over one year in duration, paid 3 percent, and were offered only to institutions. Some $200 million of the proceeds from that issue was made available to assist England in the war effort. Another $200 million of United States Treasury certificates was issued to assist France and Italy for the same purpose. After the United States declared war, President Woodrow Wilson imposed an embargo upon the export of gold, including coin, bullion, and currency. Persons leaving the United States could not carry more than $200 in

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gold and $5,000 in cash. Silver raised some side issues during the war. A jump in silver prices occurred in September of 1917. This was the highest price for silver since 1878. Prices then sharply declined. Congress authorized the Secretary of the Treasury to retire silver certificates and then to sell the silver that backed those certificates. The Treasury Department sold to Great Britain 200 million ounces of silver for use by the government of India. The Liberty Loans Within three weeks of the declaration of war against Germany by the United States, Congress approved $5 billion in Liberty Loans that paid interest not to exceed 3.5 percent. Railroad bonds were then paying 4.79 percent. The Liberty Bonds had a maturity of thirty years but could be redeemed by the government in fifteen years. They were tax-exempt, except for estate taxes. To provide immediate funds, certificates of indebtedness were issued by the government in anticipation of the Liberty Loan proceeds. The secretary issued some $4 billion of those certificates in 1917 to meet government expenses. The certificates were used to provide liquidity through repurchase transactionsthat is, the certificates were purchased by the Federal Reserve Bank of New York for short intervals and then resold to the original sellers. This repo process was also used for repurchases of bankers acceptances. The first Liberty Loan was issued in June of 1917 for $2 billion. These securities could be converted into bonds bearing a higher rate should any future Liberty Bond issues pay more than 3.5 percent. In 1918, Congress set a limit of 4.25 percent interest on its bonds with maturities of more than five years. The Secretary of the Treasury noted that the first Liberty Loan was the largest single piece of financing ever undertaken by the government of the United States.6 Another Liberty Loan was authorized in October of 1918 for $3 billion. It was oversubscribed by over a billion dollars. This loan paid a rate of 4 percent, but did not have as much exemption from federal taxes as the first Liberty Loan. Another Liberty Loan for $6 billion soon followed. In 1918, the American public subscribed to almost $7 billion of a single issue of Liberty Loan bonds. In May of 1919, a Victory Loan was authorized for $4.5 billion. The total amount of money borrowed through the Liberty Loans was in excess of $18 billion. These tremendous loan programs allowed the federal government to finance its own war efforts and to loan its Allies almost $12 billion during World War I. The Liberty Loan program was carried out and supervised largely by commercial and private banks. The Federal Reserve Board handled administration of the Liberty Loan programs, but the promotion of their sales was conducted privately. Commercial banks purchased approximately $5 billion or 20 percent of the debt issued to finance the war.7 Liberty Loan Committees were established across the country to aid sales of the remainder. In New York, over 300 bond salesmen were seconded to the Liberty Loan

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Committee by the banks and bond houses. The National City Co., Harris, Forbes & Co., and the Guaranty Trust Co. were among those loaning their bond salesmen to the Liberty Loan Committee. Booths were open in department stores and bond salesmen were assigned to those locations. Taking a leaf from Jay Cookes book, the government widely advertised Liberty Bonds to assure their success. A War Loan Organization was established that created a speakers bureau and distributed posters and advertisements to push the sale of Liberty Bonds. Some 2 million individuals volunteered to sell these bonds. Movie stars, including Charlie Chaplin and Douglas Fairbanks, were used to promote sales. Over a million newspaper articles supported the sale of these bonds. Some 2,700 editorials, over 1,000 cartoons, approximately 16,000 columns of newspaper publicity, and over 1,500 pages of paid newspaper advertisements were devoted to Liberty Loan sales. Some 45,000 pieces of advertising literature further promoted Liberty Bond sales, as did thousands of signs. Prospective Liberty Bond purchasers were told that the purchase of a single $50 bond would buy 1,000 trench mortar shells, 100 hand grenades, or knives, forks and spoons for an entire company of soldiers.8 The public was urged to borrow money in order to buy more Liberty Bonds. Participation certificates allowed the public to purchase Liberty Loans in installments. Five $10 participation certificates could be exchanged for a $50 Liberty Bond. The certificates were to be presented to the Federal Reserve Bank of New York in exchange for a 3.5 percent gold bond with coupons attached. In another twist, Liberty Bonds were sold on margin under installment plans. Thrift and war savings stamps, which were issued in denominations of as little as twenty-five cents and up to five dollars, were another means used to attract small investors. War savings stamps matured in five years and were sold at a discountthat is, a stamp purchased for $4.12 would mature at $5. Treasury savings certificates of $100 and $1,000 were authorized. Over $800 million in war savings and thrift stamps were sold. As a result of the bond-selling campaigns, the Liberty Loans were oversubscribed. The sales campaigns had the further effect of vastly increasing securities ownership in America. Some 200,000 individuals could be described as investors before World War I, while an estimated 20 million individuals bought Liberty Bonds during the war. More than half of the adults in the United States bought Liberty Bonds in one form or another. The flotation of the Liberty Bonds created a much larger public interest in general securities than there had been before. That created a tremendous market for the borrowing of capital by industry.9 When more funds were needed by the government during the war, the First Chicago National Bank and other banks purchased millions of dollars of Treasury securities for their own accounts. Additional monies for the war effort were raised through taxes. Americas entry into the war resulted in the adoption of special taxes on bankers and brokers. Inheritance taxes, which taxed the whole estate, were enacted. The

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income tax was increased, and an excess profits tax was enacted. The latter was a tax on profits in excess of those obtained by businesses from 1911 to 1914. The rate for the excess profits tax varied from 20 to 60 percent. As an example, the United States Steel Corporation earned over $144 million in one quarter. The company set aside about $50 million of that amount to cover the excess profits tax and other war taxes. In 1917, income tax revenues exceeded customs duties for the first time in United States history. Within a few years, income tax revenue would be ten times that of customs duties. Taxes and loans were needed. The cost of World War I to the United States would total about $36 billion. The national debt increased from $1 billion to $15 billion during World War I and would reach $25 billion in 1919. Great Britain found itself nearly bankrupt in 1917, a sharp contrast to its dominant position in international finance in the prewar years. It owed $400 million on a maturing loan that had been underwritten by J.P. Morgan & Co., but the United States advanced almost $700 million to Great Britain, allowing it to continue the war effort. Even with the massive requirements of the Liberty Loans, Wall Street continued to finance foreign governments. On August 22, 1917, J.P. Morgan & Co., acting for the British government, placed $15 million of ninety-day British Treasury bills in the United States. This was intended to become a weekly affair. U.S. Consols and U.S. registered 4s were also being sold in the United States during the war by Great Britain. War Finance The American government created several large organizations to deal with shortages and other problems encountered by the war. The War Finance Corporation (WFC) was established in 1918 for the purpose of subsidizing and underwriting bank loans to war industries. Its stock was held by the Treasury and managed by a board of directors appointed by the president. The WFC was authorized to issue $3 billion in bonds. The government also supplied the WFC with capital of $500 million. The WFC provided $17 million to the Brooklyn Rapid Transit Co., whose $57 million in gold notes were maturing in July of 1918. The WFC conditioned that advance on a requirement that the holders of the maturing notes exchange at least 70 percent of their holdings for new three-year, 7 percent notes. A direct loan was made by the WFC to the United Railways Company of St. Louis in the amount of over $3 million. The WFC loaned over $200 million to the railroads, which was the bulk of the loans it made during World War I. The WFC did not make more loans because the private market was able to finance most of the war effort without government assistance. A Bureau of War Risk Insurance was created in the Treasury Department in 1914 to insure merchant ships. The War Risk Insurance Act created the Government Life Insurance Program for soldiers and other servicemen. This program provided for renewable term insurance with benefits of up to $10,000 for individuals serving in the military.

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In December of 1917, the government took control of the railroads. Lightless nights were ordered in December of 1917 to conserve energy. Albert H. Wiggin, the state fuel administrator, directed that there be six lightless nights a week in New York. The fuel administrator asked businesses not to burn fuel on Mondays except to prevent damage from freezing. The NYSE tried to trade on Mondays without heat or light, but this proved unsuccessful. It began closing on that day. Bernard Baruch, the speculator, was appointed by Woodrow Wilson as chairman of the War Industries Board. Baruch went on to serve every President until his death in 1965.10 In his position at the War Industries Board, Baruch bought war materials at the rate of $10 billion a year. Charles M. Schwab, the head of the Bethlehem Steel Company, was placed in charge of the countrys shipbuilding efforts during the war. A young Joseph Kennedy left his position as president of the Columbia Trust Co. in Boston to become the manager of a Bethlehem Steel shipyard. John D. Ryan was appointed director of aircraft production for the army in April of 1918. The financiers were contributing in other ways. In May of 1917, Henry Davison of J.P. Morgan & Co. became chairman of the Red Cross War Council. The Red Cross soon announced that it had obtained $100 million in private contributions for war relief work. Davison suggested that corporations should declare extra dividends of 1 percent or more in order to assist the Red Cross. United States Steel was among those agreeing to this plan. Eventually donations to the Red Cross during the war totaled over $134 million. World War I was expensive in money as well as lives. Estimates for direct expenditures of the belligerent parties exceeded $200 billion. At the end of World War I, Great Britain would owe the United States over 800 million. France owed 600 million. Much of the debt to the Allied governments was canceled, but Britain was still using 1 percent of its income tax receipts in 1965 to repay its debt. Financial relief from America continued. A postwar United Kingdom loan of $250 million was made by J.P. Morgan & Co. on November 1, 1919. Two French Republic loans in September of 1920 and June of 1921 totaled another $200 million.

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2 War and the Stock Market

The Dow Jones Industrial Average more than doubled between 1915 and 1917 as the war raged in Europe. The number of shareholders in United States companies had increased from 4.4 million in 1900 to 8.6 million in 1917. Daily trading volume on the NYSE fluctuated between one and two million shares per day. Trading activity picked up considerably in September of 1916, but the stock market suffered a reverse in January of 1917 when the German government announced that it would be conducting unrestricted submarine warfare. Further pressure was placed on the market when the United States declared war on April 6, 1917, ending the bull market enjoyed by America while the war was only a European affair. The outbreak of war, the large loans obtained through the Liberty Bonds, and the large amounts of foreign finance being sought in the United States caused a violent disruption of the capital markets. Securities prices dropped, causing concern with the liquidity of financial institutions.11 One problem was that the savings banks were investing in the stocks of public utilities that threatened to become illiquid, because the securities markets were being drained of funds by foreign and United States government loans. The Money Committee The massive loans that were being floated to fund the war were drawing funds away from the call money market. By September of 1917, Wall Street brokers were experiencing difficulty in obtaining call loans. This presented the danger that investors might be forced to sell their margin securities, which would then precipitate a panic. Another problem was that, as banks began to withdraw loans from the call market and lend on Treasury securities, pressure was being placed on interest rates. The Treasury and the Fed expressed concern that this could jeopardize Treasury financing. Those concerns were addressed by the Liberty Loan Committee in New York, which formed the Subcommittee on Money Rates. More popularly referred to as the Money Committee,
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this entity sought to assure that adequate funds were available for the call money market. It was composed of Benjamin Strong, governor of the New York Federal Reserve Bank and chairman of the New York Liberty Loan Committee, and eight officials from New York City banks. The committee was later expanded to include representatives of about sixty-five banks in order to assure that the supply of loans to the stock exchange was maintained. The Money Committee was called upon to coordinate the availability of call money when government flotations that were in progress or impending might create a money shortage. The Money Committee arranged a pool of $450 million for call money loans that would be available for the stock market at all times. Another $200 million was apportioned for the call market on an as-needed basis. To further assure low rates for call money, a money desk was created on the floor of the NYSE. Previously, brokers had secured funds by competitive bidding at the money post on the floor. The money desk changed this methodology by allotting funds to brokers at a set rate of 6 percent on the principle of first come, first served.12 To assist its efforts, the Money Committee requested daily reports from banks and trust companies on the amount of their call money market loans. The Money Committee sought to assure that credit to the stock market was limited to necessary requirements and not for speculation. Despite the efforts of the Money Committee, the market continued to be unstable. On November 1, 1917, after a collapse in prices, the NYSE sought to monitor speculative short selling by requiring all members to supply lists of stocks that were borrowed for short sales and the names of customers from whom they were borrowed. The House Committee on Rules held hearings in 1917 on a House resolution to investigate charges made by Thomas W. Lawson, the copper magnate and financier, that stock market manipulators had been trading on secret information contained in one of President Wilsons notes to the belligerent powers. Nothing came of that investigation. Although a brief rally occurred when Jack Morgan visited the NYSE, prices dropped again after the announcement that the Bolsheviks were gaining control in Russia. The market later rallied with news of Allied victories, but another sharp break in stock prices occurred at the end of April 1918. Speculation began to increase in August of 1918 as the war approached its end. The Money Committee then reversed its position and sought to restrict funds into the call market in order to dampen speculation. The committee sought to use moral suasion to limit margin loans. The Federal Reserve Board assisted by sending a letter to the banks and trust companies requesting that they exercise care in issuing credits that were not necessary for the war effort. On September 5, 1918, Benjamin Strong sent a letter to the president of the NYSE requesting that its members furnish a daily statement of the amount of money borrowed on time and on call. He was concerned that speculation would heat up as Allied victories mounted. The NYSE agreed to this request. The Money Committee suggested increases of margin on stock trans-

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actions from 20 to 25 percent. Later, in October of 1918, the committee requested that margin requirements be increased from 20 to 30 percent on mixed collateral loans and to 37.5 percent on loans secured wholly by industrial stocks. This action was sought in order to dampen speculation, which had risen sharply, as had been feared by Governor Strong. A few months later, after the Armistice, the committee reduced margins required by bank loans to 20 percent. Speculation was renewed, and the Money Committee again recommended that 30 percent margin be required by the banks on all regular loans. The banks agreed to that request, but the Money Committee came under criticism for its regulatory efforts, and it voted to dissolve itself. Although the committees controls were scheduled to expire in any event on January 10, 1919, its tenure was extended for a short time. Thereafter, conditions in the money market eased, and the Money Committees activities ceased. The Capital Issues Committee The role of the independent Treasury system was shifted to the Federal Reserve banks during World War I. The Federal Reserve Bank of New York sold and distributed almost half of all securities offered by the Treasury during the war and handled its foreign exchange and its arrangements with and loans to foreign governments.13 The Fed was strengthened during World War I by patriotic appeals to the banks asking them to join the system. The Fed extended its reach further by becoming a regulator of the securities markets. Treasury Secretary William McAdoo announced in January of 1918 that he was creating a voluntary program for submission of new securities issues for government review. That review process sought to assure that unnecessary private sector securities offerings did not divert capital needed from the war effort. The secretary turned this review function over to the Federal Reserve, which formed a Capital Issues Committee (CIC) to review applications. The CIC included Paul M. Warburg, as well as two other members of the Federal Reserve BoardCharles S. Hamlin and Frederick A. Delano. An advisory committee of private bankers to assist the CIC included Allen B. Forbes of Harris, Forbes & Co. and Henry C. Flower, president of the Fidelity Trust Company of Kansas City, Missouri. The CIC was modeled after a British committee that had been established in 1915 to review private issues of new securities in excess of $100,000. The CIC worked closely with the War Industries Board, which was headed by Bernard Baruch. Initially, municipal securities offerings of $250,000 or more were reviewed by the CIC, but that level was reduced to $100,000 on February 24, 1918. The effect of this process was virtually to halt school construction in most states. The CICs review covered industrial and public utilities securities issues of $500,000 or more. Among the loan flotations approved by the CIC was a $60 million offering by Armour & Co., for 6 percent, convertible gold debentures. This offering was exceptionable because it was made by

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a syndicate of Chicago investment bankers, rather than New Yorkers. The Continental and Commercial Trust and Savings Bank was among those in the underwriting group as well as Halsey, Stuart & Co. The CIC approved a $25 million, 7 percent, gold note offering by the Procter & Gamble Company in March of 1918. Another offering by Winchester Repeating Arms Co. was for $8 million of one-year, 7 percent gold notes. Legislation in 1918 formalized the authority of the CIC. The War Finance Corporation Act that was signed by the president on April 5, 1918, authorized the CIC to determine whether securities issues were compatible with the national interest. This legislation was to continue in effect until six months after the end of the war. The CIC consisted of seven members, three of whom were required to be members of the Federal Reserve Board. The CIC was assisted by twelve district committees composed of individuals who provided local knowledge on securities offerings. The CIC was directed by the legislation to continue its review of equity offerings in excess of $100,000 for the purpose of conserving investment capital in order to insure an adequate supply thereof for the use of the Government and essential war industry and to give effect to the Governments policy of war business first. 14 The CIC sought to determine whether individual offerings would interfere with the financial operations of the Treasury and whether the funds being sought were for a purpose compatible with the public interest. The CIC was to ration capital for use only by those enterprises and industries which served some immediate and definite investment, military or economic need.15 The CICs review covered over 2,000 applications for new securities offerings. In total, the CIC reviewed securities issues valued in excess of $3.7 billion. The CIC in effect became the predecessor to the Securities and Exchange Commission (SEC), which regulates the stock markets today. The CIC even had an Enforcement Division, and it was no paper tiger. The CIC disapproved almost $1 billion in securities issues over a six-month period. Numerous other applications for securities were withdrawn after criticism by the CIC. The CIC sought to continue its role after the war. The committee advised Congress that continuing federal supervision of securities issues was needed in order to check the traffic in doubtful securities, while imposing no undue restrictions upon the financing of legitimate industry.16 The CIC believed that the magnitude of the traffic in securities justified intensive regulation:
Before the war this traffic amounted to tens of millions of dollars annually, but reports made to the committee from all parts of the country . . . indicate that this traffic has greatly increased during the war, due to high wages and to the further fact that millions of people have invested in liberty bonds. The estimate of $500,000,000 annually devoted to the purchase of . . . fraudulent or worthless stocks seems to the committee to be too conservative. This sum represents sheer waste and net loss to the people and the Nation not only of dollars but of morale, confidence, and the incentive to serve. The Nations loss can not be measured alone in money values, but in terms of those things which make for good citizenship.17

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The CIC pointed out the vast sums being lost by the public and diverted away from legitimate enterprises through the sale of fraudulent or worthless securities. It sought legislation that would correct this evil and stop doubtful issues. The CIC proposed the creation of an Economic Vigilance Committee to stop fraudulent securities offerings. The CIC found that purveyors of fraudulent securities usually sought to victimize inexperienced investors,18 who were induced to sell their Liberty Bonds at less than market prices and to use the proceeds to purchase worthless securities. Another scheme condemned by the CIC involved sales to farmers of membership interests in a Farmers Service Company that had no assets or business. The promoters claimed that memberships were not securities that would be subject to regulation under state blue-sky laws. As another example, the CIC noted that it had turned down an underwriting of $1.8 million of stock in a company that was to build automobiles and tractors. The underwriting was proposed by an individual who had no experience in the business and no model or plan for production. The securities industry had been greatly enlarged by the distribution of Liberty Bonds. Consequently, the purveyor of stocks and bonds is no longer put to the necessity of seeking out a select list of prospective purchasers with money to invest. He now has the entire American public, and the transaction becomes one of persuasion to trade: to trade a Government bond bearing a low rate of interest for stocks or bonds baited with promise of high rate of return and prospect of much riches.19 The CIC stated, This unlicensed and unrestricted traffic is a crevice in our financial structure through which flows the constant torrent of funds in utter wastage. It can and should be stopped; but more than that, it is a source of heavy financial loss to hundreds of thousands who have a right to look to their Government for the protection this committee recommends should be given.20 The CIC concluded that state blue-sky legislation had been effective only with respect to companies that were operating in a single state. In 1917, the banking commissioner in Kansas claimed that the blue-sky law of that state had saved investors $6 million and that more than 1,400 companies were being investigated for their securities activities. When the companies expanded across state lines, however, the securities commissions of the states were powerless to regulate the activities outside their own state. Although a national association of blue-sky commissioners had been formed, they too were constrained by the reach of each individual members state laws. The CIC believed that federal regulation was needed. It noted that regulation of securities had long been the practice of many nations. This was true of the leading countries of Europe as well as the English colonies. In England such regulation has existed in some form since 1862.21 The United States was almost alone among the advanced nations in not having securities regulation. The CIC did not mention that one nation was taking an even harsher approach to speculators. In Russia, Lenin was closing the exchanges and demanding that speculators be shot on the spot.

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The CIC was forced to suspend its activities when the war ended. Carter Glass, who had been appointed Secretary of the Treasury on December 6, 1918, took up its cause. Glass had previously been the chairman of the House Committee on Banking and Currency. While Secretary of the Treasury, Glass charged that the NYSEs encouragement of speculation by margin trading was unsound and dangerous to the general welfare. Glass claimed that an open and notorious manipulation of stock prices had occurred after the removal of the controls of the Money Committee.22 He was right to be concerned. A rash of speculation and customer abuses occurred in the markets when the war ended. Stock prices increased by some 25 percent between April and November of 1919. Hundreds of millions of dollars of worthless stock were being offered in the country. On August 8, 1919, President Woodrow Wilson asked Congress to adopt a federal securities act in order to stop speculation and to prevent the fraudulent methods of promotion by which our people are annually fleeced of many millions of hard earned money.23 This was the legislation recommended by the CIC. Several other bills were introduced in the next two years that sought to prevent the deluge of fraudulent promoters and their success in exchanging the worthless securities of resourceless projects for Liberty Bonds.24 In 1920, the so-called Volstead Bill sought to allow the Attorney General to investigate fraudulent securities sales when conducted through the mail and to issue cease and desist orders. One bill sought to make it illegal to engage in activities that evaded state blue-sky laws. Several other bills sought to regulate securities trading. None were passed. Securities Trading Problems continued with the Liberty Bonds. Those bonds were marketable and could be sold and resold. In contrast, the bonds that would be sold during World War II were not marketable. Instead, the World War II bonds would be redeemable at predetermined values by the government. This protected the holders against price fluctuations. Harry Truman learned the difference the hard way. He bought Liberty Bonds while in the service during World War I. The future president sold the bonds when he returned from the war and received only $80 for each $100 bond. He was disturbed when those same bonds later traded for $125. Other people were more astute in their securities investments. Ty Cobb, the baseball player, purchased some 300 shares of the CocaCola Company after World War I for less than $11,000. His annual income from Coca-Cola dividends reached $350,000 within eight years.25 Eventually, after additional purchases, Cobb was receiving over $1 million a year from his Coca-Cola dividends. He was but one of a growing number of wealthy individuals. By 1917, there were more than 40,000 millionaires in the United States, ten times the number that existed in 1892. Their leader was John D. Rockefeller, but he was working on reducing his fortune. By the end of World

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War I, Rockefeller had given $275 million to charity. Between 1917 and 1922, he gave away another $475 million to his children. The NYSE changed the way it quoted stocks. Traditionally, stocks had been quoted as a percent of par value. This meant that a stock quoted at sixty was selling at 40 percent off its par value of $100. After October of 1915, stocks were traded simply on their dollar price. Changes were made in the clearing and settlement process. The NYSE clearinghouse, which had been created in 1892, did not provide for the clearance of money settlements. During and after World War I, however, brokerage firms often had difficulties processing orders as volume increased. The NYSE created a clearing corporation in order to ease that situation. It took over the functions of the clearinghouse of the NYSE and was to be capitalized at $500,000. A NYSE specialist was suspended for one year during the war for improper activities in dealing with an odd-lot house. In December of 1918, the NYSE issued a directive that was designed to keep stop orders held by specialists confidential. Traders had been able to determine what those stop orders were from the books of specialists, which permitted the traders to anticipate those orders for their own benefit. In October of 1914, the firms of J.L. Holland & Co. and Paul Lambert & Co. in New York failed. The NYSE claimed they were bucket shops with extensive wire connections all over the United States and Canada. Other nationwide firms would experience similar difficulties. One of the most aggressive efforts at creating a nationwide brokerage firm was begun in 1912 by Jones & Baker, a midwestern firm that also had some 400 employees in New York. Jones & Baker had several departments including a statistical department, an information bureau, and a telephone services division. It was the first full line brokerage firm.26 The firm published its own newsletter called Jones & Baker Curb News. The firm ran private wires to homes of favored clients. Jones & Baker claimed to be the largest broker in America by 1917, but L.L. Winkelman & Co. was a competitor. By 1918, the Winkelman firm had offices in numerous cities, particularly in the Midwest. Both Jones & Baker and L.L. Winkelman & Co. were curb market firms. Both of these wire houses encountered difficulties and went bankrupt in the early 1920s. It is not clear why they failed, but the Winkelman firm had liabilities of $10 million at the time of its demise. Branch offices were being opened by other firms. J.S. Bache & Co. had ten branch offices in 1919. E.F. Hutton had six branch offices in that year. James E. Bennett & Co., a member of the Chicago Board of Trade, had twenty-five branch offices. Bartlett Frazier Co. had seven branch offices. Thompson & McKinnon had six branch offices, as well as thirty-eight correspondents. Shearson, Hammill Co. had six branch offices and seven correspondents in 1919. Other firms were appearing. In 1915, Hartshorne & Picabia was touting Diamond Match Company stock as a remarkable investment with speculative possibilities.27 Anglo-French five-year gold bonds in denominations of $100, $500, and $1,000 were advertised in the New York Times by Kissel,

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Kinnicutt & Co. The bonds were secured by the riches of two of the worlds greatest nations.28 Curtis & Sanger acted as underwriters for the City of Columbia, South Carolina, in the issuance of tax anticipation notes in 1918. Freeman & Co. made a market in Liberty Bonds. Josephthal & Co. acted as a broker in New York. At least two brokerage firms advertised their specialty in Standard Oil stocks. A.A. Housman & Co. sold French Republic 5 percent bonds. The National City Company, the securities affiliate of the First National City Bank, provided tax analysis in 1917 on the income tax, the war income tax, and the war excess profits tax. The National City Company sold high-grade bonds to the public. E.M. Fuller & Co. offered a ten payment plan in Chicago in 1917. Investors were asked to put 20 percent down and to pay the balance of their securities purchases in nine equal monthly payments. W. Steele Westwood sought funds for investment in an unnamed established banking house that had 500 percent potential profit and established earnings of 34%.29 A Chicago investment house that was a member of the NYSE was seeking a salesman for investment securities in 1919: Must be clean, progressive man capable of earning over $7,500 per annum.30 Blyth, Witter & Co., the California firm, was particularly active in public utilities securities. Investment trusts were blooming. In 1914, The American Investment Company was formed. Between 1916 and 1920, other investment trusts followed, including the First Investment Company, the Commercial Finance Corporation, the Mutual Finance Corporation, the Pennsylvania Investing Company, and the Overseas Securities Corporation. William Salomon & Co. was the underwriter of a $15 million, 7 percent, convertible preferred stock issue for the Willys-Overland Company in November of 1915. Willys-Overland was then the second largest manufacturer of automobiles. It ran into some difficulties after the war and was taken over by Walter C. Chrysler, who had left General Motors. The company became the Chrysler Corporation. The Pierce Arrow Motor Company that was operating in 1916 was sold to the Studebaker Corporation in 1928. An automobile merger that failed was an earlier effort to combine Willys-Overland, Chalmers Motor Company, Hartford Motor Company, Packard Motor Company, and Auto-Light Company. This merger was to have been accomplished through an offering of a $30 million, twenty-year, 5 percent bond issue. Henry Ford engaged in a leveraged buyout of the minority shareholders in his company in 1919. Ford paid over $100 million for their stock. He borrowed $75 million of that amount from a syndicated credit arranged by Chase Securities Corp., Old Colony Trust Co., and Bond & Goodwin Co. They funded the credit by ninety-day commercial paper that was rolled over three times. The stock of General Motors Company was oversold when a rumor circulated that additional stock would be issued for the purchase of the Chevrolet Company. The rumor proved untrue, leaving the shorts short. The end of the war caused a drop in the stock price of the General Motors Corporation, and

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William C. Durant formed a syndicate to prop up the price of the stock. This effort was unsuccessful. The Du Pont Company agreed to invest $25 million in General Motors in 1917, and Durant was able to retain control of the company, at least for a time. Woodrow Wilson used a letter of credit drawn on Brown Brothers as a source of funds for his attendance at the Versailles Conference after World War I. Earlier, in May of 1918, Alexander Brown & Sons had organized a national group of investment bankers to sell twenty-year land bank bonds. The syndicate included Harris, Forbes & Co., Brown Brothers & Co., Lee Higginson & Co. and National City Co. The issue was for $75 million. The land bank bonds were exempt from federal, state, municipal, and local taxation. They were redeemable at par plus accrued interest five years after the date of their issue. The bonds were issued under the auspices of the Federal Farm Loan Board, a bureau in the Treasury Department. In order to assure their acceptance, former Supreme Court Justice and failed presidential candidate Charles Evans Hughes, then a private lawyer, provided an opinion that the bonds were constitutional. The bonds paid 4.75 percent to their first redemption date, which was 1923, and 5 percent thereafter. The land bank bonds were secured by a deposit of an equal amount of United States government bonds or first mortgages on farm lands that were guaranteed by the National Farm Loan Association. The mortgages could not exceed $10,000 or one-half of the appraised value of the mortgaged land. These bonds were lawful investments for all fiduciary and trust funds under the jurisdiction of the federal government and in many states. During World War I, Salomon Brothers & Hutzler was one of the largest sellers of Liberty Bonds. In 1917, the firm became a registered dealer in Treasury securities. Henry Goldman, who joined Goldman Sachs & Co. in 1885 and was the son of Marcus Goldman, left that firm in 1917 after disagreeing with his partners over their lack of support for Germany during World War I. Commercial paper was being quoted at varying rates for the nature and number of endorsers. For example, rates varied for choice double and prime single names and at a higher rate for good single names in 1915. The choice double names were paying between 3.25 and 3.75 percent, while good single names were paying 4 percent.31 J.P. Morgan & Co. was making advances of cash on call against bankers acceptances to dealers and discount houses. Financial Changes The credit card industry began in 1914 when Western Union, department stores, and hotels began to offer charge cards. The express companies role in finance was changing. The Interstate Commerce Commission had investigated the express business and found numerous abuses. In 1913, Congress created the parcel post system, which made deep inroads into the express business. The government removed much of the remaining competition when it took

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over the private express business during World War I. This directly affected the American Express Companys 10,000 offices and 15,000 employees. The other major express companies were the Adams Express Company, Wells Fargo, the United States Express Company, and the Southern Express Company. After the government takeover, the express companies merged their business into a single entity, which was first named Federal Express and then the American Railway Express. The express companies received stock in that enterprise, but were essentially out of the express business. Some of the companies continued on with other business, but the Adams Express Company became simply an investment trust.32 The American Express Company continued its money order business and its travelers checks. Kuhn, Loeb began marketing ordinary shares of the World Dutch Company in 1916. The shares of the company were deposited under a deposit agreement and certificates of beneficial ownership were issued for those shares. These certificates were known as American shares and were listed on the NYSE. Another issue was made in 1918, but the certificates were then being called New York shares. The Equitable Trust Company of New York was used as a depository for the shares. This was the beginning of the American depository receipt. Securities trading was spreading around the world. Three stock exchanges were operating in Shanghai after the war: the Shanghai Stock Exchange, the Stocks and Commodities Exchange, and the Shanghai Chinese Merchants Stock Exchange. The first gold bullion fixing was held by members of the London Gold Market in September of 1919. Thereafter (with the exceptions of a fifteen-year period between 1939 and 1954 and a two-week period during March of 1968), the five members of the London Gold Market met each working day to fix the price of gold, which established gold prices around the world. The Wall Street Journal more than doubled its circulation between 1912 and 1920. Other information services were growing as well. Poors Publishing Company began issuing credit ratings in 1916. The Standard Statistics Company began its credit ratings in 1922. Fitch Publishing Company followed with its own credit ratings service in 1924. The Dow Jones Industrial Average was expanded from twelve to twenty stocks in 1916. A number of bear raids occurred in the stock market between 1919 and 1921. The stock market dropped during that period, and the Goodyear Tire & Rubber Co. was almost bankrupted. The company was saved by a restructuring in which Dillon, Read & Co. and others underwrote $30 million of twenty-year bonds for the company. Goodyear issued an additional $27 million in convertible debentures. A further $33 million of preferred stock was given to trade creditors to meet their claims. Crum & Forster in New York acted as agents for insurance companies and organized investment companies to purchase and hold the securities of insurance companies. Crum & Forster formed the Hutchins Securities Co. in 1909 and Richard Wiley, Inc. in 1914 for that purpose. In 1919, Crum & Forster

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formed even more investment companies for insurance company stocks, including the Reserve Resources Corporation, the Hutchins Investing Corporation, and the Reserve Investing Corporation. These companies were set up to assist the insurance companies when they needed a large source of funds. The National Convention of Insurance Commissioners defined group insurance in 1918 as covering at least fifty employees. The insurance industry faced a major challenge when flu killed approximately 5 percent of the American population in the winter of 1918 and 1919. This loss of life nearly bankrupted the life insurance industry. Pension Plans By 1911, eleven public utility companies had pension plans. The American Telephone & Telegraph Company began a pension plan in 1913. Sears, Roebuck began a profit-sharing plan in 1916. The U.S. Rubber Company established a pension plan for its employees in 1917. Following World War I, pension plans for employees became more popular and often used deferred annuities that were purchased through insurance companies. Nearly ninety companies had adopted employee stock purchase plans before 1919. By 1923, another 121 companies had adopted retirement plans for their employees benefit. Those plans held over $90 million in assets. A future giant, the Teachers Insurance and Annuity Association (TIAA) was organized in 1918 by the Carnegie Foundation to provide retirement plans for teachers. TIAA later created its College Retirement Equity Fund (CREF) unit as a means for teachers to invest in stocks. Compensation had its limits. In Rogers v. Hill,33 the Supreme Court held that an incentive plan for executives of the American Tobacco Company was an improper waste of corporate assets. The scheme was simple: James Duke, who was leaving the company, offered his executives 10 percent of any amount the company earned over its current earnings. Duke, the benefactor of Duke University, thought this was fair since the shareholders would be receiving 90 percent of those increases. Tobacco sales expanded quickly during this period, and the directors were soon receiving massive amounts of compensation. A federal circuit court upheld this scheme but it was discovered that one of the judges hearing the case had been bribed. On appeal, the Supreme Court simply could not accept that such large payments were appropriate. Disturbances Attacks on Wall Street were mounted from other quarters. In 1919, leftist radicals began sending mail bombs to many prominent people in the United States, including Jack Morgan and John D. Rockefeller. The bombs were intercepted by the post office before they could be delivered. Among other prominent individuals escaping bombings were the Attorney General, A. Mitchell

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Palmer, and Franklin Roosevelt. Jack Morgan was the apparent target of another bomb that exploded outside the offices of J.P. Morgan & Co. on September 17, 1920. Contained in a horse-drawn wagon, the bomb injured more than 200 people and killed 33, including a Morgan employee. A young Joseph Kennedy was knocked down by the blast. The windows on the New York Stock Exchange were broken, and the building that housed the Morgan firm at 23 Wall Street was badly scarred. Property damage totaled $3 million. The culprit was never apprehended, but Paul Avrich, a history professor at Queens College in New York, has identified an individual he believes was responsible for the bombing. Apparently, the bomber was protesting the indictment of two anarchists, Nicola Sacco and Bartolomeo Vanzetti, who were later executed. The bomber died in Italy in 1963. In 1919, Charles Ponzi, the owner of the Old Colony Foreign Exchange Company, operated a get-rich-quick scheme that promised 50 percent profits: a quarterly profit of $5 for every $10 invested. He took millions of dollars from the innocent and gullible. Ponzis scheme involved the creation of a company called the Securities and Exchange Company (SEC). He claimed that SEC was buying international postal reply coupons in Europe that could be redeemed at favorable exchange rates. Crowds of individuals seeking to invest in Ponzis scheme gathered outside his office. In fact, Ponzi was using the funds of new investors to pay off the old investors. Six banks failed after it was revealed that Ponzis entire program was a gigantic fraud. Ponzi was said to have swindled $15 million from 40,000 people. Ponzi was sentenced to prison, but he skipped bail and emerged as a promoter in the Florida land scandals in the middle of the 1920s. Not all small investors were powerless victims. In 1917, Robert J. Frank, a Chicago attorney who held forty shares of stock in the Burlington Railroad, filed a lawsuit challenging its control by the Great Northern and the Northern Pacific railroads. He claimed that Burlington was being run for their benefit to the detriment of other shareholders. The general counsel for the Burlington noted that the attorney had bought the shares knowing of the control situation. Just what induced Mr. Frank, with full knowledge of the situation, to buy a few shares of stock and then immediately complain of burdens imposed upon him as a stockholder must be left to surmise.34 Accounting The accounting industry became more formalized in 1917 when the American Institute of Accountants prepared a document entitled Uniform Accounting, which provided guidelines as to what should be undertaken in an audit. The first federal effort to improve accounting standards occurred in 1917 when the Fed, at the urging of the countrys first Secretary of Commerce, William C. Redfield, published a booklet entitled Approved Methods for the Preparation of Balance Sheet Statements. There was a need for improvement.

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Barrow, Wade, Guthrie & Co. was claiming in 1908 that it was the oldest accounting organization in America, having been established in 1883. That firm audited Bache & Company from 1913 to 1917. During that period, a Bache employee pilfered some $1 million. A court held that the certified public accountants were liable for negligence in failing to detect this defalcation. However, the amount of their damages was only $2,000, which was the auditors fee.

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3 The Futures Markets

Chicago would dominate futures trading in America during the twentieth century, but other exchanges were trading futures and commodities. New York had seven commodity exchanges in operation before World War I, including the New York Burlap & Jute Exchange and the Maritime Exchange. Other exchanges dealt in produce, cotton, coffee, fruit, hay, dairy products, poultry, and metals. The fruit and hay exchanges in New York were really cash markets, and there was little speculation in those commodities. The New York Produce Exchange traded futures in wheat, cottonseed oil, and a dozen other commodities. The New York Coffee Exchange was the primary coffee market in the United States. The government of Brazil sought to eliminate that exchange as a price-setting mechanism for coffee by using government funds to fix coffee prices. That effort was unsuccessful, but Brazil did disrupt prices. A sugar market was organized on the New York Coffee Exchange in 1914 after the foreign sugar exchanges stopped trading because of World War I. It was intended to be a world exchange for the purchase and sale of sugar but was closed by government order when America entered the war. The Coffee Exchange changed its name to the New York Coffee and Sugar Exchange in 1916. The New York Cotton Exchange was the leading cotton market. It used some eighteen grades for classifying cotton that ranged from fair to middling. The New York Cotton Exchange had competition from the New Orleans Cotton Exchange and the Liverpool exchange. Cotton on call contracts provided purchasers of cotton with more flexibility in fixing their prices. Under these contracts, cotton millers agreed with a cotton dealer to buy a specified amount of cotton, but the price would not be set until a later date. The price would then be determined on the basis of futures contract prices on a commodity exchange. The New York Mercantile Exchange (NYMEX) allowed futures contracts to be traded that did not provide for delivery. Instead, either party to a transaction could avoid delivery by paying a maximum penalty of 5 percent. Quotations on this exchange were published by a committee of buyers of butter and eggs. Critics claimed that those quotations were being set for
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the advantage of members. The New York Metal Exchange had been operating in New York since the 1880s, but had declined in importance after the turn of the century. Like the NYMEX, that exchange published market reports, but there had been no actual sales on its floor for several years. Prices were set by an exchange quotation committee or were fixed by large metal firms for their contracts. The New York Metal Exchange would experience a revival in 1928 when it was reorganized as the National Metal Exchange. It then traded futures in tin and later copper. The exchange later added futures contracts in silver. Regulatory Issues Some regulation of the futures markets was conducted by the commodity exchanges. A Council of Grain Exchanges had been formed in 1908 to encourage uniformity among the rules and procedures of the exchanges across the United States. It was not successful because each exchange desired to retain its own prerogatives. Although most of the commodity exchanges prohibited outright difference trading, the Chicago Board of Trade (CBOT) and the Kansas City Board of Trade allowed contracts known as bids and offers. These were really puts and calls or privileges that operated much like difference trades. The exchanges all prohibited wash sales, and the exchanges in Chicago, Minneapolis, and Milwaukee prohibited cross trading, but the practice was not defined in their rules. Most of the grain exchanges prohibited false or fictitious purchases or sales. By 1919, the CBOT prohibited any member from being involved as both principal and agent in the same transaction. It sanctioned members for failing to execute commodity futures trades during the hours of regular trading and required that transactions in the exchange be executed by open outcry on the floor. Sales had to be made public and could not be restricted or specified for acceptance by any particular member. Curb trading was prohibited by the Minneapolis, Milwaukee, Kansas City, and St. Louis grain exchanges. The CBOT required that transactions for future delivery be confirmed before six oclock in the evening on the day the trade was made. The exchanges generally tried to supervise market letters or circulars sent out to customers by their members in order to prevent the letters from exciting pure speculation.35 Exchange rules provided for the discipline of members. Members charged with rule violations were given a formal hearing before an exchange disciplinary committee composed of other members. Bucket shops remained a problem. Such operations were prosecuted on a national scale in 1909. In 1916, the Attorney General in Pennsylvania brought an action that demanded the forfeiture of the charter of the Consolidated Stock & Produce Exchange in Pittsburgh. Members of that exchange had been criminally prosecuted for running a bucket shop. The Hughes Committee, which investigated the securities markets after the Panic of 1907, had also focused on the commodity exchanges. The committee was concerned with the abuses

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that occurred, but it found that futures trading was useful in allowing the hedging and more orderly distribution of commodities. The Bureau of Corporations published a report (the Garfield Report) on futures trading in cotton. The report concluded that futures trading had prevented sudden and violent price fluctuations. This forestalled legislation for a time, but continued manipulations by speculators resulted in calls for legislation to regulate the commodity markets. Some twenty-five bills were introduced in Congress between 1907 and 1909 that were designed to regulate futures trading. As president, Theodore Roosevelt proposed legislation to prevent gambling in commodities and securities, and to prevent the cornering of markets. Several bills were introduced to achieve the presidents goal. No legislation was passed, but efforts to impose regulation continued. In 1910, additional bills were introduced that sought to restrict futures trading. They were all unsuccessful. A young Sam Rayburn promised in his campaign for Congress in 1911 that he would seek legislation that would prohibit gambling in commodity futures. Rayburn stated that any species of gambling is a moral wrong as well as an economic wrong.36 That campaign pledge would remain unfulfilled for many years. Reformers did get an unexpected boost from the Supreme Court. An effort had been made in the late 1800s to amend the Sherman Antitrust Act to apply it to commodity futures trading. Although that amendment failed, the Supreme Court held that James Patten, the grain speculator, could be prosecuted criminally under the antitrust laws for his corner in 1909.37 The Cotton Futures Act The Democratic Party platform for Woodrow Wilsons presidential campaign advocated legislation that would suppress the pernicious practice of gambling in agricultural products by organized exchanges or others.38 That legislation was not enacted, but the Department of Agriculture had earlier launched an effort to establish uniform grade standards for commodities. That concern was heightened by disruptions in the cotton markets as a result of price differences between cotton grades. A committee on the New York Cotton Exchange set standards to measure those differences, but critics charged that the exchanges standards were arbitrary. In 1906, the cotton crop was badly damaged by weather, but the committee failed to correct for the resulting differences. The result was that hedging nearly stopped on the New York Cotton Exchange. This led to an investigation by the Bureau of Corporations. The New York Cotton Exchange failed to respond to its recommendations, and continuing problems resulted in the enactment of the United States Cotton Futures Act of 1914. The Cotton Futures Act imposed a tax of two cents per pound for cotton sold under a contract of sale for future delivery. The tax was not required to be paid if certain conditions were met. Among those conditions were a requirement that the contract specify the grade, type, sample, or

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description of the cotton involved in the contract, the price per pound at which the cotton was to be bought or sold, and the time when shipment or delivery of the cotton was to be made. Delivery of cotton under the contract could not be effected by a set-off or ring settlement. Rather, the actual transfer of the cotton was required. The Secretary of Agriculture was designated as the referee of any disputes under such contracts. The 1914 Cotton Futures Act was successfully challenged in court on a rather technical ground. A district court in New York held that the act was void because it had originated in the Senate rather than the House. Since it was a revenue measure, this violated the Constitution.39 That problem was resolved and a new statute was enacted in 1916. This legislation exempted futures contracts in cotton from the tax when they met certain criteria. The orders for these contracts had to be in writing, showing the quantity of the cotton involved and the identity of the seller and buyer. The cotton had to be within grades established by the Secretary of Agriculture. The Cotton Futures Act required price differences between deliverable grades to be based on those prevailing in the markets. The Department of Agriculture was authorized to establish a system for inspecting, grading, and labeling cotton. Although the Cotton Futures Act did little to stop abuses involving price manipulations, it did create a uniform system by which farmers could classify and price their crops. Another reform effort involved the classifying and storage of grain. Congress passed the Grain Standards Act and the Warehouse Act in 1916 to assure integrity in the marketing of grain and other commodities in the United States. That legislation established uniform grading standards for grain and imposed minimum standards on warehousing facilities. Wartime Trading The declaration of war on Germany by the United States in April of 1917 resulted in frenzied trading on the commodity exchanges. Unlike the New York Stock Exchange, the CBOT and the New York Produce Exchange did not suspend trading. The CBOT was able to continue its boast that it had not closed its doors since its creation before the Civil War. Price advances, however, quickly increasing by some 50 percent, soon became a matter of concern. A sharp rise in wheat prices caused by the war was accentuated by reports of a short crop. The increase in wheat prices caused much criticism, and the CBOT began restricting trading in several of its contracts. The CBOT stopped trading in wheat contracts on May 11, 1917, after wheat prices climbed to $3.25 per bushel, the highest price in history at that point. Three months earlier, on February 3, 1917, wheat had been trading at only $1.44 per bushel. The CBOT settled prices at $3.18 in open contracts after it halted trading. Other exchanges followed suit. On June 1, 1917, the Chicago Butter and Egg Board stopped trading in egg and butter futures. Corn was another commodity experiencing rising prices. On July 11, 1917, the CBOT prohibited members from making futures contracts in corn

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to be delivered in the following year at a price in excess of $1.28 per bushel. Maximum prices were fixed by the CBOT for oats. Later, in November of 1917, the CBOT limited the amount of grain that a trader could trade. In addition, price limits were placed upon the amount that grain prices could fluctuate up or down in a single day. When those limits were reached, trading was stopped for the day. Such price limits would be employed on the stock exchanges as well. The sharp rise in commodity prices that occurred with the declaration of war raised governmental concerns. The United States Attorneys office in Chicago called in some forty prominent operators on the Chicago Board of Trade to discuss their activities. Following that meeting, the CBOT suspended trading in the contracts in which these individuals had positions. The CBOT took the further step of prohibiting trading in bids and offers, but this did not ease the governments concerns. Congressman Fiorello La Guardia charged that speculators were pushing prices so high that many Americans were going hungry. Congress responded by granting President Wilson virtually dictatorial powers over prices of food in order to stop speculation and price manipulations. The president was given the authority to set a guaranteed price for wheat at not less than two dollars a bushel. On August 10, 1917, the Food and Fuel Control Act was enacted and the Food Administration was created for the purpose of controlling food prices. Despite those controls, prices nearly doubled during the war. Herbert Hoover was placed in charge of the Food Administration. On August 12, 1917, Hoover proposed that the United States buy the entire 1917 wheat crop at a set price of $2.32 a bushel. The Food Administration then formed the Grain Corporation, headed by Julius Barnes, for the purpose of buying and selling wheat at the principal terminal markets. The Food Administration divided the United States into zones, and the Grain Corporation maintained offices in each of those zones to purchase all of the grain delivered into designated elevators. The Grain Corporation then became a marketing agency for agricultural commodities. Hoover requested that the CBOT stop all trading in the September wheat contract. The CBOT agreed to that action. The Grain Corporation then assumed control of the wheat markets. Price controls were extended over other basic commodities. On August 16, 1917, the New York Coffee and Sugar Exchange suspended trading in futures contracts for sugar at Hoovers request. The sugar industry was then placed under government control. Cotton was another commodity experiencing price volatility with Americas entry into the war. The Liverpool Cotton Exchange and the cotton market at Le Havre closed in June of 1917. The New York Cotton Exchange was directed by the government to restrict price movements on cotton futures trading in August of 1917. That action came too late for one speculator, H.L. Hunt, who had shorted the market and lost heavily. Down but not out, Hunt would, within a few years, become the richest man in the world after he acquired some speculative oil leases in Texas.

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The Food Administration issued an order in February of 1918 that sought to prevent speculation in green coffee on the New York Coffee and Sugar Exchange. On February 20, 1918, the CBOT adopted a resolution that required all market letters, opinions, or advice concerning prices of corn and oats to be suspended. This included opinions or market letters issued by wires, public statements, private correspondence, or by telephone. The CBOT had previously advised members that, in publishing market news that could affect the market, they should limit their letters to statistical matters, that such information had to be correct and reliable, and that all rumors were prohibited. In February of 1918, a syndicate was formed to finance the Cuban sugar crop. The syndicate agreed to provide a revolving credit of $100 million, but only $16 million was needed. Shortages mounted. Beefless Tuesdays were announced by government officials as a patriotic measure for supporting the war. They were followed by wheatless Wednesdays. On April 10, 1918, the CBOT prohibited spread contracts between particular delivery months for corn and oats. It set limits on the aggregate trading by any individual firm or corporation in grain. The limit was 200,000 bushels. On the following day, April 11, 1918, Herbert Hoover, the federal food administrator, asked the commodity exchanges to limit trading by small traders who were being encouraged by private wire houses to speculate. He likened the wire houses to bucket shops. Despite restrictions on trading, cotton prices continued to rise, reaching a level in April of 1918 that had not been seen since November of 1866. The market then plunged, and the New York Cotton Exchange limited daily price movements for cotton futures to a maximum of two cents a pound. The New Orleans Cotton Exchange imposed restrictions on speculative trading. Prices continued to drop as American victories mounted. The War Industries Board prohibited short selling of cotton after prices declined sharply on November 11 and 12, 1918, but prices continued their downward plunge as war demands eased. Restrictions on futures trading in grain were lifted as the war concluded. In September of 1918, the CBOT announced that it was abolishing maximum prices on futures contracts, and all contracts were to be allowed to run to maturity. In December of 1918, restrictions on the grain markets and futures trading were further reduced. The CBOT advised its members that they could resume the issuance of opinions on market movements. The Food Administration notified the CBOT that, after January 1, 1919, the exchange could remove all quantity restrictions on trading in futures contracts in corn, oats, rye, and barley. The Food Administration stated, however, that the exchanges and their members would be held accountable for any manipulative practices. The New York and New Orleans cotton exchanges announced in December that their restrictions against foreign and speculative short selling were being removed. Trading in coffee futures was resumed on December 26, 1918.

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Postwar Problems After government restrictions were lifted in 1919, silver prices jumped to $1.375 per ounce, but soon fell back to 59 cents an ounce. Gold was another opportunity. Although the gold standard imposed by law in 1900 meant that gold was no longer subject to much speculation, the United States government was buying all the gold presented to it with no questions asked, provided that it met certain purity requirements. Here come refiners, pawnbrokers and dentists . . . to turn in gold.40 By 1919, the United States Assay Office held more gold than any other place in the world. High commodity prices during World War I spurred agricultural production, a lot of which was speculative in nature. One survey found that among the new farmers in Montana seeking to profit from high prices caused by the war were two circus musicians, two wrestlers, a cigar maker, a deep sea diver, and a professional gambler. Grain prices had risen between 1910 and 1920, but so had farm debt, which climbed from some $3 billion in 1910 to almost $8.5 billion in 1920. That debt would weigh heavily when the boom in farm prices ended. The price of wheat was $2.19 per bushel in 1919, but dropped to $1.05 per bushel in 1922. At the end of 1921, corn was at 41 cents a bushel, down from $1.86. Other farm commodity prices plunged sharply in the middle of 1919. Those price drops were claimed by critics of the Federal Reserve Board to have been exacerbated by that agency because it had raised its discount rate and tightened money. The economic boom that followed the conclusion of World War I began to collapse. The drop in business that began in 1920 had by 1921 ended in one of the most violent crashes of prices that the nation has ever experienced.41 Farm prices fell by 40 percent. Land values dropped by some $20 billion between 1920 and 1927. New Orleans banks were refusing to lend money to planters unless they reduced their production. The debacle of prices in 1920 and 1921 reduced the farmer to a condition worse than he has suffered under for 30 years.42 Bankruptcies rose, causing hardships in the cities as well as on the farms. One of those affected was Harry Truman. His haberdashery, while initially successful, failed when crop prices dropped and customers cut their spending on clothes. This was not the first blow that Truman had suffered from the commodity markets. His father had lost $40,000 in a single futures transaction on the Kansas City Board of Trade some twenty years earlier. At age fifty-one, John Truman was wiped out.43 The Trumans had to sell their home, and Harry Truman had to give up college and quit his piano lessons. Truman was not the only future president to be thrust into poverty by his fathers commodity speculations. Lyndon Johnson had a similar experience. His father made money in the cotton futures markets between 1902 and 1905 but he lost all he made and more in 190506 when the market collapsed. Lyndon Johnson said that [m]y daddy went busted waiting for cotton to go up to twenty-one cents a pound, and the market fell apart when it hit twenty. For a time, the Johnson family could not pay its grocery bills.44

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Although restrictions on futures trading in corn, oats, rye, and barley were removed in January of 1919, futures trading did not resume in wheat until July of 1920. When restrictions were lifted, an orgy of speculation occurred, causing prices to react dramatically. Prices broke sharply downward. The price of wheat dropped from $3 to $1.58 a bushel before the end of 1920 and thereafter fell to 85 cents a bushel. The markets faced a great bear raid that was maintained for nearly ten consecutive months in the face of the greatest export demand for wheat this country had ever experienced.45 The shorts drove prices down from $2.75 to $.85 per bushel. The FTC Study President Woodrow Wilson ordered the Federal Trade Commission (FTC) and the Department of Agriculture to investigate the drop in wheat prices, which was being blamed on the grain gamblers.46 The FTC conducted a massive investigation of the grain trade. Its voluminous reports included a broad examination of every aspect of the trade. One volume assessed the relative importance of cooperatives in the grain trade and the role of the elevators and warehouses. Another volume examined the merchandising and shipping of grain and the role of the middlemen in marketing grain in the United States. The report reviewed the development of the CBOT and other commodity exchanges, including those in Milwaukee, Minneapolis, Duluth, Kansas City, Omaha, St. Louis (where cat pelts were being sold), Peoria, Louisville, Cincinnati, Indianapolis, Toledo, and Buffalo. The FTC found that [p]erhaps the most important function assumed by the exchanges, aside from providing a regulated market procedure and trading halls for their members, is that of collecting, recording, and distributing quotations and market information. For these services the trade at large is almost wholly dependent upon the exchange organizations.47 The FTC examined the role of margins in the futures industry. Margin requirements were becoming mandatory as clearinghouses assumed responsibility for transactions on the floors. The Chicago Mercantile Exchange, by 1919, was requiring that margin be collected from customers and that margins be adjusted to reflect changes in market values. Several exchanges did not require margins. The CBOT and the Minneapolis Grain Exchange allowed margins of up to 10 percent. Margins were usually required to be deposited in a bank approved by the exchange. The Peoria Exchange, which did not trade in futures contracts, imposed margin requirements for forward or deferred shipment contracts, but those rules were almost never enforced for competitive reasons. The FTC study concluded that margins in the futures industry were not partial payment for the purchase price of the commodity under contract. Rather, margins were used as good-faith deposits to secure performance. The FTC study found that low margin levels accentuated market drops because small traders became overextended and often pyramided

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their profits. When prices dropped, many of those traders were unable to meet their obligations, requiring their accounts to be liquidated. This selling pressure then drove prices lower. The FTC focused on other aspects of commodity speculation in its study. The commission reviewed the use of privileges or options, the development of private wire systems to aid speculation, and the use of news services to promote futures trading. Job-lot trading on the exchanges was examined. Most futures contracts were traded in large increments such as 5,000 bushels, but some were traded in smaller job lots of 1,000 or 2,000 bushels. That practice would decrease after World War II. The FTC study examined the role of futures in pricing commodities and the usefulness of hedging. The FTC noted that speculators often traded in both stocks and commodities, and that most futures transactions were conducted without delivery taking place. Instead, the contracts were liquidated by offsetting transactions that did not require delivery. The FTC concluded that, while futures trading aided in the efficient distribution of commodities, abuses were occurring that artificially affected prices. Between 1884 and 1921, some 200 bills were introduced into Congress that sought to regulate futures and options trading. Professor W.M. Duffus at the University of Kansas had advised Congress in 1918 that there was a growing belief on the part of farmers that the grain exchanges should be eliminated. Those efforts met with little success, but the decline of agricultural prices after World War I and the FTC study led to legislation that was designed to provide federal regulatory controls over the futures markets. In the hearings on this legislation, the Futures Trading Act of 1921, a number of abuses were decried. There were objections to the annual bear raids that were said to be playing directly into the hands of European importers, who are enabled to buy millions of bushels of wheat in the futures market at a reduced price.48 One congressman cited cases of embezzlement by bank officials and others in order to fund their gambling in futures trading. There were complaints of a number of suicides that resulted from losses in futures gambling. A senator stated that [a] bookkeeper in a grain operators office tells me the country would be shocked if it knew how many women were playing the market. 49 Congress was informed of large-scale manipulative activities. Rumors were used to manipulate prices. One scheme involved a claim that green bugs were destroying the wheat harvest. Samples of the bugs were mailed to the exchanges. The perpetrator of this hoax then purchased futures contracts and profited when prices rose. Afterwards, he announced that the bugs were harmless and sold short as prices dropped. Legislation Many persons advocated, as a remedy for these abuses, that all futures trading be abolished.50 Herbert Hoover, who was then the Commerce Secretary, came to the defense of the exchanges, testifying that the Chicago Board of

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Trade was the most economical and efficient agency for the marketing of foodstuffs found anywhere in the world.51 Nevertheless, Hoover was in favor of some federal regulation, noting that short selling had been depressing prices and imposing hardship on the farmers. Hoover proposed legislation that would limit the amount of trading to 200,000 bushels per speculative trader. This proposal was rejected. Instead, the Futures Trading Act of 1921 imposed a tax on futures contracts that were not traded on the exchanges licensed by the federal government. Such licensed exchanges were called contract markets. This requirement was designed to eliminate bucket shops by making over-the-counter futures illegal. The tax was prohibitive in amount, which meant that there could be no off-exchange trading under this statute. Contract markets had to prevent manipulation. The Futures Trading Act included a provision requiring disclosure and record keeping by large traders. It was thought that secrecy was necessary to manipulate the markets, so reporting and record keeping requirements would frustrate such activity. In 1922, the Supreme Court held that the Futures Trading Act was unconstitutional as an improper use of Congressional taxing powers.52 Two weeks later, however, new legislation was introduced. That swift action was motivated by a straight-out manipulation of the market almost immediately after the Supreme Courts decision.53 The price of wheat was driven up four cents and then driven down by thirty-two cents. Congress then enacted the Grain Futures Act of 1922, which was really a repeat of the Futures Trading Act, except that it was enacted under Congresss commerce powers in the Constitution. This legislation was upheld by the Supreme Court.54 The Grain Futures Act was administered by a commission composed of the Attorney General, the Secretary of Commerce, and the Secretary of Agriculture. The Department of Agriculture was given day-to-day control over regulation of the futures markets. The secretary established the Grain Futures Administration in the Department of Agriculture to carry out that function. Abuses Remain Manipulation continued despite these measures. A congressional resolution directed the Secretary of Agriculture to investigate a sharp drop in wheat prices in 1923. Congress was concerned that traders were trying to push down farm commodity prices by bear raids. The secretary found sharp price fluctuations but could not establish that they were the result of manipulative activities. Violent price volatility in sugar futures contracts occurred in February, March, and April of 1923. No economic justification was found for a rise in prices from $3.65 to $4.07 per a hundredweight between February 1 and February 8, 1923. Prices continued to increase until April 16, when they peaked at $5.97. Refined sugars prices, which were even higher, increased from $6.70 per a hundredweight in February to $9.30 per a hundredweight in March and

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April. An antitrust action brought against the New York Coffee and Sugar Exchange and its officers was dismissed. A scandal occurred in 1925 in the warehousing of grain. The Grain Marketing Company was a farmers cooperative that failed after revelations that Chicago Board of Trade inspection procedures had been manipulated by the Armour Grain Company. The farmers who were damaged by that manipulation were awarded $2.7 million. The Illinois Warehouse Act of 1927 was passed to stop such abuses. Wheat prices continued to fluctuate, rising from $1.19 per bushel to $2.05 between July of 1924 and January of 1925. Wheat prices then collapsed to $1.36 in April of 1925. The CBOT authorized daily price limits in 1925 because of unusual trading activity. Nevertheless, a squeeze on wheat prices caused difficulties in the following year. A Senate resolution was then passed to require investigation of grain trading by the Secretary of Agriculture. The department found that large speculators had concealed their trading through the use of several accounts. Although these individuals had caused price fluctuations that were felt in every other large grain market in the world,55 the secretary could find no illegal manipulation. One of the worst abusers was a member of the Chicago Board of Trade, one Arthur Cutten. A Congressman would later claim that Cutten owned more of the grain than anyone since Joseph in Egypt.56 Cutten was rumored to have made a total of $11 million from wheat and corn manipulations in 1924. Cutten was not always successful. He pushed wheat prices from $1.05 a bushel to more than $2 a bushel between 1924 and 1925. The corner collapsed when Argentine wheat was brought to the market. This only caused Cutten to buy more wheat. He was eventually forced to reduce his position by the Chicago Board of Trade. Even so, his $540,000 income tax bill for 1925 was the largest ever recorded in northern Illinois.57 Jesse Livermore, the Great Bear, was on the other side of the market in the Cutten corner and lost $3 million. Livermore had made large profits from his trading during World War I. His gains were even larger after he sold short when the war was concluded. Livermore and Cutten would tangle again in the futures pits in Chicago, and Cutten was said to have lost several million dollars in one fight with Livermore. J. Ogden Armour bested Cutten in one battle in the wheat pit by inducing the Chicago Board of Trade to change its rules to allow delivery in freight cars. This broke Cuttens corner. Cutten had another setback when the Business Conduct Committee at the Chicago Board of Trade convinced him to sell wheat during one of his corners for the good of the exchange. Other traders anticipating those sales sold in front of him. Cutten later claimed that his elevator ride to meet with the Business Conduct Committee cost him a million dollars. The Grain Future Administration charged Arthur Cutten with failing to report the number of contracts he was holding as required by the Grain Futures Act. The government found that Cutten had used numerous accounts in order to allow himself to hold contracts for a substantial amount of wheat

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without disclosing that fact to the government. The Supreme Court subsequently ruled that the Secretary of Agriculture could not deny Cutten trading privileges in futures contracts because the act did not apply to persons who had manipulated the market in the past. The court ruled that the statute applied only to a person who was in the process of manipulating commodity prices.58 This ruling made little sense and enraged the government. The Internal Revenue Service then sought over $1 million in taxes from Cutten from the trading that was the subject of the action by the Grain Futures Administration. This pressure forced Cutten from the grain pits, and he began speculating in securities. Cutten would become equally infamous in that market. The Grain Futures Administration continued to encounter problems with large speculators. As a remedy, the Secretary of Agriculture sought to have Congress authorize limitations on the number of contracts held by large, speculative traders. Legislation was introduced that sought to limit the number of contracts held by speculative traders in any one delivery month of a commodity futures contract. Another bill would have confiscated cotton that was withheld from the market in order to manipulate prices. This bill appears to have been a throwback to the prohibitions against regrating and engrossing that had arisen in the Middle Ages. These legislative efforts were not successful, and manipulations, squeezes, and corners in corn and wheat continued. By the end of the 1920s, futures contracts were being traded on some twenty-five commodities on a like number of futures exchanges. The volume of trading on the futures exchanges during 1929 was over $40 billion. The largest futures exchange was the Chicago Board of Trade. A seat on the Chicago Board of Trade sold for $62,500 in 1929, a price that would not be reached again until 1973. Other exchanges included the Dallas Cotton Exchange, the Duluth Board of Trade, the Houston Cotton Exchange, the Louisiana Sugar and Rice Exchange in New Orleans, the Memphis Cotton Exchange, the Memphis Merchants Exchange, the New Orleans Cotton Exchange, and the New York Burlap and Jute Exchange. Additional Exchanges The New York Cocoa Exchange was formed in 1925.The Rubber Exchange of New York was created in February of 1926. Demand for this commodity had grown with the growth of the automobile. The National Raw Silk Exchange was formed in New York in 1928. In 1929, the New York Hide Exchange was organized. The Chicago Live Stock Exchange traded futures in live hogs, and the Chicago Mercantile Exchange began trading potato futures. The New York Coffee and Sugar Exchange traded molasses futures. The New York Cotton Exchange began trading futures contracts on wool tops, that is, wool suitable for spinning. Orders for the future delivery of silver were executed on the National Metal Exchange by, among others, Ettinger & Brand in Chicago. Crude rubber futures were being traded in New York. The Odd-

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Lot Cotton Exchange was conducting business in New York in 1926. This exchange was trading cotton in lots of less than 100 but more than 10 bales. The Odd-Lot Exchange used the quotations of the New York Cotton Exchange for this trading until that exchange directed the Western Union Company and its subsidiary, the Gold & Stock Telegraph Company, to withhold those quotations. The New York Cotton Exchange was responding to claims that the Odd-Lot Cotton Exchange had succeeded another exchange whose members had been convicted of conducting a bucket shop. The Odd-Lot Cotton Exchange sued the New York Cotton Exchange under the antitrust laws, but the Supreme Court rejected that claim. The NYMEX, which had sold $3.5 million in Liberty Bonds during World War I, was using blackboard trading in which bids and offers made on the exchange floor were recorded on blackboards. When the bid price matched the offer price, the trades were executed. In order to obstruct the view of members as little as possible, the board boys posting prices were required to be left- or right-handed depending on the location of the boards so as to obstruct their viewing as little as possible when prices were changed. Transactions on the NYMEX were largely cash transactions for many years. Nevertheless, there was some futures trading in butter and eggs as early as 1903, and rules for futures trading were adopted in 1921. The NYMEX began trading futures on butter and eggs in 1925. In that year, a membership on the NYMEX was selling for $800. The NYMEX played a leading role in seeking legislation that banned the sale of oleomargarine, which was being labeled and sold as butter. Clearinghouses and Other Issues Clearinghouses were playing an increasingly important role in futures trading. Direct settlements were used on some commodity exchanges in which the two brokers simply offset or netted their buy and sell transactions with each other. Most futures trading conducted on the New York exchanges were settled traditionally by ring settlements. Ring settlements involved multilateral netting arrangements among several brokers trading in the ring. Those parties would simply offset their buy and sell transactions with each other and cancel the contracts upon payment of differences in prices. The Sugar Clearing Association in New York was an organization separate from the exchange that provided a clearinghouse where the ring settlements were made. About 75 percent of all transactions were offset through this ringing process. The rest were matched. Only one-tenth to one-quarter of 1 percent of the contracts were settled by actual delivery. The CBOT organized a clearing association before the turn of the century for handling money balances arising from settlement among members. It did not handle settlement of contracts. That same method was also used on the New York Cotton Exchange. Modern clearinghouses were established by the

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exchanges after World War I. These clearinghouses became the buyer and seller in each transaction. This allowed the clearinghouse to guarantee performance on the contract. That role of the clearinghouse facilitated the liquidation of contracts and made them more fungible. The clearinghouse guarantee reduced counterparty risk of default because the clearinghouse rather than an individual trader guaranteed performance. That guarantee was backed by the clearinghouse members, and clearing funds were created through transaction charges that provided a fund for payments in the event of defaults. The clearinghouses used a twenty-four-hour settlement system that required transactions to be cleared and settled before the beginning of trading on the next day. This was made easier by the fact that there were no certificates for commodity futures contracts, such as those used for stock transactions. The New York Produce Exchange was one of the first exchanges to create a separately incorporated clearinghouse that assumed responsibility for transactions and controlled margin requirements. The Chicago Butter and Egg Board, which became the Chicago Mercantile Exchange in October of 1919, established a clearinghouse for its transactions. The other exchanges would follow in future years. The NYMEX opened its clearinghouse in March of 1924, which increased futures trading there. The CBOT began its clearinghouse system in 1925 by creating a separately incorporated clearing facility. Scalpers were operating on the futures exchanges. These were traders who traded for their own accounts and sought only to make small profits by constantly buying and selling futures contracts in order to take advantage of small price changes. Speculators often traded in both stocks and commodity futures, switching from one to the other as opportunities arose. There were efforts to combine both functions on a single exchange. Despite these experiments, side-by-side trading of futures and stocks never became popular in the United States. The CBOT had a department for dealing in stocks by the 1920s. The exchanges in New York often traded both commodities and securities. The New York Cotton Exchange set up a securities department for trading stocks of textile companies. The New York Produce Exchange was authorized to deal in securities. Gambling transactions were occurring in mining stocks on that exchange before the Panic of 1907. Not surprisingly, the New York Produce Exchange came under attack from the NYSE for its securities trading. By 1920, the New Produce exchange was trading only a few bank and insurance company stocks. Commodity trading, as well as securities, was conducted on the Consolidated Stock Exchange. By 1909, however, the only commodity being traded on that exchange was wheat in contract sizes smaller than those on the New York Produce Exchange, which had contracts of 5,000 bushels. The Consolidated Stock Exchange sought to expand its commodity futures trading operations to Chicago, but the CBOT acted to prevent its grain quotations from being used by the Consolidated Stock Exchange. This placed the Consolidated Stock Exchange at a considerable disadvantage.

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4 Banking in the Twenties

Consumer Finance A growing problem for consumers was the loan shark who charged extortionate interest rates that were often collected under the threat of violence. Consumer finance protection began in 1916 in America with a consumer credit law that was designed to stop such abuses. This Uniform Small Loan Law, developed by the Russell Sage Foundation, was intended to require disclosure of all consumer charges and to legitimize bona fide consumer finance companies. It would be difficult to exaggerate the loan shark evil when the Russell Sage Foundation started its studies in 1908.59 One of the first loan offices operating under a state small loan law was opened in Massachusetts in 1911. Still, loan-sharking continued. An investigation by the Comptroller of the Currency revealed that usurious interest rates from 200 percent to 2,000 percent per annum were being charged to farmers for loans of short periods. The loans often resembled the loans of pawnbroker operations. Banks were not above such practices. In one instance, a national bank loaned $3.50 to a woman for six days with an interest charge of one dollar, which was 5 percent per day or 2,400 percent per annum. Consumer installment loans were a way to purchase goods without the need for a bank loan. Retail installment businesses expanded rapidly between 1915 and 1929. The total of such arrangements was stated to be about $19 million in 1920. By 1924, installment credit amounted to some $2 billion. About 50 percent of that amount was to purchase automobiles. Outstanding installment credit would reach $3.5 billion by 1929. Much of the demand for installment purchases was for automobile purchases and durable goods such as household appliances. The Bankers Commercial Corporation, which was created in 1904 to provide discount retail piano paper, that is, retail notes for a piano purchaser, appears to be the genesis of the sales finance companies that become popular after World War I. Several sales finance companies then appeared that purchased retail installment contracts from merchants making
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such sales for consumer goods. Some 1,400 finance companies were in operation by 1924. There would be even more by World War II. Several of these finance companies began operating on a regional and national scale. So-called labor banks were being organized by the trade unions for their membership. There were thirty-three such banks in the United States by 1927 with assets of over $120 million. New York raised the ceiling on the amount that could be held in individual accounts in New York State savings banks in 1926 to $7,500 from $5,000. The assets of the savings and loan institutions (S&Ls) quadrupled between 1914 and 1926, and the number of their depositors increased to over 10 million. Over $6 billion was being held in the mutual savings banks for depositors in 1922. By the end of 1928, over 12,000 thrift institutions in the United States held assets totaling over $8 billion. Herbert Hoover, the Secretary of Commerce and future president, helped develop the concept of second mortgages by convincing Julius Rosenwald, who built Sears, to issue them at 6 percent interest. Banks, which had been demanding 15 percent, quickly followed. During the agricultural crisis that occurred from 1920 to 1922, the War Finance Corporation provided farm credit in amounts that totaled over $330 million. Following that depression, the Agricultural Credit Act established twelve Federal Intermediate Credit Banks that were to be supervised by the Federal Farm Loan Board. The Intermediate Credit Banks did not lend directly to farmers. Instead, they rediscounted agricultural paper (warehouse receipts and livestock mortgages) for agricultural cooperatives and warehouses. Such paper was required to have a maturity of at least six months and less than three years. National Agricultural Credit Corporations were authorized to loan on agricultural paper of nine months maturity or on livestock paper of three years maturity. Only one such organization was ever created. Another entity, the Rediscount Corporation, was allowed to rediscount agricultural paper. Money Markets and the Fed About $1.3 billion in commercial paper was outstanding in 1920. That figure would shrink to about $320 million by the end of the decade. The Fed was requiring audited financial statements to be supplied by firms seeking to discount commercial paper through the Federal Reserve System. The discount window at the Federal Reserve banks allowed commercial banks to borrow short-term funds in time of need. Discount rates could be adjusted to make such borrowing more or less attractive. A newcomer to the money market in 1921 was overnight borrowings by the New York banks that were members of the Fed. Such borrowings were later expanded to other banks in the Fed system. These transactions were referred to as Fed fundsthat is, excess deposit balances of Fed member banks. Those Fed funds could be loaned to other banks, usually on a one-day basis at interest. The use of Fed funds allowed Fed member banks to borrow excess reserves instead of using the discount window at the Federal Reserve banks.

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William Harding, an Alabama banker, was serving as a member of the Federal Reserve Board in 1917. He later became managing director of the War Finance Corporation. Charles Lindbergh, the congressman and father of the famous flier, sought to impeach the Federal Reserve Board in 1917, claiming that it was in cahoots with the National City Bank, Kuhn, Loeb & Co., and J.P. Morgan & Co. But the money trust was not much of a concern to his son, who carried a $500 bank draft from the Equitable Trust Company of New York on his famous flight in the Spirit of St. Louis in 1927. Lindbergh also used a Brown Brothers letter of credit to pay expenses in Paris after his historic flight. The young Lindbergh later married Anne Morrow, the daughter of a senior partner at J.P. Morgan & Co. The subtreasuries that had been created in 1846 were abolished in 1920. Their duties were assumed by the Federal Reserve banks, the Treasury, and the mints. The Federal Reserve System was experiencing difficulty in inducing state banks to become members because of high reserve and other requirements. In 1917, however, Congress required all member banks of the Federal Reserve System to keep their reserves with a Federal Reserve Bank. This provided an incentive to join the system. Among those joining was the Bank of Italy in California, which became a member in 1919. Federal Reserve notes were adding to the currency. The notes were obligations of the United States government that were issued by a Federal Reserve Bank. They were redeemable in gold on demand at the Treasury Department or in gold or lawful money at any Federal Reserve Bank regardless of the bank that issued them. Federal Reserve banks were required to maintain a gold reserve equal to at least 40 percent of the amount of their Federal Reserve notes. Federal Reserve notes were also liens on the assets of the issuing bank and were secured by collateral security equal to 100 percent of the amount of the note. The collateral security could consist of commercial paper endorsed by a member bank, the notes of a member bank secured by eligible paper, obligations of the United States government, bills of exchange endorsed by a member bank, bankers acceptances that were bought by a Federal Reserve Bank, and gold certificates. The largest bill ever issued by the United States was a $100,000 gold certificate. It contained a picture of President Woodrow Wilson. Bank robbers were netting Fed notes as part of their haul. The Newton brothers gang from Texas successfully robbed a number of banks, but were captured shortly after they robbed a mail train of $3 million at Roundout, Illinois, on June 12, 1924. The Fed was struggling with monetary policy. The country experienced an expansionary period after World War I that the Fed tried to slow. At the same time, farm commodity prices were disrupted by overproduction, and a commodity inventory panic resulted in a recession in the farm belt. The economy had recovered by 1923. It was then thought that the Fed had stabilized the situation and prevented a panic in the financial markets, even though farm prices were declining sharply. This led many to believe that this nation has

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undergone its last money panic and that the Fed could safely guide the economy during troubled times.60 In truth, the Federal Reserve System did little to alleviate the recession in the farm belt. The Fed sought to use moral suasion, or what it called direct action, in order to control credit and dampen the speculation that occurred at the end of the war. The Fed was criticized by a joint committee of Congress for failing to increase interest rates in 1919 in order to curb speculation. After that rebuke, the Fed sought to maintain high rates. Before an appropriate policy could be determined, however, the economy slackened. There was a need in 1920 for pumping up the economy as the farm recession deepened, but the Federal Reserve System was not able to change course so quickly. It kept discount rates inflated and thereby restricted credit. The sharp contraction of the money supply between 1920 and 1921 was accompanied by a collapse in wholesale prices, which dropped by 56 percent, dragging down some 24,000 commercial firms. If anything, the Feds restrictions on credit exacerbated those economic difficulties. Another problem was that a power struggle began almost immediately after the Reserve banks opened for business in November 1914 when the Fed pressured the Reserve banks for lower and more uniform discount rates, and the Reserve Bank Governors resisted.61 This internecine struggle was compounded by the fact that New York Federal Reserve Bank sought prominence over the other Federal Reserve banks, as well as the Washington-based Federal Reserve Board. Of particular concern in this power struggle was the Federal Reserve Systems open market operations. Those operations involved the buying and selling of government securities and eligible private debt issues in order to expand or contract the supply of money. The Open Market Desk that was managed by the New York Federal Reserve Bank was the means for conducting most open market operations. The other Reserve banks, however, were resisting New Yorks dominance over monetary policy and were sometimes pursuing their own open market operations. The Fed held a symposium on credit policy in 1922, from which evolved its open market operations that sought to provide stability to the money market through open market purchases and sales of government securities. Secretary of the Treasury Andrew Mellon sought to centralize authority over open market operations in 1922. He obtained legal opinions that the Federal Reserve Board had the authority to restrict the open market operations of individual Reserve banks. The Reserve banks resisted that claim, but a compromise was reached establishing a committee to coordinate the individual Reserve bank orders to buy and sell government securities. The members of the committee included the governors of the New York, Boston, Philadelphia, Chicago, and Cleveland Reserve Banks. This was the Committee of Governors on Centralized Execution of Purchases and Sales of Government Securities by Federal Reserve banks. The life of this committee was not much longer than its name. In 1923, a Reserve bank made purchases without going through the committee. Secretary Mellon then caused a new

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committee to be created, the Open Market Investment Committee, to handle open market operations for all of the Federal Reserve banks. The members were the same as those of the earlier committee. The Open Market Investment Committee sought to carry on its own operations independent of the Federal Reserve Board, but the board instructed the committee to liquidate its entire portfolio in 1923. That action was followed by a recession that lasted over a year. Another sharp recession occurred between October 1926 and November 1927, after the Federal Reserve Board tried to stop interest rates from falling. The fight continued between the Federal Reserve Board and the Federal Reserve Bank in New York over control over monetary policy. New Yorks position in this debate was due not only to its role as the leading city of finance, but also to the fact that Governor Benjamin Strong of the New York Federal Reserve Bank was both domineering and persuasive. Strongs death in 1928 diminished the New York Federal Reserve Banks authority on the Open Market Investment Committee but came too late to affect the policies dealing with the frenzied speculation in the stock market. This schism between New York and Washington over monetary policy would have grave consequences in the events that led to the stock market crash of 1929. Monetary policy would also vie in importance over the rest of the century with government fiscal policy as the best means to control economic growth. As John Maynard Keynes noted, however, business and investment activities could not work properly if the money, which they assume is a stable measuring-rod, is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteerall proceed, in large measure, from the instability of the standard of value.62 Banking Operations Almost 30,000 banks were operating in the United States in 1921. That vast number was the result of prohibitions against branch banking, which precluded the growth of large banks and encouraged small local institutions. The side effect of those restrictions was numerous small and weak banks that depended on a single towns economy. From the beginning of the national banking system until 1916, only some 600 national banks had failed. The number of state and national banks increased by about 15,000 between 1900 and 1920. About 2,000 of those institutions failed during that same period. By 1922, there were 8,210 national banks and some 20,000 state banks. About 6,000 banks were organized during the 1920s, but the overall number of banks declined by a like amount. That decline was due to bank failures and mergers. Some 20 percent of commercial banks failed during the 1920s. Whereas about 500 commercial banks suspended from 1915 through 1920, nearly 6,000 did from 1921 through 1929.63 Most of the banks that failed were country

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banks located in small towns in the West. The failure of these small banks did not have much immediate effect on the financial system. Large banks were getting bigger by merging with each other. Some 350 bank mergers occurred each year between 1921 and 1925. That number increased to over 500 in 1929. New York was still the center of finance. Some ninety banks were operating on Wall Street in the 1920s, as well as some sixty life insurance companies and twenty-five trust companies. The New York banks were becoming more innovative. The National City Bank developed a plan to finance the construction of buildings by sales of stock. Such financing was to be an alternative to the use of mortgages. The National City Bank established a cash management program for large corporations that allowed them to keep their deposits at a minimum. Most large and medium-size banks had credit departments. Banking institutions often shared information so that borrowers who were rejected for credit could not go shopping for another bank. The banks continued their foreign exchange business. The National City Bank suffered a $5 million dollar loss in currency exchange in Brazil in 1921, as the result of a dishonest trader. Such individuals would later be called rogue traders. In order to facilitate trading of foreign shares, which could not be transferred easily by American investors, the American Depository Receipt (ADR) was used by the Guaranty Trust Company and the New York Curb Market. This allowed foreign shares to be held by a bank or trust company in an account and receipts for those securities were then sold to American investors. ADRs facilitated speculation and trading in foreign securities that would have otherwise been precluded by foreign registration and ownership requirements. ADRs became more popular in 1927 after the British government prohibited its companies from registering their shares overseas. The commercial banks had started personal loan departments by 1918. By the end of the 1920s, some 200 banks had established such departments. The National City Bank in New York created a department for small consumer loans in 1928 as the result of efforts by the Attorney General to provide competition to the loan sharks. It proved to be a profitable business. The very first day that we opened, there were 3,000 people in a line that circled around Madison and 42nd Street, three times, and the police were there to keep the people in line.64 The National City Bank received inquiries from some 1,200 banks around the country asking about the department. Banks began imposing charges on checking account services, which were used by many bank depositors in the 1920s. The banks sought to increase revenues further by becoming financial department storesopening trust departments, providing safe deposit box facilities, and engaging in underwriting and other securities activities. Banks acting as trustees for the investments of clients still remained hamstrung by the prudent man rule, which limited their investments. Some states adopted legal lists of securities that trustees could use for trust investments. Even as late as 1926, there was no uniformity among states as to what were legal investments for trustees.

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The creation of the Federal Reserve System and the authority given to the national banks for trust activities had undercut the advantages that the trust companies had previously enjoyed. In 1917, the Bankers Trust Company changed from a trust company to a commercial bank and became a member of the Federal Reserve System. Bankers Trust was expanding its business. Having established a retirement plan for its own employees in 1913, the bank began acting as trustee for other corporate pension plans. It created a subsidiary with 300 employees to handle its bond business and to participate in underwritings. The changes were beneficial to Bankers Trust stock prices. At one point, its stock was being sold at over $1,000 per share. Branch Banking The McFadden Act, adopted in 1926, codified the existing practice of buying and selling investment securities by national banks. At that time, national banks held some $6 billion of such securities. The McFadden Act allowed national banks to buy and sell investment securities valued at up to 25 percent of their capital and surplus for any one issue. This statutory provision was intended to apply only to nonrecourse, readily marketable, debt securities such as bonds, notes, or debentures. Such instruments were commonly known as investment securities. These investments, the call money market, and their securities affiliates tied the banks closely to the securities markets. By October of 1929, over 50 percent of the assets of the national banks were held in securities or in call loans. During the twenties, commercial loans declined markedly relative to loans on securities and on real estate.65 The McFadden Act confirmed the right of national banks to engage in the safe-deposit business, it extended from one to five years the amount of time that a national bank could make a first mortgage loan on city property, and it eased restrictions on interlocking directorships among banks. In addition, the Federal Reserve Acts restriction on the amounts of money that could be loaned to any one person by a national bank was loosened somewhat. National banks were permitted to loan amounts in excess of 10 percent of their capital when the loans were secured by warehouse receipts for readily marketable, nonperishable staples that were insured. The McFadden Act encouraged nonfarm real estate loans. National banks were permitted to divide their shares into amounts less than $100. This was intended to create a broader market for bank stocks. More importantly, the McFadden Act addressed the issue of branch banking. At the turn of the century, only 5 national and 82 state banks had branches. In total, they had 119 branches. By 1920, the number of branch banks had increased substantially. Branch banks then held some 15 percent of loans and investments of commercial banks. In 1923, there were 91 national and 500 state banks that had a total of over 2,000 branches. In 1924, some 500 state banks had over 1,500 branches among them. Branches outside of home office

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areas began to increase even more in 1925. California was the most liberal state in allowing branch banking. Some 80 banks in that state had over 475 branches. The branch bank leader was Amadeo Giannini, who by 1918 had a chain of 24 banks in California, including the Bank of Italy. Giannini was so caught up in expanding his banking empire that he had his Rolls Royce designated a fire truck so that he did not have to obey the California speed laws while buying banks and opening branches. Giannini greatly expanded his network during the 1920s to several hundred branches and banks. He bought the Bank of America of New York and its over 30 branches for $17 million. Giannini replaced his holding company for his banks in California with the Transamerica Corporation. Opposition to branch banking was growing. The American Bank Association had long been opposed to branch banking. It adopted a resolution against branches in 1916, and a similar resolution in 1922. The Comptroller of the Currency sought legislation to limit branch banking because of his concern that unlimited branch banking would mean the destruction of the national banking system. Before the enactment of the McFadden Act, the national banks were still limited to one bank office, but they could have branches in the city in which they were located. Such branches could only accept deposits and pay out funds. The McFadden Act allowed national banks to establish branches under conditions similar to those for state banks. Although Congress wanted to discourage the extension of branches, it wanted to put banks in the Federal Reserve System on a more equal level with nonmember state banks. The McFadden Act provided for the creation of new branches by national banks in states that permitted banks to have branches and in cities with a population of more than 25,000. If there were more than 25,000 persons residing in the city, but not more than 50,000, one branch was permitted. If the population of a city was between 50,000 and 100,000, two branches were allowed. If the city had a population of more than 100,000, the bank was limited to the number of branches permitted by the Comptroller of the Currency. These limitations were designed to assure that the large national banks did not drive small country banks out of business by multiple branches. The McFadden Act permitted the retention of any branches already in operation by a state bank that converted into a national bank or consolidated with a national bank. Branch banking initially increased after the McFadden Act was adopted. Even so, the actual effect of the McFadden Act, until it was repealed some seventy years later, was to restrict branch banking. The ultimate effect of the McFadden Act was to allow state legislators and regulators to prevent out-ofstate banks from opening branches within their borders.66 It allowed the state banks to curb branch banking by national banks through restrictive legislation. Eager to protect their local banks, most states passed such legislation. To avoid such restrictions, chain banking and group banking became popular. The chief distinction between chain and group banking was that chain

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banks were closely held, and their stock was not publicly traded, while a group bank was under common control, usually through a holding company that would exercise centralized control over the various banks it held. The holding company was exempt from the banking laws at that time because it was not a bank. Numerous such holding companies were formed in the 1920s,67 and their stock was often the subject of speculation. International Banking The Federal Reserve Act allowed banks with capital of over $1 million to establish branches and agencies abroad. The National City Bank had opened several foreign branches at the outbreak of World War I. The Edge Act was adopted in 1919 to expand the ability of national banks to make investments in companies that were engaged in international business. These Edge Act corporations were to be federally chartered corporations that engaged in international banking or financial activities. Edge Act corporations were required to limit their activities in the United States to those which were incidental to their international transactions. In January of 1917, National City Bank opened branch offices in Russia, but they were seized on November 6, 1917, after the Bolsheviks revolted. Banks in Russia were nationalized in December of that year. This caused a large loss to National City Bank and serious questions remained as to the liability of the National City Bank for the $26 million of deposits that were nationalized. In America, the National City Bank created a school to train its bankers as early as 1915. They lived in a communal house in Brooklyn and were exposed to all departments of the bank as part of their training. In 1916, the National City Co., the securities affiliate of the National City Bank, acquired control of the N.W. Halsey firm, one of the larger retail securities firms, with offices in New York, Chicago, San Francisco, and other cities. The National City Co. expanded its reach even further when it took over the bond department of the National City Bank. Bank Securities Affiliates Charles E. Mitchell was hired to run the National City Co. Mitchell was previously employed at the Trust Company of America in New York City, where he had been given a harsh lesson on Wall Street during the Panic of 1907. Mitchell later formed his own investment banking firm, but left it to become president of the National City Co. The National City Co. was facing competition. In 1917, the Chase National Bank established a securities affiliate, as did several other banks in cities across the United States. These bank affiliates were underwriting securities issues and were even acting as retail broker-dealers by selling stocks to the public. The securities affiliates of the banks played a large role in the markets in the 1920s. They were handling about half of all the securities underwritings.

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The National City Co. acted as an underwriter in over 20 percent of all the bond offerings in the United States during the 1920s. It was a significant underwriter for municipal and state governments and for over 150 foreign bond issues between 1921 and 1929, including $500 million of bond offerings by German companies in the United States. The National City Co. maintained a secondary market where customers could buy and sell previously issued bonds. The National City Co. maintained a policy of selling only bonds to the public until 1927 when it added common stocks to its inventory. At its peak, the National City Co. was selling $1.5 billion of securities to the public each year. In one five-year period, the National City Co. distributed some $6 billion of stock. It was said to be the largest broker-dealer in the world in terms of volume of securities distributed to the public. The National City Co. had offices in fifty-eight cities in the 1920s. Additional sales facilities were maintained in twenty-six offices of the National City Bank in New York and in the eighty-nine offices of the National City Bank located abroad. The National City Co. expanded its international presence further in 1923, when it acquired the United Financial Corporation of Montreal, one of the largest investment bankers in Canada. The National City Co. used a private wire system with lines extending over 11,000 miles to bind its operations together. Charles Mitchell wanted the National City Co. to sell securities to the public just as United Cigar Stores sold cigars. To that end, the National City Co. advertised widely in newspapers and magazines, including Harpers and Atlantic Monthly. National City Co. claimed that its judgment as to which bonds are best for you is based on both strict investigation of the security and analysis of your own requirements.68 The National City Co. employed almost 2,000 individuals. Some 350 of those individuals were salesmen, who were provided with leads to prospective customers by the National City Co.s main office. In 1927, National City Co. salesmen were given the names of 50,000 prospective customers. That number was increased to over 120,000 in 1928. Another 54,000 names were added in 1929. Salesmen at the National City Co. were encouraged to engage in high-pressure sales activities when contacting prospective customers. Excitement was generated by news flashes that could be transmitted to customers to create a sense of urgency in investing. Sales contests were used, including one in which $25,000 in prize money was awarded. The salesman accumulating the highest number of points won the contest. The points were based on the amount and identity of the shares being sold. For example, a salesman received four points for selling a share of Missouri-Kansas-Texas preferred stock, but only one point for a share of General Mills common stock. This gave the salesmen an incentive to sell stock to gain points, rather than to further their clients interests. Charles Mitchell was well compensated for his aggressive sales programs at the National City Co. Mitchells salary was $25,000 a year, and he was given a bonus of $529,230 in 1927. Mitchells success with the National City Co. led to his promotion to president of the National City Bank. This in-

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creased his annual compensation to over $1 million. Between 1927 and 1929, Mitchell received about $3.5 million from the National City Bank and the National City Co. as bonuses and salary. The National City Co. began speculating in securities for its own account, including large amounts of stock in the Anaconda Copper Mining Company. The National City Co. found a ready market for this stock through sales to its customers. The National City Co. joined with John D. Ryan, Daniel Guggenheim, and Harry F. Guggenheim to form a joint account to trade Chile Copper Co. common stock. The Guggenheims received a profit of $400,000. The National City Co. received profits of its own that amounted to several hundred thousand dollars. Once again, the National City Co. sold the shares that it had accumulated for its own account to the public through its high-pressure sales operations. The National City Bank was heavily involved in Cuba in the 1920s. Its total exposure in Cuba was almost $80 million, which was almost 80 percent of the banks capital. The National City Co. had its customers purchase many of the Cuban properties that the National City Bank had to foreclose on after the debtors failed to meet payments. This self-dealing was hardly a ringing endorsement of the banks integrity, but the National City Co. became even more infamous for its sales of Peruvian bonds and bonds from the State of Minas Garaes in Brazil. Those bonds soon went into default. The bank and its affiliate had plenty of notice that there was a likelihood that Peru and Brazil would default on their obligations, but sold the bonds to the public anyway. The National City Co. seemed to be oblivious to conflicts of interest. It used extensive selling campaigns to market the stock of the National City Bank. Some $650 million of stock in the bank was sold to the public. Salesmen were urged to have their customers switch their investments to the stock of the National City Bank, and salesmen were paid a premium for sales of the banks stock. The National City Co. was trading the stock of the National City Bank for its own account. This allowed the bank to avoid a restriction in the National Banking Act, which prohibited a national bank from buying and selling its own shares. At times, the National City Co. was selling the banks stock short, even while it was recommending the stock to customers. In 1928, the capital stock of the National City Bank was removed from the list of stocks trading on the NYSE at the banks request. The reason given was low trading volume and a wide spread in price. Charles Mitchell added another reason. He stated that there were elements of danger in permitting the stocks of this bank to be subject to the recurring and occasionally violent waves of speculation on the Exchange.69 After removal of its listing on the NYSE, the stock of the National City Bank was traded in the over-the-counter market, which allowed the National City Co. to control trading and to support its price. The National City Banks stock began to trade at an enormous premium of up to $580. It had started as $20 par stock. Chase National Bank was the largest commercial bank in the United States at the end of World War I. Its assets exceeded $1 billion by 1927, and the bank

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had twenty-seven branches, many of which were acquired through acquisitions. Although its securities affiliate, the Chase Securities Corporation (CSC), did not enter the retail stock business until 1927, that affiliate thereafter began selling stocks in offices throughout the United States and abroad. The securities business of CSC expanded rapidly, and it too began trading for its own account in securities that its sales force would then sell to the public. Like the National City Bank, the Chase National Bank removed its stock from trading on the NYSE for speculative purposes. J.P. Morgan & Co. Jack Morgan turned over to the United States government the house at Princes Gate in London that had belonged to his grandfather Junius Morgan. It was put into use as the American embassy in 1922, and Joseph P. Kennedy was among the ambassadors who would live there. Earlier, J.S. Morgan & Co. in London had been renamed Morgan Grenfell & Co. J.P. Morgan & Co. was still acting as banker for the world. The Morgan firm was the lead underwriter for offerings in the United States by the French and Chinese governments in 1921 and the Polish and Rumanian governments in 1922. In 1923, Morgan acted as underwriter for the Cuban and Austrian governments and later for the Japanese government. J.P. Morgan & Co. was the underwriter of bonds and loans for the Italian government in 1925. J.P Morgan & Co. even acted as a precursor to todays International Monetary Fund by imposing conditions on government financing in France to assure that it could repay a proposed loan. Those restrictions included reduced government spending and a tax increase. The partners at J.P. Morgan & Co. decided to re-expand their positions on the boards of the companies they advised or controlled during the 1920s. The number of directorships they held increased from the 350 criticized by the Pujo Committee in 1912 to 2,400 in the 1920s. Government Finance Federal finance was stabilizing. The currency of the United States was composed of gold, Federal Reserve notes, and Treasury currency in the 1920s. The latter included silver coins, silver certificates, United States notes, Treasury notes, national banknotes, Federal Reserve banknotes, and small coins. Andrew Mellon, who was forced to resign from the board of directors of over fifty corporations when he became Secretary of the Treasury, oversaw the redesigning of the bills used for currency. Although this saved the government over $1 million in printing costs, it was just chump change to the secretary. He approved federal tax refunds of over $7 million to himself personally and another $14 million to his companies while serving as Treasury Secretary. The federal government was still borrowing to fund its operations. Tax anticipation certificates were sold in anticipation of annual income tax pay-

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ments in 1918 and 1919. Treasury notes were being offered in 1921. These were government obligations with maturities from three to five years. The government began issuing long-term Treasury bonds in 1922 that were then paying 4.5 percent and were to mature between 1947 and 1952. The 1920s would witness great debates over German reparations and the repayment of the loans that had been made to the Allies during World War I. The penalties imposed on Germany had been severe, and it defaulted on its reparations payments in December of 1922. The French and Belgian governments then seized the Ruhr. The German economy was in a disastrous condition and inflation was rampant. There was concern that a revolt of the starving billionaires would occur in Germany, where currency was being valued by the foot or was weighed, rather than counted, because the bills required for even small transactions had grown too huge to count. Ten dollars in American currency was said to be enough to buy a large house in the inflation that rendered the mark valueless. A movement was afoot that favored forgiveness of reparations in order to allow Germany to recover. Equally strong objections were voiced to such a course. Similar concerns were raised with respect to forgiving the debts of our Allies, which totaled over $10 billion. Calvin Coolidge was among those who thought that the Allies should repay their debts. He was reported as having said, They hired the money, didnt they? Even so, the United States was eventually forced to make significant concessions to its Allies in their debt payments. After World War I, the League of Nations created a Financial Commission that was to provide loans to the defeated countries. The league held tariff conferences, and the Brussels and Genoa Conferences in 1920 and 1922 were an attempt to create a more efficient international monetary system. These efforts were not successful. The total reparations that Germany was deemed to owe to the Allies was set at $33 billion in 1921. This was a staggering load for its faltering economy. John Maynard Keynes, the economist, argued that the reparations demanded from Germany were too onerous and that the war debts among the Allies should be canceled. He thought that German reparations should be limited to actual physical war damage. A commission was set up by the League of Nations to study the German reparations issue in January of 1924. The United States sent Charles G. Dawes, a Chicago banker, and Owen D. Young, the president of General Electric, as its representatives to the commission. The resulting Dawes plan reduced the annual payments required from Germany to about $600 million. The plan envisioned that the German government would borrow money in the American market and use those funds to pay reparations to the Allies, who would in turn repay their debts to the United States. J.P. Morgan & Co. thereafter arranged some $200 million in loans for Germany. The Dawes plan granted a gold loan to Germany. In 1924, the German government issued a $110 million, 7 percent, twenty-five-year offering of bonds in the United States that were sold at $92, providing a yield of about 7.75 percent. J.P. Morgan & Co. was the underwriter and the issue was oversub-

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scribed ten times. The underwriters commission was estimated to be $5.5 million. Much more relief was needed, and an international conference was held in 1929 to again deal with the problem of German war debts. The resulting Young plan, formulated by Owen Young, replaced the Dawes Plan. It alleviated some of the burden on Germany and reduced Allied debts. Under the Young plan, the Allies evacuated Germany and a schedule of reparations payments was set that was to last until 1982. It replaced the indexed payment scale used by the Dawes plan for set payments. The Young plan was to be financed by a $125 million loan underwritten by Lee, Higginson & Company in Boston as the head of a large underwriting group. Unfortunately, this did not forestall further economic problems in Germany that would set the stage for World War II. Meanwhile, an earthquake in 1923 nearly destroyed the economy of Japan. That country too would seek financial security through conquest.

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Chapter 3 The Crash

1 The Stock Market Expands

Between 1922 and 1929, over $60 billion of securities was issued in the United States. The number of stockholders increased from 12 million in 1920 to 18 million in 1928. Although the number of millionaires continued to grow, that group received less than 7 percent of the dividends declared in 1924. [H]alf of all the corporate stock in the United States [was] owned by those having net incomes of less than $12,500.1 By 1924, one family in ten owned corporate stock. A study of five bond issues sold in the United States between 1923 and 1925 by Austria, Japan, Germany, England, and Belgium found that about 50 percent of the issues were sold to small investors. More than 2 million individuals owned stock in the railroads. The securities of the American Telephone & Telegraph Company (AT&T) were held by over 700,000 individuals. The number of shareholders in the Standard Oil Company of New Jersey increased from about 7,500 in 1917 to over 77,000 in 1926. Some public utilities companies during the 1920s allowed their customers to buy the utilitys stock when paying monthly gas or electric bills. Par value for most stocks was $100, but one professor advocated a lower par value in order to attract more small investors. That advice was followed. The Standard Oil Company of New Jersey reduced its par value from $100 to $25. In 1922, the Eastman Kodak Company exchanged ten shares of no par stock for each $100 of par stock. Small investors found other ways to enter the market. In selling to small investors, . . . the deferred or easy-payment plan has become very popular.2 More women were trading stocks. They were a promising market. It was estimated that women possessed over 40 percent of the total wealth of the nation in the 1920s, and some 20 percent of investors were women. They appeared to be aggressive investors. Women were thought to account for 35 percent of stock market volume. About 37 percent of the shareholders of the U.S. Steel Corporation were female. Over half the shares of AT&T were owned by women. Although women who hung around the brokerage firms to watch tickers continued to be called mud hens, their presence was actively sought by the brokerage firms, and the brokers set aside
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private offices for women to use. A woman tried to buy a seat on the NYSE in 1927, but was refused. There were some women partners in brokerage houses, but they were few in number. Insurance companies began to sell group annuities in the 1920s as a means of creating a retirement program. Pension plan growth was encouraged by the government. The Civil Service Retirement System established a pension program for federal employees in 1920. Congress created a pension plan for Federal Reserve employees in 1924. The Revenue Act of 1921 exempted from taxation employer contributions to private profit-sharing trusts. By the middle of the 1920s, some 400 private pension plans were in operation, covering almost 4 million employees. Most of these plans were defined benefit plans for individuals working in large corporations such as U.S. Steel. This meant that the employees received a pension in a specified amount that was determined by such factors as their salary and length of service. Employee stock purchase plans were popular. Between 1921 and 1925, over 160 such schemes were adopted by companies. By 1928, several hundred more companies had stock purchase plans. Employees participating in these plans often paid for this stock through deductions from their paycheck. The NYSE The NYSE moved again in 1922 because more space was needed. Between 1920 and 1926, the number of stocks listed on the NYSE increased from 691 to over 1,000. Trading volume on the NYSE exceeded 450 million shares in 1926 and grew to over 1 billion shares in 1929. Large amounts of that trading were being conducted on margin. The NYSEs Money Desk was reopened on the floor to accommodate the need for call money for margin transactions. Brokers arranged loans at that desk from banks who were willing to supply call money. By 1922, brokerage firms were requiring margins of 17 percent. Later in the decade, margins were increased to 20 percent. Stock loans made in connection with short sales were an important part of the brokerage business. Short sellers did not own the stock being sold, but delivery was still required. The short seller was, therefore, required to borrow the stock from a third party and to return it later. If prices dropped, the short seller could buy the stock for less than it was sold for and return the shares to the lender, making a profit on the difference between the purchase and sale prices. A loss would occur if prices increased. The sellers broker usually arranged stock loans for short sellers. Brokers loaned securities of their customers to the shorts. The broker borrowing the stock was required to place a deposit with the lending broker. Additional deposits were required if the price of the stock increased. If the value dropped, then margin in the amount of the decrease was returned to the borrowing broker. When the short seller covered his position, the sellers broker purchased the stock in the market and delivered it to the lender. The lender of the stock then returned the margin deposit. In in-

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stances where a stock was in demand, stock lenders would charge a premium, as well as interest. In some cases, premiums were as much as $8 a share. Short sales against the box were conducted where the seller owned the stock but did not want to deliver that particular stock for tax or other reasons. The seller would borrow the stock for the purpose of making delivery. Options were another short-selling tool. Short sellers often used options to hedge themselves against a market rise. NYSE members were increasingly separating their functions into floor brokers, floor traders, and specialists, but they would still sometimes perform multiple functions. The specialist had become an established institution on the NYSE. These traders made a continuous market in particular securities by accepting bids and offers throughout the trading day. Every stock on the NYSE had at least one specialist in the 1920s. Members could act as a specialist in any stock. Some stocks had more than one specialist, and some specialists acted as such for more than one stock. The specialists role was, and is, a controversial one. The specialist filled market orders and kept customer limit orders and stop orders in his book, which provided him with superior knowledge of order flows in the event of a change of market direction. This gave the specialist a tremendous advantage over the general public because he traded for his own account in anticipation of market moves and before the public had a chance to react.3 The specialists contended that they traded for their own account in order to maintain a close and orderly market in the securities for which they acted as specialists. More narrow spreads between bid and ask prices, and the continuous market they provided, were said to justify their superior time, place, and information advantage. The specialists claimed that the market regulated their conduct and kept them honest; otherwise they would lose the goodwill of the brokers who provided their order flow. Critics said that such discipline was loose, at best, and that there was no formal, legal obligation on the specialist to act fairly. Floor brokers executed customer orders on the floor of the NYSE. These individuals were sometimes called two-dollar brokers because they charged two dollars as their commission for an order of 100 shares. Floor traders were freelance dealers who traded for their own account. Floor traders did not have to pay commissions for their own trading and had a time and place advantage over other traders because of their position on the floor. These traders tended to accelerate market trends and accentuate market fluctuations. The NYSE had a post on the floor where trading in ten-share lots was permitted, but most small transactions were handled by the odd-lot dealers. These individuals specialized in buying and selling amounts less than a round lot of 100 shares. Odd-lot dealers were not paid a commission; rather, they were compensated by markups or markdowns. The odd-lot dealer would usually sell odd lots at one-eighth to one-quarter of a point below or above the prevailing price for round lots. During the 1920s, the NYSE required settlement of securities to occur on

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the next full business day following the trade date. Settlement meant payment and delivery of the securities. The NYSE created a Central Delivery Department to handle securities certificates and documentation for their transfer. The NYSE Stock Clearing Corporation dealt with money settlements, as well as receiving and delivering the stock certificates. The NYSE continued to resist efforts to have itself incorporated, but it led a campaign between 1921 and 1924 to stop bucket shop operations. Salesmen for the bucket shops continued their high-pressure tactics, which led to their being referred to as dynamiters in the 1920s. The NYSE established a Fraud Bureau to work with the Better Business Bureau to curb improper securities practices. In 1922, the NYSE began regular examinations of its members that were carrying margin accounts. Firms carrying large accounts were subject to such inspections twice each year. Later, the NYSE began using a questionnaire system, which required an audit of its members books and records to determine whether they were in financial difficulty. The NYSE did not require, but did encourage, the use of independent, outside accountants. Those accountants sought to have auditing standards governed by accepted accounting principles, or what are now called generally accepted accounting principles. Other Markets The New York Produce Exchange was trading 250 different securities in 1928. Several failures occurred in 1922 on the Consolidated Stock Exchange. Included among them was Edward M. Fuller & Co. The Attorney General in New York began an investigation of members of the Consolidated Stock Exchange under the states Martin Act, which prohibited fraudulent securities activities. This caused a panic on the Consolidated Stock Exchange and more firms failed, including M.C. Schneider and Courtlandt, Ward & Co. The Consolidated Exchange did not recover, and it came to an ignominious end in 1926.4 By the end of the 1920s, the second largest stock exchange in America was the San Francisco Stock Exchange. Over fifty other stock exchanges were operating in cities across the United States and Canada, including Colorado Springs, Louisville, Kansas City, Wheeling, Richmond, and New Orleans. Trading volume grew on the regional exchanges, as speculation increased during the 1920s. Volume on the St. Louis Stock Exchange was approaching 1 million shares by 1929. The Los Angeles Curb Exchange, which was formed in 1928, traded some 18 million shares in its first year. The over-the-counter market was flourishing. By the end of the 1920s, over 50,000 unlisted security issues were being traded by brokers. Curb traders operating on Broad Street in New York continued to provide a colorful spectacle as they received orders by hand signals from clerks posted in the windows of adjoining buildings. Gambling continued on the curb market. Much of the money bet in the famous Black Sox Scandal had been placed with curb bookmakers.5 This popular tourist attraction ended in 1921 when

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the New York curb brokers went indoors at 86 Trinity Place. The New York Curb Market became even more formalized when it established a clearinghouse in 1923. The New York Curb Market changed its name to the New York Curb Exchange in 1929. This institution would become the American Stock Exchange in 1953. Among the issues being traded on the New York Curb Exchange when it opened were anticipated offerings of securitiesthat is, when, as and if issued securities. Samuel Untermyer, chief counsel to the Lockwood Committee in New York, which had proposed security disclosure legislation after being originally formed to study a housing shortage in New York, sought to stop when-issued trading on the curb market in 1922. Untermyer called this phantom stock. Over-the-counter trading continued in brokers offices. Various organizations, including the Unlisted Securities Dealers Association and the Association of Dealers in Bank Stock, tried to coordinate that activity. Those two organizations would be consolidated into the New York Securities Dealers Association in 1932. Over-the-counter auction markets for securities were being conducted in Boston, Buffalo, and Philadelphia by R.L. Day & Co., A. J. Wright & Co., and others. The number of new stock issues grew from about 1,800 in 1921 to over 6,000 by 1929. New issues of equity securities began to outnumber bond issues. Prior to 1928, the number of bond issues exceeded the number of stock offerings. By 1929, over 60 percent of all securities issues were stocks. That number had only been 15 percent in 1921. Bonds were largely traded in the over-the-counter market, but some bond transactions were conducted in a separate room at the NYSE. Trading on the NYSE included United States government bonds until that business was shifted off the exchange and into the over-the-counter market. The NYSE listed several German stocks and bonds that had been underwritten in the United States in the 1920s. There were many types of securities available for investment in the 1920s. They included industrial securities, government, state and municipal bonds, public utilities securities, and railroad bonds. Municipal governments were issuing anticipation notes. These were bonds issued in anticipation of special assessments. Corporate bonds, or debentures as they were called, were sold under long and complex indenture agreements, which defined the rights of the bondholders, usually in terms most favorable to the lender. Bonds were sometimes convertible into stocks or had warrants attached that granted an option on common stock or another security at a specified price. Bonds or preferred stock were sold with common stocks attached, or preferred and common stock might be sold in units. Most large companies had several classes of stock. One popular form of capitalization was the sale of two classes of common stock, class A and class B. One class would have a preference over the other in dividends, but have little or no voting powers. An increasing phenomenon during the 1920s was the issuing of preferred or other stocks with greatly restricted voting rights, so that control could be maintained by a small group of insiders while capital for the enterprise was raised from the public. Thus the advantages of diffusion of ownership had been secured with-

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out relinquishing any of the control of management.6 The NYSE amended its rules in 1926 to pressure companies to provide equal voting rights to their shareholders when their stock was listed on the NYSE. Information Wall Street was becoming more sophisticated. By the 1920s, most of the leading financiers and about half of the business community had some college training. Financial information about companies was still difficult to obtain. After becoming president, Calvin Coolidge rejected an effort by Professor William Z. Ripley to have the Federal Trade Commission require corporations to file more complete financial reports. The president believed that such matters should be left to the states. The NYSE attempted to increase financial reporting by the companies it listed for trading. About two-thirds of the listed companies agreed to supply financial reports and another 200 or so listed companies were required to file financial reports with the Interstate Commerce Commission. Forecasting services were growing. They included Roger W. Babsons Statistical Organization, Moodys Investor Service, and the Committee on Economic Research at Harvard. Ratings services included Financial World, Brookmire Economic Service, Fitch Publishing Co., Poors Publishing Co., and the Standard Statistical Corporation. John Moody had published the first rating scheme for bonds in 1909 and was rating most of the U.S. bond market by the 1920s. The Standard Statistics Co., was rating stocks and bonds, and Fitch Publishing Co. began issuing ratings in 1924. Poors Publishing Co. was rating stocks and bonds by 1916. Poors was using a three thirds rating system for its credit ratings for corporate fixed income instruments. This system was based on three factors: prior financial performance, current financial information, and expected trends. Several publications provided information on publicly traded securities. They included Poors, Moodys, Standard Statistics, and the Commercial & Financial Chronicle, which had been started in 1839. Other financial publications included Duns Review, the Wall Street Journal, and Forbes magazine, which was started in 1917. Barrons, created by Clarence W. Barron, became a magazine for Wall Street in 1921. The Dow Jones Industrial Average achieved prominence in the 1920s as a barometer for the condition of the stock market and the economy. That index stood at about 100 in 1924. By 1925, it had increased to over 380. The Dow had competition from the forerunner of Standard & Poors. Standard Statistic Company published a stock price index based on 421 stocks in 1926. The New York Times was trying to compete by publishing a daily and yearly range of prices for forty domestic bonds as an index. It additionally published market averages that gave the daily, monthly, and annual ranges of fifty stocks, as well as a yearly range of twenty-five railroads. Fortune magazine would not be founded by Henry Luce until 1930.

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Investments A merger mania occurred during the 1920s, and the holding companies expanded again. They pyramided themselves by allowing one company at the top of the structure to control a whole web of companies, each of which could sell the noncontrolling portion of its stock to the public. One of the largest holding company systems was established by Samuel Insull in public utilities in the Midwest. The Van Sweringen Brothers in Cleveland would use holding companies to control large railroad systems. Americans were investing outside our borders in the 1920s. Almost $1.4 billion of foreign securities was offered in the United States between 1924 and 1925. Over $500 million of American funds was invested in mineral and forest products in Canada by 1924. Some $25 million was invested in Honduras by one company in 1923. By 1929, American investments outside the country exceeded $15 billion. The international arbitrage of securities was a finely developed business by the 1920s. The advent of transatlantic communications assured that arbitrageurs would keep prices on both sides of the ocean in line. This was a sophisticated business because of currency differences and the fact that securities were quoted in New York in a manner that was different from that in other countries. Settlement terms also differed. Domestically, the commission houses used private wires to transmit orders to the NYSE from their branch offices. Some 500,000 miles of private wires were in use as the market surged in the 1920s. This included over 100 private wires between New York and Chicago. Some brokerage firms specialized in futures trading; others traded only securities, and some firms did both. In 1920, McDonnell & Co. was specializing in rights and scrips, including scrip for tobacco stocks that paid an 8 percent dividend. E.W. Wagner & Co., a brokerage firm, provided a weekly financial review for investors. Shields & Co. offered investment securities. Halsey, Stuart & Co. had offices in New York, Chicago, St. Louis, Philadelphia, Minneapolis, Boston, Milwaukee, and Detroit. This firm touted safety and 7.75 percent returns on first mortgage investments of the Utah-Idaho Sugar Company in 1920. Large increases in beet sugar prices were predicted on the basis of newspaper reports, and it was stated that sugar was an essential food product that was assured a constant demand. To telephone Halsey, Stuart & Co. in New York in 1920, one simply asked the operator for Hanover 8000. Halsey, Stuart & Co. was the underwriter for a number of public utility offerings. Among others, the firm handled much of Samuel Insulls offerings for his empire of utility companies. Josephthal & Co. was offering rights and subscription warrants in 1927. White, Weld & Co. offered short-term notes, foreign bonds, government, municipal, railroad corporation, and public utility securities. This firm prepared investment lists for banks and trustees as well as individual investors. The firm had offices in New York, Boston, and Chicago. Salomon Bros. & Hutzler were selling United States Treasury 6 percent certificates. The firm

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was a dealer in all other issues of Treasury certificates, and this Discount House was purchasing bankers acceptances for future delivery of thirty, sixty, or ninety days. This service will permit the definite elimination of risk as to rates and fix the financing of transactions involving future delivery of bills, irrespective of market conditions.7 Salomon Bros. & Hutzler had offices in Philadelphia, Boston, and New York. The firm could be reached by telephone in New York by asking the operator for Bowling Green 3050. In 1927, Salomon Bros. & Hutzler, Hallgarten & Co., and Redmond & Co. were underwriters for an offering by the Province of British Columbia for two-year gold, 4.5 percent Treasury bills that were payable in gold coin of the United States in New York City or in gold coins of Canada in Canada, at the holders option. The firm of A.G. Becker & Co. offered profitable investments in South America. Merrill Lynch and Other Giants Full-service brokerage firms arrived. They included Ira Haupt & Co. and Horace Stoneham & Co. A giant was being created by Charles Merrill, a former professional baseball player. He had begun his career on Wall Street in 1909 at George H. Burr & Co., a commercial paper firm. In 1913, Merrill went to Eastman Dillon & Co. and, in 1914, formed his own firm, Charles E. Merrill & Co. It later became Merrill, Lynch & Co. The Lynch was Edwin C. Lynch, a former roommate and assistant to Merrill. Merrill, Lynch & Co. was located at 120 Broadway in New York in 1921 and soon had offices in Chicago, Detroit, Milwaukee, Denver, and Los Angeles. During the 1920s, Merrill, Lynch & Co. engaged in underwritings for chain store operations such as Western Auto and S.S. Kresge. Merrill, Lynch was also selling 8 percent preferred stocks and investments in commercial paper. It offered investment advice through advertisements in the New York Times. The firm provided descriptive circulars about various stocks upon request. These included the Spicer Manufacturing Corp., and the Waring Hat Manufacturing Corp., and Analysis No. D270 covered the Melville Shoe Corporation 8 percent preferred stock. Kidder, Peabody was an underwriter for AT&T stock. Lamborn & Co. specialized in sugar stocks in 1920. Shallow Texas Wells were being advertised by J.R. Bridgeford & Co. Parkinson & Burr offered Imperial Japanese Government 4.5 percent sterling bonds. F.J. Lisman & Co. offered Bush Terminal Buildings Co. bonds, which it claimed offered absolute security. Unfortunately, that claim did not prove entirely true: The Bush Terminal Company went into bankruptcy in the 1930s. In 1923, Jerome B. Sullivan & Co. offered Mexican government, state, and railway bonds. Jelke, Hood & Bolles, a member of the NYSE, announced that it had created a department to deal in New York City and state bonds, as well as federal and joint-stock land bank bonds. Dillon, Read & Co. and the Northern Trust Company of Chicago were offering joint-stock land bank bonds in 1923. These were exempt from tax.

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Dean Witter left Blythe & Witter Co. in 1924. His new firm, Dean Witter & Co., specialized in public utilities and municipal securities in the West. Tucker, Anthony & Co., an East Coast firm, was offering Missouri Pacific Railroad Company, 5.25 percent, secured gold bonds. This firm was a member of the New York Stock Exchange and had offices at 120 Broadway in New York. W.A. Harriman & Co., Dominick & Dominick, and the Union Trust Company of Pittsburgh placed a tombstone announcement in the Chicago Tribune in 1924 for West Penn Power Company 7 percent, cumulative preferred stock. The tombstone noted that the accounts of the company were audited annually by Hurdman & Cranstoun of New York and that the law firm of Sullivan & Cromwell had passed on all legal matters in connection with the stock offering. The preferred stock dividends were exempt from normal federal income tax. J.P. Morgan & Co. was still the leading investment banking house. Dillon, Read & Co., Lee Higginson Co., Kidder, Peabody Co., and Blair & Co. were other large underwriters. Speyer & Co., J. & W. Seligman Co., and the Ladenburg Thalmann firms were important in railroad issues. Bonbright Co., Harris Forbes Co., Halsey, Stuart & Co., and Coffin & Burr Co. were underwriting public utility securities. In addition to Merrill Lynch, two leading investment bankers in merchandising and retail fields in the 1920s were Lehman Brothers and Goldman Sachs. Other firms acting as investment bankers included E.B. Smith & Co., C.D. Barney & Co., White Weld & Co., Stone & Webster Co., Field Glore & Co., Hallgarten & Co., E.H. Rollins & Sons, and the Brown Brothers firm. In the 1920s, the motion picture industry began demanding more and more finance. Paramount began raising large amounts of funds in 1926 and 1927. Its bond and stock offerings were handled by Kuhn, Loeb & Co. Syndicate Operations In the 1920s, before the enactment of federal securities laws, the investment banking business was said to be one of dignity and mystery.8 Syndicate operations for underwritings in the 1920s were of short duration, usually lasting from thirty to sixty days. Before World War I, securities issues over $1 million had been considered large. By the 1920s, $25 million issues were not unusual. This growth required an expansion of the size of the underwriting syndicates. The selling syndicates became larger and more widely dispersed geographically. There were three types of selling syndicates. In the first, the so-called unlimited liability selling syndicate, each member of the syndicate agreed to take a pro rata share of the issue at a fixed price and to take down their share of any unsold securities that remained at the time the syndicate expired. The underwriters used a market out clause that allowed them to escape a firm commitment, if market conditions undercut the offering price. In the second type, the limited liability selling syndicate, the liability or obli-

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gation of each member was limited to the amount of their commitment. When they sold that amount, they did not have to take up a proportionate share of any unsold securities. A third type of syndicate was called the selling group. This was like a limited liability selling syndicate, but its members were not responsible for the expenses of the underwriting. The syndicate members were responsible only for expenses connected with their own retail distribution of securities and were required to take up only those securities for which they subscribed. All three forms of syndicates in the 1920s made it a violation of the syndicate agreement to sell at any price other than the public offering price. The manager of the syndicate traded on the open market in order to maintain that offering price. This was called stabilizing. Managers were using scale-up orders as part of their stabilizing activities. These were buy orders designed to stimulate the market during distribution. The syndicate sought to keep the market above the offering price and to prevent any security that was sold by a distributor from coming back into the market and depressing the offering price before the distribution was completed. If a security was sold back into the market, it was viewed as a violation of the agreement of the syndicate members to place the securities for investment. Such activity was monitored by taking the serial numbers of the securities. Therefore, when the securities were sold back into the market, repurchase penalties were imposed upon a syndicate member. These penalties usually consisted of a cancellation of the commission on the sale of those securities. The syndicate members who sold the securities could be required to take them up for their own account. Later, it became common to restrict the repurchase penalty to the cancellation of commissions, rather than requiring the syndicate member to buy the security. William Durant The automobile industry continued its demands on finance. After automobile sales dropped in 1920, William C. Durant, the head of General Motors, tried unsuccessfully to support the price of its stock. Durant lost some $120 million dollars in that effort. Durant then found himself outgunned in a fight for control over the company. During that battle, clearing of the stock of General Motors Company was suspended by the NYSE. At that point, Durant had almost $40 million in outstanding margin calls. The Du Pont family had invested heavily in General Motors, and Pierre Du Pont brought in J.P. Morgan & Co. to aid the companys finances. Durants financial situation was troubling because of the large borrowings he had made on General Motors stock. There was concern that his failure could set off a stock market panic. In an act of desperation, Durant formed Durant Corporation to offer GM securities for $18 a share to small stockholders. There was to be a fifty-share limit, and a time payment plan, and purchasers could make payments by passbook deposits. This arrangement was intended to sell the shares by Durant but to keep

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them out of the marketplace and to maintain their price. This was a rather imaginative piece of financing, but it failed to work. A holding company was formed to stabilize the stock of General Motors. It became Du Pont Securities Company and replaced the Durant Corporation. A stabilizing pool had been formed by Du Pont and John Raskob for the General Motors stock, but Durant was in such bad financial condition that this effort did not save him. J.P. Morgan & Co. raised money to bail out Durant. A new company was formed to hold the General Motors stock owned by Durant. The newly formed company then issued $20 million in notes that were to be taken up by New York banks. J.P. Morgan & Co. was to sell that loan to the banks. With Morgans assistance, Du Pont de Nemours Company and the Du Pont familys Christiane Securities Company acquired a one-third interest in General Motors. This gave the Du Pont interests control of General Motors and would earn the Du Pont family $300 million in dividends. Durant was removed from his position as an executive at General Motors in 1920. He was the last senior executive to be fired by General Motors until 1992. Durant turned to other speculations and was said to have used his inside information to double his money each month.9 Durant bought the charter of the Liberty National Bank. He sought to turn the Liberty into a peoples bank. In 1924, Durant was operating a syndicate that bought some $4 billion in stocks. Durant reportedly bought another $1 billion in stock in 1928. Durant continued to speculate in General Motors stock. He used John Jacob Raskob, chairman of the Democratic Party, to make speeches touting General Motors as an investment. Durant was not alone in his speculative forays into the automobile securities. Allen A. Ryan had cornered the stock of the Stutz Motor Company in 1920. He was then suspended from the NYSE. Herbert Swope was another speculator of some notoriety in the 1920s, often trading on inside information. Durant had tried to corner the stock of the Fisher Body company. It was run by Fred Fisher and his several brothers, who had started out as blacksmiths. In 1918, the Fisher brothers agreed to supply General Motors with all of its bodies. Thereafter, the Fisher Body Corporation sold 300,000 of its 500,000 shares to General Motors Corporation for $27.6 million. Fisher Body was dissolved in 1926, and General Motors stock was exchanged for the Fisher Body stock. Fred Fisher and his brothers would receive a total of some $200 million for their business. They used that money to speculate in securities, purportedly making as much as $50 million in pools that manipulated the stock prices of Montgomery Ward and the Radio Corporation of America (RCA). More Automobiles The first Model T sold for $850, but Henry Ford kept reducing its price. In 1923, Ford allowed his customers to buy their Model Ts through installment sales. Purchasers paid $5 a week for a year to buy the car, which they could

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not pick up until payment was complete. By this time, Ford was selling over 2 million cars a year. In 1926, Ford went to a five-day workweek. By then, 15 million Model Ts had been sold. Dillon, Read, & Co. sought to purchase the Dodge Company from the heirs of the Dodge brothers in 1925. The brothers had apparently succumbed to the effects of adulterated Prohibition whiskey. A partner at Bache & Co. obtained an option on the brothers stock from their widows and that option was sold to Dillon, Read. The Dillion, Read firm outbid J.P. Morgan & Co. for the option, paying a 10 percent fee. Dillon, Read financed the acquisition of the stock covered by the option by selling bonds and preferred stock and nonvoting class A common stock to the public. Dillon, Read kept the class B voting stock and maintained control of the company. Casualty insurance became more popular as the automobile began to exact a toll on America. The number of automobile deaths increased from 1,291 in 1911 to 18,871 in 1926. Between 1911 and 1932 more than 300,000 Americans were killed on the roads.10 State Farm Mutual was formed in 1922 by George Jacob Mecherle. It was soon the largest automobile insurer. In 1926, the Farm Bureau Mutual Automobile Insurance Company was founded. It later became Farm Bureau Insurance and then changed its name to Nationwide Insurance in 1955. By 1929, over $1.6 billion in assets were held by the casualty companies. Automobile finance would become another industry spawned by Detroit. Large industrial loan companies provided wholesale and consumer loans for automobile and other purchases. They included the General Motors Acceptance Corporation, the Commercial Investment Trust Corporation, the Commercial Credit Company, Hare & Chase, the Merchants and Manufacturers Securities Corporation, the Industrial Acceptance Corporation, the National Bond and Investment Company, and the Pacific Finance Company. Those firms would be joined by financial subsidiaries created by Ford and other motor companies. By 1925, some 75 percent of new and used autos were being sold on time by credit. Financial Troubles The period between 1920 and 1921 saw a number of large firms facing failure, including the Goodyear Tire and Rubber Company. These troubled companies were often reorganized by creditors committees, rather than by a receiver. Readjustments demanded by these committees were, all too often, unfair to the stockholders. Manipulation of securities prices was becoming another problem. A corner in the stock of Piggly Wiggly, a grocery chain in the South, occurred after several stores failed in 1922. Those stores were using the Piggly Wiggly name, but had little to do with the company. Nevertheless, bear traders used their failure to drive down the price of the Piggly Wiggly stock. Clarence Saunders, the Piggly Wiggly president, then spent $10 million to purchase over half of

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the companys outstanding shares. Saunders pushed the price of the stock up ten points over what it had been before the bear raid. Saunders began selling Piggly Wiggly stock on the installment basis through newspapers. He wanted to make sure that the shares were widely dispersed and could not be acquired to corner the stock. The NYSE objected to this practice. This angered Saunders, and he then paid his margin purchases in full and demanded delivery of the stock. At that time, Saunders had virtually all of the available floating supply of the Piggly Wiggly stock, and delivery was not possible because the brokers were short the stock. Saunders used Jesse Livermore and Frank Bliss, two high-profile speculators, to perfect this corner. They pushed the price of the Piggly Wiggly stock from about $50 to over $124. The NYSE, however, gave the short traders additional time to deliver their stock, which undermined the corner, and Saunders suffered a large loss. The NYSE then delisted the Piggly Wiggly stock. Frank E. Bliss, who was known as the Silver Fox of Wall Street, worked with Jesse Livermore again to manipulate the price of the stock of the Computing Tabulator Company from $40 to over $80. Bliss and Livermore made more than $1 million in profits. The Computing Tabulator Company later became International Business Machines (IBM). Another battle involved a squeeze on the short traders speculating in the stock of the Wheeling & Lake Erie Railroad. The price of that stock increased by over $100 a share and then dropped by some $60. President Warren G. Harding was reported as owing his broker $180,000 upon his death in August of 1923. Harding had been speculating through a blind account. The Teapot Dome Scandal broke in 1921 when the Secretary of the Interior, Albert Fall, secretly leased the navys oil reserves at Teapot Dome to Harry Sinclair and Edward Doheny. The secretary was paid a bribe of $500,000 for access to the government oil leases. Fall was later convicted of criminal activity, but Sinclair continued his operations. Arthur Cutten, of commodity futures fame, would later form a pool with Sinclair to trade in the stock of the Sinclair Consolidated Oil Corporation. This operation was financed by the Chase National Bank at the behest of the banks chairman, Albert H. Wiggin, who made a personal profit of $877,654 from the pool. The pool itself cleared over $12 million in profits. Chase Securities Corporation joined in another pool with Jesse Livermore for more profits. Before he became president, Franklin D. Roosevelt was among the investors who organized the Federal International Investment Trust to provide credit to foreign importers of American products. The promoters sought to have this entity chartered by the Federal Reserve Board and to have its stock approved as a legal investment for national banks. That charter was not granted, but the trust was given a commission for guaranteeing half of the loans of Montevideo, Uruguay, that were made by Supervielle & Co. The trust did not have to put up any of its own funds to earn that commission. A more rapacious speculator was accumulating a fortune. Joseph Kennedy was a major player in the boot-

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legging business during the 1920s. He was, at the same time, receiving an education in the stock market from his employment at the brokerage firm of Hayden, Stone. There, he conducted a pool in the stock of Todd shipyards and made over $200,000 on a tip that Henry Ford was going to buy the Pond Creek Coal Company. The courts were imposing liability on directors who were not directing. In Bates v. Dresser, the Supreme Court held that a president of a bank was liable for the theft by an employee of over $300,000.11 The employee had developed a unique scheme whereby he falsely credited customer deposits to conceal his theft. Justice Oliver Wendell Holmes found that the banks president was liable for those losses because the president had been notified of the possibility that the employee was speculating in copper stocks. It was shown that the employee was living at a pretty fast pace and was supporting a woman, as well as driving an automobile, all on a salary of only $12 a week. The banks outside directors avoided liability because they had relied on a bank examiners semiannual report to assure themselves that everything was in order. In Barnes v. Andrews,12 Justice Learned Hand held that a director who failed to attend corporate meetings had breached his duty of care to the corporation. No damages were found because his failure to attend meetings did not appear to be the cause of the failure of the company.

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2 The Market Surge and Investment Trusts

Investment Trusts Investment trusts provided the means by which many investors were gaining access to the securities markets. A Senate committee found that during the 1920s a veritable epidemic of investment trusts afflicted the Nation.13 This was no overstatement. Some 140 investment companies were formed between 1921 and 1926. A new investment trust was being created every other day in 1928; the rate reached one a day in 1929. Between 1928 and 1929, the number of investors in investment trusts increased from 55,000 to over 500,000. By 1924, over $75 million was invested in investment trusts. Prior to that year, less than $15 million had been invested in those entities. In 1925, investment trusts were holding over $150 million securities. That figure quickly doubled and then doubled again. The assets of the investments trusts rose to over $1 billion in 1928. Another $2.1 billion was added in 1929. The NYSE began listing investment trusts in 1929. The first companies traded were the Sterling Securities Corporation and the General Public Service Corporation. Investors in these companies were told that, by investing $15 a month, they could accumulate $80,000 during their lifetime and provide themselves with a monthly income of $400. Investment companies were promoted as a way for small investors to diversify their security holdings. It was said that this investment medium provided investors with the opportunity of investing small amounts in a large number of securities, diversified according to undertaking, geographical location, and type of security.14 This was likened to a form of insurance in which the law of large numbers would be applied to reduce risk. The investment companies offered expertise in the management of the investors funds. Some investment companies specialized in particular types of investment securities, while still others concentrated on particular sectors such as oil companies, railroads, banks, or chain stores. Most of the investment companies operating in the 1920s were closed-end
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management companies. A closed-end company sold stock in itself and did not redeem its shares. The closed-end investment company operated much like any other corporation except that its business was to invest in securities. The managers of the closed-end investment company selected the securities for its portfolio and determined investment strategies. Funds were raised through common and preferred stock offerings and bond issues. The use of bond offerings provided leverage to the common stock holders, who hoped that investment returns on the borrowed funds would exceed their cost. The common shares of the investment company were valued in the market on the basis of the expected performance of the investment strategies of portfolio managers. They often traded at a discount. Other forms of investment trusts were appearing. The fixed investment trust appeared in 1923. Sometimes called bankers shares, fixed trusts, or bankers trusts, and now referred to as a unit investment trust or a defined assets fund, these were simply portfolios of securities pooled and sold to the public. Unlike in the closed-end investment companies, the structure of the portfolio in a fixed trust did not change. The securities were held in the fixed trust until they matured in the case of bonds or until the trust was dissolved in the case of equities. The fixed trusts initially involved an arrangement in which high-priced securities were deposited with a trustee and low-priced participation certificates were issued against such deposits and sold to the public. Later, lower-priced securities were added to the fixed trusts. The fixed trusts did not have managers to trade or adjust their portfolio. Instead, they employed banks as trustees for the securities held in trust. The banks would distribute interest or dividend payments and principal upon maturity. The first of the fixed trust offerings was made by the United Bankers Oil Co. The securities placed in this trust were from the Standard Oil companies. This trust was not successful. Another unit investment trust that encountered difficulties was holding securities of the Ford Motor Company of Canada. The unit investment trust certificates were offered at a large premium without apparent reason, and fraud was later charged. Between 1924 and 1926, several other unit investment trusts were formed. The Bankers Trust Company of New York formed such a trust to hold Cities Service Company securities. The shares were deposited with Bankers Trust and 300,000 nonvoting shares were issued that represented ownership in the 30,000 shares of Cities Service Companys stock that were placed in the trust. Other fixed trusts held securities of the Great Atlantic and Pacific Tea Company (A&P) and May Department Stores. A middle ground between the fixed trust and the management type closedend investment company was the Nation-Wide Securities Co. It accumulated 300 shares of stock in 25 corporations in diversified industries. Nation-Wide then sold its own shares for $10.25 each, raising $3,279,000. This trust was designed to avoid the problem of the fixed trust that prevented substitution of securities under any circumstance. Nation-Wide allowed substitution when a

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company began to fail, but did not seek actively to trade its portfolio. Another variation was illustrated by an advertisement in the New York Times that offered insuranshares trust certificates. These certificates represented stocks in selected insurance companies and were sold to investors who wanted to diversify their investments. Diversification was achieved because the insurance companies themselves diversified the investment of their reserves. In another scheme, Edge Act corporations were used to create a mechanism that operated similarly to the British investment trusts. Investors wanting foreign securities could purchase the stocks of the Edge Act company, which in turn would hold foreign securities. The First Federal Foreign Investment Trust was such a company, but the concept did not really become popular. Another form of investment company issued face-amount certificates. These instruments, which had been sold even before 1900, were investment contracts in which the issuer agreed to pay at maturity the face amount of the certificate to the purchaser in exchange for specified installment payments. The installment payments were usually made in amounts of $5 or $10 per month over a ten- to fifteen-year period. The investor could surrender his investment at an earlier time for a reduced amount. A variation of the faceamount certificate was the installment or periodic payment plan. These were essentially interests in investment companies that were sold to small investors through installment payments. Some of the payments were as low as $5 a month. John J. Raskob, the builder of the Empire State Building and the leader of the Democratic effort to have Alfred Smith elected president in 1928, was among those urging small investors to participate in such investment schemes. Raskob proposed the creation of an investment trust in 1929 that would allow investors to buy shares on an installment plan by purchasing $500 worth of stock with a $200 down payment as margin. The rest would be paid off in installments of $25 per month. The stock in the investment trust would secure the loan. The open-end mutual funds, which continually buy and sell their own securities and dominate the market today, were created in Boston in 1924. None of them, however, achieved great importance in the investment company field before 1927.15 The first open-end mutual fund was the Massachusetts Investors Trust. It was the brainchild of Edward G. Leffler. Leffler and George Putnam formed Incorporated Investors in 1925 as an open-end investment company. Its shares were sold by Parker, Putnam & Nightingale. The State Street Investment Corporation was formed by Paul Cabot, Richard Saltonstall, and Richard Paine in 1924. It became an open-end investment company in 1927. This company continuously sold and redeemed its shares. The redemption was based on the net asset value of the shares, less a charge, which was usually $2. This structure allowed only one class of securities and required the managers to maintain some percentage of assets in liquid securities so they could meet redemption demands. The investment trusts were often sponsored and managed by investment

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bankers and the securities affiliates of large banks. The American International Corporation (AIC) was founded after World War I by Frank Vanderlip at the National City Bank, Otto Kahn, James A. Stillman, Cyrus H. McCormick, and several other financiers. AIC was initially formed to complement National Citys trade finance activities. AIC began business with capital of $50 million, which was raised by a private offering. Some $25 million of the stock of AIC was offered to the shareholders of the National City Bank in New York, with another $24 million to the individuals who had agreed to assist the company. The final $1 million of capital was obtained in the form of preferred stock that could be held only by directors of the company, as well as officers and employees. These were called managers shares and were common in England and Germany, but not the United States. The company created several subsidiaries engaged in various business enterprises. It was not particularly successful, and its capital dropped to $23 million in 1923, when it became a diversified investment company that chiefly held listed securities. The Big Investment Trusts Kidder, Peabody & Co. was among the investment bankers that formed closedend investment trusts during the 1920s. One of these was the New England Cotton Yarn Company, which sold its properties for stock of the companies purchasing its assets and then became a holding company. The yarn company then sold the stocks of the purchasers, which left it with liquid assets of about $6 million. Kidder, Peabody Co. gained control of the yarn company and converted it into an investment trust. The companys name was changed to the Kidder, Peabody Acceptance Corporation, and senior securities were sold to the public by that corporation. This company provided commercial credit, financed imports and exports, and managed a portfolio of securities. It purchased substantial blocks of securities that had been underwritten by the Kidder, Peabody firm. This ready market appealed to Kidder, Peabody, and it organized other investment companies that bought large amounts of securities that were underwritten by Kidder, Peabody. These entities included Kidder Participation, Inc., Kidder Participation, Inc., No. 2, and Kidder Participation, Inc., No. 3. Clarence Dillon began work at William A. Read & Co. as a salesman and became a member of the firm in 1916. In 1922, the name of that firm was changed to Dillon, Read & Co., a New York joint-stock association. Dillon was the head of this investment banking firm, and under his leadership it became a powerhouse on Wall Street.16 Dillon, Read & Co. created its own investment trust in 1924. By 1926, the assets held by this entity, the United States & Foreign Securities Corporation (USFSC), were valued at $35.8 million. This investment trust had two classes of preferred stock and a class of common stock. The preferred stock paid a 6 percent cumulative dividend. Allotment certificates were sold to the public at a price of $100. These certifi-

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cates consisted of one share of first preferred stock and one share of common stock. Dillon, Read & Co. bought the second class of preferred stock and a controlling portion of the common stock for itself. Other stock was sold to Clarence Dillon and his associates. Dillon, Read & Co. sold some of its stock in USFSC for a profit of over $6 million. This was in addition to the firms $340,000 share of the $1 million underwriting commission paid to market the securities of the investment trust to the public. Dillon, Read & Co. made many more times per dollar in its investment in USFSC than the investing public did. The latter put in $25 million, as compared to the $5.1 million that Dillon, Read invested. Pool operations were conducted in the stock of USFSC through Dominick & Dominick, a New York Stock Exchange firm. Options were sold to Dominick & Dominick by principals of Dillon, Read & Co. This allowed those individuals to effect large profits on the stock that they had purchased at a bargain price from USFSC. Dillon, Read & Co. found other ways to milk this cow. It acted as broker and received commissions for the purchase of securities by USFSC. This was no small sum. USFSC bought and sold over $46 million in securities through Dillon, Read & Co. In 1928, Dillon, Read & Co. had USFSC organize a new investment company, called the United States & International Securities Corporation. It too was controlled by Dillon, Read. An offering of the new investment company shares was made to the public and $50 million was raised. Dillon, Read received commissions and syndicate fees of over $1 million for floating this new company. The Goldman Sachs Trading Corporation was a popular investment trust that sold over 900,000 shares. It was formed in December of 1928 with capital of $100 million. All but $10 million of that sum was raised from the public, which bought the stock of the company at $104. The Goldman Sachs Trading Corporation stock was soon trading at $136.50. Five days later, its price had reached $222.50. This was twice the value of the assets held by the investment trust. The stock of the Goldman Sachs Trading Corporation eventually reached $326. The Goldman Sachs Trading Corporation created the Shenandoah Corporation, which sold its shares at $17.50. They more than doubled in price on the first day to $36. Shenandoah Corporation in turn sponsored the Blue Ridge Corporation, which sold securities totaling $142 million to the public. The Blue Ridge Corporation had assets totaling $127.4 million by August of 1929. Other investment companies began pyramiding themselves. The National Investors Corporation was organized to act as a holding company of shares in other investment companies it sponsored and managed. The Mohawk Investment Corporation was devoting its entire attention to the investment of trust funds in 1929. Otis & Co. created Continental Shares, Inc., in 1926 as an investment company. It was really a venture capital fund that sought to take advantage of special situations such as the death of the proprietor of a firm, which required the sale of securities at prices advantageous for a merger or other acquisition. Another large investment trust was

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the International Securities Trust of America, a closed-end investment company that was formed in 1921 in Massachusetts. This entity issued both preferred and common stocks. The American Investment Company, formed in 1914 in Wisconsin, issued common stock, preferred stock, and bonds and invested the proceeds in a group of diversified securities. In 1917, this investment trust was invested in short-term bonds and first-class stocks. By 1926, the American Investment Company was investing in a broad range of securities and within a year had invested in over 100 different companies. Investment Trust Abuses The American investment trusts in the 1920s were distinguishable from their British counterparts by the fact that British companies generally took a longterm position and did not actively trade their portfolios. In contrast, the investment trusts formed in the United States in the 1920s were founded in speculative desire and dedicated to capital appreciation rather than investment return.17 Although sold to the public as a means to diversify their investments, the investment trusts frequently acquired concentrated holdings in particular industries, thereby subjecting the investor to the very risk he was seeking to avoid.18 Many of the investment trusts gave shareholders only a general description of their investment strategies. The actual portfolios of the investment trust were sometimes kept secret from the shareholders. Indeed, the management type companies were often called blind pools because shareholders did not know what stocks management would be selecting for investment. There were other abuses. Sponsors retained control of the trusts and assigned to themselves warrants, options, and other features that allowed them to obtain large profits from the securities transactions of the investment trusts. The investment trusts were used as a dumping ground for securities being underwritten by their sponsors. The investment trusts often raised funds through bond sales, which increased their leverage and encouraged speculation with other peoples money. The investment trusts were additionally buying stocks on margin, which allowed them to pyramid their winnings and leverage themselves even further. Some investment companies were formed by irresponsible individuals. Investment companies would radically change their trading strategies without informing their shareholders, and much self-dealing by those operating the investment companies occurred. Periodic payment plans had sales loads from 17 to 20 percent. Total charges for these plans could amount to 30 percent. Small investors were subjected to switching operations from one investment company to another. These were efforts by dealers to have their customers sell shares of one investment company and use the proceeds to buy those of another. This allowed the salesman to increase the loads or commissions charged to customers. The NYSE proclaimed in 1924 that its members should avoid involvement with investment trusts that did not protect investors. New York authorities

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later warned that the investment trusts were being used to defraud investors. A deputy attorney general of the state asserted that investment trusts were merely blind pools engaging in speculation.19 Nevertheless, an effort to adopt legislation to regulate the investment trusts failed in New York in 1927. Several states, including California and New Jersey, did adopt regulations, but they did not stop abuses. Recognizing that the investment trusts were not being managed with the same prudence as the classical trust, the Investment Bankers Association sought to have the term investment trusts dropped in favor of the term investment company, and that term was eventually accepted. Other Abuses Abuses in the stock market were not limited to the investment trusts. Arthur Cutten, the rapacious speculator from the futures markets, moved his operations to Wall Street in the 1920s and began manipulating stock prices. Cutten arrived on Wall Street at the peak of the bull market and took large positions in Montgomery Ward & Co. and Continental Oil. He ran up the price of the Baldwin Locomotive Works from $100 to $265. Cutten was rumored to have made $100 million from his stock market speculations. Jesse Livermore became a great stock market speculator in the 1920s. Livermore claimed that he would not engage in a trade unless he obtained at least ten points in profit. Livermore joined with Cutten and Michael J. Meehan in conducting numerous pools on Wall Street to manipulate security prices. Stocks in which pools were operating included Studebaker, Zenith Radio, Kroger Grocery, International Telephone & Telegraph, Firestone Tire, Bendix Aviation, Archer Daniels Midland, the American Tobacco Company, Gimbel Bros., R.H. Macy & Co., McGraw-Hill, R.J. Reynolds Tobacco Co., Borden Co., and Chrysler Co. Other speculators manipulating the market included Charles Topping and Frank Bliss. George Breen, a speculator who participated in the Sinclair Consolidated Oil Corporation pool, pushed Kolster Radio stock up $25 in 1929. The stock then dropped from $95 to $3. Joseph Kennedy was making large profits from the pools and other schemes. The NYSE did not view the pools as illegal, and Kennedy told his friends that they should take advantage of that fact: Wed better get in before they pass a law against it! One of Kennedys most famous coups involved the thwarting of a bear pool that was attacking the stock of the Yellow Cab Company. The bears were supported by the Checker Cab Company, and Kennedy had been hired by Yellow Cab to defeat them. The Manhattan Electrical Supply Company was a target of an unsuccessful pool. A former Texas district attorney who was a member of that pool lost $4 million. A pool in the Anaconda Copper Company stock was managed by Ben Smith and Tom Brag of W.E. Hutton & Co. Some $30 million was contributed to the pool by Percy Rockefeller, Charles Mitchell, William Durant, and others. The National City Co. made profits of $20 million when it sold over one million shares of Anaconda Copper Company stock to its customers at

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inflated prices. Options were at the center of many pool activities. The stock pools in the 1920s often started with the purchase of an option with a stock price higher than the market. The pool then began driving the stock price up, inducing others to purchase. Buy and sell orders were entered by the pool to slowly drive the price up with large volume. Wash sales and publicity were used to pump the stock prices even higher. False rumors were circulated as to the companys prospects. When the market was above the option price, the pool exercised the option and sold the stock at the inflated price, as well as other stock that was picked up during the manipulation. In some instances, the pools would sell put options on stock. For example, in order to stimulate interest, the pool operators would sell the stock to an individual who would have the right to put the stock back if it dropped below a specific price. This guaranteed the third party against loss and attracted buying interest into the market. Professional publicists were used to push up stock prices by planting stories with reporters from the New York Times, the Wall Street Journal, and other prominent newspapers. Touting of stocks in the newspapers, a practice called scalping, was common. This involved the writing of a newspaper column that would recommend that readers purchase a particular stock. The author and his cohorts would purchase the stock before the newspaper report appeared and then profit when the publication induced large numbers of investors to buy. One pool operator, John J. Levinson, made $1 million in a single year from his operations. He handled pools in Borg-Warner, Pitney Bowes, and Celotex. Levinson was aided by Raleigh T. Curtis, who published a column in the New York Daily News entitled The Trader. Curtis would tip his readers on particular issues that were being manipulated by Levinson. Curtis was paid $19,000 for this publicity. Congressman Fiorello La Guardia would later discover that A. Newton Plummer, a corporate publicist, was paid almost $300,000 to arrange for the publication of articles in the press in support of pool operations. One of those stocks was the Indian Moto Cycle Company. Plummer arranged for these articles to be published in various newspapers including the New York Times and the Wall Street Journal. Plummer later published a book in which he confessed to the systematic bribery of financial reporters by Wall Street interests. Plummer paid for over 20,000 separate stories that were circulated in over 700 newspapers.20 Among others, Plummer paid an Associated Press reporter $50 a week to carry stories that pushed stocks supported by Plummer and his clients. Another publicist, David M. Lion, was given options to help publicize pool operations. Between 1928 and 1930, he made over $500,000 from those options. William J. McMahon was paid $250 a week to broadcast radio reports boosting stock prices that were the subject of a pool operation. McMahon was identified to his listeners as an economist and the president of the McMahon Institute of Financial Research. Similarly, the old counselor was paid by Halsey, Stuart & Co. to tout stocks it was pushing over the radio. Another way to push up the price of stock that was the subject of a pool operation was to have market letters sent out by brokerage firms through their branch offices.

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Wallace and Co., which operated out of Jersey City, New Jersey, published a newsletter, The Tape and Ticker, which was sold to over 12,000 subscribers for a fee of $5 per month. The company spent more than $70,000 in postage and telephone bills to promote their enterprise using a boiler room. One of the stocks touted by The Tape and Ticker was American Electric Switch Common A, which was listed on the New York Produce Exchange. The price of that stock increased from $17 to about $25 but then the stock was stricken from trading on the exchange. Trading in the market was an insiders game in other ways. Investment bankers often provided shares in potentially hot new issues to preferred customers. This virtually assured these customers large profits when the shares were sold to the public. For example, the Aviation Corporation of America made an offering of 2 million shares of common stock at $200 a share in March of 1929. W. Averell Harriman and Robert Lehman, who were on the executive committee of the company, gave their special friends, including a polo instructor and a neighbor, stock at a low price before this hot issue was sold to the public. Preferred Lists J.P. Morgan & Co. and Drexel & Co. used a more august preferred list of prominent individuals to whom hot issue shares were allocated. This included shares in the Alleghany Corporation, which was about to be formed by O.P. and N.J. Van Sweringen; the shares were being sold through a when-issued market on the NYSE. The stock was underwritten by J.P. Morgan & Co. at $20 per share and sold to prominent individuals in anticipation of a sharp price rise. The individuals on the preferred list included John J. Raskob, chairman of the National Democratic Committee; Joseph Nutt, treasurer of the Republican National Committee; Charles Francis Adams, Secretary of the Navy; Edmund Machold, Speaker of the Assembly of the State of New York; Silas H. Strawn, president of the Chamber of Commerce of the United States and of the American Bar Association; and William Woodin, who would later become Secretary of the Treasury. This stock went from $20 to $57 a share within five months. Other individuals on the Morgan preferred list were F.H. Ecker, president of the Metropolitan Life Insurance Company; Calvin Coolidge; Bernard Baruch; Albert H. Wiggin, chairman of Chase National Bank; Charles E. Mitchell, president of the National City Bank, which had its own preferred list; Richard E. Whitney, an officer of the NYSE; John W. Davis, a Democratic candidate for president; William McAdoo, Secretary of the Treasury under Wilson and a senator on the Banking Committee; General John Pershing; and Newton D. Baker, President Wilsons Secretary of War. Charles Lindbergh was also on the Morgan preferred list. His father was the congressman from Minnesota who had sought to have the money trust investigated by the Pujo Committee after the Panic of 1907. Public offerings provided opportunities for rich fees for the originating syndi-

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cates, banking syndicates, intermediary syndicates, and retail or selling syndicates. Prices were marked up on the securities being underwritten at each stage. Investment bankers participating in the organization of new companies were sometimes given a perpetual option warrant that entitled the investment banker at any time without limit in the future to purchase from the corporation its common stock at a fixed price.21 J.P. Morgan & Co. received a million of these warrants from the United Corporation. The investment bankers, through their syndicate, supported the price of the offering during its distribution by confirming sales substantially in excess of the total issuecreating the appearance of a hot issue. Support operations were designed to maintain the market at artificial levels. The effect of these operations was to create the illusion of a stable market, but when the underwriters ceased their support of the market after the distribution was completed, prices would drop. High pressure and deceptive sales methods were used to sell stocks being underwritten. Shareholder rights were being reduced. In 1927, Delaware allowed its corporations to remove preemptive rights of existing shareholders. Such rights had entitled shareholders to purchase offerings of new issues in order to maintain their proportional voting and ownership rights. Delaware authorized corporations to issue blank stock, which allowed the board of directors to set voting powers, preferences, and other rights after subscriptions to the shares were completed. These changes all gave management more control over companies they did not own. Commercial bank officers and directors were using their positions and bank funds to engage in trading and pool operations, often in the stock of their own bank. Albert H. Wiggin, the chairman of the Chase National Bank, was one of the most abusive. He put almost $200 million into speculative operations involving Chases stock, and he participated in pool operations in other securities. Wiggins trading operations resulted in personal profits of $10.4 million, often through short sales. Wiggin received a profit of just over $4 million from his short sales during a two-week period. Although it was unseemly for the chairman to sell his banks own stock short in such quantities, Wiggin later claimed that his short sales were justified because the stock was trading at a ridiculously high price. At the same time, the Chase Securities Corporation was selling the banks stock to the public. Real Estate Real estate was another source of speculation in the 1920s. A Florida land boom in 1925 attracted many speculators and swindlers. The Marx Brothers play The Coconuts was a parody on the speculation engendered by that boom, which soon collapsed. Among those speculating in Florida real estate was William Jennings Bryan. Jesse Livermore was involved in various Florida land schemes. He was later sued for over $1 million dollars by a group of investors whose complaint ran almost 900 pages. Land speculation was oc-

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curring in North Carolina and California. A commercial property boom was unfolding in the major cities as more and more skyscrapers dotted the landscape. Many of those commercial real estate projects were funded through real estate bonds that were sold to the public. Although real estate bonds had been issued before 1907, they did not become popular until after World War I. Real estate mortgage bonds valued at $50 million were issued in 1919. That amount grew to $500 million by 1923 and doubled to $1 billion in 1925. The mortgage bonds that were sold in the 1920s varied from earlier mortgage bonds, which had been issued by investment banking firms that stood behind the bonds. The mortgage bonds of the 1920s were backed only by mortgages on the property that had varying degrees of priority. For those wanting more security, so-called guaranteed mortgages were available. One of the largest issuers of these mortgages was the Title Guarantee & Trust Co., which had been formed in 1883. It sold more than $2 billion in guaranteed mortgages to savings banks, other institutions, and individual investors. Some insurance companies were providing guarantees on real estate bonds. The guaranteed mortgage bonds varied in their terms. The guaranteed mortgage could cover an entire piece of property, or a portion of a loan on a property, or investors could obtain a group series certificate that gave them an undivided share of a specific amount and number of mortgages. One of the latter mortgages allowed an investor, for $1,000, to participate in 122 different mortgages. Sometimes separate companies would provide the guarantee for the mortgages. For example, the Bond & Mortgage Guarantee Co. guaranteed mortgages that were issued by the Title Guarantee & Trust Co. One of the large mortgage bond houses during the 1920s was S.W. Straus & Co. Other mortgage firms included Greenebaums, G.L. Miller & Co., and the American Bond and Mortgage Co. They all claimed to be completely safe. In the 1920s, Straus began offering bonds that had only second and third mortgages on commercial real estate and then it offered bonds secured only by general mortgages and collateral trust bonds that were secured by subordinated mortgages. Mortgage bonds were issued in large amounts for overvalued properties, allowing the promoters to use the bonds to pay for the land and building and even provide a profit. The real estate bonds were often supported by unreliable appraisals of the property, and problems associated with the properties were frequently not disclosed. The mortgage bond market soon ran into difficulties because of such malpractices and overbuilding. Several real estate bond houses failed, including G.L. Miller & Co. in 1926, the American Bond & Mortgage Company, and the Empire Bond & Mortgage Company. Another failure was the New York Real Estate Securities Exchange. Located at 12 East 41st Street, this exchange had a large trading floor and established listing requirements for real estate mortgage companies and trust securities. It did not have a long life. It opened on October 1, 1929, and would fail in the wake of the stock market crash of 1929.

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3 The Stock Market Crash of 1929

Speculative Orgies An optimism was present in the market during the 1920s that led to an orgy of speculation. Books were claiming that business cycles and economic crises were a thing of the past. The president of the NYSE announced that [w]e are apparently finished and done with economic cycles as we have known them.22 Yale professor Irving Fisher proclaimed in 1929 that the American economy had reached a permanently high plateau and that the stock market should go a great deal higher. Voices of caution were ignored. While serving as Secretary of Commerce, Herbert Hoover had warned of the dangers of speculation in stocks as the market soared. Hoover asserted that the monetary policies of the Fed were promoting credit inflation: These policies mean inflation with inevitable collapse that will bring the greatest calamities upon our farmers, our workers and legitimate business.23 In 1928, however, Secretary of the Treasury Andrew W. Mellon assured the country that there was no danger: the creation of the Fed meant that we are no longer the victims of the vagaries of business cycles. The Federal Reserve System is the antidote for money contraction and credit shortage.24 Stock prices on the NYSE doubled in the 1920s. Volume hit a new high of 5 million shares on June 12, 1929. Much greater volume would be experienced later in the year. The Dow Jones Industrial Average passed through the 200 mark in December of 1927. Security prices increased by over 37 percent in that year, and a further increase of over 43 percent was experienced in 1928. Over $11 billion was added to securities values in 1928, as speculation drove up stock prices to unheard-of levels. A few examples will suffice. Between March of 1928 and October of 1929, the price of General Electric shares increased by over $250. Montgomery Ward saw its stock price jump by over $300 a share. The stock of the First National Bank rose $140 dollars after it declared a 25 percent dividend. The price of those shares rose to $8,000, jumping $500 on a single day in July 1929.
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The NYSE was supplying bid and ask prices through a bank of telephone operators. Quotations were available from other sources on about 25,000 unlisted bonds and 30,000 unlisted stocks. The Dow Jones Industrial Average was expanded to thirty stocks in 1928. Speculation was becoming a national pastime. Brokerage firms opened branch offices at the United States Amateur Golf Championship and in major hotels. Brokerage firms were even arranging bets for their customers. Tales of riches made by unsophisticated individuals in the stock market were common. A stenographer was reported to have made $15,000 in two days on General Motors stock. A waiter made $90,000 from tips supplied by brokers. A brokers valet was said to have made $250,000. Such stories brought investors flocking to the market. Investors were told to Be a Bull on America. The investment trusts were supplying an easy way to invest. In October of 1929, it was reported that [m]ore reference has been made in the last two weeks to investment trust activities in the stock market than to any other group.25 At that time, there were some $900 million of investment trust securities being offered to the public. Several large issues of securities were sold to the public by the TriContinental Corp., the Alleghany Corp., and Kreuger & Toll. The latter firm issued $50 million of 5 percent bonds. Over 1.5 million securities accounts were being used to trade or hold securities in 1929. A comparison of the number of shares actually transferred on the books of listed corporations with the number of transactions in their stocks on the NYSE evidenced that most transactions were short-term in nature. This was viewed as speculative trading, rather than investment for long-term capital growth and dividends. Over 1.5 billion shares were traded in 1928. Daily volume on the NYSE reached 10 million shares a day in the following year. The record for a day was 16 million shares. Almost 100 million shares were traded in August of 1929. For all of 1929, over one billion shares were traded on the NYSE, and combined trading on all exchanges in 1929 was 1.8 billion shares. To accommodate this volume, the NYSE increased its membership by 25 percent and added new space. The New York Curb Exchange was booming. One of its seats sold for $254,000 in 1929. Manipulations Speculation continued to be accompanied by manipulation. In 1929, over thirty banks made loans to finance syndicate or pool operations. Those loans totaled over $76 million. In that year, over 100 issues on the NYSE had their prices manipulated by pool operations. They included the Alleghany Corporation, American Ice, American Tobacco, Archer Daniels Midland Corporation, Bendix Aviation, Bethlehem Steel, Borden Co., Chrysler Co., Continental Can Co., Curtiss Wright Co., Firestone Tire, International Telephone and Telegraph Co., Kreuger & Toll, Kroger Grocery, R.H. Macy & Co., Phelps Dodge Co., Pillsbury Flour Mills, R.J. Reynolds Tobacco Co., Safeway Stores, Studebaker, and Zenith Radio. Other targets of the pools included Montgom-

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ery Ward, Standard Oil, and the Fox Film Corporation. The two specialists on the NYSE for Fox Film were paid $10,000 in connection with a pool operation involving that stock. One of the two speciaists claimed that he was given this payment in appreciation for the work he had done in running an orderly market.26 RCA was the subject of one of the more famous pools. This operation, which was under way in March of 1929, was managed by two brokerage firms, W.E. Hutton & Co. and M.J. Meehan & Co. The latter firm was owned by the NYSE specialist for the RCA stock, Michael J. Meehan, who had been selling theater tickets when World War I broke out. Meehan opened his own firm and installed brokerage offices on ocean liners to allow people to speculate while traveling abroad. Irving Berlin was among those trading on the le de France in 1929. By 1929, Meehans firm had over 100 employees and held eight NYSE seats. Arthur Cutten aided the RCA pool. In a one-week period, over 1.4 million shares were bought and sold for the pool. The price of RCA stock increased dramatically. The pool participants included Percy A. Rockefeller, Walter P. Chrysler, John J. Raskob, and William C. Durant, as well as Mrs. David Sarnoff, the wife of the RCA president. In all, there were some seventy individuals in this pool, and their profits were in the millions of dollars. The RCA pool was assisted by a column in the New York Daily News that touted the stock. RCA was not itself a speculative operation, and there was good reason for investing in its stock. RCA had sales of $176.5 million in 1929 with profits of almost $16 million. The radio, which preceded the television and Internet as the means for mass communication, was growing rapidly with sales increasing by almost 200,000 units between 1928 and 1929. Margin Concerns Leverage was another speculative tool that was provided through margin accounts. About 600,000 accounts were trading on margin in 1929. This was about 40 percent of the securities accounts open during that period. Call loans to brokers by the banks were about $2 billion in 1922. That amount increased to over $8 billion by October of 1929. At that time, the federal budget was just over $3 billion. The $8 billion in call loans takes on its properly impressive dimensions when compared to the entire national debt of the United States: $16.9 billion.27 The margin traders were said to have affected the national economy in a manner immensely disproportionate to their numbers.28 The banks were abusing the system by borrowing federal funds through the Federal Reserve System. At one point, banks were borrowing from the Fed at 3.5 percent and relending those funds in the call market at 10 percent. Before his death, Benjamin Strong at the New York Federal Reserve Bank had thought that lower interest rates and cheaper money in America would stop the outflow of gold from London to New York and would stabilize international finance. Strong, whose iron-willed personality would become the

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model for future Fed leaders, was working with Montagu Norman, a governor of the Bank of England, to maintain an expansionist monetary policy in order to allow England to return to the gold standard, which it did in 1925. A conference of central bankers from England, France, and Germany was held at the New York home of Ogden Mills, the Secretary of the Treasury. Strong attended on behalf of the Fed, and he agreed to keep interest rates low. Montagu Norman represented the Bank of England. A partner at J.P. Morgan & Co. lamented that Strong and Norman had Benjamin Strong. Leader of the New York sowed the wind. I expect we will Federal Reserve Bank, his death left monetary policy adrift in the months preceding the stock have to reap the whirlwind. market crash of 1929. (Portrait by Garf Strong warned that his efforts to Melchers, courtesy of National Portrait Galcontinue an expansionist approach to lery, Smithsonian Institution.) monetary policy from the New York Federal Reserve Bank might be frustrated by the Washington Federal Reserve Board, if pressures arose to curb speculation in the stock market. This prediction proved to be correct, and the removal of Strong from the scene by his death from tuberculosis in October 1928 set monetary policy adrift as speculation in the stock market approached a climax. Strong had advocated a short, sharp increase in interest rates if an increase was needed to curb speculation. President Hoover requested the NYSE to limit speculation as the market boomed. The NYSE had previously announced a fifteen-point program for the protection of public customers. It increased margin requirements to 17 percent and then to 20 percent in 1929. Previously, margins had been 10 percent. The Federal Reserve Board began to increase call money rates up in 1928 in order to curb speculation. On February 7, 1929, the board warned the public about the excessive amount of the countrys credit absorbed in speculative loans.29 The market then experienced a downturn as the board and the Bank of England sought to reduce credit to speculators. The call money market rate rose from 12 to 14 percent early in 1929. In late March, the rate increased to 20 percent, but the higher rates drew more money into the call market. Congressman Arthur Capper charged that Wall Street was pulling out of the midwestern banks funds that were needed to support local businesses: For western bankers to throw their millions into New Yorks call money market, that the stock gamblers may bet the entire countrys available resources on their gigantic poker game as they have been doing the last weeks, seems almost criminal.30

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The Federal Reserve Boards efforts to curb margin trading were being opposed by speculators who wanted the market to continue its upward course unchecked. On April 3, 1929, William C. Durant met with President Hoover and urged him to stop the Fed from restricting credit to the stock market. Durant wanted the Federal Reserve to lower the discount rate, not raise it. Durant advised Hoover that the Fed policy limiting margin credit would result in a market break. Hoover was unmoved. He warned against stock speculation in April of 1929 and began to sell his own stocks. The president asked Richard Whitney, a leading figure on the NYSE and the brother of a partner at J.P Morgan & Co., to have the NYSE curb the speculators. Hoover also recommended legislation that would separate the functions of investment and commercial banking. Charles Mitchells promotion from the National City Co. to the presidency of the National City Bank also led him to a directorship at the Federal Reserve Bank of New York in 1929. The Federal Reserve Board continued its efforts to cool the market, but was frustrated by disputes with the New York Federal Reserve Bank and Mitchell. After the Fed sought to restrict credit in 1929, Mitchell announced that the National City Bank would loan $25 million into the call money market to provide liquiditydespite any opposition from the Federal Reserve Board. Mitchell asserted that the National City Bank would make $5 million available when call rates went to 16 percent and would add another $5 million each time the rate rose one point. At that time, the First National Bank was borrowing money from the Fed and using that money to make call loans. Its affiliate, the National City Co., was the nations largest distributor of securities. Although the New York Federal Reserve Bank wanted to curb speculation, Mitchells announcement may have had its tacit approval. The Federal Reserve Bank of New York was concerned that a stock market panic could occur if too much pressure was placed on the call money market. In retrospect, Mitchells action also had to be examined in the context of the fact that his bank was loaning call money funds at 15 percent, which did not do much to encourage speculation. The Federal Reserve Board in Washington was, nevertheless, much concerned with his action. Senator Carter Glass of Virginia was incensed by Mitchells announcement. The Senator demanded Mitchells resignation as the director of the New York Federal Reserve Bank. Glass was opposed to speculation and sought to curb short sales by imposing a 5 percent tax on transfers of stock certificates held less than sixty days. That legislation was not passed. The NYSE stated that Senator Glasss proposal would have resulted in closing stock markets all across the country. The dispute between the Federal Reserve Board in Washington and the New York Federal Reserve Bank on how to deal with the call money market and interest rate policy largely paralyzed monetary policy during almost the whole of the important year 1929.31 The result of this bureaucratic wrangle was that the Fed was ineffective in stopping speculation and actually under-

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mined confidence in the market, even though the Fed was placed at the center of monetary policy. A 5man committee, dominated by the New York Bank, was replaced by a 12-man committee of the 12 Federal Reserve Bank governors in which New York played a less important role. That shift stacked the cards heavily in favor of a policy of inaction and drift.32 The result of the increased interest rates ordered by the Federal Re- Carter Glass. A frequent critic of Wall Street, serve Board was to slow the economy, Glass led the effort to separate investment but they had little effect on specula- banking from commercial banking. (Portrait by Samuel Johnson Woolf, courtesy of the Nators. Even as the Federal Reserve tional Portrait Gallery, Smithsonian InstituBoard tried to pressure the banks to tion. Gift of Muriel Woolf Hobson and tighten credit to reduce speculation Dorothy Woolf Ahern.) in 1929, corporations were stepping in to fill the gap and supply money to the call market. The board could not control that source of credit. By 1928, corporations were providing about half of the call market loans needed by stockbrokers. These corporations issued securities to raise funds that were then loaned into the call market at high interest rates. Corporations contributed $7 billion or so into the call market in 1929. The Standard Oil Co. of New Jersey had outstanding broker loans of $97 million in September of 1929. Cities Service Co. had $41.9 million in outstanding broker loans at one point and made a cumulative total of $285 million in call money loans in 1929. The Crash It is difficult to isolate a single event that caused the stock market crash of 1929. Interest rates were increasing and monetary policy was adrift, but the real problem seems to have been that the market was simply overheated, and the bubble burst. The market break began on August 8, 1929, when the Fed increased its rediscount rate to 6 percent from 5 percent. This caused the market to drop as call loan margin rates increased. Some $2 billion in share values was lost on August 9, 1929 after the Feds action. This appeared to be a temporary setback. The Dow Jones Industrial Average resumed its upward course, peaking at 381.17 on September 3, 1929, a level that would not be reached again for almost a quarter of a century. On September 5, 1929, Roger Babson, a popular investment adviser, predicted a crash in the market. He had made similar claims before with little effect, but the Dow Jones Industrial Average dropped by sixty points after his last prediction. This event was called

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the Babson Break. The discovery of a massive fraud in England engineered by Clarence Hatry further unhinged the market. On October 23, 1929, the market began another sharp slide. The call money market rate was at 9 percent when the market began its plunge. At that time, brokerage firms required customers to hold as much as 75 percent margin on their stocks, but margin calls still forced massive liquidations. Volume on the NYSE exceeded 6 million shares on October 23, 1929. The market drop occasioned by the sales on October 23 resulted in still more margin calls, which added further selling pressure to the market on the following day. On Black Thursday, October 24, 1929, millions of shares were dumped at whatever the market would bring. No one knew exactly what was happening on the market at any given time. The NYSE ticker was so far behind as to be useless; the closing sale did not go on the tape until 7:08 that evening.33 Some 20 million shares were sold that day on the NYSE and through the curb market. Winston Churchill happened to be present in New York and was visiting the NYSE in the middle of this crisis. He noted that enormous blocks of securities were being sold at a third of their old prices and half their present value, and for many minutes together finding no one strong enough to pick up the sure fortunes they were compelled to offer.34 Although Churchill found the floor a scene of surprising calm and orderliness, the gallery was closed after he departed. During that day, some $10 billion in stock values disappeared as the market plunged. The most devastating panic in the history of the United States was under way. A meeting of New York bankers was held that Thursday at the offices of J.P. Morgan & Co. Among those present were George F. Baker Jr.; Thomas W. Lamont of the J.P. Morgan firm; William C. Potter, representing the Guaranty Trust Company; Seward Prosser, representing Bankers Trust; Albert H. Wiggin, the president of the Chase National Bank; and Charles E. Mitchell, president of the National City Bank. Apparently, the younger J.P. Morgan (Jack) was not present, but the bankers still tried to reenact the events of 1907 when the elder Morgan had stopped the panic. The group agreed to provide a pool of funds to rally the market in amounts variously estimated to have been from $20 million to over $200 million. Edward H.H. Simmons, the president of the NYSE, was on vacation during the October crash. Richard Whitney, the exchanges vice president, took over for him. Whitney had been educated at Groton and Harvard and had married the widow of a Vanderbilt. He was commissioned to conduct the buying for the bankers pool. Whitney went to the United States Steel post on the floor of the stock exchange and ostentatiously bid $205 for that stock. The last offer had been $195. Whitney purchased at least $20 million of United States Steel and other stocks in his foray across the floor. In total, the bankers may have injected as much as $1.4 billion into the market through loans and additional securities purchases in their effort to stop the market plunge. Although they were able to rally the market for a time, it began to falter once again. The bankers then refused to

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continue their support. Critics later charged that the bankers had supported the market only temporarily to allow themselves time to sell out their own positions, along with their favorite customers. Brokers loans declined by $3 billion in the ten days that followed October 24, 1929. The Monday following the rescue effort by Morgan and the other bankers saw a further sharp market break with volume exceeding 9 million shares. Black Tuesday occurred on October 29, 1929, when 3 million shares were sold in the first thirty minutes of trading on the NYSE. Share volume on the NYSE was over 16 million shares on that day. That volume would not be reached again for almost forty years. From Labor Day of 1929 until October 29, the value of the leading industrial stocks had declined by some 40 percent. The Dow Jones Industrial Average dropped 23 percent in the trading that occurred on just two daysOctober 28 and 29. That drop would not be matched until October of 1987. Stock losses for just the month of October 1929 totaled some $50 billion, an amount exceeding that spent by the United States in waging World War I. The value of the stocks listed on the NYSE in September of 1929 was $90 billion. Their value was reduced to $16 billion by 1932. A rally occurred in the stock market in November of 1929, which continued through the spring of 1930, but it was a weak one. In December of 1929, a scandal on the London Stock Exchange, involving a large fraud by a promoter, caused a drop in the London market, and funds were recalled from the United States. This contributed to further uncertainty in the United States market. Although the Dow Jones Industrial Average rose to almost 300 by 1930, it began dropping until it reached 41 on July 8, 1932. [A]n investor who bought in 1929 had to wait until 1954 to see the Dow industrials claw back to their October 1929 highs.35 The stock market crash had its effect on bonds. Their prices dropped substantially after the crash. The four leading bonds listed on the NYSE were trading at about 40 percent of par. The investment trusts were especially hard hit by the stock market crash. Two affiliated investment trusts, the United Founders Corp. and the American Founders Corp., were the largest investment trusts in the country in the 1920s. The price of American Founders Corp. stock was over $30 in 1929. In 1935, it was selling at less than 38 cents per share. The stock of the United Founders Corp. dropped from a high of over $75 in 1929 to 25 cents a share in 1935. The Goldman Sachs Trading Corporation lost $60 million in capital and surplus; its shares were being quoted at $1.75 in 1932, down from a high of $326. Some of the Goldman Sachs Trading Corporation shares had embedded options, which required the company to buy more shares as its stock prices declined. The Blue Ridge Corporation, the investment trust that was a spinoff of the Goldman Sachs Trading Corporation, saw its shares drop from a high of $100 to just $3 after the crash. By July of 1932, those shares were selling for 63 cents. The assets of the Kidder, Peabody investment trusts were valued at $85 million in 1929. In May of 1931, they were valued at $20 million.

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Many small investors had pyramided their holdings by buying more stock on margin as the value of their earlier purchases increased. This increased their leverage, but accentuated market drops and magnified losses when they were forced to sell as prices declined sharply. Large numbers of investors suffered losses on foreign bonds whose placement was often the result of overeager promotions by the investment bankers. Three Peruvian loans underwritten in the United States in 1927 and 1928 were sold for a total of $90 million. Those bonds defaulted. By 1937, they were selling for as low as $22.50. Other foreign countries that had entered the American market were Cuba, Bolivia, Brazil, and Argentina. Their securities dropped to 7 percent or less of their par value after the market crashed. Aftermath Despite the legends, the suicide rate in New York remained unchanged through the stock market crash. Nevertheless, there were some such victims. Among those committing suicide after the stock market crash of 1929 was the president of Union Cigar. The price of the stock of his company dropped from $113 to $4. The president of the New York County Trust Company, James J. Riordan, shot himself after the crash. Winston Churchill witnessed one unhappy investor hurtle past his window in the New York hotel where he was staying. Untold numbers of other investors were ruined by the crash, including some of the bigger speculators. William C. Durant, who had bet $1 million on the election of Herbert Hoover, made about $8 million through his securities speculations in 1928. Durant began selling his stock before the crash, but he still lost as much as $40 million as the market plunged. Durant Motors continued operations for a time, but an effort to create a Durant Acceptance Corporation failed and the company went into dissolution. The Fisher brothers also lost millions of dollars, and Herbert Swope, managing director of the New York Morning World, owed some $2 million. The market crash was said to have cost Arthur Cutten tens of millions of dollars. A number of celebrities also lost heavily in the crash. Irving Berlin lost his fortune. Eddie Cantor, the entertainer, was left owing $300,000 after the crash. He sued Goldman Sachs for $100 million as a result of his losses in the Goldman Sachs Investment Trust. That suit was later settled, presumably for something less than the amount prayed for in the complaint. Groucho and Harpo Marx were two other victims. Groucho had invested about $150,000 of his savings in the market in 1929. He was trading on margin and had bought call options. Groucho had to mortgage his house and borrow money on his insurance policy in order to meet his margin calls, and he was left with substantial debts after his securities were sold. Harpo Marx had been introduced to the stock market by Joseph Kennedy. Harpo used Newman Brothers & Worms as his broker and had accumulated large profits on his stock positions

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by 1929. Harpo lost it all in the crash. Charlie Chaplin had left the market in 1928 and was able to hold on to his winnings. Will Rogers, the comedian, had sold his stock investments before the crash upon the advice of Bernard Baruch. Baruch did not himself entirely escape the effects of the market crash. He lost some $5 million, but still had plenty of assets to keep him among the wealthy. Before coming to visit the New York Stock Exchange, Winston Churchill, about to enter his wilderness years, had toured Canada in a railroad car supplied by Charles Schwab. Later, Churchill traveled with Bernard Baruch in Baruchs private railcar. Rubbing elbows with these titans of finance apparently convinced Churchill that there was a fortune to be made in the American securities market. The future prime minister began speculating heavily in United States stocks. He particularly liked Simmons stock because of its advertisement: You cant go wrong on a Simmons mattress. Churchill was further impressed by the fact that he could hear his stock market investments quoted over the radio, and he found a stock ticker in every major hotel in California. Unfortunately, Churchill had arrived at the end of the boom. He lost almost $100,000 in a single day during the stock market crash. Churchill would have to write furiously to restore his finances, but he would continue to fantasize aloud about what a wonderful life it would be to be a speculator. 36 Churchills broker was William Van Antwerp of the E.F. Hutton firm. Apparently, this was the same William C. Van Antwerp who had written a book in 1913 on the role of the stock exchange. Appended to his book was the Hughes Commission report that condemned speculative trading after the stock market panic in 1907.37 Cornelius Vanderbilt III lost $8 million in one hour as his portfolio dropped in value during the crash. The Rockefeller fortune had more than doubled during the 1920s. John D. Rockefeller tried to calm the markets during the stock market crash of 1929 by buying a million shares of Standard Oil of New Jersey. He advised the public that depressions have come and gone. Prosperity has always returned, and will again.38 Rockefeller stated that he had been buying common stocks for some time because he believed that the economy remained sound. Actually, Rockefeller was in somewhat of a spot. He had given away most of his wealth to his children and to charity before the crash. It looked as if he was in some financial peril, as the value of his remaining fortune shrank from $25 million to $7 million. Meanwhile, the net worth of his son, John D. Rockefeller Jr., was cut from $1 billion in 1929 to half that amount in 1934. Juniors annual income dropped from $56 million to a comparably paltry $16 million. The Foshay Utilities Group in Minneapolis, Minnesota, went bankrupt after the crash. The Union Industrial Bank of Flint, Michigan, was found to have been the victim of a fraud by several of its officers. They had used over $3 million of the banks funds to speculate in the securities markets and lost it all when the market collapsed. The real estate bond market was falling even before the stock market crashed. Over $36 million of real estate bonds de-

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faulted in 1928. The New York Real Estate Securities Exchange was fatally crippled. Several real estate mortgage firms failed, including the American Bond & Mortgage Company and the Empire Bond & Mortgage Company. Numerous other real estate bond houses continued to fail into the 1930s. S.W. Straus & Co. was among them. It defaulted on bonds totaling over $200 million and was placed in receivership in 1932. The firm had over 60,000 customers. Although more than 5,000 banks would fail between 1929 and 1933, most brokerage firms survived the crash. They had increased their margin requirements by as much as 50 percent during 1929. Margin levels were as high as 75 percent before the market crashed. This protected the brokerage firms from large losses. Additional aid was given by a decision on the part of the bankers and the Fed to allow the banks to take over call money market loans from customers. The Fed provided the liquidity needed to accomplish that transfer. This lessened the need to dump stocks in the market and eased pressure on what was already a disastrous situation. The Fed dropped its rediscount rate to 4.5 percent on November 13, 1929, in order to further relieve the crisis. This is not to say that the brokerage firms did not sustain any damage. Kidder, Peabody nearly failed in 1931 and had to be rescued by J.P. Morgan & Co. One disruptive failure involved Caldwell & Co., a Nashville, Tennessee, firm that began operation in 1917 and specialized in municipal bonds. Its failure brought down some 120 banks, including the National Bank of Kentucky. The Louisville Trust Company and the Security Bank, which were controlled by the BancoKentucky Company were closed. The failure of the BancoKentucky revealed several abuses. One brokerage firm, Wakefield & Co., had clerks earning less than $2,500 a year who were able to borrow sums exceeding $100,000 from the bank. The president of the bank, James B. Brown, owed Wakefield $3.5 million. Goldman Sachs lost millions of dollars after the crash. It had a large number of underwritings for which it had firm commitments. Goldman Sachs had to take up those securities at their distribution prices even though their market prices were greatly depressed. Its reputation was injured badly by the losses in the Goldman Sachs Trading Corporation. Between 1930 and 1935, Goldman Sachs did not act as the head of a single underwriting. The crash caused other brokerage firms to change their sales approach. Clarence Hodson & Co. promised a program of conservative investments. It claimed that its investment methods were old fashioned and that many people who had disregarded investment safety had suffered. G.E. Barrett & Co. was claiming that the True Index Of Wealth is not market value of principal, but income therefrom.39 Numerous advertisements in the New York Times after the crash were promoting safety, security, and income. Peabody, Smith & Co., Inc. was among those making such claims. Some speculators were able to avoid the effects of the crash. Joseph Kennedy started selling his shares in 1928. Reportedly, he had overheard a shoeshine boy passing on market tips. This convinced Kennedy that a bubble was under

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way that would eventually burst. He was quoted as saying, Only a fool holds out for the top dollar.40 John Raskob published an article in Ladies Home Journal in the summer of 1929 entitled Everybody Ought to Be Rich. He urged small investors to invest $15 every week in securities. At the same time, Raskob was selling his own stocks. The Morgan firm did not have a terrible year in 1929. The partners paid some $11 million in taxes, and the firms net worth, when combined with Drexel & Co., increased by over $27 million. Things did not look all that bad for those not involved in the market, at least not in the beginning. In November of 1929, Sears, Roebuck & Co. announced that its sales would set a new record. Montgomery Wards sales were up. Chevrolet announced that its production was up by over 30 percent, but Buicks shipments were off.41

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4 The Banking Crisis

President Hoover assured the country that it had nothing to fear after the stock market crash of 1929. There was in fact reason to hope that the depression that followed the crash would be of short duration. The economy appeared to rally in the beginning of 1930, and the president proclaimed that the worst was over. In fact, it had just begun. The upswing soon dwindled, and the nation found itself in the worst depression in its history. Over 26,000 businesses failed in 1930. The total national income of the United States dropped by more than 50 percent between 1929 and 1933. Average weekly wages were cut almost in half. The number of unemployed went from 3.2 percent of the workforce in 1929 to 24.9 percent in 1933. Sixteen million people were out of work in 1933. A massive deflation of values occurred, as the wholesale price index decreased by about one-third. Between 1929 and 1933, retail prices fell almost 25 percent, and farm commodity prices dropped over 60 percent. In 1932, farmers were receiving as little as twelve cents a bushel for corn and forty cents a bushel for wheat. Cotton was selling for less than a nickel a pound. A similarly large deflation of stock values was experienced in the securities markets. The Dow Jones Industrial Average dropped by over one-third in 1930. It was under 60 in 1932, down from its high of 381 in September of 1929. Illustrative was the stock of the New York Central Railroad, which fell from over $250 in 1929 to under $9 in 1932. The price of B & O stock went from $140 to $3. The shares of the Transamerica Corporation dropped from $67 in 1929 to under $3 in 1932. National City Bank stock dropped almost $500 after the bank posted a loss of over $12 million in 1932. Even the net worth of J.P. Morgan & Co. was cut by more than 50 percent between 1929 and 1932. Bank Failures Restrictions on branch banking had resulted in a large number of very weak banks, and they were unable to cope with the decline. Even the strong ones saw
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their survival threatened. Bank failures became an everyday occurrence. Over 250 banks failed in November of 1930. Another 350 failed in December. In total, over 1,300 banks failed in 1930. The National Bank of Kentucky was one of the first large banks to fail. It touched off a panic that spread to groups of affiliated banks in several other states. That panic led to depositor runs, which caused the banks to call in loans and sell assets. This put further downward pressure on the market as those assets were sold. In December of 1930, the Bank of United States (not to be confused with the nineteenth-century Bank of the United States) announced that it was insolvent. It was the largest bank failure in history. This New York bank had over 400,000 depositors and was called the pants pressers bank. Total deposits were about $286 million. The Fed refused to rescue the bank. Its failure was widely attributed to activities in its securities affiliate and touched off a run on other banks. Over 2,000 banks failed in 1931. By 1932, one in four banks in the United States had failed. Ironically, the very existence of the Federal Reserve System seemed to relieve the big private banks like the House of Morgan from playing the liquefying role they had assumed in earlier panics, such as 1907.42 However, the Fed seemed to be paralyzed during the crisis. Herbert Hoover urged the banks to work together to stop the crisis. In October of 1931, the National City Bank took over the Bank of America in New York, which had been acquired in 1928 by the Transamerica Corporation of A.P. Giannini and turned into a national bank. The Bank of America, which had been founded in 1812, had lost 50 percent of its deposits by 1931. There was no federal safety net to provide confidence to depositors. Most of the 24,000 banks in the country were state institutions, operating under forty-eight conflicting, inadequate, and often vicious codes of law.43 Herbert Hoover and his Treasury Secretary, Andrew Mellon, tried to have the private banks create a $500 million pool to support failing banks. In response, several banks formed the National Credit Corporation (NCC) in October of 1931 to lend funds to banks that were in distress. The NCC was modeled after the National Currency Associations of 1910 that were created under the AldrichVreeland Currency Act. The NCC sought to have banks organize themselves into associations in the various Federal Reserve districts. The NCC obtained funds through subscriptions for renewable gold notes and was authorized to issue up to $1 billion of such notes. The associations could then make loans to other members when needed. This was not a very successful operation because the troubled banks did not want to admit to the other banks that they were in financial difficulty. Further, the amount of the loans was limited. NCC only provided about $10 million in loans before it stopped functioning. The Reconstruction Finance Corporation President Hoover realized that the federal government had to play a wider role in the ever deepening crisis. With his support, the Reconstruction Finance Corporation (RFC) was created in 1932 to provide funds to banks and other businesses in the private sector. Hoover intended that the RFC would be

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Jesse Jones (on right, with Howard Hughes). As head of the RFC, Jones provided a financial lifeline for many institutions. (Courtesy of Collections of the Library of Congress.)

comparable to the War Finance Corporation of World War I in managing the economy and allocating capital resources. The RFC was given capital of $500 million and authority to borrow $1.5 billion more. The RFC made loans totaling $118 million in 1932. All but $2 million were repaid by 1937. The amount that the RFC could lend was later expanded to $10.5 billion, and the agency would eventually spend or loan many billions more in fighting the depression. A Railroad Credit Corporation was created to supply funds to the railroads. The RFC made additional loans to the railroads because the banks had heavily invested their funds in railroad securities. As a result, there was concern that railroad failures could further endanger those banks. The RFCs chairman, Jesse Jones, was a Texas banker who became governor of the Fed before joining the RFC. He was authorized to lend to banks and other financial institutions. Although the RFC could make loans to small businesses, only a small number of such loans were made during the depression. The RFC focused on purchasing the preferred stock, notes, and debentures issued by banks in order to shore up their capital. Several thousand banks were given such assistance44 in amounts totaling over $1.1 billion. A.P. Giannini was among those in need of assistance. The RFC injected over $75 million of capital into his Bank of America to keep it going. The RFC also provided support to more than 1,100 building and loan associations between 1932 and 1933 in amounts that totaled over $100 million. The RFC provided $50 million of funds to the Continental Illinois National Bank & Trust Com-

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pany in Chicago. The RFC required Continental Illinois to strengthen its management and to write off over $100 million in bad loans. The RFC provided assistance to another national bank that was headed by the wife of Zane Grey, the author of a number of popular Western novels. To secure these loans, Mr. and Mrs. Grey pledged the future royalties on his novels and movie rights. Such financing would anticipate the securitizing of entertainment royalties at the end of the century. Government Programs President Hoover took other steps to shore up the economy. Indeed, it has been conceded that practically the whole New Deal later put in place by the administration of Franklin Roosevelt was extrapolated from Hoovers programs.45 Hoover proposed the establishment of a Federal Home Loan Bank System to help home owners with their mortgages. Congress approved that proposal in 1932. The Federal Home Loan Bank Act sought to rescue failing savings and loan institutions (S&Ls) by channeling cash to that industry. The act created twelve Federal Home Loan Banks that provided loans to S&Ls, mutual savings institutions, and insurance companies. The Home Loan Banks rediscounted first mortgages on family dwellings costing less than $20,000 with maturities of no more than fifteen years. The Home Loan Banks could not make direct mortgage loans. Rather, they were to act as rediscount entities by lending on home mortgages. The Home Owners Loan Act of 1933 authorized the Federal Home Loan Bank Board to grant charters to federal S&Ls. The Treasury could purchase up to $100,000 of the preferred shares of any such association. This legislation was so delayed and standards were set so high that it was not effective. S&Ls were particularly hard hit by the depression. The S&Ls lost about onethird of their assets by 1935. The number of associations dropped by some 5,000 by 1940. Interestingly, only eight mutual savings banks failed during the depression. Credit unions proved to be another hardy creature. The number of credit unions increased by some 8,000 during the 1930s. Their assets grew from $34 million to over $250 million during the depression. Despite its massive capital and lending authority, the RFC proved to be ineffective in stopping the banking crisis. Over 4,000 banks failed in 1933. The total number of bank failures between 1930 and 1933 exceeded 9,000, which was more than one-third of the banks in the United States; those banks held deposits totaling over $800 million. The RFCs efforts were handicapped by legislation enacted in 1932 that required monthly reports on loans made by the RFC. When, at the insistence of Congress, the RFC began publishing the names of banks that had received these government loans, several banks claimed that these disclosures had precipitated their failure by destroying depositor confidence. Those banks experienced depositor runs because the very fact that they were obtaining RFC loans was viewed as a sign that the

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banks were about to fail. Other banks then became reluctant to seek help from the RFC. Another problem was that the banks often sat on the funds received from the RFC in anticipation of depositor runs. Consequently, those funds did little to spur a recovery. Bank Runs Bank runs caused by loss of investor confidence resulted in the failure of many banks. The bank runs were based on a variation of the prisoners dilemma. That is, individual depositors would withdraw their funds at the first hint of possible insolvency, even though they knew that their withdrawal would panic other depositors and cause a run on the banks deposits that would cause the bank to fail. Because bank assets were largely illiquid, only those first in line would be paid with the small amount of liquid assets available to the bank. If everyone had only made their normal withdrawals, the bank could have continued on as before. In earlier years, banks could simply suspend specie payments and issue notes to meet this liquidity crisis. That option was no longer available. The Civil War legislation that taxed state banknotes out of existence precluded the use of such notes. This left the banks helpless in facing the onslaught of depositors all seeking their funds at once. A run would begin in one state and quickly spread to another. One future Goldman Sachs partner earned $5 a day for standing in line in bank runs in order to save the position of depositors. The movie Its a Wonderful Life, based on a run on a savings and loan association, was a warming small-town story that James Stewart made famous by quelling the panic of depositors with a commonsense plea, but the overall picture was more alarming. Over $100 million was paid out by Chicago bankers in a six-day period in June and July of 1932. One banker in Utah, Marriner S. Eccles, instructed his tellers to act in slow motion in order to delay payments to customers. Withdrawals were counted out in small denomination bills. Eccles would thereafter be appointed chairman of the Fed, and he would hold that post from 1934 until 1948. In October of 1932, Nevada declared a statewide banking moratorium. Banking troubles spread everywhereMemphis, Little Rock, Mobile, Cleveland, St. Louis, San Francisco, New Orleans, Kansas City. The cities hardest hit by bank failures were Chicago, Detroit, and Cleveland. The Union Trust Co. in Detroit resorted to some questionable accounting practices to conceal its worsening condition. The bank entered into repurchase agreements with the National City Bank and Bankers Trust Co. in New York. Union Trust Co. sold its doubtful loans to those entities at inflated prices and then agreed to repurchase them after its accounting period closed. This maneuver concealed the losses on the Union Trusts balance sheets. Such practices would later be called parking. Financial legerdemain could not save the banks in Michigan. The banking system in that state broke down entirely during February of 1933.46

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One large group of banks that failed in Michigan was the Detroit Bankers Co., which controlled forty other banks. It was declaring large dividends even as the economy was crashing, which helped undermine the groups financial stability. Disaster struck even harder with the failure of the Guardian Detroit Union Group, which was a holding company for several bank and trust companies. In total, the holding company controlled ten national and ten state banks, seven securities companies, and other financial institutions. Henry Ford and his son Edsel held stock in the Guardian Detroit group. Although they were subject to double stock liability and would have to bear a loss of $45 million, the Fords refused to subordinate their deposits in order to allow the RFC to make additional loans to the Guardian Union Group that would have kept it afloat. Henry Ford was warned that his refusal would cause the bank group to fail, as well as another large bank holding company in Detroit. Fords response was, Let the crash come. Everything will go down the chute. But I feel young. I can build again.47 A bank holiday was declared in Michigan for eight days after the Guardian banks failed. That action, and the failure of other Michigan banks, touched off a panic. Depositor runs required governors in Iowa and Louisiana to declare bank holidays. Bank runs then began all over the nation, and banks toppled one after the other. Statewide banking holidays were declared in Nevada, New York, and other states as confidence in the banking system evaporated. A shortage of money occurred when the banks closed. Scrip was issued by corporations and municipal governments to pay employees. As much as $1 billion in scrip may have been issued during this period. Chicago schoolteachers rebelled after being paid with scrip for ten months. Tokens and barter were common. Canadian dollars and Mexican pesos were used for currency. The president appealed to the country on February 3, 1932, to stop hoarding currency. Colonel Frank Knox was put in charge of a national antihoarding campaign. In addition, the Secretary of the Treasury announced the sale of 2 percent Treasury certificates in denominations from $50 to $500. These baby bonds were issued to obtain money from hoarders. The New Deal Franklin Roosevelt stepped into the presidency during the bank panic. He ran against industrial dictatorship and a steam driven economy. Roosevelt believed that the day of the builders of industrial plants and organizers of corporations had ended. They were as likely to be a danger as a help. He proclaimed that the day of the great promoter or the financial Titan, to whom we granted everything if only he would build, or develop, is over.48 Roosevelt asserted that citizens of the United States want their fair share in the distribution of the national wealth. I pledge to give to the American people the New Deal, the new pact, the opportunity it has been waiting for. Roosevelt declared a national bank holiday on March 6, 1933, under the Trading with

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the Enemy Act. The president explained his action in a fireside chat to the nation on March 12, 1933. He informed the public of the need to restore trust in the banks. The president assured the country that banks would not be reopened unless they were safe. On March 9, 1933, Congress enacted the Emergency Banking Act. This legislation was designed to allow the Federal Reserve Board to restore liquidity to the system. The act authorized the RFC to provide banks with additional capital. Banks were allowed to resume business after examination and licensing by the Treasury Department to assure that they were solvent. Numerous banks were quickly reopened. The effect of the banking collapse was, nevertheless, devastating. In New Orleans, only one bank opened as the same institution after the bank holiday. The crisis continued elsewhere. The banks were called upon to rescue New York City in 1933. J.P. Morgan and other investment bankers pledged over $50 million to help the city. More legislation was adopted. The Banking Act of 1933 was sponsored by Representative Henry B. Steagall from Alabama and Senator Carter Glass from Virginia. The Glass-Steagall Act established federal deposit insurance to protect customer bank deposits and to maintain faith in the banks in order to prevent depositor runs. This insurance was to be administered by the Federal Deposit Insurance Corporation (FDIC), which was capitalized at $150 million. The capital stock structure of the FDIC provided for class A and class B shares. Class A stock was to be held by member and nonmember banks. The class B stock of the FDIC was to be held by the Federal Reserve banks. The FDIC assessed member banks of the Federal Reserve System 0.5 percent of their deposit liabilities as the means for funding the FDIC guarantee arrangement. Banks that were members of the Federal Reserve System were required to join the FDIC. State banks could be admitted upon application. Initially, bank deposits were insured only up to the first $2,500. There was doubt as to whether the FDIC arrangement would work. Eight states had created guaranty fund arrangements after the Panic of 1907. They were takeoffs on the New York guaranty fund of the nineteenth century. The guaranty system in Oklahoma proved to be inadequate when the largest bank there had failed in 1909. Many of the Oklahoma banks had also adopted national charters in order to avoid the requirement of paying into the guaranty fund. The remaining state deposit guaranty schemes failed after the market crash in 1929. The FDIC, however, had more credibility and resources. The federal government guaranty was sufficient to stop the bank runs that were placing such strain on the financial system. The number of bank failures dropped dramatically after creation of the FDIC. Assessments on the banks for FDIC insurance were even reduced because liabilities were so small. The amount of deposit insurance was increased to $5,000 in 1935. The Glass-Steagall Act contained other provisions. It authorized the Fed to call any advances made to a bank that disregarded a warning from the board against increasing margin loans. This was an effort by Congress to prevent a

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recurrence of the Charles Mitchell episode in which he had announced that National City Bank would provide call loan money in 1929 despite the efforts of the Fed to limit speculative credit. Congress sought to preclude banks from paying interest on demand deposits. This prohibition was intended to discourage interior banks from investing their funds in the call money market. The rate of interest on time deposits was to be set by the Fed. That restriction would have a devastating effect on the banks and S&Ls later in the century. The Glass-Steagall Act created a Federal Open Market Committee composed of the seven Fed Board members and the five reserve bank presidents. Previously, in 1930, the Open Market Investment Committee had been replaced by the Open Market Policy Conference. This committee had representatives from all of the Reserve banks and was to conduct open market operations. It was given statutory authority by the Banking Act of 1933. Still, the Open Market Policy Committee was not effective and was replaced under the Banking Act of 1935 by the Federal Open Market Committee. Its meetings were to be held in Washington at least four times each year. The statute prohibited Federal Reserve banks from engaging in open market operations except in accordance with the regulations adopted by the Fed. Congress thereby sought to centralize monetary policy, which had been in such disarray during and before the stock market crash of 1929 because of differing views of the Fed in Washington and the efforts of the New York Federal Reserve Bank to dominate policy. The Federal Open Market Committee was to control the money supply by buying and selling government securities. The failure to allow branch banking was said to have deepened the bank crisis, because banks could not diversify their operations. The Banking Act of 1933, nevertheless, continued restrictions on interstate branch banking. The states were to determine whether the banks located within their borders could have branches. A national bank could have branches anywhere a state bank could. In the early 1930s, twelve of the twenty-two states that had prohibited branch banking amended their laws to allow at least some branching, but the banks were still precluded from conducting interstate banking. Another result of the many bank failures in the 1930s was the repeal of laws subjecting bank stockholders to double liability. This provision was removed in order to make bank stocks more desirable as investments. Banking capital, nevertheless, remained scarce, and the RFC continued to supply funds to the banks. In October of 1933, for example, the RFC invested $25 million of capital into the Manufacturers Trust Company. The Glass-Steagall Act contained other provisions that would haunt finance for the rest of the century. This legislation sought the complete divorcement of commercial and investment banking. The powers of national banks were already limited by the National Bank Act that was enacted during the Civil War. National banks were allowed to engage in the business of banking and to exercise incidental powers necessary for that business. The Glass-Steagall Act of 1933 excluded equity securities activities from such

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powers unless those securities involved bank-eligible securities. Specifically, commercial banks were prohibited from engaging in the issue, floatation, underwriting, public sale or distribution either wholesale, or retail or through a syndicate participation, of stocks, bonds, debentures, notes or other securities.49 Historians remain uncertain as to why Congress adopted this prohibition. A study of the 2,955 national banks that failed between 1865 and 1936 concluded that securities activities were not even in the top seven categories of reasons for those failures. Presumably, the separation of functions required by the Glass-Steagall Act was due to the failure of the Bank of United States, which had a large securities affiliatethe City Financial Corporation. Bernard K. Marcus and Saul Singer, the two most senior officials at the bank, were indicted, convicted of fraudulent banking practices, and sent to Sing Sing prison. The affiliate, however, was not shown to have caused the banks failure, and the Bank of United States eventually returned 83.3 cents on each depositors dollar during the liquidation. A Fed official testified during the GlassSteagall hearings that, while there had been abuses with the bank affiliates, the board did not advocate prohibiting banks from having securities affiliates. The best support that can be given for the Glass-Steagall Act is Glasss own statement that the Federal Reserve System had been transformed into an investment banking system, while the purpose of the Fed was to create a commercial banking system free of speculation. Senator Glass was concerned that a member bank could engage in speculative operations and then, when its reserves were impaired, take eligible paper for rediscount and use the additional funds so gained for more speculation in a roundabout way.50 The real reason for this legislation may have been congressional annoyance with Charles Mitchells defiance of the Federal Reserve Boards efforts to curb call money before the crash. Mitchells action was certainly intended to benefit his banks security affiliate, the National City Co. The Glass-Steagall Act sought to assure that securities activities of bank affiliates were sharply circumscribed. Bank affiliates were prohibited from being principally engaged in securities underwriting and dealing activities. The legislation did not define what was meant by being principally engaged. That omission would provide a loophole for the banks to reenter the securities business fifty years later. The Glass-Steagall Act did not prohibit the banks from continuing to act as underwriters of state government bonds, and the banks could continue to deal in United States government securities. It permitted banks to purchase and sell investment securities for their customers. The legislation sought only to preclude their dealing in or underwriting securities. The Investment Bankers Split The passage of the Glass-Steagall Act meant that J.P. Morgan and other investment bankers would have to choose between their commercial banking and corporate underwriting activities. J.P. Morgan & Co. became a commer-

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cial bank. It split off its investment banking functions into a new entity Morgan Stanley & Co. Three of the seventeen J.P. Morgan & Co. partners resigned to form Morgan Stanley. They were Harold Stanley, William Ewing, and Henry S. Morgan, the son of Jack Morgan. Several Morgan employees joined the new Morgan Stanley firm. Most of the remaining officers, directors, and shareholders of Morgan Stanley came from J.P. Morgan or from the Guaranty Co. of New York. Although Morgan Stanley was supposed to operate independently of J.P. Morgan & Co., they were closely linked. Morgan Stanley & Co. was initially incorporated but changed to a partnership in 1941 in order to qualify for membership on the NYSE. Morgan Stanley & Co. specialized in a high grade bond business and acted as an underwriter in common and preferred stocks. Bankers Trust Company sold over $100 million in travelers checks in the 1920s, but it discontinued that business as foreign travel dropped during the depression. Bankers Trusts securities subsidiary (the Bankers Company) was liquidated with the coming of the Glass-Steagall Act. Another large investment banking affiliate affected by the Glass-Steagall Act was that of the Guaranty Trust Company of New York. The affiliate was employing some 500 individuals when it was dissolved. Many of its personnel went to Edward B. Smith & Co., which later became Smith Barney & Co. Some executives at the Guaranty Company scattered to other investment banking firms, including Lazard Frres; Kidder, Peabody; the Blyth firm; and Morgan Stanley. Still another official at the Guaranty Company joined the investment banking firm of Drysdale & Co. The National City Company was liquidated by the National City Bank in 1934 in order to comply with the requirements of the Glass-Steagall Act. This affiliate had been badly injured by the stock market crash. Its capital dropped to about $21 million in 1932, down from about $130 million in 1929. The stock market crash had left Brown Brothers & Co. in difficult financial circumstances. In 1931, Brown Brothers and the Harriman firms merged, becoming Brown Brothers, Harriman & Co. At the time of the merger, Brown Brothers had been in existence as a business for over a century. W. Averell Harriman and Prescott Bush, the father of a future president, became partners in the new firm of Brown Brothers, Harriman & Co. This partnership engaged in commercial banking activities and investment banking. When the Glass-Steagall Act was adopted, Harriman, Ripley & Co. was organized to engage in investment banking activities. Most of the individuals in Harriman, Ripley & Co. came from Brown Brothers, Harriman & Co., but some were recruited from the National City Co. Harriman, Ripley & Co. had offices in Chicago, Philadelphia, Boston, and New York that sold retail securities and engaged in underwriting. A lot of its business was in municipal securities and in equipment trust certificates. The stock of Harriman, Ripley & Co. was owned from 1938 to 1946 by E. Roland Harriman and W. Averell Harriman with their families. In 1946, the company was reorganized and the brothers inter-

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ests were reduced to 43 percent of the voting stock and 97 percent of the nonvoting stock. The Equitable Trust Company was having difficulty after the stock market crash. The Rockefellers put Winthrop Aldrich, the son of the senator, in charge of the firm. He negotiated a merger with Chase National Bank that was consummated in 1930. The Chase National Bank then became the largest bank in the world, with assets of over $2 billion. Aldrich became chairman of the Chase National Bank after Albert Wiggin was forced to retire. Chase was among the national banks that received aid from the RFC. The RFC purchased $50 million of Chases preferred stock, but that was only a short-term crisis. Chase was able to redeem that stock within three years. Chase National Banks securities affiliate, the Chase Securities Corporation, had generated over $40 million in profits before the market crash. That affiliate had even grown after the crash through the acquisition of Harris Forbes & Co. Harris Forbes & Co. was itself the successor to N.W. Harris & Co., that had been formed in Chicago in 1882 by N.W. Harris, the father of the modern bond salesman.51 N.W. Harris & Co. had expanded to Boston and New York. In 1907, the firm formed Harris Trust & Savings Bank in Chicago. Chase Securities Corporation acquired the stock of Harris Forbes & Co. in 1930, and the name of the company was changed to Chase Harris Forbes Corporation. Chase began conducting its securities business through that entity. After the passage of the Glass-Steagall Act, however, Chase was forced to liquidate the Chase Harris Forbes Corporation. Over 1,000 employees were discharged. The First Boston Corporation was the survivor of the securities affiliates of the First National Bank of Boston and the Chase National Bank. First Boston Corporation had become a separately owned company in 1934 after it divorced itself from the commercial bank operations of the First National. It then obtained an option from the Chase Corporation on the name of Harris Forbes, its goodwill and stock. Eleven Harris Forbes employees and seven of its officers joined First Boston Corporation. The remaining officials of Harris Forbes were cast adrift and joined other investment bankers including Kidder, Peabody and Field Glore. First Boston Corporation had over 600 employees by 1934. The firm had a trading department, in which it conducted trading for its own account as principal, as well as a municipal department and a corporate bond department. First Boston opened offices in New York, Boston, Chicago, Pittsburgh, Cleveland, Philadelphia, San Francisco, and Springfield, Massachusetts. Another firm, the Union Securities Corporation, was created in 1938 to carry on the investment banking business of J. & W. Seligman Co. after the enactment of the Glass-Steagall Act. J. & W. Seligman continued to engage in brokerage, investment counseling, and other securities activities other than underwriting. The Union Securities Corporation gradually built up its underwriting business and was a major underwriting and distributing house in the 1940s.52 The Chase National Bank often accepted equity stock of corporations in

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workouts for debts that could not be paid during the depression. Many of those arrangements later turned out to be quite profitable. Chase began making term loans in the 1930s. This was a change from the time-honored practice of seasonal borrowing.53 This change in lending practices required banks to rely more on cash flow analysis than specific collateral for credit decisions. The banks established the prime rate system for lending to corporate customers. The most creditworthy corporate customers could borrow at the prime rate, while corporations posing greater default risks borrowed at higher rates. The prime rate became the key basis for loan interest rates in the 1930s and many years afterward. Chase rid itself of the American Express Company, which it had acquired in 1929 in order to gain control of that companys popular travelers check business. The American Express Companys cash flow and money operations were what had attracted the interest of the bank. After the stock market crash, Albert Wiggin used American Express Company funds to speculate in the market, and large losses resulted. Wiggin was given control of the American Express Company in exchange for his shares in the Chase bank. Wiggin held almost 24 percent of American Express stock until 1949. Further Reforms More banking legislation arrived in 1935. The Banking Act of 1935 replaced the Federal Reserve Board with the board of governors of the Federal Reserve System. The chairman and a vice chairman were given administrative authority over the board. The term of office for governors was set at fourteen years, and the number of governors was reduced to seven. The act also eliminated ex officio members of the Fed, including the Secretary of the Treasury, a step that was intended to make the board more autonomous. The act sought to strengthen the Federal Reserve Boards authority over national banks, but reserve requirements were made more flexible for banks, depending upon their location. National banks were allowed to make ten-year, rather than just five-year real estate loans. None of this inspired the Fed to play any meaningful role in ending the depression. An effort by the New York Federal Reserve Bank to increase the money supply by open market operations was shut down by the Washington Federal Reserve Board. A purchase of $1 billion in government securities in 1932 by the Fed was again too little too late. Indeed, it was criticized as raising the danger of inflation, which was a specter that had haunted the world economy since the postwar German economic crisis. After that futile gesture, the Fed seems to have abandoned the scene altogether for some years. In 1931, over 50 percent of the investment portfolios of mutual savings banks in the United States consisted of first mortgages on residences. The remaining investments consisted largely of railroad bonds, United States government and municipal bonds, and public utility bonds. Many first mortgages

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went into default as the depression deepened. The Glass-Steagall Act did not provide access to the Federal Reserve System for savings banks. In order to provide those banks with a facility that would provide liquidity in the event of a crisis, the Savings Banks Trust Company was formed. Its capital was provided by the savings banks in New York, and funds were provided by the Reconstruction Finance Corporation. This institution steadied the savings and loan business. Even so, over 1,700 thrift institutions failed in the 1930s. The Home Owners Loan Corporation (HOLC) was created by Congress in 1933 to assist individuals who could not meet their mortgage payments. HOLC bought mortgages from holders in order to avoid foreclosure and eased the terms of the mortgagesextending maturity dates and reducing interest rates so they could be paid back. In order to prevent foreclosures, HOLC advanced almost $3.1 billion to refinance home mortgages on more than one million homes between 1933 and 1936. The National Housing Act of 1934 created the Federal Housing Administration (FHA) and the Federal Savings and Loan Insurance Corporation (FSLIC). The FHA protected mortgage lenders by guaranteeing full repayment of defaulted loans that were covered by the legislation. FSLIC insurance protected small depositors at thrifts by insuring their deposits up to $5,000. Membership in FSLIC was required for federally chartered S&Ls. State-chartered associations could join if they chose to do so. The FHA was given $300 million capital and was authorized to issue bonds guaranteed by the federal government. The Home Mortgage Relief Act of 1935 provided additional funding to relieve stresses on home mortgages. The Federal Credit Union Act was enacted in 1934. By then forty-one states had passed credit union legislation. The Federal Credit Union Act authorized national charters for credit unions. The legislation restricted credit unions from offering banking services to anyone other than their members. Federal credit union membership was limited to groups having a common bond of occupation or association or to groups within a well-defined neighborhood or rural district. The definition of what constituted a common bond or occupation would be stretched considerably over the years.

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5 Congress Investigates the Stock Market

The Crisis Deepens The little bull market that sprang up in early 1930 did not last long. The Dow Jones Industrial Average dropped by over one-third by the end of that year, and a devastating bear market followed. The Dow fell to a low of 41.22 on July 8, 1932. That was about 10 percent of its high in 1929. By 1932, NYSE stocks had lost over $74 billion in value from their 1929 high. NYSE seats were selling for less than $70,000 in 1932, down from over $600,000 in 1929. Bonds were another casualty of the crash, losing $18 billion in value between 1930 and 1933. A large percentage of the outstanding bond issues in the market were in default, including over $1 billion in guaranteed mortgage bonds. The commercial paper market was another victim. Only about $218 million in commercial paper was outstanding at the end of the decade. Controversy arose over whether short selling on the NYSE was the cause of the market decline. A former ambassador to Germany, James W. Gerard, attacked the practice in a nationwide radio broadcast in 1931. Short selling became a focus of congressional concern in 1932. The Senate Committee on Banking and Currency conducted an investigation of the NYSE after it appeared that there had been a concerted effort to hammer down the price of securities on the stock market.54 President Hoover, meeting with NYSE officials, expressed concern that bear pools operating on the exchange were hurting the economy. The president warned that, if the NYSE did not implement reform, federal legislation would result. The NYSE did, thereafter, prohibit short sales below the last quoted price in order to stop scale-down orders that were being used to drive down market prices. The NYSE also prohibited short selling for a period of two days after the Bank of England announced it was suspending gold payments in 1931. The Bank of Englands suspension caused stock exchanges across Europe to close. The NYSE made some other limited efforts at reform. One of its officials, Richard Whitney, announced that members could no longer
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participate in pool operations. Specialists were prohibited from disclosing information concerning customer orders held in their book. Brokers were required to sign an agreement pledging fair treatment of customers. Member firms were required to obtain authorization in writing before lending customers securities. The NYSE imposed further restrictions on discretionary accounts traded by customers men. These were individuals who purchased and sold securities as a broker (a salesman sold securities for a firm as principal). The NYSE prohibited customers men from sharing the profits of customers or guaranteeing customers against losses. The latter agreements exposed brokerage firms to large liabilities and endangered other customers. The NYSE had sought to further strengthen its regulations by requiring periodic statements for listed corporations, and it required investment trusts to publish a portfolio of their securities. In 1933, the NYSE required independent audits of financial statements of listed companies. Previously, only about 25 percent of NYSE listed stocks had published annual reports, and independent audits had not been required. The New York Curb Exchange required unlisted companies to file financial reports, after an investigation by the Bureau of Securities of the New York attorney generals office uncovered abuses. Railroads were required by the Interstate Commerce Commission to publish annual balance sheets and other information. Some states, including Massachusetts, required an annual balance sheet. Even with these requirements, many gaping holes remained in the disclosures made to investors, particularly for new issues of securities. Moreover, there was little uniformity in accounting standards. The volume of trading on stock exchanges in the United States in 1932 was around 500 million shares. About 75 percent of that amount was transactions on the NYSE. This was a drop in volume of more than one-third from 1929. Proprietary and dealer transactions for the accounts of members of the NYSE were responsible for a large amount of that trading. Still, trading continued. In 1933, there were over 6,000 equity stock issues listed on the exchanges, as well as over 3,700 bond issues. Between 1928 and 1933, securities commissions exceeded $1.6 billion. An additional $325 million or more was earned by brokerage firms on interest payments on funds they held.55 J.P. Morgan & Co. sought to support the bond market in 1932 through a compaign called Stars and Stripes Forever in which thirty banks pledged $100 million for the purpose of buying high-quality bonds, but lesser quality bonds were left to suffer. The Revenue Act of 1932 imposed a federal tax for the first time on the transfer of bonds. In February of 1932, New Yorks governor, Franklin Delano Roosevelt, had legislation passed that increased the stock transfer tax. The federal tax on securities was doubled in 1933. New York City announced the adoption of a tax of four cents per share on all sales of stock in 1933. This caused the NYSE to revolt, and it began building a new exchange floor in New Jersey to avoid the tax. Some 1,500 men worked around the clock in shifts of about 500 each, building trading posts and other facilities.56 The

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New York authorities then retreated, and the New Jersey Stock Exchange was abandoned. The rain of bad news in the securities market continued. The international empire of Ivar Kreuger, the Match King, failed. The Swedish Match company that Kreuger had organized in 1917 dominated the match industry throughout the world. In 1923, Kreuger created an American subsidiary, the International Match Corporation. Lee, Higginson & Co. conducted a large offering for that subsidiary in America. Other offerings followed, totaling some $145 million. Kreugers empire expanded to include banking, telephones, and newspapers, and he became a heroic figure in finance. Kreuger even appeared on the cover of a national magazine the day before the stock market crashed in 1929. President Hoover invited him to the White House after the crash for advice on how to handle the economic situation. In reality, Kreuger was a charlatan. Among other things, his holding company, Kreuger & Toll, had listed a large issue of thirty-year, 5 percent sinking fund gold debentures on the NYSE that were supposed to have been collateralized by securities valued at 120 percent par. After the bonds were sold, Kreuger substituted Yugoslavian bonds of little value for the valuable French government bonds that had been originally used as security for the bonds. Kreuger was able to accomplish this substitution because the indenture agreement allowed substitution based on par value rather than market value. Similarly, the common stock of the Swedish American Investment Corporation was purchased by Kreuger with securities that he valued at over $30 million. In fact, those values were largely fictitious. Kreuger was using forged bonds as collateral to support his tottering enterprises, and he had been falsifying the accounts of his empire. After financiers began to question his bona fides, Kreuger engaged in elaborate charades to conceal his schemes. When Percy Rockefeller came to visit him, Kreuger had himself interrupted several times with fake phone calls from many national European leaders seeking Kreugers advice. This greatly impressed Rockefeller, who was said to have stated, Gentlemen, we are fortunate indeed to be associated with Ivar Kreuger.57 Kreuger scrambled frantically to keep his empire intact after the stock market crashed. He had a stroke, however, and his house of cards began to collapse. After Kreugers suicide in March of 1932, it was found that he had engaged in broad-scale forgery and creation of fictitious accounts. When the Match Kings empire imploded, investors lost everything. Millions of dollars had simply vanished. Kreugers failure ruined Lee, Higginson, his investment banker. Claims against Kreugers empire exceeded $1 billion. The Kreuger & Toll empire was really a blind pool because Kreuger did not disclose his operations. In fact, he emphasized secrecy in his companys finances as a selling tool. The collapse of the Alleghany Corporation, which was the center of the Van Sweringen brothers empire, was another disaster. The Van Sweringens had begun their investment in the railroads in 1916 by acquiring the Nickel

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Plate road. Later, the brothers acquired control of the Chesapeake & Ohio and several other railroads,58 including the much abused Erie. The Van Sweringens then began pyramiding corporation upon corporation, investment trust upon investment trust, and holding company upon holding company.59 Investor funds were used to leverage the brothers controlling position through their holding company structure. At the top of the pile was the Alleghany Corporation, under which the Van Sweringens organized their railway holdings in 1929 with the help of J.P. Morgan & Co. The Alleghany Corporations pyramid structure had several tiers of holding companies. The Van Sweringens maintained control at the top of this pyramid even though their holding company owned only a very small portion of the companies at the lower levels. This holding company structure enabled the Van Sweringen brothers to acquire a controlling interest in a vast network of railroads on a shoestring investment. The Van Sweringen brothers, with a capital investment of $1 million, obtained control of one of the four railroad systems in the eastern part of the United States, as well as the Missouri-Pacific Railroad in the Southwest. The Van Sweringens sold about $160 million in preferred stock and bonds through J.P. Morgan & Co. and others. Some of those securities were distributed to the J.P. Morgan & Co. preferred list of influential people; a few names added to that list at the Van Sweringens request included Newton D. Baker; K.D. Steere, a partner in Paine Webber & Co.; and an attorney, John P. Murphy. The Van Sweringens enormous empire was at one point valued at $3 billion. Their holdings comprised coal mines, office buildings, and over 20,000 miles of railroads, including the New York, Chicago & St. Louis Railroad, the Missouri Pacific Railroad, the Chesapeake & Ohio Railway, the Wheeling and Lake Erie Railway, the Erie Railroad, and the Hocking Valley Railway. The whole Van Sweringen empire collapsed as the depression took hold. The stock of the Alleghany Corporation dropped from $56 in the summer of 1929 to 12.5 cents in 1933. The Van Sweringen brothers both died broke within a few years, but the Alleghany Corporation would survive. A further blow to the economy was struck with the fall of Samuel Insulls holding company system in Chicago. Insull, who had started out as Thomas A. Edisons secretary, controlled an empire of utilities through Insull Utility Investments a holding company that was at the top of a pyramid of 100 holding companies and over 250 operating companies. Another key part of this holding company system was the Corporate Securities Co. of Chicago. Some subsidiaries in the Insull holding company structure were six tiers removed from the ultimate holding company. Insulls holding company included four utility systems under its umbrella that provided more than 10 percent of the electric power in the United States. The combined assets of the system were valued at $2.5 billion. The failure of this vast network of companies was a shock to everyone. Losses to investors totaled hundreds of millions of dollars. The investigations that followed the Insull collapse revealed that Insull had his own preferred lists. They included a lieutenant governor of Illinois,

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several state and federal judges, the speaker of the state house of representatives, and others. Insull and his son were indicted for mail and wire fraud in selling worthless stock to unsophisticated investors and for manipulating stock prices through wash sales and fictitious transactions. Harold L. Stuart and eight other officers, directors, and employees of the Halsey, Stuart firm, which handled the Insull underwritings, were indicted as well. Insull fled to Greece to avoid prosecution. The United States Senate ratified an extradition treaty with the Greek government, which expelled Insull, and he fled from arrest on a yacht. Congress quickly passed special legislation for his arrest when he arrived in Turkey. Insull was sent back to the United States, but he was later acquitted of all criminal charges. Congressional Investigations Charles R. Morris, the author of a book on the causes of financial crises, states that the stock market crash of 1929 was probably an event of relatively minor significance in causing the Great Depression.60 Nevertheless, federal regulation of the securities markets became an issue in the presidential campaign in 1932 when Herbert Hoover charged Franklin D. Roosevelt with responsibility for the depression that resulted from the crash. After all, Roosevelt was the governor of New York, where the speculative frenzy of the 1920s had been centered. Roosevelt was himself a speculator, investing in wildcat oil operations, dirigibles, German real estate (that he purchased with depreciated German money), and some speculative issues of securities. Roosevelt was, nevertheless, able to turn Hoovers charges against the Republicans. The Democratic Party platform in 1932 sought to require stock and bond advertisements to be filed with the government and disclose information as to bonuses, commissions, principal invested, and interests of the sellers in the securities. Franklin Roosevelts acceptance speech at the Democratic Convention focused on the dry subject of finance. He proclaimed a need for the letting in of the light of day on issues of securities . . . which are offered for sale to the investing public. Roosevelts campaign against Wall Street received popular acceptance from the country, and his election allowed him to implement a New Deal for the American public. In his inaugural address, Roosevelt stated that the practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men. He attacked the rulers of the exchange of mankinds goods, but he assured the American public that the money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truth.61 The presidents concerns were heightened after a sharp market drop in the wake of the banking panic in 1933. The NYSE had opened for trading on Saturday morning, March 4, 1933, but was forced to close almost immediately. The NYSE remained closed between March 4 and March 15, 1933, as the banking crisis reached its climax.

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Roosevelt sought legislation from Congress to establish regulatory control over the securities and commodities markets, as well as the banks. Roosevelt advised Congress that unregulated speculation in securities and commodities was one of the most important contributing factors in the artificial and unwarranted boom which had so much to do with the terrible conditions of the years following 1929. The president expressed his belief that exchanges for dealing in securities and commodities are necessary and of definite value to our commercial and agricultural life. Nevertheless, it should be our national policy to restrict, as far as possible, the use of these exchanges for purely speculative operations. Roosevelt sought legislation that would permit regulation by the Federal Government of the operations of exchanges dealing in securities and commodities for the protection of investors, for the safeguarding of values, and so far as it may be possible, for the elimination of unnecessary, unwise, and destructive speculation.62 Congressional investigations of the stock market crash had been lagging before Roosevelts election. Fiorello La Guardia had livened things up when he came to testify with a trunk full of documents brought to the hearing room under police escort. The trunk contained canceled checks of A. Newton Plummer, the publicist who paid newspaper reporters to tout stocks. Nevertheless, Congress did not aggressively seek legislation until Roosevelt demanded reform. The Senate Committee on Banking and Currency then began a two-year investigation of the securities markets. In 1933, Ferdinand Pecora, an able and aggressive attorney, was retained as the committees counsel. Pecora was a relentless inquisitor. Although the hearings had their lighter moments, as when a midget was placed in Jack Morgans lap, a number of startling and undesirable practices in the securities markets were revealed. Like the Pujo Committee, the Banking and Currency Committee found that the wealth of the nation was being placed under the control of financiers.63 Some seven million individuals owned stock in American companies, but almost 90 percent of them owned less than 100 shares. One percent of the stock owners owned 50 percent of the shares. By 1935, 0.1 percent of U.S. corporations owned over 50 percent of all corporate assets and earned 50 percent of the corporate income. More dramatically, 5 percent of U.S. corporations owned 87 percent of all corporate assets. The investment bankers continued their control of large corporations even though they had only a relatively small personal stake in those companies. The number of directorships held by partners at J.P. Morgan & Co. and other financiers continued to evidence inordinate control over vast portions of the economy. J.P. Morgan & Co and Drexel & Co. held over 120 director positions in some ninety companies that had almost $20 billion in assets. Twenty of those directorships were on the boards of fifteen banks and trust companies. Kuhn, Loeb & Co. held almost sixty directorships in over forty companies between 1927 and 1931, as well as six directorships on the boards of five banks and trust companies. Dillon, Read & Co. held a large number of

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directorships. Albert H. Wiggin, while head of the Chase National Bank and the Chase Securities Corporation, held fifty-nine directorships in various corporations, including Armour & Co., American Express, Western Union, International Paper Co., and the American Sugar Refinery. Interlocking directorships often created conflicts of interest. For example, bank officers serving as directors on the boards of companies dealing with their banks were faced with conflicts of interest in extending loans to those corporations. Another concern for Congress was competitive bidding for corporate securities underwritings. The investment bankers tended to have monopolies over particular business sectors. Kuhn, Loeb & Co. and J.P. Morgan & Co. handled most railroad financing in the United States. The investment bankers were receiving excessive compensation in the form of options that were connected with underwritings and finders fees paid to individuals who recommended investment banking business to them. A finders fee was paid by Kuhn, Loeb & Co. to Louis Dreyfus & Co. in the amount of $450,000 for referring a $90 million underwriting from the Mortgage Bank of Chile. This was a fee of 0.5 percent. These finders fees and large underwriting profits encouraged flotation of securities without regard to their soundness. Sales practices in the securities industry were also found to be less than admirable. Some $25 billion of worthless securities had been sold to the public during the 1920s. Those sales were made possible because of the complete abandonment by many underwriters and dealers in securities of those standards of fair, honest, and prudent dealing that should be basic to the encouragement of investment in any enterprise.64 One would have to turn the pages of history back to the days of the South Sea bubble to find an equivalent fantasy of security selling.65 A House committee found that alluring promises of easy wealth were made with little or no attempt to bring to the investors attention those facts essential to estimating the worth of any security. High-pressure salesmanship rather than careful counsel was the rule in this most dangerous of enterprises.66 Congressional investigators were harshly critical of the investment banking affiliates of commercial banks. Affiliates such as the National City Co., had been used by the banks to speculate in their own stock, to participate in market operations designed to manipulate the price of securities, and to conduct other operations in which commercial banks [were] forbidden by law to engage.67 The commercial banks had referred their depositors who were interested in investing to their securities affiliates. Bank employees were even given a service allowance for sales of securities to their customers whom they recommended to the affiliates. The affiliates then unloaded securities they owned upon these depositors. The Senate Banking and Currency Committee charged that this was a breach of the banks fiduciary duty to depositors who had sought disinterested investment advice. Such activities were not harmless. The National City Co. had traded in Anaconda Copper stock that it recommended to its clients in 1929. The stock was then selling for over $100

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per share. By 1932, it had dropped to $4. Nevertheless, in recent years, historians have asserted that Pecoras charges, including those directed against the National City Co. and Charles Mitchell, were unfounded. Among other things, empirical studies have established that underwritings by bank affiliates performed better than those written by the private investment banks. But that may not be much of a comparison since the investment banks had also engaged in many questionable underwritings. By March of 1931, some $100 million of bonds that were underwritten by J. & W. Seligman & Co. and the National City Co. in the United States were in default. Foreign bond issues sold by bank affiliates were of particular concern. The investment bankers sold over $6 billion in foreign bonds in the United States between 1923 and 1930. The National City Co. had sold two bond issues for the Peruvian government in 1927 and 1928 without disclosing that Perus credit was questionable, at best. Moodys had rated the bonds as A and later downgraded them to Baa. The bonds were offered at $96.50 in 1927; in 1933, they were quoted at less than $8. The National City Co. had underwritten a bond issue for the State of Minas Gerais, Brazil, in 1928 even though that state had previously defaulted on a French loan. The bonds were offered at $97.50 by the National City Co. to investors in the United States. The bonds were in default in 1932 and were trading around $21. During the same period, Chase National Bank was making some questionable loans to the president of Cuba at the time it was conducting business with the Cuban government and having its affiliate underwrite bond issues for Cuba in the United States. There was little disclosure of the financial difficulties facing the Cuban government and of conflicts of interest on the part of Chase National Bank. Chase raised $60 million from American investors from the Cuban bond issues, which defaulted in 1933. Other foreign bond issues sold to the public without adequate disclosure included the City of Rio de Janeiro, the Republic of Brazil, and the Mortgage Bank of Chile. In 1934, of the approximately $7 billion of foreign securities outstanding in the United States, about $3 billion were in default. By 1931, Latin American bonds had depreciated by 75 percent. Peruvian bonds were even worse, depreciating by over 90 percent. Insider Trading Insider trading by corporate officials caused further congressional dismay. Among the most vicious practices unearthed in congressional hearings was the flagrant betrayal of the fiduciary duties by directors and officers of corporations who used their positions of trust and the confidential information which came to them in such positions, to aid them in their market activities.68 The unscrupulous employment of inside information by officers, directors, and large stockholders who, while not directors and officers, exercised sufficient control over the destinies of their companies to enable them to acquire and profit by information not available to others was shocking in its magnitude.69

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Albert Wiggin, the president of Chase National Bank, in particular used his position at Chase and as a director of other corporations to trade on inside information. For example, when he learned that a company in which he was a director was in financial difficulty, he would sell shares before that news was announced to the public. The states had no effective prohibition against insider trading. Several states had held that directors could trade in the stock of their corporation exactly as other individuals could. The New York courts had so ruled in a case that was decided in 1868.70 This majority view meant that insider trading was legally permissible. Only a minority of courts, including those in Georgia and Kansas, prohibited directors from trading in the stocks of their companies on the basis of inside information. The federal courts adopted a special facts doctrine that required disclosure by a director or officer in stock transactions of their corporation when there were facts of a peculiarly important nature that should be disclosed. Nevertheless, insider trading flourished. Other abuses were also examined by Congress. The National City Bank was making large loans to its officers and directors, often without adequate collateral. Sometimes the loans were not repaid. The Chase National Bank made loans of $11.8 million to a company controlled by its president, Albert Wiggin. These loans to officers and directors were frequently used for speculation. The Senate Banking and Currency Committee placed much blame on the banks for encouraging speculation through brokers loans and the financing of syndicate and pool operations. Wiggin testified before the committee that the Chase Securities Corporation and another subsidiary had put over $800 million into various pools that were manipulating securities prices. The investment trusts were another matter of concern. The committee found conflicts of interest and breaches of fiduciary duty by investment managers who controlled the trading and operations of the investment trusts. The investment trusts were used to unload securities owned by the persons controlling the companies. One investment trust, the Pennroad Corporation, was used to protect the Pennsylvania Railroad from purchases of strategic properties by competing companies instead of providing investors with a diverse investment opportunity, as claimed in its promotions. Some other sleazy dealings were disclosed in congressional hearings. The National City Co. made a $10,000 loan to the general manager of the Port of New York Authority shortly after the National City Co. was appointed to be the underwriter of a large bond issue for the Port Authority. The loan was never repaid, and no note for it could ever be found. Tax avoidance schemes in connection with securities transactions were popular. James Forrestal, a future Secretary of Defense, used his position at Dillon Read to invest in various foreign corporations in order to avoid taxes on income. This saved Forrestal about $100,000. Albert Wiggin used foreign corporations as well as short sales, to avoid taxes. One popular scheme involved the sale of securities to a relative, usually the taxpayers wife, near the

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end of the tax year at a loss. The securities would be repurchased in the next year. Thomas Lamont, a J.P. Morgan & Co. partner, established losses of over $100,000 from sales of securities to his wife in 1930. Charles Mitchell sold his wife over 18,000 shares of National City Bank stock to establish a tax loss of almost $3 million. Mitchell later repurchased the stock from his wife. This allowed Mitchell to avoid paying any income tax in 1929 even though he earned over $1 million. Mitchell was forced to resign from the National City Bank after this scheme was revealed and after heavy criticism was leveled at his activities at the National City Co. Although Mitchell was indicted for tax evasion, he was acquitted after an appeal to the Supreme Court. Nevertheless, the IRS continued to seek collection of $728,709 in unpaid taxes plus a 50 percent penalty. Eventually, the Supreme Court required Mitchell to pay both the tax and the penalty. Down but not out, Charles Mitchell formed his own firm, C.E. Mitchell, Inc. It did not last long because Mitchell decided to join Blyth & Co., where he was named chairman of the board. Dean Witter had resigned from Blyth, Witter & Co. in 1924 and formed a new firm known as Dean Witter & Co. Blyth, Witter & Co. continued to operate under that name until 1928, when it became Blyth & Co. Blyth & Co. began operating as a broker in 1929, but that business was short-lived as a result of the market crash. Blyth & Co. incorporated in 1930 and operated as an investment banking firm. It built a large sales organization for distributing the securities that it was underwriting. Blyth & Co. had a trading department, as well as the buying department that handled negotiations of securities underwritings. Under Mitchells tenure, and during the worst of the depression, Blyth & Co. increased its capital by over 400 percent. Margin Trading Other flaws in the securities markets were reviewed by congressional committees. Prospectuses were found to have widely misrepresented risk and omitted disclosures. These misleading documents were circulated by investment bankers and, in condensed form, often published in the press. Congress closely examined the role of margin in the stock market crash of 1929. Members of the NYSE had borrowed more than fifty times their capital for margin during the 1920s. Easy credit had extended to other areas of the economy. As Winston Churchill noted, The prosperity of millions of American homes had grown upon a gigantic structure of inflated credit now suddenly proved phantom. Apart from the nation-wide speculation in shares which even the most famous banks had encouraged by easy loans, a vast system of purchase by installment of houses, furniture, cars, and numberless kinds of household conveniences and indulgences had grown up.71 On June 20, 1929, the NYSE imposed a 25 percent margin requirement; some brokerage firms were charging as high as 50 percent. When banks started

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calling in brokers loans during the crash, stock prices dropped even further because of the resulting selling pressure. The NYSE made little effort to curb margin abuses. However, it did require margin for trading securities on a when issued basis. Margin trading declined dramatically after the crash. H. Fisk & Sons announced in 1930 that it would no longer handle margin trading. In 1932, outstanding call loans were only about $240 million, down from $8 billion in October of 1929. Congress, nevertheless, made margin trading a focus of consideration. The Senate Committee on Banking and Currency defined margin trading as speculation in securities with borrowed money.72 The debate over margin credit involved something called the real bills theory of banking. Conservative economists believed that banks should invest only in so-called real bills or short-term loans, which were self-liquidating and which could be used by industry to finance sales. The real bills doctrine sought to limit lending to commercial transactions in order to limit inflation and speculation. This doctrine urged that discounts be limited to acceptances covering actual commercial transactions, so as to forestall the expansion of promissory notes.73 Loans on securities did not fit within the real bills doctrine and were thought to have drawn credit away from industry and other enterprises that would build the economy. The real bills doctrine asserted that credit should be available to provide for a real need of business, not for speculative activities.74 This meant that loans paid out of earnings from the assets being funded were good loans, while loans to carry speculative assets such as securities were bad loans. The effect of the real bills doctrine was to increase money supply during booms and to decrease it in recessions. The harm done by the real bills doctrine was catastrophic in the period beginning in 1928. . . . The attempt to curb stock market speculation completely shut the doors to money supply after April, 1928.75 One congressional committee concluded that brokers were willing to lend credit to anyone based on the security of their stock positions because the liquidity of the market allowed the brokers to sell stocks quickly in the event of decline. This encouraged unqualified persons to speculate. Excited by the vision of quick profits, they assumed margin positions which they had no adequate resources to protect, and when the storm broke they stood helplessly by while securities and savings were washed away in a flood of liquidation.76 After examining these and other abuses, the Senate Banking and Currency Committee concluded that the stock exchanges would not effectively regulate their members activities without governmental supervision. During the speculative orgy of 1928 and 1929, stock-exchange authorities made no adequate effort to curb activities on the exchanges. On the contrary, they conceived it as no part of their function to discourage excessive speculation or to warn the public that security values were unduly inflated.77 The Senate committee and its counterpart in the House supported legislation to regulate the offer and sale of securities to the public.

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Securities Legislation The securities industry marshaled strong opposition to the securities legislation being proposed by the Roosevelt administration. Richard Whitney, who had become the president of the NYSE, led that opposition. Over 5,000 letters and telegrams sent to President Roosevelt protested controls on the securities industry. They were often form letters inspired by the Whitney-led forces. Whitney himself sent out over 2,000 communications to corporate officers and stockbrokers, urging them to oppose the enactment of securities legislation. President Roosevelt stated that he had never seen such an organized drive to resist legislation: [L]etters and telegrams bearing all the earmarks of origin at some common source are pouring into the White House and the Congress.78 Fifteen hundred lobbyists were said to have been sent to Washington to fight the securities legislation. However, the lobbying effort failed. The revelations of wrongdoing in the securities industry and the inability, or unwillingness, of the exchanges to deal with them convinced Congress that legislation was needed. The result was the enactment of a series of statutes to regulate most aspects of the securities industry. Those statutes still govern our markets. The first key piece of legislation was the Securities Act of 1933. It was modeled, at least in part, after the English Companies Act, which required prospectuses for public offerings of securities that disclosed pertinent information about the issuing company. The Securities Act of 1933 sought to impose upon the seller of a new security the duty to make fair, complete, and adequate disclosure to the investor, with appropriate penalties for violations of that duty.79 This legislation required full disclosure of material information about companies making securities offerings to the public. It added to the ancient rule of caveat emptor, the further doctrine let the seller also beware. The Securities Act of 1933 put the burden of telling the whole truth on the seller. It should give impetus to honest dealing in securities and thereby bring back public confidence.80 As the Senate Banking and Currency Committee warned, this legislation did not guarantee the present soundness or the future value of any security. The investor must still, in the final analysis, select the security which he deems appropriate for investment. The law simply sought to assure the investor of complete and truthful information from which he may intelligently appraise the value of a security, and to safeguard against the negligent and fraudulent practices perpetrated upon him in the past by incompetent and unscrupulous bankers, underwriters, dealers and issuers.81 Distribution of securities to the public was made unlawful by the Securities Act of 1933 unless a registration statement was filed with the federal government that contained complete and full disclosure on the company issuing the security and other material information, including underwriters fees. The issuer of the securities covered by the registration statement had to wait twenty days after filing the registration statement before making an offering.

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The offering had to be accompanied by a prospectus making full disclosure to investors. The Securities Act of 1933 prohibited paid endorsements of securities. This was designed to stop the touting of stocks by paid news reports. The required disclosures and the twenty-day waiting period were deemed necessary to combat the abuses of highly geared selling organizations, with the resultant speedy disposal of issues before the public has had an opportunity to adequately appraise their value. The waiting period allowed the government an opportunity to review the statement and assure that it complied with regulatory requirements. The Securities Act of 1933 exempted certain securities from its regulation, including those issued by federal, state and municipal governments, short term commercial paper, and certain other securities. Initially, the Federal Trade Commission was given the authority to administer the Securities Act of 1933. That assignment was short-lived. The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) and transferred to it the role of administering the provisions of the Securities Act of 1933 and other federal securities regulation. This new agency, the SEC, was to be a five-member commission whose members were appointed by the president with the advice and consent of the Senate. Although Richard Whitney had asserted that the exchanges should be allowed to regulate their own members conduct, the Securities Exchange Act of 1934 required the stock exchanges to register with the SEC as national securities exchanges. The exchanges were then subject to the oversight of the SEC. In addition to creating the SEC, the Securities Exchange Act of 1934 required companies with securities listed for trading on an exchange to maintain current financial information and to file periodic reports with the SEC that would be publicly available. The act gave the SEC authority to implement those requirements and establish accounting standards. Congress imposed additional regulatory controls over proxy solicitations, which had often been abused by individuals in control of corporations. The SEC was given the authority to regulate proxy materials, and fraud in such solicitations was prohibited. One problem the SEC would encounter was that a great deal of stock was being held in street namethat is, the stock was held in the name of the broker rather than in the name of the actual customer. This arrangement impeded the flow of information from the company to the actual beneficial owner and interfered with proxy voting rights. The Securities Exchange Act of 1934 sought to purge the securities exchanges of those practices which have prevented them from fulfilling their primary function of furnishing open markets for securities where supply and demand may freely meet at prices uninfluenced by manipulation or control.82 Manipulation of stock prices was barred by Congress under this legislation. This included such manipulative transactions as wash sales, matched orders, and the spreading of false rumors. Individuals were prohibited from acting alone or in concert with others to engage in securities transactions with the intent of creating actual or apparent trading in a security for the purpose of

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raising or depressing the price or for the purpose of inducing the purchase or sale by others. This provision sought to stop pool operations, as well as every other device used to persuade the public that activity in a security is the reflection of a genuine demand instead of a mirage.83 The SEC was given authority to regulate options trading, and short selling was subjected to its supervision. The federal securities laws were viewed to be draconian by Wall Street, but they did not go far enough for others. During the debates on the Securities Exchange Act in 1934, Representative Charles Truax from Ohio was particularly exercised about the financiers,
I am for the bill because it is doing something to Wall Street instead of doing something for Wall Street. I am for this bill, because it will do something to the bloodiest band of racketeers and vampires that ever sucked the blood of humanity. . . . Something has been said about teeth and tusks in this bill. Both of them are too light for me. I would equip this bill with triple-plated, copper riveted, razor-honed spear points steeped in the poison of the deadliest snakes of India.84

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Chapter 4 Regulating Finance

1 Monetary Policy and the Depression

The economic crisis that followed the stock market crash of 1929 paralyzed the nation. Over 8 million individuals were unemployed by 1931. That number would increase by 50 percent in early 1932. Tales of hardship and degradation during the depression are now legendary. Executives were selling apples, migrants were fleeing the farms, and beggars and bums were riding the rails and living in shantytowns called Hoovervilles. It was an employers market. Things were so bad during the depression that department stores in New York were able to require elevator operators to have bachelors degrees. Industrial production was cut by more than half in 1933. American steel production operated at 12 percent of capacity. Barter exchanges were operating in more than 500 cities where members worked in exchange for food or clothing. Some of the barter exchanges issued their own scrip. Over 80,000 businesses failed between 1929 and 1932. Almost 30,000 business went down in 1931 alone. Over 450,000 corporations were still in business in that year, but they were operating with a collective deficit of over $5 billion. Henry Ford stopped production of his cars as demand slowed to a trickle in 1931. In March of 1932, a hunger march on the Ford Motor Company turned into the Battle of River Rouge, in which numerous unemployed workers were injured and several were killed. The Ford Motor Company was hurt as well. It suffered a deficit of over $140 million in 1932. Still, there was a feeling among the American public that recovery was just around the corner. That was not to be the case. By 1933, over 500,000 home mortgages had been foreclosed. The situation in the farming community was equally distressful. In 1932, about 20,000 farm mortgages were being foreclosed monthly. Benjamin Strong, the Federal Reserve Bank governor in New York between 1916 until his death in 1928, had argued that open market operations by the Federal Reserve banks could be used countercyclically to stabilize the economy. That view was not shared by all or even most bankers.
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Monetary Policy and International Finance The paralysis in monetary policy caused by the split between the Federal Reserve Board in Washington and the regional Reserve banks meant that the Federal Reserve System could do little or nothing to relieve the crisis during the depression. As President Hoover observed, the Federal Reserve Board proved to be a weak reed for a nation to lean on in a time of trouble.1 The Feds bias was to do nothing during the depression, as long as interest rates were stable or falling. The governors of the Federal Reserve banks could not grasp the extent of the catastrophe.2 Contributing to the Feds inaction was the rejection of the long-held belief that monetary policy was a potent instrument for promoting economic stability.3 Money was viewed as a passive factor during the depression. This viewpoint was reflected in governmental policy and was thought to have exacerbated the effects of the depression and prevented recovery. Economists are still debating whether the governments monetary policy was to blame for the depression. As it was, the money supply dropped by 33 percent between October 1929 and March 1933. The Hoover administration announced that it was cutting taxes, but that had little effect. Although the issue is still debated by economists, an increase in tariffs seems to have worsened the situation by reducing, and in some cases halting, international trade. The Smoot-Hawley Tariff Act, passed by Congress in 1930, imposed tariffs that averaged over 40 percent, an increase of some 20 percent over prior tariff measures. These were the highest import duties in American history. The Smoot-Hawley tariffs resulted in reciprocal tariffs by other countries, which led to the adoption of U.S. import quotas, which led to further retaliation by other countries. World trade declined by about two-thirds between 1929 and 1933. The Trade Agreement Act of 1934 sought to relieve this situation by creating a negotiating process in which tariff barriers would be lowered reciprocally among the nations of the world. This was the first step toward liberalizing trade and was a predecessor to the General Agreement on Tariffs and Trade (GATT). It did not stop the depression. England had returned to the gold standard in 1925 at the insistence of Winston Churchill, then chancellor of the Exchequer, and over the opposition of John Maynard Keynes. A widening worldwide depression forced England off the gold standard in 1931. International finance was also setting the stage for the next world war. The Germans had been borrowing money in the financial markets in the United States to make reparations payments to the British and the French, who were in turn using those funds to pay off their loans to the Americans. The Dawes plan of 1924, which sought to solve the reparations issues left over from the Great War, proved to be ineffective. The Young plan had tried to reschedule the German debt and to convert the reparations owed by Germany into bonds. Germany was required to make monthly payments to retire these bonds. A new entity, the Bank for International Settlements (BIS), was created to receive and monitor those payments. The BIS was owned

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by central banks of the countries receiving reparations. The United States could not hold BIS stock because of legal limitations, but a group of private banks held the stock on its behalf. Deposits at the BIS were to be kept in gold or Swiss francs or invested in bonds. BIS, which began operations in 1930 and was based in Basel, Switzerland, was later enlarged to include several other central banks. BIS then expanded its functions to provide international clearing arrangements among its members central banks and treasuries. BIS served as a mechanism to clear foreign exchange and provide for issuing paper securities instead of transferring gold among nations. It sought to promote the co-operation of central banks and to provide additional facilities for international financial operations.4 BIS would play a central role in setting international banking policy and regulation later in the century, but it was not successful in shoring up the credit of Germany. Germany went off the gold standard, which placed pressure on gold stocks in the United States. To stem demand, the Fed increased discount rates, which caused bond prices to drop and further weakened the banks in America. In the meantime, the financial situation in Germany continued its deterioration, and a young Adolf Hitler was able to fight his way to power on the back of the unrest engendered by Germanys prostrate economy. The Boden-Credit-Anstalt, a large bank, failed in Austria in 1930. It was followed about a year later by the most important commercial bank in Austria, the Credit-Anstalt fr Handel und Gewerbe. Several other banks in Hungary and Germany failed. Germany declared a moratorium on intergovernment obligations. This touched off a panic in Europe, and the effects were felt in America, where the banking system was already in turmoil. Other international problems intruded. In 1932, the English government effectively forced its citizens to exchange their 5 percent bonds remaining from World War I for 3.5 percent bonds, without any maturity date. Thereafter, interest rates in the market increased with the result that those who converted their loans lost a substantial part of their investment. Chile defaulted on its foreign debts, including $20 million owed to the National City Bank. Several other Latin American countries defaulted, as did numerous other nations. The Johnson Act was passed in 1934 to prohibit Americans from purchasing foreign securities of any government that was in default to the United States. This dried up international financing in the United States, since most countries were in default. The Gold Standard Is Abandoned England abandoned the gold standard in 1931. The United States took the same step a few years later. Hoarding of gold was widespread, and great amounts were being exported. After his inauguration, Franklin Roosevelt prohibited the export of gold, using the authority of the Trading with the Enemy Act. In March of 1933, Congress authorized the president to prevent the hoarding of gold. Roosevelt then nationalized gold stocks and prohibited Ameri-

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cans from holding gold bullion or coin. Individuals could keep up to $100 in gold coins or gold certificates, as well as their personal jewelry. Those persons who surrendered their gold to the government received $20.60 per ounce in paper money. The government greatly devalued that currency. By January of 1934, those persons who exchanged their gold had lost 41 percent of their investment. When the government started buying gold in October of 1933, it licensed private companies to make its purchases. One such company was the United States Gold Buying Service, which operated in the Empire State Building in New York City. This firm advertised that it was buying gold such as Gold teeth and bridgework, rings, watches.5 The government took in about 5 million ounces of gold from American citizens. Except for jewelry, they would not be allowed to own gold legally again until December 31, 1974. The nationalization of gold had the unexpected effect of laying the groundwork for the arrest of the kidnapper of the son of Charles Lindbergh. The ransom money had been paid to the kidnapper, Bruno Richard Hauptmann in gold certificates whose serial numbers had been recorded by government investigators. Hauptmann continued to cash the gold certificates even after their recall by President Roosevelt. A suspicious gas station attendant wrote down Hauptmanns license plate number, and he was arrested. The kidnapper was convicted in one of the most celebrated trials of all time and sentenced to death. Hauptmann, it turned out, had been speculating with the ransom money in the stock market. Congress passed a joint resolution in 1933 that gold clauses in private and governmental contracts were to be void as against public policy. Nullifying the gold clauses was necessary because the government planned to reduce the gold content of the dollar. The gold clauses would have required payment in the prior weight and fineness and would have imposed hardship on debtors. This congressional action was upheld by the Supreme Court in the gold clause cases.6 The Court held, somewhat disingenuously, that bonds requiring payment in gold were not contracts for delivery of a commodity. Rather, such provisions were for the payment of money and, as such, were subject to the power of Congress to set monetary policy. An issue arose after the gold clause cases as to whether purchases of bonds payable, at the option of the holder, in fixed amounts of foreign money were affected by the abrogation of gold clauses by Congress. Apparently, there were a lot of these bonds in the cotton belt, and the bonds of the Southern Pacific had such provisions. The Supreme Court held that the abrogation of the gold clause was applicable to such foreign currency covenants. In Perry v. United States,7 the Supreme Court held that the government could refuse to redeem Liberty Bonds in gold. The bond at issue was a part of the fourth Liberty Loan. It was a 4.25 percent bond payable in United States gold coin of the present standard of value. The Supreme Court held that this obligation could not be changed by Congress. But the Court went on to hold

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that there were no damages because there was no domestic market for gold. The Supreme Court made a similar ruling with respect to gold clauses in railroad bonds. Despite these rulings, the validity of gold clauses was still being challenged in 1996, long after the prohibition on gold transactions had been lifted. A federal circuit court in California then held that bondholders could not enforce gold clauses in railroad bonds that had been issued at the beginning of the century. The court held that the gold clauses were unenforceable as a result of the legislation passed in 1933 that made the discharge of obligations payable in gold also payable in legal tender. For a three-month period in 1933, the United States had a floating exchange rate. In what was called a bombshell, Roosevelt announced in July of 1933 that he gave little importance to fixed exchange rates. In September of that year, the government determined to set an official gold price based on world market rates. On October 22, 1933, Roosevelt announced his decision to devalue the dollar by manipulating the price of gold. In a fireside chat, the president stated that the Reconstruction Finance Corporation (RFC) would be purchasing all of the gold mined in the United States. On October 24, 1933, the president announced that the federal government would fix the price at which the RFC would buy gold. Roosevelt believed that, by raising the cost of gold, he could cause the price of other commodity prices to rise as well. Roosevelts gold-fixing sessions were rather informal affairs. While having breakfast in bed, the president would set its price with Dean Acheson, the acting Secretary of the Treasury, and Jesse Jones, the head of the RFC. Roosevelt would write down the price of gold that the three agreed upon at these bedside meetings and everyone present would initial it. Roosevelt wanted the price to be fixed in this manner, without any given formula, in order to discourage speculators. Dean Acheson found this approach to monetary policy entirely too cavalier for his taste and of doubtful legality. He resigned from the government when, after this and other disagreements, Roosevelt refused to appoint him formally as Secretary of the Treasury. The RFC began issuing ninety-day notes that could be subscribed for in gold. The initial offering price for gold was $31.54 per ounce, but was gradually raised through the issuance of RFC notes to over $34. Before the price was fixed by the president, gold had been selling at $20 per ounce. This resulted in the accumulation of large gold stocks by the United States that gave rise to storage problems and created what was called a liquidity trap. Congress authorized the president to reduce the amount of gold to the dollar in order to inflate its value, to issue up to $3 billion in greenbacks, and to take other actions that would inflate the currency. The Gold Reserve Act of 1934 officially repealed the Gold Standard Act of 1900. It provided that the currency of the United States could not be redeemed in gold, except as authorized by the federal government. Only the Secretary of the Treasury could buy and sell gold. This legislation sought to stabilize the exchange rate for the dollar. It created a $2 billion fund that the Secretary of the Treasury could

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draw upon for stabilizing activities. This authority was used in 1935 to prevent a run on the French franc. That success was not long-lived; within a year, the franc had to be devalued. The New Deals gold policy did result in an increase of the federal governments gold stocks from about $8.2 billion in 1934 to over $22 billion in 1941. The Silverites Return After the passage of the Gold Reserve Act of 1934, President Roosevelt decided to stop his gold price fixes and to set its price at a flat $35 an ounce. By then, the dollar had been devalued by some 40 percent through the governments gold purchasing programs and the presidents price setting. This brought the silverites back from their grave. In 1932, the Senate Banking and Currency Committee sought in 1932 to have the government purchase silver bullion in order to overcome the oversupply of silver in the markets of the world due to the debasement and melting up of silver coins by governments and the disposing of the metal in the open market.8 The committee wanted the government to purchase silver with silver certificates that would increase the money supply and inflate the economy. Silver agitation resumed and resurrected the populist movement, at least for a time. The radio priest, Father Charles E. Coughlin in Detroit, was making weekly radio broadcasts calling for the monetization of silver in order to increase its value. Father Coughlin additionally wanted to nationalize the American banking system. At the same time, this unselfish man of the cloth was secretly speculating in silver. A list of silver speculators published by the Treasury Department in 1934 also included the name of Father Coughlins private secretary. Congress granted the Secretary of the Treasury authority to purchase domestic silver in 1933 and to convert it into silver dollars. The Treasury was to receive seigniorage on its salesthat is, the Treasury was to obtain a profit on the difference between the price it was paying for the silver and the value it placed on its coins. As in the past, that silver currency did not become popular, and silver was nationalized in August of 1934. The president required all silver to be turned into the mint except for that being used in the arts (jewelry and tableware) and for silver coins. The government was authorized to buy silver with silver certificates. The Silver Purchase Act of 1934 directed the Secretary of the Treasury to purchase silver and to maintain a ratio of one dollar in silver to three dollars in gold in the governments monetary stocks. The president was authorized to nationalize all silver in the country, which he did at a price of just over fifty cents an ounce. In June of 1934, the president had to ask for a supplemental appropriation to pay expenses occurring because of the Silver Purchase Act. A tax of 50 percent was imposed on speculative profits from silver, but the price for silver set by the government touched off worldwide speculation in that precious metal, as its price increased. The Silver Purchase Act of 1934, nevertheless, required the commodity exchanges in America to suspend trading in silver.

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The first major effect of the enactment of the silver-purchase program was the closing of the silver exchange in New York City, thus forcing all transactions in silver to be made outside the borders of the United States.9 As the Senate Agriculture Committee noted, the Silver Purchase Act of 1934 drove the silver market offshore and destroyed the leading silver market in the world in New York. The committee further complained that the Treasury Department had bought 60 million ounces of silver in London over a period of a few weeks, which increased prices and benefited foreign speculators. The silver purchase program of the federal government was even said to have destabilized the government in China. The Silver Purchase Act was an effort to appease the populist advocates of silver. It could not be justified on economic grounds. That legislation was said to have cost American taxpayers $1.5 billion that was given to silver owners and producers, which was more than what the government made available to support farm prices. The United States Treasury stopped minting silver dollars in 1935. Nevertheless, the silverites continued their pressure. In 1935, the Senate Committee on Agriculture expressed concern that the Federal Reserve banks had not adequately used their authority to purchase silver under the Silver Purchase Act of 1934. The committee stated that the New York Federal Reserve Bank and other Federal Reserve banks are enemies of and opposed to the wider use of silver in our monetary system.10 Nevertheless, by 1938, the Treasury had accumulated about 40,000 tons of silver valued at about $1.5 billion. This large stock caused a storage problem, which was overcome by burying the silver at West Point until 1963, when the Silver Purchase Act of 1934 was repealed. By then, the government owned over 3.2 billion ounces of silver. Fort Knox The government was facing additional storage problems with the gold it was accumulating. The Gold Act of 1934 resulted in the collection by the national banks of all the gold and gold coins held by private individuals. The Treasury and War Departments then began searching for a place to store that treasure. A location near the center of the country was desired so that the gold would be protected in the event of an invasion. The government wanted the gold vault located on a military base as further security. Fort Knox, Kentucky, met both those specifications. The United States Gold Depository was built there in 1936 at a cost of $560,000. The first gold arrived in 1937 in 40 trains totaling 200 railroad cars. The train used for the first shipment was bristling with gunners and preceded by a dummy train.11 Government Intervention The federal government kept searching for some lever to pull or a button to push that would bring the economy out of the depression. Direct intervention

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by the federal government was slow in coming, but would eventually be massive. The Emergency Relief and Construction Act signed by President Hoover in 1932 provided for relief to the needy. The funds were allocated as loans at 3 percent interest, but repayment was eventually waived. The RFC had been another effort at government intervention. Although designed to provide government control over the economy such as was exercised during World War I, the RFC was actually only a timid affair under the Hoover administration. The Democratic national platform on which Franklin Roosevelt campaigned called for a drastic reduction of government expense. It demanded balanced federal budgets, the reduction of the army, that a sound currency be preserved at all hazards, and that the government be removed from all fields of private enterprise.12 After his inauguration, however, Roosevelt began a massive intrusion into the American economy and financial system. Yet, despite unprecedented spending, Roosevelt had an equal lack of success in stopping the depression that was impoverishing the nation. The New Deal was fueled by continuing efforts to destroy the Money Power and High Finance.13 Wall Street reacted bitterly to that attack and to the Roosevelt administrations intervention and efforts to take over the economy. The financiers were especially incensed by the decision to take the United States off the gold standard. The Liberty League was formed by leaders of the business community in 1934 to oppose the New Deal. Gerald McGuire, a Wall Street bond salesman and former commander of the American Legion, tried to formulate a military takeover of the government on behalf of Wall Street. McGuire claimed to have $3 million available to finance his coup dtat at the White House. This money had been raised by Grayson Mallet-Prevost Murphy, a New York stockbroker who supposedly had connections with J.P. Morgan & Co. McGuire planned to raise an army of 500,000 veterans to capture Washington. Major General Smedley Butler, a two-time Medal of Honor winner and retired Marine, was approached to lead this coup. The plotters proposed Hanford MacNider, another former American Legion commander, to be the new president. Suggestions were made that Douglas MacArthur would be available as an alternative. It was unclear whether this threat was serious. Smedley Butler turned against the plotters, and the newly formed House Un-American Activities Committee conducted an investigation that never really proved anything. MacArthur denied any involvement. The government continued to seek a solution to the crisis. The Federal Emergency Relief Act provided funds to the states for emergency relief. The Federal Emergency Relief Administration pumped some $3 billion into state and local governments in the form of aid. The role of the RFC was expanded. It was allowed to make loans to state and municipal governments, to foreign securities holders, and to farmers through the Secretary of Agriculture. In 1934, the RFC applied $10 million in capital to a newly authorized ExportImport Bank that was to promote trade with the Soviet Union. Previously in 1933, the RFC had financed a $4 million loan with the Amtorg Trading Cor-

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poration, an entity owned by the Soviet government. This loan allowed the Soviets to buy more then 60,000 bales of cotton from American companies, including Anderson, Clayton & Co. in Houston. President Roosevelt then created the Export-Import Bank to promote trade with Russia. The bank was handicapped by the fact that the Johnson Act prohibited the government from loaning money to foreign countries that were in default on their debts to the United States for loans made during and after World War I. The Soviet Union was such a debtor, having repudiated some $200 million in debt for loans made in 1917. President Roosevelt agreed with the Soviets to settle their debt by a partial payment and some forgiveness. The Export-Import Bank was to finance Russian purchases in the United States in a way that would allow payment of the Soviet debt. This agreement never reached fruition, and no credit was given to the Soviets by the Export-Import Bank. Other foreign countries sought loans, and a second Export-Import Bank was set up to conduct business with all countries except the Soviet Union, including China and Cuba. The ExportImport Bank made a $16 million loan to the Franco government in Spain in 1939 in order to assist its purchases of American cotton. Additional cotton loans were made to Italy, Poland, and Czechoslovakia. An international economic conference was held in London in June of 1933 to consider the issue of stabilization of exchange rates. The World Economic Conference was, inexplicably, torpedoed by Roosevelts bombshell message on July 3, 1933, that the United States would not be a party to any exchange rate stabilization efforts and would not return to a gold standard.14 England, the United States, and France did later agree to work together to maintain stable exchange rates among their currencies. England had established an equalization fund for such purposes. Holland, Switzerland, and Belgium joined this stabilizing arrangement. This agreement did not prevent the French franc from being devalued in 1938. The Bonus Army The War Risk Insurance Act of October 6, 1917, had created an insurance system for the World War I veterans. Congress gradually added benefits including the so-called Bonus Law, which was twice vetoed before being passed in 1924. The Bonus Law gave veterans a bonus of one dollar a day for home service and $1.25 a day for service overseas. Payment of the service credit was deferred for twenty years but interest of 4 percent was to be paid. About 3.5 million veterans received Adjusted Compensation Certificates to reflect their service bonuses. These certificates would usually pay $1,000 upon the death of the holder or the full amount in 1945, if the holder survived that long. The veterans wanted their money early because of the depression. The amount they wanted totaled some $2.2 billion, which was about half the federal budget.

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A Bonus Expeditionary Force marched on Washington in 1932 to demand an early payout. Thousands of veterans appeared in support of this proposal. After protests became disorderly, President Hoover sent troops led by General Douglas MacArthur to disperse the bonus marchers. MacArthur took to this task with zeal and drove the marchers from their camp in the Anacostia flats near the Capitol inflicting over 100 casualities, including two babies that died from gas delivered by the troops. Participating in this military operation against the veterans and their families were future generals Dwight D. Eisenhower and George S. Patton Jr. Agitation continued, and Congress passed a bonus bill for World War I veterans in 1935. It was to be funded by greenbacks that would be specially printed for that purpose. President Roosevelt vetoed that legislation. Congress responded the following year with another bonus bill in which payments were to be made in bonds that would pay interest. President Roosevelt again vetoed the legislation but was overridden by Congress. NIRA The New Deal was less sparing in other areas. The Roosevelt administration established numerous agencies to pull the country out of the depression. The National Industrial Recovery Act (NIRA) sought to provide a method for the government and industry to work together to achieve economic recovery. The National Recovery Administration (NRA) was authorized by NIRA to create codes to govern the conduct of business. In exchange for good behavior, businesses subscribing to the NIRA codes would be given antitrust immunity for a period of two years. The Codes of Fair Practice established production limits, maximum hours, minimum prices, and minimum wages. Unions were given the right to bargain collectively with employers. The NRA worked with industry under NIRA to draw up rules for fair competition. When approved by the president, a code became binding on all participants in the affected industry. Employers supporting the codes displayed a Blue Eagle emblem in their businesses. One NIRA code sought to regulate sales practices by the brokerage houses in 1933. This code established rules for underwriting and retail sales, regulation of salesmen, and registration of investment bankers. Although subscribing to this code was voluntary, almost 3,000 brokerage firms and investment houses agreed to comply with its terms. Eventually, over 95 percent of all industrial workers were covered by NIRA Codes. Over 500 such codes and almost 200 supplementary codes were adopted by American businesses. Even so, NIRA was not particularly successful. That act was also declared unconstitutional by the Supreme Court in the so-called sick chicken case, which challenged the NIRA code in the poultry industry.15 Following the action of the Supreme Court, efforts by industrial leaders were conducted to continue the NIRA codes voluntarily, but it was a losing battle. President Roosevelts court-packing scheme was a result of the setbacks in the Supreme Court over the economic and financial legislation that he had

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been sending to Congress. That effort was not successful, but he obtained control of the Court through subsequent appointments. Thereafter, the Supreme Court became reluctant to strike down other New Deal legislation. The Public Works Administration, the Civil Works Administration, the Works Progress Administration, and the Emergency Work Relief Program were designed to create jobs for the unemployed. The Civil Works Administration was organized in 1933 to provide four million jobs. The Emergency Relief and Construction Act, which was passed in July of 1932, provided $300 million for distribution to state and local authorities. More Relief Agencies The Federal Emergency Relief Administration was later given $500 million to provide emergency aid to state and municipal governments. It was the forerunner to the Works Progress Administration (WPA) and was headed by Harry Hopkins. He was soon providing relief to some 10 percent of the population of the United States. The WPA provided jobs to over 8 million individuals during its tenure16 and spent more than $13 billion. The Public Works Administration was given $3.3 billion to spend on its programs. The Roosevelt administration created a National Youth Administration in 1935 to provide relief to young people. The Civilian Conservation Corps was another effort to provide relief and to create jobs for the economy. The government sought to put America back to work by, among other things, establishing vast electrical power generation projects at Mussel Shoals and the Columbia River. The Tennessee Valley Authority was created in May of 1933. It provided employment by building dams to generate electricity and to control flooding. The RFC provided assistance by purchasing stock of the Electric Home and Farm Authority from the Tennessee Valley Authority in 1935. The RFC was given expanded lending powers in 1934. It provided working capital to businesses through loans with terms of up to five years. Jesse Jones, the head of the RFC, did not believe that businesses should be given any more capital than necessary through the RFC. He imposed tough standards, and it was claimed that anyone who could obtain a loan through the RFC could obtain one privately. Nevertheless, some aid was given. In 1938, the RFC purchased $18.8 million of equipment trust certificates from the Southern Railway in order to allow that railroad to buy new railroad cars and equipment. Those certificates permitted railroad equipment to be purchased on an installment plan. Title to the equipment was given to a trustee for the benefit of that holder of the security. In total, the RFC loaned more than $1 billion to some ninety railroads. The RFC would expend more billions to support the banks and other American businesses. Much of that relief was in the form of loans, and most of those loans were repaid. Among the businesses rescued by the RFC was the National Department Store, Inc. The RFC created a subsidiary, the RFC Mortgage Company, to provide

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relief to the mortgage market. Its mission was to reorganize financing for buildings and other commercial properties that were in receivership. Help was needed for this sector of the economy. Eighty percent of outstanding mortgage real estate bonds were in default by 1935. Over $2 billion in guaranteed mortgages and mortgage certificates on New York City real estate defaulted. Another $2.5 billion of real estate bonds were in default in Chicago. The RFC provided assistance to guaranty and casualty companies in the 1930s. The RFC Mortgage Company funded the Federal National Mortgage Association (Fannie Mae), which was created in 1938 for the purpose of establishing a mortgage market. This market was to allow the sale by financial institutions of mortgages guaranteed by the Federal Housing Administration. These and other federal agencies created during the 1930s encouraged the amortization of mortgages in which part of the principal would be paid along with the periodic interest payments. Maturities were also extended to allow for smaller monthly payments. Social Security The Emergency Relief Appropriations Act in 1938 provided $3.75 billion for public works. This was to be used, in the words of Franklin Roosevelt, for pump-priming in order to get industry moving again. A number of proposals for government spending were not adopted. The American Medical Association was able to thwart efforts to create federal medical insurance. The association carried the day by its warnings of the dangers of socialized medicine. Other socialist schemes were afoot. Upton Sinclair was running for governor of California on an End Poverty in California Plan in 1934. Silvio Gesell advocated a plan under which the government would use stamped currency that would induce holders to spend their money more quickly. Dr. Francis Townsend came up with a system to relieve the hardship of the elderly. His Old Age Revolving Pensions program would pay $200 monthly to all of the elderly, provided that they were not working and that they agreed to spend the money when they received it. He proposed to fund these payouts through a 2 percent transactions tax. Senator Huey Long of Louisiana engaged in demagoguery with his own Share the Wealth program. Long wanted to guarantee each family a minimum annual income of $2,500. Each family in America would be given an additional $5,000 to buy themselves a home, an automobile, and a radio. The money to fund this plan was to come from confiscating the estates of the rich, such as the Rockefellers. These schemes were abandoned in favor of the Social Security Act that was drafted by Marion Folsom, the treasurer of Eastman Kodak Company. That legislation created a federal pension system funded by taxes on employers and employees. Retired workers were to receive payments beginning at age sixty-five. The Social Security Act provided additional assistance to the blind and to dependent children. The first Social Security check was mailed

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to Ida May Fuller in 1940. She would not die until 1975 when she was 100 years old. The Social Security Act excluded many workers, such as farm laborers, the self-employed, teachers, and household servants. The coverage of Social Security programs would later be expanded. By the end of the century, the American government would be expending more than $400 billion per year for Social Security and related programs such as Medicare. Very few of the elderly were actually provided any benefits from pension plans, even those of state governments, in the 1930s. Less than 15 percent of employees were covered by a retirement plan. Interestingly, the number of private pension plans began to increase rapidly after 1937. Some employers were more generous than others. During the depression, General Electric provided employees insurance, mortgage assistance, pensions, bonuses, profit sharing, and other benefits. Unemployment insurance was created in 1935. Employees who were laid off from their work were given payment for a limited time. The Fair Labor Standards Act was passed in 1938. It established a minimum wage requirement. The minimum wage was then twenty cents per hour (later raised to forty cents) and working hours were limited to a maximum of forty-four (later forty). This minimum wage law was said to be the result of efforts by northern textile industries to be better able to compete with the South by forcing the southern textile mills to pay higher wages. Debate rages even today over whether the minimum wage has been beneficial to labor or whether it simply fuels unemployment by making American workers less competitive. Another product of the depression was the American vacation. Workers were not traditionally given vacations, but the depression encouraged this practice as a way of reducing excess capacity. Taxes The New Deal sought to fund its massive aid programs, in part, by increasing taxes. The Revenue Act of 1932 had initially contained a national sales tax, but that was stricken from the bill. Taxes were raised, and 500,000 new taxpayers were added to the rolls. In 1935, inheritance and gift taxes were adopted. Corporate and personal income taxes were increased. A surtax was imposed on individual incomes in 1935. An 18 percent tax was assessed during the depression on corporations that had incomes of more than $25,000. Another tax was adopted for undistributed corporate profits, but it was eliminated in 1939. These taxes did little to increase government revenues, and they certainly did not improve the economic situation. The Treasury Department was using tax anticipation bills between 1935 and 1938 and also in 1941. These bills matured close to the payment date for quarterly tax payments. They were used to ease the effect of withdrawals on the banks as depositors withdrew funds to meet their tax payments.

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2 The Federal Securities Laws

Joseph Kennedy Joseph Kennedy was appointed by President Roosevelt to be the first chairman of the Securities and Exchange Commission (SEC). Kennedys reputation as a ruthless speculator and bootlegger made him an unlikely choice for such a position. Kennedy was threatening, however, to call loans that he had made to the Roosevelt election campaign unless he was given a high-level appointment. Before taking his seat at the SEC, Kennedy participated in a pool that was manipulating the stock of Libbey-Owens-Ford Glass Co. The pool initially sold that companys stock short and drove its price down. The pool then bought shares at depreciated prices and began pushing the stock price up. The pool made profits of almost $400,000 from this operation. Kennedy was paid $60,000 for his participation. Other members of the pool were Edward P. Chrysler and Kuhn, Loeb & Co. In another shady operation, Kennedy was trading on insider information with Bernard Baruch in the stock of the Brooklyn Manhattan Transit Corporation. Kennedys reputation as a market operator led critics to claim that his appointment was like setting a wolf to guard a flock of sheep. It was justified by others on the equally cynical ground that one needed to set a thief to catch a thief. Despite his background, Kennedy proved a remarkably effective chairman. He worked hard at the job and gave the SEC much credibility on Wall Street. SEC Regulations Kennedy was faced with distrust from the investment banking community when he became SEC chairman. He sought to assure them that Wall Street could continue to operate under the new federal securities laws. Some underwriters tried to avoid application of the federal securities laws through various dubious schemes. Kuhn, Loeb & Co. conducted a $2 million bond offering without using the mails or interstate commerce, which were the predicates for
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application of the SECs jurisdiction. The bonds were sold verbally, and all of the correspondence and communications as well as delivery of the bonds were effected by private messengers. The offering was later registered with the SEC, however, when the SEC challenged the right to list securities on the NYSE without such registration. One investment banker, Salomon Brothers & Hutzler, conducted an offering for Swift & Co. as its agent, rather than as underwriter, in order to avoid liability under the federal securities laws. Kennedy was eventually able to convince the investment banking community that offerings could be made under the federal securities laws without undue concern for liability. Foreign of- Joseph P. Kennedy. When Kennedy became the first chairman of the SEC, his appointferings were even appearing again. ment was likened to setting a thief to catch a The German government registered an thief. (Portrait by Samuel Johnson Woolf, offering of scrip certificates in 1934 courtesy of the National Portrait Gallery, under the federal securities laws. Nev- Smithsonian Institution. Gift of Muriel Woolf ertheless, one striking change that Hobson and Dorothy Woolf Ahern.) followed the creation of the SEC was the increase in private placements.17 The securities in these offerings were sold to wealthy individuals and institutions and did not have to be registered with the SEC. Private placements avoided the additional expense, delays, and liabilities associated with public offerings of securities under the federal securities laws. Section 10 of the Securities Exchange Act prohibited the circulation of rumors or reports in order to manipulate securities prices, as well as tipsters and the employment of publicity agents and radio voices to tout stocks.18 This provision would provide the basis for the SEC to attack fraud in the market and would generate thousands of shareholder lawsuits in future years. Another provision, Section 16 of the Securities Exchange Act, sought to curb insider trading. It required disclosure of transactions by insiders in their companys own stock. In addition, Congress sought to restrict the opportunity of officers and large shareholders to obtain short-term profits from inside information by requiring them to forfeit such profits if made within a sixmonth period between the purchase and sale of the stock. This provision applied to officers, directors, and 10 percent shareholders. The reporting requirements in Section 16 sparked some interesting disclosures in 1934. John Rockefeller Jr. was shown to be the owner of over $250 million in securities of Socony-Vacuum, Standard Oil of New Jersey, and Standard Oil of California.

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Section 16 of the Securities Exchange Act additionally prohibited short sales by officers, directors, and large shareholders. This provision was called the anti-Wiggin amendment in honor of the vast profits Albert Wiggin, the chairman of Chase National Bank, had made from selling his own banks stock short. The statute came too late to stop Wiggin, but he did not get off scot-free. Wiggin was forced to resign from his position at Chase after Senate hearings revealed that he had made millions selling the banks stock short. Wiggin was later sued in a class action brought by shareholders of the Chase National Bank. In 1937, a settlement was reached in which Wiggin agreed to pay $1 million each to Chase and to Amerex Holding Corporation, which was formerly Chase Securities Corporation. Wiggin had to give up his lifetime $100,000-a-year pension upon his retirement from Chase. The Securities Exchange Act of 1934 imposed federal controls over margin trading. This provision followed a Congressional decision that margin trading had a disproportionate effect during the stock market crash of 1929, causing wide fluctuations in securities prices. As in the past when call loans were called, selling pressure was increased on the market, causing a further downward effect on securities prices. Each drop in prices resulted in more margin calls, which required further selling to meet those calls. Many small investors simply did not have capital to meet margin calls other than through the sale of their securities. Congress wanted to protect margin investors from buying securities on too thin a margin. The Federal Reserve Board was given the power to reduce the aggregate amount of the countrys credit resources that would otherwise be directed into speculation and away from commerce and industry. The Banking Act of 1933 authorized the Fed to restrict national banks from engaging in speculative operations. This included prohibiting Federal Reserve banks from making loans as agents for nonbanking corporations, which had been the basis for bringing call market funds into the market for speculation. The Securities Exchange Act of 1934 granted the Fed further authority to regulate margin credit. Under this legislation, the Fed was to set minimum margin requirements, and the SEC was to enforce those requirements. Regulation T was adopted under this authority by the Fed. Initially, 25 percent margin was required for loans by broker-dealers to customers, but that amount would be increased over the years. Broker-dealers were required to register with the SEC under the Securities Exchange Act of 1934. At first, this requirement applied only to brokers on the exchanges, but it was extended in 1936 to include brokers operating in the over-the-counter market. The SEC was given the authority to prohibit brokers from rehypothecating customer margin securities in amounts greater than were owed to the broker for the securities. Broker-dealers were required to maintain minimum capital and a ratio of aggregate indebtedness to capital of no more than 2,000 percent, or less, if required by the SEC. This was apparently the amount imposed by the NYSE for brokerage firms that carried margin accounts.

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A total of twenty-four securities exchanges registered with the SEC in 1934. The exchanges trading in 1934 included the New Orleans Stock Exchange, the Richmond Stock Exchange, the San Francisco Curb Exchange, the San Francisco Mining Exchange, and the St. Louis Stock Exchange. Nineteen exchanges received temporary exemptions from registration. Ten stock exchanges closed after the SEC was created. They included the Boston Curb Market, the Buffalo Stock Exchange, the Chicago Curb Exchange, the Denver Stock Market, the Hartford Stock Market, the Milwaukee Grain and Stock Exchange, the New York Mining Exchange, the New York Real Estate Securities Exchange, the Seattle Stock Exchange, and the Wheeling Stock Exchange. The New York Produce Exchange decided not to continue securities trading. Holding Companies Joseph Kennedy did not remain at the SEC for long. He was succeeded by two able chairmen that he had helped to have appointed. They were James Landis, a former professor at the Harvard Law School who would later become dean and be convicted of tax evasion by the Kennedy administration in the 1960s, and William O. Douglas, a future Supreme Court justice. More securities legislation followed Kennedys departure from the SEC. Abuses in holding company structures had long been a problem and culminated in the Insull and other disasters. The Hughes Committee had pointed out the dangers of holding companies over twenty years earlier, after the Panic of 1907. Holding companies were then being organized so that bonds and preferred stock formed the basis for most of systems capital. The common stock that provided actual control of the corporation was owned by another corporation. Such ownership allowed the creation of a pyramid structure that permitted a small group of individuals with a minimum of capital to maintain control over numerous companies by limiting the voting rights of certain classes of stock. The Hughes Committee had noted that the holding companies had spread widely in a manner not anticipated by the legislature. But its concern did little to stop the increased use of the holding company structure. By 1925, holding companies controlled about 65 percent of electric utilities in the United States. In 1932, some 75 percent of the private electric utilities were concentrated in thirteen holding companies, including the Insull empire, the United Corporation, and the Electric Bond and Share Co. Natural gas pipelines were another heavily concentrated industry that was in the hands of a dozen holding companies. The Public Utility Holding Company Act of 1935 followed a report totaling over 100 volumes by the Federal Trade Commission on the concentrated structure of the holding companies and the problems they engendered. This legislation required holding companies to register with the SEC. The act sought to simplify the holding company structures of the utilities. The Public Utility Holding Company Act of 1935 was intended to be a death sentence for large holding company empires such as that main-

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tained by Insull.19 Under this legislation, the controlling holding company could not be more than three times removed from any of its subsidiaries. The implementation of these requirements was delayed considerably by the legal talents of John Foster Dulles. He led an organized effort by the holding companies to resist regulation. Some 200 injunctions were issued by courts around the country to block the SEC from enforcing that legislation. The issue was not decided finally until 1946, when the Supreme Court upheld its provisions. The Whitney Scandal Speculators were still around. The American Commercial Alcohol Corporation issued additional shares in 1933: Sell em Ben Smith and insiders began pumping up the stock on the large board with matched orders and the stock price moved from $20 in May of 1933 to $90 in July. After the pool operators sold their shares, the stock plunged back to under $30.20 Michael Meehan, a specialist on the NYSE and the leader of the famous RCA pool, may have lost as much as $40 million when the stock market crashed. He was one of the first targets of the SECs new enforcement powers. Meehan was investigated by the SEC for manipulating the stock of Bellanca Aircraft. The SEC found that Meehan had set up a network of traders to engage in matched buy and sell orders in order to push up the companys stock price. Meehan checked himself into a sanitarium for the mentally disturbed after he came under attack by the SEC. He was expelled from the NYSE. SEC actions were also brought against other prominent individuals on Wall Street including Charles Wright of White, Weld & Co., and Thomas Gagen. One of the biggest scandals in finance during the depression involved Richard Whitney, a leading figure on Wall Street. Whitney had worked in the Food Administration in 1917, but returned to Wall Street where he rose to leadership on the NYSE. It was Whitney who was sent by the Morgan bankers to rally the market during the stock market crash of 1929. Whitney was elected president of the NYSE in 1930 and was the chief defender of the securities industry during the congressional investigations that followed the election of President Roosevelt. Whitney was a proponent of resisting government regulation. He was so zealous in his views and so protective of the NYSE that he was moved to proclaim in the course of the Senate hearings that the Exchange is a perfect institution. Whitney stepped down as president of the NYSE in 1935 in order to pursue private business interests, but he remained a trusted member of the financial community. Among other things, Whitney was the treasurer of the New York Yacht Club and a trustee of the Gratuity Fund at the NYSE, which provided death benefits for widows and children of deceased members. Whitneys personal business did not prosper. After losing millions in a Florida fertilizer venture, he turned to an applejack enterprise called Jersey Lightning. Whitney thought that the lifting of Prohibition would return a large profit quickly because applejack did not have to

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wait for aging, as bourbon and Scotch did. That prediction turned out to be less than accurate. There seemed to be no shortage of bourbon or Scotch before or after Prohibition was lifted. Whitney had borrowed large sums from his brother, a partner in J.P. Morgan & Co., to finance his operations. He then began borrowing from others on Wall Street. It was not enough, and Whitney began stealing money from his own firm and customers. Whitney stole $150,000 from the New York Yacht Club, and he took several hundred thousand dollars from the NYSE Gratuity Fund. Whitney was able to cover a theft at the Gratuity Fund by borrowing from his brother George, who in turn had borrowed the money from Thomas Lamont in the Morgan firm.21 Whitney continued to borrow from his friends, but he was running out of friends. When he approached Sell em Ben Smith, the speculator, for a loan, Smith asked Whitney what the security for the loan would be. Whitney replied that his face was the security. Smith replied that this was putting a pretty high value on your face. A regulatory questionnaire sent to Whitneys firm in 1937 by the NYSE raised concerns and resulted in an audit. The audit discovered his theft from customer accounts, and District Attorney Thomas E. Dewey had Whitney indicted. Besides the money he had stolen from the New York Yacht Club and the NYSE Gratuity Fund, Whitney had stolen a further $100,000 in securities from his father-in-laws trust fund. Whitney had been able to borrow another $6 million from his fellow exchange members before his fraud and mismanagement were discovered. Whitney was expelled from the NYSE and was sent to the prison at Sing Sing, where he was elected captain of the baseball team. NYSE Reforms Although the Whitney firm was the last NYSE member firm to fail until the 1960s, the NYSE would suffer some serious side effects from that scandal. It would be forced to restructure its operations and become more sensitive to regulatory concerns. The stage for reform had already been set. In the wake of the criticism and investigations that led to the enactment of the federal securities laws, the NYSE adopted several trading rules. One rule prohibited short sales at prices below the last sale price of a security, and options trading was prohibited on the floor. Another rule required members to review and submit their advertising material to the NYSE for approval. These rules were an improvement, but were not enough to satisfy the SEC. The agency issued a report recommending changes in the NYSE governing structure in 1935. The report sought broader representation on the governing committees of the exchange. Revisions in nominating procedures for board members were suggested to allow greater democracy. The SEC wanted even greater reforms in the NYSEs governing structure after the Whitney affair. William O. Douglas, who became chairman of the SEC in 1937, continued to push for a more adversarial role for the NYSE in policing member conduct. Douglas was a

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vigorous and active chairman, and he clashed frequently with Wall Street. Douglas evidenced that he was fully prepared to take over the NYSE, if it did not become more responsive to the SECs regulatory concerns. An exchange lawyer challenged Douglas with, Now that you are going to take over the Exchange, perhaps youll need some technical advice. Its not self operating. It needs manpower and brains. Perhaps I can help you. Indeed, Douglas responded, tell me, where do you keep the paper and pencils?22 Pressure from the SEC caused the NYSE to appoint a committee in 1938 to review its organizational structure and to strengthen its self-regulatory role. The committee was headed by Carl C. Conway, chairman of Continental Can, and included Adolph A. Berle Jr., a leading critic of corporations and their governing structures, and William McChesney Martin Jr., then a partner at A.G. Edwards and Sons, a St. Louis brokerage firm. The Conway Committee recommended that the NYSE hire a full-time, salaried president and professional staff to replace the members who had, theretofore, been responsible for administration. The committee recommended reducing the size of the board and increasing representation of out-of-town members and the public. The Conway Committee reforms were implemented in 1938. William McChesney Martin Jr. was appointed as the NYSEs first full-time president. He was then thirty-one years old. In September of 1938, the NYSE elected three public representatives to its board of governors. The NYSE increased its regulatory role. Member firms were required annually to answer long questionnaires concerning their financial condition. They also had to file quarterly reports. Independent audits were required annually, and supervisory audits were increased. In 1938, the NYSE required members to make available a statement of their financial condition to customers upon request. In August of 1939, an examining committee of the NYSE reported on issues involving customer protection. The NYSE adopted rules that prohibited partners of member firms from trading on margin if their business with the public involved margin. Capital requirements for member firms doing business with the public were increased by about 25 percent. The NYSE was not the only exchange having difficulties in the new regulatory era that followed the creation of the SEC. The New York Curb Market was the subject of an investigation by the Attorney General in New York. Afterward, several hundred securities issues were delisted from the exchange. In 1938, the Chicago Stock Exchange announced a major reform of its operations. This included the hiring of professional managers and a full-time salaried president, rather than a part-time one elected by the members and who was himself a member. SEC Efforts The SEC was directed by the Securities Exchange Act of 1934 to prepare a report on the feasibility and advisability of segregating the functions of bro-

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kers and dealers. The SEC conducted an extensive examination of the issue. It submitted a report to Congress that focused on the role of traders on the exchanges, rather than broker-dealers in the over-the-counter market. The SEC report noted that floor traders and specialists were given special time and place advantages that were not available to other traders. This was particularly true when the tape was running late during heavy volume. The SEC did not advocate the complete separation of principal and agency functions on the part of specialists. Instead, the SECs report criticized the role of floor traders who were trading for their own account on exchange floors without any obligation to maintain a fair and orderly market. The SEC would spend the next several decades ridding the exchanges of those traders. Following the Whitney scandal, William O. Douglas advocated the creation of a brokers trust company that would handle securities settlements and would settle margin and cash payments. Douglas thought that this might avoid fraud such as that perpetrated by Whitney. Such a trust company was to be a central depository for securities. The NYSE was able to resist this proposal, assisted by a report submitted by the accounting firm of Haskins & Sells, which stated that a central depository for securities transactions was not practical despite the fact that NYSE volume in 1939 was the lowest since 1923, dropping over 10 percent from the prior year. The Douglas proposal would not be adopted until the 1960s, after the industry suffered a crisis that threatened the very existence of the NYSE and resulted in the bankruptcy of many of its members. The federal securities laws were structured according to a concept of selfregulation. That concept had been embodied in the Code of Fair Competition adopted under the National Industrial Recovery Act by the investment bankers. The NIRA was declared unconstitutional in 1935, but the committee that administered the NIRA code continued to act for the industry as the Investment Bankers Conference. This group was formed in 1936 to create a selfregulatory mechanism for the securities industry. The exchanges were another self-regulatory mechanism. Although SEC chairman William O. Douglas believed in self-regulation by the exchanges to supplement the SECs powers, he thought that self-regulation meant that government would keep the shotgun, so to speak, behind the door, loaded, well-oiled, cleaned, ready for use but with the hope that it will never have to be used.23 After the Whitney scandal, Douglas was quite willing to use the shotgun to mandate reform. A Washington conference of national securities exchanges resulted in a report and recommendations with respect to possible amendments of the federal securities laws. The NYSE suggested proposals that would ease the regulatory burden on the exchanges. That suggestion was met by opposition from Douglas, who called the whole effort a phoney.24 Wall Street responded to the SECs threatening posture with a capital strike: The underwriters actually went on strike to protest SEC policies.25 Jerome Frank became chairman of the SEC after Douglas left to become a justice on the Supreme Court

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in May of 1939. Frank, who would himself become a federal circuit court judge, sought to prohibit brokers from using customer free credit balances without customer permission, and he wanted to curb the use of brokers loans. Another proposal sought the creation of a brokerage bank. The NYSE rejected that request. The NASD Amendments were made to the Securities Exchange Act of 1934 that extended its application to the over-the-counter market in 1936. This legislation required issuers of publicly traded over-the-counter securities to file audited financial statements with the SEC in the same manner as required for exchange-listed companies. The SEC was expanding its regulation over the brokerage firms. The agency established a shingle theory in the courts, which held that brokerage firms were professionals who, by hanging out their shingles, were implicitly warranting to the public that they would deal professionally and fairly with customers. The New York Security Dealers Association was formed in 1932 by a group of over-the-counter market dealers to represent their interests in the growing over-the-counter market. The associations purpose was to promote high business ethics among its members and to uphold fair and equitable principles of trade. The industry did not always succeed in that goal. The SEC investigated the over-the-counter trading activities of several firms in Cleveland, Detroit, and the Pacific Northwest in 1937. Thirteen individuals were subsequently convicted of criminal violations, and numerous civil actions were brought against corporations and other individuals. The widespread nature of these violations convinced the SEC that additional regulation was needed in the over-the-counter market. In response to that concern, Congress enacted the Maloney Act of 1938 (named after Connecticut senator Francis Maloney, who sponsored the legislation drafted by the SEC). That legislation adopted the concept of a self-regulatory organization for the over-the-counter market that would be the counterpart to the exchanges for listed securities. The SEC was given oversight authority over that associationthe National Association of Security Dealers (NASD). The SEC was given additional authority to adopt rules to prohibit fraud in over-the-counter trading and to impose regulations on broker-dealers operating in that market. After its creation, the NASD began adopting rules to govern trading in the over-the-counter market. One such rule provided for price maintenance during an underwriting by syndicates and selling groups. In 1939, the NASD brought an action against a group of dealers who were selling at prices lower than permitted by this rule. The offering involved a syndicate of sixty-seven underwriters that was managed by Halsey, Stuart & Co. The offering was for an issue of $38 million in bonds of the Public Service Company of Indiana. The selling group agreement fixed the selling concession at 1 percent. If any

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member of the group was able to purchase bonds on the open market below the initial offering price, the managers were entitled to withhold selling concessions on those securities. Some of the members of the syndicate, nevertheless, had undersold the bonds. The practice of pegging the market during the distribution process had been severely criticized and has been greatly restricted by certain provisions of the National Securities Exchange Act of 1934.26 Nevertheless, stabilizing activities during underwritings continued to be the subject of abusefor example, underwriters could bid up prices to create a hot issue and sell their own positions into that artificial market. To avoid that concern, underwriters agreed not to trade for their own account during a distribution, except to stabilize prices up to the issuing price. Underwriters generally did not recommend a security being distributed to customers. The SEC added a further requirement in 1939 that underwriters state in the prospectus of a new issue that the underwriters would be supporting the market during the distribution through stabilizing transactions. Accounting The NYSE worked with the American Institute of Certified Public Accountants to improve accounting standards. The accounting industry was having its own difficulties. A most famous case for accountant liability was Ultramares Corporation v. Touche.27 That decision was rendered in 1931 by Judge Benjamin Cardozo, who held that the auditors for the Ultramares Corporation had been grossly negligent in failing to discover a fraudulent scheme that had involved listing false assets on the books and records of the company. Another accounting case involved the McKesson & Robbins pharmaceutical company, which was put into receivership in 1938. It was discovered that some $20 million of assets on the books of the company were fictitious and had been created by a fake foreign crude-drug business. The president of McKesson & Robbins was F. Donald Costear. Actually, his real name was Phillip M. Musica, and he had been convicted of several commercial frauds in the 1920s. Musica had various relatives working for him under assumed names at the drug company. A fictitious Canadian factor was created to carry out this fraud, and a group of dummy banks was set up to disguise the operation. Musica committed suicide after his fraud was revealed. Price, Waterhouse & Co., the accountants for McKesson & Robbins, failed to uncover this scheme in their annual audits. The SEC concluded that Price, Waterhouse & Co.s examinations had conformed to generally accepted accounting principles but that accepted accounting procedures at that time were inadequate. Following the McKesson & Robbins scandal, the NYSE began to require more independence on the part of public accountants. The American Institute of Accountants tightened auditing procedures. Although the SEC generally deferred to the accounting industry in establishing accounting standards, it began issuing periodic accounting releases that defined the manner in which accounting

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principles should be applied to financial statements. Increased SEC regulation gave a boost to the accounting profession as clients upgraded their financial reporting. Trust Indenture Act More legislation was arriving. The Trust Indenture Act of 1939 followed a study by the SEC on abuses in public offerings of bonds. Trust indentures are master agreements that govern the terms and conditions of debentures issued by corporations. Initially, trust indentures were used for mortgage bonds but were later extended to unsecured bonds. The bond or debenture itself was a simple document, but the trust indenture was a long, complex instrument spelling out the rights of the bondholders. The trust indenture designated a trustee to make sure that the issuers obligations were being met and that the bondholders rights were upheld. An SEC investigation and hearings by Congress determined that trustees often failed adequately to assure that issuers were meeting their obligations under the trust indenture agreement. Indenture agreements were written favorably to the issuing company and sought to limit or disclaim all liability on the part of the trustees who were administering the terms of the indenture agreements. The SEC and Congress found that indenture trustees often did not provide bondholders with basic information concerning default under the indenture agreement. Congress was particularly concerned with ostrich clauses, which allowed indentured trustees to assume that there was no default until they received notice from at least 10 percent of the security holders. The trustee was allowed to make this assumption even if it had actual knowledge of a default. In addition, Congress discovered that trustees often had financial interests that conflicted with those of the bondholders. The Trust Indenture Act of 1939 sought to lessen conflicts between trustees and bondholders and to clarify the role of the trustees. The act sought to provide full disclosure for the issues of bonds, notes, and debentures. This legislation required the rights of debenture holders to be specified in the indenture agreement. The Hughes Committee, in 1909, had found abuses when corporations were placed in receivership. Those receiverships sometimes lasted more than ten years. During that period, stockholders lost control of their corporation, and even secured debtors were precluded from foreclosing on their debt. Receivers were using receivers certificates to finance the operations of the companies while in receivership. These certificates were given precedence over first mortgage bonds in the event of liquidation. Following the failure of the mortgage bonds, protective committees were established that frequently induced investors to give up important claims and privileges. The SEC conducted an examination of the reorganization process of corporations experiencing financial difficulty. The SECs investigation of protective and reorganization committees concluded that such committees were often riddled

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with conflicts of interest and were being used as fronts for management. The SEC found that many reorganization committees were unnecessary and were being used to increase managements control over the company even when it was not in serious financial straits. The Bankruptcy Act was amended to provide more flexibility to debtors. These amendments authorized the reorganization of corporations as an alternative to their liquidation. The Chandler Act, which amended the federal Bankruptcy Act, required that reorganization plans for large corporations be reviewed by the SEC.

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3 Commodity Market Reforms

Speculation The annual reports of the Grain Futures Administration repeatedly pointed out the ill effects on American grain producers of price manipulations caused by grain gamblers. These depredations included a July 1926 squeeze in wheat, a July 1928 squeeze in corn, and congestion in the September 1928 corn contract. In response to a Senate resolution, the Secretary of Agriculture found that large-scale buying and selling operations had completely disrupted the wheat market in 1926. The resulting price changes were felt in every other large grain market in the world.28 In 1927 and 1928, legislation was introduced to limit the number of futures contracts that a speculator could hold in any one delivery month. It was thought that such a restriction would prevent corners and squeezes by large speculators. Another bill provided for the confiscation of cotton withheld from the market with the intent to manipulate prices. Those bills were not enacted. Wheat prices dropped sharply on the Chicago Board of Trade in May of 1929. That was only a warning of what was to come. Commodity prices collapsed almost completely in the wake of Black Thursday on the stock market. The result was an economic catastrophe, and farmers were devastated as the value of their crops shrank. Farm Relief Relief was provided to the farmers by the Agricultural Marketing Act of 1929, which created the Federal Farm Board. That agency was given $500 million to use as a revolving fund for loans to agricultural cooperatives. It was thought that such loans would allow the cooperatives to hold their members grain until prices were more advantageous and allow a more rational marketing system. The Agricultural Marketing Act of 1929 additionally created various corporations that were to buy grain surpluses in order to hold them off the market and increase prices. The Federal Farm Board tried to restrict specula214

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tion in commodities and to limit crop surpluses. The Farm Board created a Grain Stabilization Corporation in November of 1930 to buy surplus wheat on the open market. It began buying futures contracts on the Chicago Board of Trade in an effort to support commodity prices. Mimicking J.P. Morgans effort to rally the market during the Panic of 1907, the president of the Grain Stabilization Corporation, George Milnor, went to the floor of the Chicago Board of Trade to make wheat purchases for the government. That effort failed. Wheat prices in the United States increased above those in Europe, but the federal government soon had a large surplus of wheat. That giant pile of grain became an overhang on the market and had a depressing effect on prices. The governments buying program was frustrated by its inability to limit production. Speculators such as Arthur Cutten were another problem. They were undercutting the governments buying programs by massive short selling campaigns. Those speculators were happy to sell all that the government would buy, particularly when there was no shortage of grain. Cutten was selling more than 70 million bushels of grain short on the futures markets at the same time that the Grain Stabilization Corporation was purchasing. Prices continued their decline, and the Grain Stabilization Corporation began receiving criticism of its futures trading activities. Congressman and future Supreme Court Justice Hugo Black, in particular, was objecting to the governments trading in futures contracts as a part of its price support program. The Farm Board had other problems. It had made nonrecourse loans to farmers that were secured by the farmers crops. If farm prices were too low for a farmer to pay off his loan, the government would keep the crop in discharge of payment of the loan. This assured the farmer a minimum price for his crop. The problem with this arrangement was that the government ended up owning much of the wheat that secured those loans. This increased the already enormous stockpile of government grain. The Farm Board eventually began selling its surplus stocks on the market. Those sales drove wheat prices down to less than forty cents a bushel. Trading Concerns A crisis occurred in Chicago after it was discovered that the All Russian Textile Syndicate had conducted large short selling operations on the Chicago Board of Trade over a four-day period in 1930. Those transactions caused wheat prices to decline sharply. The Soviets orders totaled some 8 million bushels of wheat and were fearfully reported to be the result of directives out of Moscow. They caused such alarm that the Chicago Board of Trade passed a resolution stating that the selling of futures upon our exchanges by any foreign government is a new development of commerce of seriously objectionable character and it must be brought to an end.29 A congressional investigation later determined that the Soviets were seeking foreign exchange and had not sought to depress grain prices. The Soviets had been out of the market

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for some time and could not contract grain sales for forward delivery. As a result, they were left to load their grain on ships and obtain whatever price was available when the grain reached the market. The Soviets were concerned that, once it was known that they were exporting large amounts, prices would drop. In order to protect themselves, the Soviets used the Chicago markets to hedge. Still, this very capitalistic strategy placed downward pressure on the market. On March 12, 1930, the Grain Futures Administration brought a test case to determine whether trading practices such as cross trading and bucketing of customer orders could be attacked under the Grain Futures Act as a form of price manipulation. The government had found that nine of the fifteen most active clearing members on the Kansas City Board of Trade were engaging in such practices. This case was reviewed by the commission that administered the Commodity Exchange Act. It concluded that, while those activities might be detrimental to customers and might even amount to fraud, such conduct did not constitute manipulation within the meaning of the Grain Futures Act. This left the government powerless to attack the speculators who, it was claimed, were driving down prices through bear raids. Thomas Howell cornered the corn futures market in July of 1931. He held over 50 percent of the July contracts, as well as 300,000 bushels of actual corn. Prices were driven up by fourteen cents a bushel, but then dropped drastically when the squeeze was completed. Howell was sued by the government for this activity, but the case was thrown out on technical grounds. President Hoover Becomes Alarmed More startling, in July of 1931, President Hoover warned the public that speculators were engaging in bear raids in the wheat futures market for one purpose, and that is to depress prices. Hoover claimed that these speculators were threatening to destroy the return of public confidence and that their intention was to take a profit from the loss of other people, even though the effect may be directly depriving many farmers of their rightful income. The president stated that if these gentlemen have that sense of patriotism which outruns immediate profit and desire to see the country recover, they will close up these transactions and desist from their manipulations.30 This was an eloquent appeal to the patriotism of those traders, but it did not stop their speculation. Senator Arthur Capper, a vociferous critic of the Chicago Board of Trade, introduced a resolution in 1932 demanding an inquiry to determine the amount of profit made and losses sustained by short sellers in wheat and cotton futures since July of 1929. That resolution was approved by the Senate Agriculture Committee, but legislation was not forthcoming. The Grain Futures Administration continued its efforts to limit the size of positions held by speculative traders. Bills to accomplish that goal were introduced in Congress but not enacted. The situation worsened when the wheat market collapsed in 1932. [A] group of speculators sought to corner the wheat market by massively

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buying wheat calls and futures.31 This group of speculators was headed by Doc Crawford, an Iowa dentist. Options trading had accounted for a substantial portion of his trading on the Chicago Board of Trade. Commodity Prices Continue Their Plunge Cotton was another commodity suffering from the depression. Cotton was selling at seventy-two cents a pound in 1929. It dropped to six cents in 1931. A Cotton Stabilization Corporation was formed in 1930 by the Farm Board to buy cotton in order to support prices. Like the Grain Stabilization Corporation, this entity was modeled after agencies used during World War I to stabilize commodity prices and to curb speculation. The government bought some 3 million bales of cotton in an effort to support prices. The result was that the Cotton Stabilization Corporation accumulated a massive surplus of cotton. It did not have the resources to continue its large-scale purchasing program, and cotton prices resumed their plunge, eventually falling to less than five cents a pound. The Farm Board was not successful in stopping the drastic decline in commodities prices. Farm income dropped by $7 billion between 1929 and 1930. Corn and wheat prices were cut nearly in half between 1929 and 1931. Corn prices plunged from eighty-one to thirty-three cents a bushel between 1929 and 1932. Commodity prices continued to fall. The Literary Digest reported in 1932 that the cost of a bushel of corn had fallen to less than a package of chewing gum.32 Wheat was trading at thirty-nine cents a bushel in 1932, down from over a dollar in 1929. Wheat then reached a 300-year low and sometimes could not be sold at all. The federal government continued to purchase surplus crops as a means to support prices. The accumulation of crop surpluses in the United States required the grain to be stored in any available structure, including churches and old school buildings. In order to deflect criticism, the commodity exchanges limited the size of speculative positions of short traders in 1932 to five million bushels. Long traders were not similarly constrained. The futures exchanges raised their margins from 10 to 20 percent, an amount equal to that of the stock exchanges. These measures were welcomed by the government, but they did not slow the continuing collapse of prices or large-scale speculation. The commodity exchanges in New York and the Chicago Board of Trade were closed on the bank holiday declared by President Roosevelt in March of 1933. This was the first time that the Chicago Board had closed since 1848. Although commodity prices jumped quickly after the president suspended the gold standard in April of 1933, that rally was short-lived. The Chicago Board of Trade closed again for two days in July when wheat prices dropped sharply. This price break was caused by ten traders who closed their positions to take profits, forcing the liquidation of other accounts that could not meet margin requirements. Those forced liquidations resulted in a further price break.

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After the collapse of grain prices in 1933, the Secretary of Agriculture held a conference of the commodity exchanges at which they were urged to take measures to restrain speculation. The exchanges agreed that they would all adopt minimum margin requirements for customers. A Code of Fair Competition was developed by the commodity exchanges under the National Industrial Recovery Act. The code required the establishment of margin requirements of a minimum of 10 percent for futures trading up to two million bushels and 24 percent on larger transactions. The code prohibited options, or privileges, as they were then called. Limits were placed on daily price fluctuations of commodities being traded. The exchanges established business conduct committees to punish violators of exchange rules. Although the Supreme Court struck down the National Industrial Recovery Act, most commodity exchanges continued to require minimum margins from customers. Only two exchanges, the New York Wool Top Exchange and the Chicago Open Board of Trade, did not have such requirements by the opening of World War II. Low margin requirements were used on the Wool Top Exchange as a way to attract customers. Government Intervention Farm prices in America remained at historic lows during the depression. The Farm Credit Act of 1933 sought to further expand and unify the federal system for supporting agricultural credit. For this purpose, production credit corporations, intermediate credit banks, and banks for cooperatives were to provide mortgage loans, short term production loans, intermediate term rediscounts, and loans to cooperatives. The Farm Credit Administration was designated as the central agency for providing credit and financial assistance to farmers. It assumed the activities that had previously been administered by several other agencies. The production credit corporations created by the Farm Credit Act allowed farmers to borrow directly from those entities. The Federal Land Banks were authorized by this legislation to make intermediate and short-term loans to farmers and cooperatives. The joint-stock land banks that had been established by the Farm Loan Act of 1916 were eliminated because they had not proved successful. Several of the Federal Land Banks failed. A Production Credit Corporation was created to provide disaster relief and seed loans. The Emergency Farm Mortgage Act, passed in May of 1933, assisted farmers to avoid the foreclosures that were becoming widespread as the depression deepened. The Farm Mortgage Corporation was created in 1934 to purchase outstanding land bank bonds and to provide additional funds for loans to farmers. The Central Bank for Cooperatives was established to provide financing for farm cooperatives. The Commodity Credit Corporation, a subsidiary of the RFC, provided additional loans to farmers. These were nonrecourse loans that forgave the debt of the farmer if the price of the crop was not sufficient to repay the loan. The Commodity Credit Corporation was initially given $3 million in funds.

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Further assistance to farmers was provided in the form of price supports. In 1933, President Roosevelt asked Jesse Jones at the RFC to lend on cotton at ten cents a pound. It was then trading around nine cents. The loan support price for cotton was increased to twelve cents in the following year, and 4.5 million bales were purchased by the government through that program. The Bankhead Cotton Control Act and the Kerr-Smith Tobacco Control Act, both passed in 1934, restricted production of cotton and tobacco through acreage allotments. By this time, federal loans to farmers were amounting to $30 million a month, made at a rate of 300 a day. The Federal Emergency Relief administrator, Harry L. Hopkins, was given the task of supporting grain prices by buying up large quantities of wheat. That effort was not successful, and another crisis appeared. Farmers in America were struck with a drought that resulted in widespread soil erosion and imposed further hardships during the depression. The crisis on the farm reached its peak between 1934 and 1936. Even with the drought, the Commodity Credit Corporation was swamped with bumper crops in 1937. In order to supply funds to the Commodity Credit Corporation, the RFC purchased cotton valued at $150 million with notes it held even though there was no legal authority for that action. This allowed the Commodity Credit Corporation to loan additional money to farmers on corn and wheat. The enormous amount of cotton loans held by the Commodity Credit Corporation was the result of efforts to peg prices through nonrecourse loans to farmers on the basis of a minimum price for cotton. One incongruous feature of the depression was the surplus of crops that was being harvested in America while many people were going hungry. This spectacle of dire want in the midst of wasting plenty bred perplexity and anger.33 Mountains of wheat were piling up in the country, while people went hungry in the cities. Milk and other commodities were being dumped in the streets to protest low prices. Animals were slaughtered simply because prices were too low to justify their feeding. The Agricultural Adjustment Act sought to have the farmers restrict their planting in order to reduce supplies and raise prices. This legislation was financed by a tax on those who processed food, such as meat packers, flour millers, and others. The Supreme Court struck down the Agricultural Adjustment Act in 1936. It was replaced by the Soil Conservation and Domestic Allotment Act, which also sought to restore farm prices by paying farmers not to grow crops. The Roosevelt administration sought legislation to impose federal regulation over the commodity exchanges, which were receiving much blame for low commodity markets. In February of 1934, the president stated his belief that exchanges for dealing in securities and commodities are necessary and of definite value to our commercial and agricultural life. Nevertheless, it should be our national policy to restrict, as far as possible, the use of these exchanges for purely speculative operations.34 The president advised Congress that unregulated speculation in both securities and commodities had led to the

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countrys financial collapse.35 Roosevelt recommended legislation that would, so far as it may be possible, eliminate unnecessary, unwise, and destructive speculation.36 Congress Investigates The legislation sought by President Roosevelt was considered by the agricultural committees in Congress. At that time, futures trading was of primary concern to the agricultural sector. This led to a regulatory schism that still exists today. Even though most futures contracts today involve financial rather than agricultural instruments, the agricultural committees in Congress retain control over futures trading, while the banking committees maintain jurisdiction over the securities industry. The hearings and investigations conducted by the agricultural committees during the 1930s found numerous abuses in the futures markets. As was the case for the securities markets, orgies of speculation had occurred on the commodity exchanges. This trading resulted in a substantial burden on the wheat and other grain markets because commissions and gambling profits were taken out before the farmer was given any payment.37 It was charged by Congressman John Rankin from Mississippi that the manipulators on the grain exchanges toil not neither do they spin, but they invariably take all of the profit of the farmers crop and leave him with the bills to pay.38 He charged that manipulation had been occurring on the cotton exchanges so as to drive the price down when the farmer is selling and to raise it after his crop is all gone.39 Other congressmen claimed that the prices American farmers were receiving for their grain was dominated and controlled by the gambling price manipulations on the Chicago Board of Trade.40 The Chicago Board of Trade was said to be one of the worlds great gambling places.41 One congressman was incensed that [w]hile the farmer [was] harvesting his wheat or grain, prices [were] hammered down to the extreme low point, but the moment the farmer parts with his grain the speculators start to raise the price and the result is that both the consumers and the farmers are mulcted by a bunch of professional dishonest speculators, . . . [who] sell millions of bushels of wheat, corn, or rye, just for the purpose of artificially lowering the price so that they can buy the grains back at a much lower price.42 Such dastardly tactics have been followed from day to day and year to year to the detriment of the growers, legitimate dealers, and the public.43 Another congressman wanted to stop manipulative short selling; that is the use of the market by the speculator who wishes to depress it, or advance it, as his interest may dictate.44 Congress found a pattern of improper practices.45 Congressmen were appalled that wheat growers in the United States had been regularly victimized by bear raids, May squeezes, and vicious short selling on a huge scale at the hands of big manipulators who had been in virtual control of the exchanges.46 It was stated that [t]he farmers of this country

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have lost hundreds of millions of dollars through the manipulation of the market on these exchanges.47 Congress expressed concern that prices on the futures market were being manipulated by small groups of traders who were exercising artificial influence on the market.48 The large speculators that were dominating trading were able to beat the market up or down through their trading to the detriment of the farmers.49 Congressional hearings found that a small number of traders had been principally responsible for the downturn in prices and their constant battering. A small group of traders on the Chicago Board of Trade had been largely responsible for the violent price fluctuations that occurred there during their periodic raids on the market. As Congressman John Jones of Texas noted, During the last fifteen years about sixteen big traders in grain have from time-to-time taken advantage of unusual conditions to make raids upon the market and to rig the market.50 Concentrated large-scale operations were causing abnormal price movements. For example, at a time when wheat was generally trading for less than $1.25 per bushel, large-scale speculators were causing wheat prices to vary by over twenty-five cents a bushel in two days. In one instance, five traders, acting on the advice of a single individual, had aggregated a 20-million-bushel long position and exerted a disturbing influence on the market. These violent fluctuations had been caused largely by these big traders, such as Arthur Cutten, who are not interested in any way in the maintenance of the market.51 Arthur W. Cutten was said to have made profits of $1.5 million in one foray into the corn futures market, between $10 and $15 million in the wheat pits, and another $30 to $80 million in the securities markets after he began trading on Wall Street in 1925. One congressman claimed that Arthur Cutten had ruined more farmers in this country than any other single man. If you could gather together all of the bones of the people he has caused to die an economic death, they would form a triumphal arch from Chicago to New York, where he went for bigger gambling operations through which he could safely ride.52 When business was lagging in the outlying offices of Chicago commission houses, a whisper that Cutten was buying wheat would cause orders to start rolling in from all over the country.53 Cutten was described as perhaps the greatest grain speculator this country ever knew.54 He was said to be the hated J.P. Morgan of the grain exchanges. Arthur Cutten fought back by commissioning a series of articles in the Saturday Evening Post in which he claimed that he was simply a misunderstood entrepreneur and that the government was ruining the markets by trying to regulate them. The government retaliated with a suit against Cutten, charging that he had filed false reports with the Secretary of Agriculture. The reports filed by Cutten stated that he was short some 400 contracts. He was actually short several times that amount. The Supreme Court dismissed this litigation on technical grounds. Cutten was, nevertheless, later indicted for tax evasion as a result of his trading activities.

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A congressman charged that the Grain Futures Act had been almost a complete failure. He stated that it has no teeth.55 Legislation was demanded to prevent excessive and abnormal transactions which result in cornering the market, or which result from excessive large-scale transactions.56 These demands led to the approval of commodity futures legislation in 1934 by the House of Representatives, but the Senate failed to act before the adjournment of that Congress. Congress was quickly reminded of the need for legislation after cotton prices plunged in March of 1935. That price break was blamed on speculators. Speculation in commodities was furthered by the fact that traders were transferring their activities from the securities exchanges to the futures markets, as federal regulation began in the securities markets. These concerns led to the enactment of legislation in 1936 that sought to insure fair practice and honest dealing on the commodity exchanges.57 The Commodity Exchange Act The Commodity Exchange Act of 1936, like its predecessor, the Grain Futures Act, required commodity exchanges to register with the federal government as contract markets. No futures trading could be conducted in commodity futures contracts on regulated commodities unless the transactions were executed through a contract market. Only certain commodities were regulated. They included grains, butter, eggs, potatoes, rice, and cotton. Options trading was banned on these regulated commodities. The Commodity Exchange Act prohibited manipulation and cheating in connection with the trading of futures contracts. Fraudulent practices were proscribed, as were wash sales and fictitious transactions. The act provided for the adoption of position limits that allowed the government to restrict the number of futures contracts that could be held by large individual speculators. This provision did not apply to hedging transactions. The Commodity Exchange Act of 1936 carried forward the Commodity Exchange Commission that had been established under the Grain Futures Act. The commission was composed of the Secretary of Agriculture, the Secretary of Commerce, and the Attorney General of the United States. The Commodity Exchange Commission was authorized to curb excessive speculation by the large market operator, and to extend regulation to the previously uncovered field of commodity brokerage in order to suppress cheating, fraud, and fictitious transactions in futures, which are seriously impairing the services of the market.58 Day-to-day regulatory control over the futures markets was retained in the Department of Agriculture. The Grain Futures Administration was to carry out that task, but it was renamed the Commodity Exchange Administration and later the Commodity Exchange Authority (CEA). Futures commission merchants (i.e., brokerage firms executing customer orders for futures contracts) were required to register with the Department of Agriculture under the Commodity Exchange Act. Futures commission mer-

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chants were required to segregate customer margin funds and maintain them in separate trust accounts. Floor brokers on the exchanges who executed customer orders were required to register with the CEA. Floor traders who traded only for their own account on the floor of the commodity exchanges were not required to register. There was no requirement that traders on the commodity exchange floors maintain a fair and orderly market, as was required for stock specialists in the securities industry. Margin The hearings on the bills that became the Commodity Exchange Act of 1936 did not focus on margin as a prime culprit in the speculative abuses that were occurring. This schism between futures and securities regulation was due principally to two factors. First, commodity margins were not viewed as a borrowing of funds, as was margin trading in the securities market. Securities margins were thought to be a diversion of capital from industry and other areas of the economy more deserving of that credit. In contrast, commodity margins were a good-faith deposit of money for performance on the futures contract. In reality, delivery was rare, and commodity margins became simply a protective device used by the exchanges and brokerage firms to guard against defaults by customers who experienced losses in their accounts. The second reason that commodity margins escaped regulation was that the Department of Agriculture had opposed the industry view that speculation in commodity futures should be controlled by margin requirements. The grain trade had thus urged Congress to use margin requirements as a substitute for position limits. However, a department witness testified that, based on past experience, the setting of margins should be left to the commission houses. The government believed that excessive speculation could be better controlled by limiting the number of futures contracts that could be held by speculators rather than by higher margins which are not so readily applicable to commodities as to stocks.59 Congress agreed with the Department of Agriculture and concluded that the most effective method for curbing excess speculation would be to limit the volume and number of contracts that could be traded by speculators. Consequently, neither the Fed nor any other government agency was authorized to set margin requirements. That authority was left entirely to the commodity exchanges. After the adoption of the Commodity Exchange Act of 1936, however, the Department of Agriculture changed its view, and the CEA began focusing on the role of exchange-set margin requirements in fostering speculation. The CEA was concerned that exchange-set margins were too low and encouraged speculation by traders. The CEA asserted that the imposition of minimum margin requirements would insure fair competition between commission firms and would tend to protect customers who, in the absence of substantial margin requirements, might be inclined to take a larger position in the market than their means would justify.60

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An economist at the Department of Agriculture had suggested progressively higher margins on large positions. The CEA believed that increased margins could keep irresponsible traders and undesirable speculative forces out of the market. The CEAs change in position came too late. After the enactment of the Commodity Exchange Act, the futures industry changed its own views and began resisting any effort by the federal government to regulate commodity futures margins. This set off a battle over whether the federal government should have control over margins. That battle would continue for the remainder of the century. Commodity Markets Numerous boards of trade were licensed as contract markets under the Commodity Exchange Act of 1936. They included the Chicago Board of Trade, the Chicago Mercantile Exchange, the Chicago Open Board of Trade, the Kansas City Board of Trade, the Los Angeles Grain Exchange, the Milwaukee Grain and Stock Exchange, the Minneapolis Chamber of Commerce, the New Orleans Cotton Exchange, the New York Cotton Exchange, the New York Mercantile Exchange, the New York Produce Exchange, the St. Louis Merchants Exchange, the San Francisco Chamber of Commerce, and the Seattle Grain Exchange. The Rubber, Hides, Raw Silk, and Metals Exchanges had been operating in New York previously, but they were merged into the Commodity Exchange in 1933. A new contract for soybeans was added by the Chicago Board of Trade in 1936. That commodity would become a popular target for speculators in future years. Speculation in other futures markets continued despite the restrictions imposed by the Commodity Exchange Act. A wide variety of individuals engaged in commodity futures speculation. In the 1930s, the Department of Agriculture reported that traders in the futures market included over 1,000 housewives, 500 unemployed individuals, several finance and loan companies, hundreds of doctors, dentists, and lawyers, numerous government officials, including several internal revenue agents, and over 100 secretaries and stenographers. Six dead men and eleven widows were also found to be trading in commodity futures. Following the creation of the CEA, numerous market problems arose. Congestion in rye and corn occurred in May of 1936. Price volatility occurred in the December 1936 corn contract on the Chicago Board of Trade, and potato trading was raising concerns. Congestion in the September 1937 corn futures contract resulted when one long trader and two short traders engaged in a furious battle with each other. The Chicago Board of Trade suspended trading on the September 1937 corn futures contract, and a settlement price was ordered. One of the traders controlled about three-quarters of the long contracts in the September delivery month. The Chicago Board of Trade expelled the Cargill Grain Company as a member in 1939 after a fight over that companys trading in corn. Cargill retaliated by complaining to the government. That tactic backfired. The Secretary of Agriculture charged Cargill with manipu-

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lating the corn market by selling short some ten million bushels of corn. Cargill was sanctioned for that conduct. This affair was said to have inspired the Cole Porter song Always True to You in My Fashion, whose lyrics included the words Mister Thorne . . . once cornerd corn and that aint hay. Speculators were disrupting cotton prices in 1939. Repeated problems with congestion in the cotton market were encountered that year as the result of the activities of just a few traders. William C. Durant (apparently the same Durant who had been fired as head of General Motors) and others were found to have been defrauding commodity customers in New York. Their scheme involved trading on both sides of the market for customers. Customers were paid profits from the winning side of the market, while the losses were allowed to accumulate. A 1938 survey by the Commodity Exchange Authority of managed accounts (i.e., customers accounts being traded by a third party) found a number of abuses. Individuals controlling the accounts frequently allocated profitable trades after the fact to their own accounts or to other favored accounts. Such fraudulent practices would continue to plague the markets for the rest of the century. The Commodity Exchange Act of 1936 was clearly flawed and did little to stop speculators from manipulating the market. Chairman of the SEC William O. Douglas sought greater regulation of commodity speculation. Douglas was particularly concerned with puts and calls in commodity trading. Franklin Roosevelt asked Henry Wallace, the Secretary of Agriculture, to clean up the commodity exchanges. Wallace defied Roosevelt because he thought Douglas, his rival, was seeking to expand the regulatory turf of the SEC by focusing attention on the commodity exchanges. This would be the first in a long series of jurisdictional battles between the SEC and commodity exchange regulators. Although trading activity on the Chicago Board of Trade declined between 1930 and 1952, the futures markets in the United States were the largest in the world. In 1939, commodity futures were traded in some fifteen unregulated commodities, including cocoa, coffee, pork bellies, soybeans, and sugar. Futures trading was valued at over $23 billion in that year. Commodity prices were increasingly being viewed as a significant indicator of economic conditions. The Associated Press published a weighted wholesale price index of over thirty commodities that gave an indication of changes in price levels and the rate of inflation or deflation, as was often the case during the depression. The prices of naval stores (including turpentine and rosin) were still being quoted in San Francisco newspapers. The Fidelity Fund was listed on the Chicago Board of Trade in 1939 because several state securities commissions did not require registration under state blue-sky laws if shares were traded on an exchange registered with the SEC. The Chicago Board of Trade had registered with the SEC and the listing of Fidelity was allowed as an accommodation. Fidelity later delisted when those state rules were changed.

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4 The Market Suffers

Some of the speculators who had survived the stock market crash of 1929 found themselves bankrupted in the 1930s. One such casualty was William Crapo Durant, who had continued his speculations. The once proud head of General Motors ended up running a bowling alley. Although he lived to the age of eighty-five, Durant died a pauper. Jesse Livermore had made millions from the stock market crash by selling short, but he too lost everything in further speculations. Livermore filed for bankruptcy in March of 1934 and committed suicide six years later in the mens room at the Sherry-Netherland Hotel in New York. Manipulations and pools continued. The so-called repeal stocks became popular targets of manipulators in 1933 when it appeared that Prohibition would be lifted. The pool in Libby-Owens-Ford Glass Co. in which Joseph Kennedy participated was assisted by the popular delusion that the company was engaged in manufacturing glass bottles and was, therefore, classified as a repeal stock. In fact, the company made no bottles and its business was in no way enhanced by the repeal of prohibition.61 The American Commercial Alcohol Corporation saw its stock price increase from $25 to over $90 in the space of some two months. The price then dropped back to $30. That stock was being manipulated by a small group of individuals who included Thomas Bragg and Sell em Ben Smith, as well as a specialist on the NYSE. E.F. Hutton & Co. was pushing American Commercial Alcohol stock, and Ruloff E. Cutten, a member of E.F. Hutton & Co. and a relative of Arthur Cutten, held options on the stock. Trading Continues More legitimate trading continued. The NYSE introduced a new 500character-per-minute ticker tape in 1930. This nearly doubled the speed of the earlier tickers. By the middle of the 1930s, the 6,000 or so broker-dealers in the United States were using over 9,000 ticker tapes to distribute stock market information in the United States and Canada. In another technological
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advance, ticker tapes were projected on a screen through Trans-Lux machines. Unfortunately, there was not all that much to report. In July of 1932, the Dow was at 41.22, down from its high in 1929 of 381.17. Only 400 million shares were traded on the NYSE in 1932. Less than 100 million shares were traded in the curb market. Trading volume did increase in 1933, after the Dow Jones Industrial Average jumped considerably. But that upswing was only temporary, and only some 300 million shares were traded on the NYSE in 1934. In 1939, there were about 870,000 shares traded per day on the NYSE, down from an average of some four million in 1929. Volume for 1939 was some 260 million shares, down from over one billion in 1929. The decline in volume was reflected in seat prices. A NYSE seat could be purchased for $50,000. To encourage more trading, the NYSE lowered the fees paid by corporations to list their stock on the NYSE, but a system of continuing fees was imposed on listed stocks. The NYSE eased its advertising restrictions and opened its gallery to the public without requiring an invitation by a member. Stocks listed on the NYSE often had as many as six competing specialists. The federal securities laws and the SEC sought to require those traders to maintain a fair and orderly market in the securities in which they specialized. Other obligations were imposed on specialists. They were required to assume affirmative obligations to trade for their own accounts in order to maintain a continuous market and provide depth and liquidity. Negative obligations were imposed on specialists to refrain from trading for their own accounts, unless necessary to maintain a fair and orderly market. Specialists were required to maintain the confidentiality of customer limit orders unless the order was published to all members. A study in 1935 found that specialists were trading for their own accounts against the daily trend of the market more often than with it. This indicated to the SEC that the specialists were not accentuating market trends and were contributing to the maintenance of a fair and orderly market. Nevertheless, the SEC issued its so-called Saperstein Interpretation in 1937, requiring specialists to engage in transactions that enhanced price continuity and reduced the effects of temporary imbalances between supply and demand. About 300 two-dollar brokers were operating on the NYSE floor in the 1930s. These brokers executed orders for commission houses with excess order flow that could not be handled by their own floor brokers. The twodollar brokers would give up the name of their principal when executing orders. The NYSE Stock Clearing Corporation was providing a centralized place for the delivery of securities and clearing of money balances and loans through net settlements. Net settlements reduced the number of physical deliveries of stock certificates, but delivery was still required in about 50 percent of transactions. A common, but still strange, scene on Wall Street in the 1930s was unarmed men carrying or wheeling boxes between their brokerage firms and the NYSE Stock Clearing Corporation. Those boxes were filled with stock certificates worth hundreds of thousands of dollars. Margin trad-

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ing continued. Brokers had lowered their margin requirements when the market crashed in 1929 in order to release some of the stress on the market. That effort failed. In 1931, the NYSE reduced its minimum margin requirement to about 20 percent. This too did not stop the market decline. After the adoption of the Securities Exchange Act of 1934, the Fed adopted Regulation T, which set minimum margin requirements. The Fed raised margin requirements for broker-dealers to over 50 percent in 1936, but reduced that requirement to 40 percent in the following year. The Fed would change its margin requirements about twenty-five times over the remainder of the century. The Fed also adopted Regulation U, which subjected banks to the same margin requirements for securities as was imposed on broker-dealers. Borrowings by NYSE members dropped to less than $600 million in 1939, down from about $8.5 billion in 1929. About eighty money brokers were supplying funds to brokerage firms in order to finance their operations. These money brokers handled time loans, which were not available at the money desk on the floor of the New York Stock Exchange. A money desk was established on the New York Curb Market in the 1930s. Previously, loans on the securities traded on that exchange were negotiated directly with the banks. An over-the-counter (OTC) market had developed outside the New York Curb Market by the 1930s. Dealers were specializing and making continuous markets in particular OTC securities. The National Quotation Bureau and the Security Dealers of North America published quotations for OTC securities. The National Quotation Bureau was publishing quotations for over 90,000 securities in 1936. Even so, only some $6 billion in securities were being issued annually during the depression, as compared to over $11 billion of new securities issued in 1929. Government Securities In 1934, Benjamin Graham published a book entitled Security Analysis, which became a standard text for security analysts. Graham and his colleague, David Dodd, sought to develop a methodology for selecting stocks for investment. Their most famous and successful pupil would be Warren Buffett, the billionaire investor from Omaha, Nebraska. R.G. Dun merged with the Bradstreet Company in 1933. Standard Statistics and Poors Publishing merged into Standard & Poors in 1941. Bill brokers were common features of the London markets, but they did not make their appearance on Wall Street until about the time of World War I. These brokers dealt in bankers acceptances and other commercial bills. By 1930, the Discount Corporation of New York was the largest dealer in bills by private issuers. Another security with a delayed entry into the United States was the Treasury bill. Although the British Exchequer had been using Treasury bills since 1877, in America the first modern Treasury bill was not issued until November 26, 1929. It was a short-term obligation sold through competitive bids that provided a return based on a

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discount off its face value. This meant that Treasury bills did not pay interest on a coupon basis. Treasury bills being issued in 1934 had maturities of up to six months. Later, in 1935, some Treasury bills had nine-month maturities. In 1937, the Treasury Department began limiting Treasury bills to ninety days. Returns were not particularly high, less than one-tenth of a percent on a threemonth note. Bonds backed by national bank notes were recalled in 1935. Other longterm bonds of the United States government, including Liberty Loan and Treasury bonds, were listed on the NYSE and were traded in the OTC market. The principal secondary market for government bonds had been the National City Co. and the Guaranty Company before the enactment of the Glass-Steagall Act. Afterward, that business was conducted by bond departments of banks and a few firms that specialized in government debt instruments. The more stable of these brokers became recognized dealers whose endorsements were accepted by Federal Reserve banks. These recognized dealers included C.F. Childs & Co., American Securities Company of Massachusetts, First National-Old Colony Corporation of Boston, Salomon Brothers & Hutzler, and Discount Corporation of New York. The First National-Old Colony Corporation was the largest single dealer in government bonds in the 1930s. The Federal Reserve Bank of New York was entering into repurchase agreements with dealers in the government bond market. Under these arrangements, the Fed agreed to buy bonds from a dealer and resell them to the same dealer at a later date at a specified price. This provided liquidity to the dealer and was used by the Fed as an alternative to making loans to dealers. In 1931, the New York Federal Reserve Bank engaged in such repurchase arrangements with the Discount Corporation of New York, the First National-Old Colony Corporation, and Salomon Brothers & Hutzler. Municipal securities were exempted from the SECs regulatory structure for registration and reporting. Nevertheless, those securities remained subject to the SECs antifraud rules. Municipal debt was not a riskless investment. Detroit defaulted on outstanding obligations totaling $400 million in 1933 and did not make final payment on that debt until 1963. A counterfeiting scheme caused Governor Alf Landon to suspend interest payments on municipal bonds in Kansas in 1937. Municipal securities were traditionally divided into four groups: general obligation bonds, revenue bonds, special tax bonds, and housing authority bonds. General obligation bonds were the most secure because they were backed by the full faith and credit of the state or municipality. The other categories of municipal bonds had lesser degrees of security. Revenue bonds, for example, were dependent on repayment from a particular revenue source such as a toll bridge or road. Industrial development bonds were developed during the depression and were first used by Mississippi in 1936. Another such issue was approved by Kentucky several years later. These bonds were similar to revenue bonds and were designed to attract industry to a municipality. These bonds were issued by the municipal-

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ity to provide funds for the construction of private corporations. The industrial development bonds were usually secured by a pledge of the rental value of the property being constructed. This meant that they were backed by the credit of the private company, rather than by the municipality. Financing Business The motion picture industry found itself entangled in problems during the depression. William Fox controlled Fox Film Corporation and the Fox Theater Corporation. He acquired control of Loews, Inc., in 1929, which in turn controlled Metro-Goldwyn-Mayer. An antitrust suit was brought by the United States to challenge that combination, and Fox agreed to divest control of Fox Films and Fox Theaters to three trustees, one of whom was himself. One of the other trustees was J.L. Stuart of the Halsey, Stuart & Co. brokerage firm. The Fox enterprise was having financial difficulties and was reorganized in 1930. There was a considerable fight over how that financing was to be conducted. General Theater Equipment, Inc., which was a large Fox creditor, obtained control of the company during that battle. General Theaters went into receivership in 1932, and Fox Films was reorganized again in 1933. William Fox declared bankruptcy in 1936 and confessed to an attempt to bribe a federal judge. Paramount Film Company was also experiencing difficulties. It was reorganized, and Harold H. Fortington, of the Royal Insurance Company and Floyd B. Odlums Atlas Corporation, a fast-growing investment company, seized control. Financing was continuing in other quarters. In 1930, William Randolph Hearst announced that his Hearst Consolidated Publications would be issuing $50, class A preferred stock. His newspapers touted this stock as a very sound investment. Ford Motor Company had organized the Universal Credit Corporation before the market crash to provide financing for Ford dealerships. It was sold in 1933 to the Commercial Investment Trust Corporation, but this entity still handled most of Fords retail financing. Most of the large automobile companies had their own credit operations. Chrysler used the Commercial Credit Company for its installment sales, and General Motors created the General Motors Acceptance Corporation in 1919 to make loans to consumers for automobile loan purchases. The automobile companies tried to require customers to use the companies captive loan arms, but the government charged that such conduct violated the antitrust laws, and this practice was stopped in 1938. The automobile companies also tried to require customers to insure the automobiles by financing through affiliated insurance companies, but the Supreme Court held that the states could prohibit this practice. Capital raising from public offerings slowed during the depression, but there were other ways in which corporations could raise money in the market. Venture capitalism was one small source of funds. A group of Chicago businessmen invested in untried businesses that promised phenomenal success

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at the risk of dismal failure. This group had actually started in 1919 when members of an accounting firm noted that some of their clients needed additional capital and that a profit could be obtained by supplying the needed funds. They then formed a corporation into which twenty-five individuals invested $25,000. Although an executive committee reported on likely investments, the investments of the corporation were made on an individual basis. No stockholders funds shall be called upon for investment, or investing, except upon his own subscription, nor will any funds of the company be used for investment purposes.62 The corporation was liquidated in 1930 with a total loss of capital. The individuals investments continued as before, and the group was reformed as a corporation in 1939. Other limited financing sources were available. Corporations sometimes made direct offerings of their securities without using an investment banker by seeking subscriptions from their existing shareholders. Funds could be borrowed more readily from several sources, including banks, life insurance companies, or other institutions. This finance was available through term bank loans, commercial mortgage loans, leasebacks, and equipment loans. Many underwriters began handling equipment trust certificates. These were serial bonds that matured at intervals over a given period and were secured by the equipment of the company issuing them. Usually, these certificates were issued by railroads or industrial companies. Capital sources were being rechanneled into corporations and away from individuals since increased federal taxation prevented individual accumulation of capital and left insurance companies and savings banks as the only large source of investment funds.63 Public security offerings were still occurring through negotiated underwritings and underwritings obtained by publicly invited sealed bids. There were variations of other underwriting formats. They included negotiated underwritings to existing shareholders with a standby commitment from the investment banking firm, which required the investment banker to take up securities that were not subscribed to by existing shareholders. The starting point for most underwritings distributed by the investment bankers was the determination of the public issuing price. This was the price that the investment banker and the issuer concluded would allow the entire offering to be put on the market and sold. The issuing underwriter then had to determine the gross spread, which was the difference between the price received by the issuer and the price at which the stock was sold to the public. Many people shared in the gross spread, including the managing underwriter, the underwriting participants, and the broker-dealers who received concessions and reallowances. The gross spreads varied depending on the nature of the security. Underwritings were conducted pursuant to an underwriting agreement between the issuer and the underwriters. The underwriters formed a syndicate with a manager that supervised the distribution. The manager was paid a management fee for allocating the securities to other participants and moni-

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toring the course of the offering. Stabilizing trades continued to be entered by the manager or other participants in order to support the security above the offering price. Those activities were subject to various administrative restrictions. Penalty clauses for unsold allotments were used in underwriting agreements, as were price maintenance clauses. Underwriting fees drew much criticism. The SEC and other critics claimed that the underwritings were dominated by a small group of investment bankers who could dictate their own fees without competitive pressure. The SEC wanted underwritings to be awarded through sealed bidding that would be open to all competent underwriters. The SEC adopted a rule in 1941 that required public utility companies to issue their securities by such a process. Investment bankers threatened a boycott of public utilities securities underwritings when the SEC first proposed this rule. The RFC then declared that it would intervene to bid on the offers in order to assure that the bids in the auction were fair. The Interstate Commerce Commission adopted similar rules for debt securities of railroads. Kuhn, Loebs business in railroad underwriting was seriously affected by that rule. New Leaders The old guard was changing. J.P. Morgan & Co. had been sidelined by the Glass-Steagall Act and was no longer dominating finance in the 1930s. The leading investment banking firm was Lazard Frres. Other leading underwriters before World War II included Morgan, Stanley & Co. First Boston Corporation, Dillon, Read & Co., Kuhn, Loeb & Co., and Blyth & Co. The financial world was changing in other ways. Goldman Sachs established a retail sales department in 1935. Drexel & Co., which had been the Philadelphia branch office for J.P. Morgan & Co., discontinued its operations after passage of the Glass-Steagall Act. A new firm, Drexel, Burnham & Co., was founded in 1935 by I.W. (Puddy) Burnham II. It would become a financial powerhouse in the 1980s and would fail spectacularly. Glore, Forgan & Co. was another rising investment banking firm. It began when Charles S. Glore formed a partnership in 1920 in Chicago. Marshall Field III joined that firm at the end of 1920, and the firm went through various name changes until it became Glore, Forgan & Co. in 1937. Marshall Field III retired from the firm in 1935. Bancamerica-Blair and Hemphill, Noyes & Co. were among the underwriters for a County of Nassau, New York, bond issue for over $2 million. E.A. Pierce & Co. was operating on the West Coast. It acquired the San Francisco, Los Angeles, and Hollywood offices of Slaughter & Russell in 1935. The firm then had offices in San Francisco, Spokane, Los Angeles, Seattle, Pasadena, Portland, and Hollywood. Dean Witter & Co. was another West Coast firm that remained in business. It offered municipal and corporate bonds, as well as assistance with federal income taxes. Dean Witter had offices in

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San Francisco and Oakland. It was a member of the San Francisco Curb Exchange, an associate of the New York Curb Exchange, and a member of the NYSE, the New York Cotton Exchange, and the San Francisco Stock Exchange. White Weld & Co. was becoming an important investment banker. That firm was started as a partnership before the turn of the century under the name of Moffat & White. It changed its name to White Weld & Co. in 1910 and became a venture capital firm, buying securities of corporations as an investment and holding them for the long term. White Weld & Co. also had a commission business and engaged in underwriting, as well as private placements. Eastman Dillon & Co., which was formed in 1910, was an investment banker specializing in Pennsylvania securities and other stocks. Kidder, Peabody & Co. was the underwriter for several corporations. It ran into trouble in 1930 after the Italian government and the Bank of International Settlements withdrew their deposits. In order to save the firm, J.P. Morgan & Co. supplied $2.5 million and arranged a $10 million revolving fund with several banks. Morgan brought new management into the firm, including Albert Gordon, a bond trader at Goldman Sachs, and two relatives of a partner at Stone & Webster. Gordon and his two partners paid $100,000 for the firm and moved its headquarters from Boston to New York. Another individual brought in to bolster the management of Kidder, Peabody was G. Herman Kinnicutt, the former senior partner of Kissel, Kinnicutt & Co., which was being liquidated. Kidder, Peabody took over the offices and organization of the securities affiliate of the Philadelphia National Bank. Several salesmen from the Chase Harris Forbes Corporation, the Guaranty Company, and the National City Co. joined Kidder, Peabody. The firm gradually regained its strength. By 1937, Kidder, Peabody was eighteenth in the number of underwriting agreements in which it acted as manager. It would reach third place in the 1940s. Bethlehem Steel Corporation had unsuccessfully tried to issue $48 million of convertible securities in 1937. The Pure Oil Company had an underwriting failure in 1937 for $44 million of 5 percent convertible preferred stock. As a result of those failures, Edward B. Smith & Co. suffered large losses. In order to save the firm, it merged with Charles B. Barney & Co. in January of 1938. The combined firm of Smith Barney & Co. operated a large retail distribution system in many cities around the country. Smith Barney had several departments, including buying, syndicate, new business, trading, sales, and municipal departments. Market Ups and Downs The Dow Jones Industrial Average rose and plunged as much as 50 percent or more in particular years during the depression. What many investors dont know is that the 1930s were almost the most volatile decade on record for stock prices.64 The Dow jumped by over 66.9 percent in 1933. In 1935, the

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stock market increased by over 47 percent. In January of that year, the NYSE began an advertising campaign to increase interest in stock investments, and trading volume reached almost 500 million shares in 1936. By 1937, it appeared that the depression was over as prices increased and unemployment began to decline. But that hope was short-lived. The stock market dropped sharply on September 7 and 10, 1937. Charles Gay, president of the NYSE, asked the SEC to close the market during this fall, but Chairman William O. Douglas refused. Douglas was petitioned by President Roosevelt to close the market, but Douglas refused that request as well. Stock prices dropped by almost 40 percent between August and October of 1937. On October 19, 1937, over seven million shares were traded on the NYSE as prices collapsed. This market drop was accompanied by a severe slump in the economy between August of 1937 and April of 1938, a period called a depression within a depression. The Dow Jones Industrial Average was just under 100 in 1938. It had reached 194.40 in 1937. It would bounce back to 158.41 by the end of 1938, but the gross national product (GNP) had still not reached 1929 levels by 1940. The SEC later concluded that the decline in the stock market was due to short selling. This event led to the adoption of an SEC short selling rule. James Forrestal and Clarence Dillon of Dillon Read advised the SEC on how to draft such a rule. The rule imposed a tick test, under which, a short sale could not be effected at a price less than the price of the last sale, under most circumstances. The depression had frozen capital. New private investment in the middle of the 1930s was only about one-third of that in 1929. There was reason for capital to remain concealed. A tax bill introduced in 1935, called the soakthe-rich bill, signaled a new effort by President Roosevelt to attack the wealthy in America.65 The legislation increased income taxes to 79 percent on incomes of over $5 million. That rate applied to only one individualJohn D. Rockefeller. Roosevelt claimed that the slowdown in investments was an effort to undermine his authority. He called it a capital strike. Although the existence of a capital strike was never proven, Roosevelt used that concern to start another fight with the financiers. He likened his fight against economic royalists to the American Revolution in 1776. Roosevelt charged that these rich people constituted an economic tyranny and that organized government was the only way to fight them. Roosevelt was said to be conducting a war against organized money, but his speeches were naked demagoguery.66 In any event, Roosevelts vilification of Wall Street did nothing to aid recovery. Wall Street in turn blamed the market break in 1937 on the government. The chairman of the Fed, Marriner Eccles, was considered by some economists to have helped send the country back into recession during 1937 and 1938. At that time, the Fed doubled reserve requirements for the banks. The Fed became chary of further monetary policy efforts for some time after this setback. Franklin Roosevelt tightened fiscal policy during the period that he

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was making his attacks on organized money. The Fed had other problems. A populist congressman from Texas, Wright Patman, saw the Fed as a conspiracy of bankers and a threat to the country. He was eager to cause difficulty for the Fed. Patman urged the District of Columbia to assess property taxes on the Feds new offices in Washington. The District did so and then, when the Fed refused payment, tried to auction off the Feds headquarters in Washington. The Fed claimed that it was part of the federal government and, therefore, exempt from taxes. The Fed eventually prevailed on this issue even though it was indirectly owned by commercial banks. The Crisis Continues At the end of the 1930s, some 500,000 corporations were filing tax returns with the federal government. There were then some 2 million business firms operating in the United States. Even so, the economy was at a standstill. More than ten million workers remained unemployed in America in 1938. This was about one-sixth of the labor force. Recovery remained elusive. In 1939, an economist at the Fed, Lauchlin Currie, contended that the depression signaled that the economy in the United States was mature and that its capacity for growth was nearly at an end. Significantly affecting the American financial system was the withdrawal from the field of investment banking of the capital funds of the commercial banks and their affiliates, which had previously been among the foremost managers and underwriters of securities issues.67 The split off of the investment bankers from the commercial bankers by the Glass-Steagall Act removed much capital from the markets. Previously, commercial bankers had supplied the capital needed to conduct underwritings. The investment bankers that were left after the investment banking and commercial banking functions were separated had only small amounts of capital and could not fill the void. The isolation of investment banking from commercial bank activities assured that the financiers would not lead the economy out of the trough into which it had fallen. The stock market crash of 1929 became for many the favorite culprit as the cause of the Great Depression. John Kenneth Galbraith, the Harvard economist, for one, placed blame on that speculative orgy decades after its occurrence. Milton Friedman, a Nobel Prizewinning economist, would later contend that the Feds failure to expand the money supply was at least in part responsible for the crash and the resulting depression. The banking crisis and the refusal of the Fed to increase the money supply created the conditions for the depression and then assured its spread and duration. Punitive tariffs, trade barriers, and the crippling of the financiers by the Glass-Steagall Act and the federal securities laws did the rest. The country remained mired in the depression despite the massive spending of the Roosevelt administration and its attacks on business. The Pujo Committees concern about corporate governance was renewed

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in the 1930s by Adolf Berle and Gardiner Means in their treatise, The Modern Corporation and Private Property. They asserted that corporations were being run for the advantage of the management, rather than of the vast number of shareholders who actually owned the company. Berle and Means separated control of corporations into majority control, minority control, and management control. Majority control meant that a shareholder or a close group of shareholders controlled the majority of the stock. Minority control meant that one shareholder held a substantial amount of stock but the remainder of the stock was widely spread. That minority ownership allowed the control group to maintain control of the proxy machinery and management. The Rockefeller family, for example, retained only a small minority interest in the Standard Oil companies after the family came under attack from the government and the press, but the family maintained control over those vast enterprises. Management control meant that there was no significant stock ownership held by any individual or closely knit group, not even a significant minority interest. In such instances, management had control of the proxy machinery and could keep itself in office without interference from the stockholders. The only real check on management in many corporations was that courts were focusing on the fiduciary duties of directors, requiring them to avoid conflicts of interest. Even so, the courts generally deferred to the business judgment of directors and officers. Professors Berle and Means, while critical of the corporation, conceded that it has, in fact, become both the method of property tenure and a means of organizing economic life. Grown to tremendous proportions, there may be said to have evolved a corporate systemas there was once a feudal system which has attracted to itself a combination of attributes and powers, and has attained a degree of prominence entitling it to be dealt with as a major social institution. Berle and Means predicted that the corporation would grow to proportions which would stagger imagination.68 In fact, the age of the giant corporation had already arrived. By 1932, the American Telephone and Telegraph Company had assets of over $5 billion and over 450,000 employees. The company was owned by over 560,000 shareholders, but no one shareholder owned more than 1 percent of the companys stock.

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5 Investment Companies and Insurance Regulation

Another form of investment company became popular during the depression. This was the periodic payment plan or installment investment plan, as it was sometimes called. These instruments were simply sales of investment company securities sold on an installment basis. The purchasers received the net asset value of their certificates as determined by the market value of the securities in the portfolio of the investment company. Face amount certificates continued to be sold during the depression. These instruments were unsecured obligations to pay a specified amount to the holder at a future date, if the purchaser made the required payments. Face amount certificates had a cash surrender value after a minimum number of payments were made. The face amounts of these certificates were usually $2,500 or less, and installment payments were made over a period of ten to fifteen years. The open-end mutual funds that continually offered and redeemed their shares were a growing presence. Although open-end mutual funds had been invented in the middle of the 1920s, they really did not become popular until about 1932. Mutual funds became even more active in 1936 and 1937 as the result of the brief upsurge in the stock market and favorable tax treatment that was granted these instruments in 1936. By 1937, there was approximately $100 million in investments by investors in open-end mutual funds. The shares of the openend mutual funds were sold at their net asset value plus a sales load. Before the depression, most investment companies had been sponsored by established brokerage firms. Open-end companies, however, were usually managed or sponsored by individuals and firms that been specially created to engage in that business. The open-end mutual funds used a principal distributor that was usually associated with the sponsors of the investment company and had an exclusive license to distribute its securities. The distributor often used wholesalers to sell those shares. The wholesalers were given a territory for their sales, and they employed retail dealers in that territory. In the 1930s, as many as 500 to 600 retail dealers could be used simultaneously to sell the shares of an investment company.
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Unit investment trusts (fixed trusts) were popular between 1930 and 1931. Over $600 million in certificates for these entities was issued during that period. Kissel, Kinnicutt & Co. was selling investment trust units in 1931 that were called corporate trust shares. This investment represented an ownership interest in common stocks deposited with the American Depository Corporation. The Chase National Bank acted as trustee. The stocks in this unit trust included those issued to twenty-eight of Americas most successful corporations and the shares were recommended as a conservative investment. Abuses The merits of particular unit investment trusts were often oversold. Richard Whitney, then president of the New York Stock Exchange, condemned such trusts in 1931, claiming that they charged excess commissions and that their advertising was often inappropriate. Congress uncovered other abuses in the unit investment trust in the 1930s, including inequitable pricing of shares, excessive sales loads, and hidden charges. Shareholders were being switched in and out of these investments, which substantially increased their commission charges. Investment companies were consolidating. The Atlas Corporation that was formed by Floyd B. Odlum as a hobby gradually grew until it had assets of over $5.7 million in 1929. Odlum had made a fortune by obtaining loans for investment through the use of borrowed securities. Between 1930 and 1936, the Atlas Corporation began purchasing other investment companies. Among those acquired was the Goldman Sachs Trading Corporation. The Atlas Corporation increased its assets to over $100 million and became the largest publicly owned investment company in the United States. It was actually an amalgamation of some thirty investment trusts. The J. & W. Seligman firm organized an investment trust, the Tri-Continental Corporation, in January of 1929. It had capital of $50 million. In August of 1929, the Seligman firm formed another investment trust, known as the Tri-Continental Allied Company, with the same amount of capitalization. The two trusts were consolidated in December of 1929, after the crash. Tri-Continental then took advantage of depressed market conditions to buy several other investment trusts, including the Wedgewood Investment Corporation, the Investors Equity Company, and the Blue Ridge Corporation. Some of the principal investment companies in the 1930s were Lehman Corporation (a closed-end company with over $81 million in assets in 1935), the Massachusetts Investors Trust (an open-end management company with assets of over $80 million in 1935), Incorporated Investors (open-end investment company with over $57 million of assets), Tri-Continental Corporation (a closed-end company with assets over $53 million), Selected Industries (a closed-end company with assets of over $47 million), State Street Investment Corporation (an open-end company with assets of almost $45 million), the Chicago Corporation (a closed-end company with assets over $43 million),

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the Blue Ridge Corporation (a closed-end firm with over $42 million in assets), the Adams Express Company (a closed-end company with almost $38 million in assets), the United States & Foreign Securities Corporation (a closedend investment company with assets over $36 million), the American International Corporation (a closed-end company with assets over $26 million), Mayflower Associates (a closed-end company with over $15 million), Prudential Investors (a closed-end company with assets over $15 million), and the Atlas Corporation (a closed-end company with assets of $100 million). Prince & Whitely, a New York Stock Exchange member firm, became bankrupt in 1930. It had sponsored an investment trust that became the Phoenix Securities Corporation. The Phoenix was sold to Wallace Groves in 1932, who used the Phoenix to acquire distressed companies. Among the stocks purchased were those of Loft, Inc., in 1938. At that time, Loft had just fired Charles G. Guth, its president. Loft was suing Guth for rights to the PepsiCola Company, which Guth had acquired and developed through the facilities of Loft. Loft was awarded control of Pepsi-Cola because it was found that Guth had abused his fiduciary duties to Loft in acquiring this investment for himself personally. Other securities acquired by the Phoenix Securities Corporation were the Celotex Company, which manufactured building products, and the Certain-Teed Products Corporation, which produced asphalt roofing and gypsum. The Alleghany Corporation was reorganized during the depression. It owned Investors Diversified Services (IDS), which was founded in Minneapolis in the 1940s. IDS sold mutual funds door-to-door. IDS ran into difficulties with the SEC in 1943, but it survived. By the late 1950s, IDS would have $1.5 billion in assets. In the meantime, as the 1930s ended, investment companies were holding some $4 billion of customer assets for approximately 2 million investors. One in ten of every American securities investors held investment company shares, but those investment companies had suffered large losses. By 1940, closed-end investment companies were often selling at substantial discounts to their net asset values. Open-end companies were seeing more redemptions than sales. Legislation A study of the operations of the investment companies by the SEC was authorized under the Public Utility Holding Company Act of 1935. The SECs investigation uncovered numerous abuses and formed the basis for legislation to regulate the investment companies. That statute, the Investment Company Act of 1940, was said to be the most intrusive financial legislation known to man or beast.69 Among other things, it required investment companies to register with the SEC. Forty percent of the board of directors of an investment company were required to be independent and no more than 60 percent of the board of directors could consist of investment advisers to the

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company. Restrictions were placed on transactions with affiliated persons. Sales loads were limited on periodic payment plans. The Investment Company Act of 1940 prohibited investment companies from issuing debt securities or preferred stock that added leverage or restricted shareholder control. Investment companies were precluded from repurchasing their own shares in most instances. Investment companies could not issue warrants on their securities, and mutual funds were limited in their ability to suspend the right of redemption. Some $448 million in assets was held in mutual funds at the time the Investment Company Act was adopted, and there were 296,000 mutual fund shareholders. The Investment Company Institute was founded in the wake of this legislation. It was an industry trade group that would seek to protect its members from additional regulation and, later, from competition from the banks. Exempted from the Investment Company Act of 1940 were trust departments and pension fund management functions exercised by the banks, even though those activities sometimes resembled mutual funds when performed collectively. The banks were aided by the Fed when it ruled that commercial banks could commingle trust accounts. Such funds had been in operation since 1927, and they effectively allowed the banks to treat trust accounts as mutual funds. This ruling would later cause a conflict with the Investment Company Institute that would find its way to the Supreme Court. Another piece of New Deal legislation imposed regulation over investment advisers. Generally, before World War I, investment advice was rendered by lawyers, banks and trust companies, and broker-dealers. The emergence of investment counselors as an important independent occupation, or profession, did not appear until after the close of the World War.70 After World War I, there was a large increase in the number of investment counselors who were acting independently of any broker-dealer or bank and trust company. Investment counseling services grew even more during the 1920s as investors sought advice from independent and unbiased experts. In addition, the number of securities had increased, and they were growing increasingly complex. Losses suffered after the stock market crash of 1929 further encouraged the use of investment counselors. A study conducted by the SEC in 1939 disclosed that, of the nearly 400 firms found to be acting as investment advisers, only ten had been organized before 1919. The SEC study found that some fifty firms were managing funds totaling over $4 billion. These advisers or money managers had become an integral part of the industry. One advisory firm operating in the 1930s was Fiduciary Counsel, Inc. This investment adviser was supervising over $200 million in funds, and its services included tax angles, which it scrutinized.71 Callaway, Fish & Co. was another firm that provided investment services. Investment firms also acted as advisers to investment companies. The SEC study revealed that most investment advisers charged their clients based on a percentage of assets being managed. The fees ranged from

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one-quarter to 1 percent of assets, depending on the amount of funds under management. Some firms based their fees on a percentage of profits earned by their clientsusually 25 percent. Other investment advisory firms charged a flat fee, regardless of performance or value of assets. A concern raised by the SEC was the propriety of performance fees. These fees were contingent upon profits for the clients account. The SEC thought that this was inappropriate because it encouraged advisers to gamble with client fundsthat is, the advisers incurred large risks in the hope of producing large returns. These arrangements were characterized as nothing more than heads I win, tails you lose propositions. The investment advisers had nothing to lose if they were not successful. The client, however, had much to lose. The SEC study found other conflicts of interests, as when an investment adviser had several clients and needed to give priority to one client over another in executions. Another questionable practice of assigning advisory contracts from one adviser to another was widespread. This resulted in the receipt of advisory services that were different from those that the client originally contracted for. These abuses convinced Congress that legislation was necessary. The result was the Investment Advisers Act of 1940. This compulsory census required advisers to register. Through registration, the act sought to identify the role being played by investment advisers and how they handled private funds. The statute prohibited fraud and the embezzlement of customer funds. Exempted from registration and regulation were bona fide newspapers and other publications, as well as teachers, broker-dealers, and banks. The SECs report on investment advisers had drawn a distinction between pitchsters and bona fide investment counselors. The Investment Advisers Act reflected that concern. In order to eliminate the pitchsters, the act prohibited investment advisers from using the name of investment counsel to describe their business, unless they were primarily engaged in providing investment advice. The act prohibited performance fees. The assignment of investment advisory contracts was prohibited without the clients consent. Market Activity Meanwhile, the market in securities continued, but not robustly. Seats on the New York Curb Exchange were selling at a low of $650 during the depression. The Wall Street Journal published a Dow Jones Index of commodity prices and a Dow Jones Futures Index, as well as a Dow Jones Bond Average index that was based on an average of forty bonds. About 6,000 brokerage firms were operating in the United States by 1940. Numerous brokerage firms had merged with each other during the depression and would continue to do so. J.S. Bache & Co. was still operating as a broker-dealer in Chicago and New York. Grant, Hall & Proctor was a member of the United Securities Dealers Association and a member of the Association of Bank Stock Dealers. Clokey & Miller, a member of the New York Security Dealers Association,

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was buying, selling and quoting the securities of Thompson Automatic Arms Corporation (maker of the tommy gun) in 1940. A firm of some importance was Stone & Webster and Blodget, which had been organized in 1927 and involved a combination of Stone & Webster, with the business of Blodget & Co. Stone & Webster engaged in underwriting and distributing securities at wholesale and retail levels. It had a municipal bond business and provided comprehensive financial services to issuers of securities and to investors.72 Stone & Webster concentrated on utility financing and gas pipelines and distribution companies in the 1940s. Its central office was in New York but it had branches in Boston, Chicago, Philadelphia, and other locations. In 1946, the firm changed its name to Stone & Webster Securities Corporation. First Boston Corporation was increasing its presence by maintaining a market in bank and insurance stocks. On April 2, 1940, Harriman Ripley & Co., Kidder, Peabody & Co., and other members of an underwriting syndicate announced an offering of 150,000 shares of Walt Disney Productions 6 percent cumulative convertible preferred stock. Christiana Securities Company was selling 7 percent cumulative preferred stock that was yielding 5 percent in January of 1941. Tri-Continental, the large investment company formed by J. & W. Seligman Co., organized the Union Securities Corporation in 1938. It took over the underwriting business of J. & W. Seligman & Co. Seligman then became essentially a broker-dealer, reducing its underwriting activities. The Union Securities Corporation quickly became a leading underwriter with offices in Hartford, Boston, Buffalo, and Syracuse. The NYSE allowed its member firms to advertise tastefully.73 Merrill Lynch was among the firms conducting advertising campaigns. It promoted peoples capitalism. Merrill Lynch & Co. had sold its retail business to E.A. Pierce & Co. after the stock market crash. At that time, E.A. Pierce & Co. was the largest wire house in the country. However, Merrill Lynch stayed in the securities business and was incorporated in 1938. A year later, the E.A. Pierce & Co. firm experienced financial difficulties. It was then rescued by Charles Merrill and Winthrop Smith. This merger allowed Merrill Lynch to extend its ancestry back to Burrell & Housman and to Gwathney & Co., which had merged and then been acquired by E.A. Pierce & Co. The Gwathney firm had begun as ship chandlers and commission merchants in Richmond, Virginia, in 1820 and later dealt in the futures markets in New York. Burrell & Housman had started business in 1885 as a New York Stock Exchange member; Bernard Baruch had worked there. It was a leading firm on Wall Street by 1907. It merged with Gwathney & Co. and then with E.A. Pierce & Co. in 1927. Merrill Lynch changed its name to Merrill Lynch, E.A. Pierce & Cassatt in April of 1940. The last name was from a Philadelphia firm that had been sold to E.A. Pierce in 1935. The combined firm had over 50,000 clients and was expanded further in 1942 through a merger with Fenner & Beane, a commodities firm. The combined firm then became Merrill Lynch, Pierce, Fenner & Beane. Merrill Lynch sought to imbue its brokers with a spirit of profes-

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sionalism, emphasizing the importance of customers and the need for its brokers to make sound recommendations to clients. Charles Merrill instituted professional training programs for the brokers hired by the firm. They were called account executives and placed on salary, rather than commission. But Merrill Lynch did not remain with a salary-only plan for its salesmen. In 1942, it began providing additional compensation based on sales performance. Later, other factors such as firm and division performance were added to determine compensation. The Glass-Steagall Act had re- Charles Merrill. As founder of Merrill Lynch, to Main Street. (Courquired the separation of commercial he brought Wall StreetArchives.) tesy of Merrill Lynch banking and investment banking functions. Several large investment banks, including J.P. Morgan & Co., had split their operations into separate businesses in order to comply. The SEC concluded in 1941 that J.P. Morgan & Co., and Morgan Stanley & Co. were continuing to operate under common control. The SEC noted that Morgan Stanley had been sponsored by J.P. Morgan & Co. when it was formed. They were using a common name and there were numerous business relationships between the two firms, including the use of the same attorneys. Family relations further bound the two firms together. Nevertheless, the firms continued their operations. The Dominion Securities Corporation in New York sold municipal bonds of Canadian government units and Canadian public utility and industrial securities in January of 1941. The firm executed orders on the Toronto and Montreal stock exchanges in New York funds at net prices. The Equitable Securities Corporation sold municipal bonds for the City of Spartanburg, South Carolina, that were paying 2.25 to 2.5 percent. In March of 1941, the State of New York offered bonds that paid 1.75 percent interest. They were underwritten by B.J. Van Ingen & Co. Smith, Burris & Co. offered $1.5 million of Merchants and Manufacturers Securities Co. ten-year, 4.5 percent debentures that had attached stock purchase warrants for shares of common stock. Their price was $102 each, less accrued interest. The State of Maryland issued bonds that were priced to yield 0.8 percent to 1.05 percent. In October of 1941, the Missouri Pacific Railroad offered 2 percent serial equipment trust certificates that would mature annually in increments beginning on October 15, 1942, and continuing through 1951. The certificates were issued for not more than 80 percent of the cost of streamlined passenger cars. The equipment trust certificates were unconditionally guaranteed by a trustee

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of the Missouri Pacific Railroad. Their issuance was subject to the approval of the Interstate Commerce Commission. These bonds were underwritten by Harris, Hall & Co., the Illinois Company, Alexander Brown & Sons, and McMaster, Hutchinson & Co. By 1940, several of the stocks listed on the NYSE were traded on one or more of the seventeen regional exchanges. The NYSE constitution prohibited its members from dealing in listed securities outside the exchange. A similar provision had been contained in its constitution and rules since 1863. The SEC ordered the NYSE to rescind that prohibition insofar as it applied to dealings on regional exchanges. The SEC did not believe that the NYSE should prevent the regional exchanges from trading its listed securities. Nevertheless, the prohibition remained for over-the-counter transactions in NYSElisted stocks. This would cause problems for the NYSE in future years. Government Investigations A number of criminal charges involving securities were brought in federal court in New York in 1941. The indictments charged that some seventy-six individuals had sold $2 million of worthless oil stocks to thousands of investors in the northeast. Most of those defendants pleaded guilty. Thirteen went to trial and eleven were convicted. The fight against concentrated wealth was stepped up under the federal antitrust laws. The Robinson-Patman Act of 1936 prohibited price discrimination. The Wheeler-Lea Act of 1938 prohibited deceptive commercial practices. The Justice Department became more active in antitrust prosecutions at the end of the 1930s when Thurman Arnold became Assistant Attorney General in charge of antitrust enforcement. Arnold had published The Folklore of Capitalism, which was critical of the antitrust laws and their application to monopolies. Despite those concerns, Arnold filed more than 200 antitrust lawsuits when he became the Assistant Attorney General. To wage that war, he increased the size of the antitrust division from a few dozen to nearly 300 lawyers. Arnold was often frustrated in the courts because the judiciary did not want to broadly apply the antitrust laws to dictate the form and limits of competition. I.F. Stone, the journalist, called Arnolds antitrust division the battered citadel of a romantic lost cause.74 In 1937 and 1938, attempts were made in Congress to adopt a federal statute requiring corporations to be licensed by the federal government. William O. Douglas had been a proponent of a federal incorporation statute, and the SEC urged a national regulation that would stop charter mongering among the states. This proposal met opposition. As a compromise, Franklin Roosevelt created the Temporary National Economic Committee (TNEC) to study the concentration of economic power in the United States. This study was conducted by the Federal Trade Commission, the SEC, and the Department of Justice. Joseph OMahoney, a senator from Wyoming, was the chairman of the committee. TNEC investigated monopolies and other anticompetitive restrictions, which it was thought

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had caused the economic contraction in 1937 and 1938. The committee concluded its inquiries in 1940, after conducting massive hearings that totaled dozens of volumes and thousands of pages of testimony. Numerous monographs were published as well. The SEC conducted a study for the committee on the shareholdings in the 200 largest corporations in the United States. It determined that a small group of shareholders controlled most of these corporations.75 TNEC recommended legislation that would require restrictions on corporate mergers and national incorporation of companies that were engaged in interstate commerce. Those proposals were not adopted. TNEC and a New Money Trust TNEC pursued some of the same avenues explored by the Pujo and Pecora investigationsthat is, to find and attack the source of the concentration of economic wealth in the United States. However, the J.P. Morgan firm was no longer a viable target for the continuing witch-hunt for a rich villain. The firm had lost much of its power as a result of the forced divesture of its investment banking business by the Glass-Steagall Act. Nevertheless, there was no shortage of new targets. The Du Pont familys sphere of influence was found to be of interest. The family owned securities valued at over $500 million. Those holdings included stock of E.I. du Pont de Nemours & Co., the United States Rubber Company, and Phillips Petroleum, as well as their interest in General Motors, which a Supreme Court decision in 1957 would conclude violated the antitrust laws. The continuing sphere of influence of the Rockefeller family was another concern. That family owned about $400 million in securities, much of which was concentrated in the oil industry. However, between 1917 and 1960, John D. Rockefeller Jr. would give over $500 million to charity himself and direct the distribution of another $500 million through Rockefeller foundations. Another group whose sphere of influence was found to be a threat was the Mellon family. This familys stock holdings totaled almost $400 million. The Mellon family holdings were the most diversified of those of any family or group in America. The Mellon familys sphere of influence focused chiefly on banking, but also included Bethlehem Steel Corp., Westinghouse Electric, Lone Star Gas, Allis-Chalmers, Pittsburgh Plate Glass Co., Pullman Inc., Aluminum Company of America, Gulf Oil Corporation, and Jones & Laughlin Steel Corp. The Mellon familys holdings in those companies varied from a very small amount to over 70 percent in the case of Gulf Oil. These disclosures were titillating, but the TNEC could not convince Congress or the public that these families should be prosecuted for acquiring their great wealth. Insurance Industry Investigation Another TNEC target was the insurance companies, which were steadily accumulating enormous reserves. However, they too proved to be less than sen-

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sational targets for the money trust witch-hunters. Indeed, many insurance companies had experienced difficulties during the depression. Over 130 insurance companies borrowed a total of over $90 million from the RFC. The National Surety Company and the Maryland Casualty Company were among those rescued by the RFC. The depression had other effects on the insurance industry. Insurance companies reduced their holdings in railroad bonds and had to foreclose on many loans on real estate property, which increased their holdings of real estate. The insurance companies suffered large losses on many of their investments. Returns dropped as the insurance companies concentrated their investments in low-interest-paying government securities. The insurance companies experienced runs on their assets because hard-pressed policyholders sought to obtain the surrender value of their policies. Several states adopted legislation that froze surrender claims. One individual who sought to be excepted from such a restriction was the Secretary of the Treasury, William Woodin, who wanted the $68,000 surrender value of his life insurance policy. That exception was denied him. Even with all those difficulties, it seems strange that Congress did not seek to regulate the insurance industry as it did securities, banking, and futures. The answer lay in the fact that the Armstrong investigation in New York at the beginning of the century had resulted in state legislation that removed the insurance companies from speculation in the stock markets. This sheltered the insurance companies from many of the speculative excesses of 1920s and kept them out of the line of fire from the congressional inquiries that sought to cripple the financiers in other areas of the economy. The TNEC did consider a proposal from the SEC that would have established a new federal regulatory body to oversee the insurance companies. An SEC commissioner also recommended to the committee that federal agents should be given visitorial powers over the life insurance companies and that the companies should be required to register and report to the federal government. The commissioner wanted life insurance companies to invest more of their reserves in common stocks. The insurance companies vigorously opposed such a course, pointing out that both the Democratic and Republican Party platforms pledged that supervision of the insurance companies would be left to the states. The result was a rejection of the SEC proposals. Industry Composition Although the insurance industry suffered during the depression, the 70 million life insurance policies in effect in 1933 grew to over 124 million in 1940, with an outstanding face amount of over $110 billion. Those policies were issued by over 300 life insurance companies with assets exceeding $28 billion. The five largest insurance companies were the Metropolitan Life Insurance Co., the Prudential Insurance Co. of America, the New York Life Insurance Co., the Equitable Life Assurance Society of the United States, and the Mu-

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tual Life Insurance Co. The Metropolitan Life Insurance Company was the second largest corporation in America. Legal reserve life insurance companies dominated the insurance business by 1940, writing about 95 percent of life insurance policies. The rest was written mostly by fraternal orders and assessment societies. The legal reserve life insurance companies agreed to pay a definite benefit for a specified premium. The benefit could not be reduced, and the premium could not be increased. The legal reserve life insurance companies were required by state laws to maintain a reserve for their policies based on the type of contract, age and mortality of the insured, and interest assumptions. Life insurance was being sold under ordinary, industrial, and group policies. Ordinary policies were issued on an individual basis with death benefits in amounts of $1,000 or more and with periodic premium payments. Ordinary policies usually required a medical examination, but industrial policies did not. Industrial insurance paid only small death benefits and was sold to people of little means. This insurance was considered a burial policy. Premiums were paid in weekly or monthly amounts and collected house to house. By 1928, about 25 percent of all life insurance in the United States were industrial policies. This evidenced that life insurance was becoming a product for working people. The American Federation of Labor had created a Union Labor Life Insurance Company in 1926. Group insurance was made available to employees under a policy issued to the employer. The employees were insured under the employers master policy without medical examination. Numerous variations in life insurance were available by the outbreak of World War II, including whole life, endowment, and term. Prudential was offering some 130 varieties of policies, but whole life policies predominated in 1940. Term insurance provided death benefits only if death occurred during a limited period or term. The cost of these policies increased with the age of the insured and was prohibitive once the insured reached the age of sixtynine. To avoid this problem, the policyholder could utilize the level premium whole life insurance concept, with an annual premium that was fixed throughout the life of the insured. The level premium was computed so that interest return on the premiums would provide the company with adequate resources to pay claims. This effectively meant that premium payments in the insureds early years were higher than those for term insurance, but less in later years. Policies that required premium payments throughout the life of the insured were called straight life policies. If the payments were for a limited number of years, the policy was called a limited payment policy. Endowment insurance combined savings with term insurance, providing insurance for a specified period as well as a specific sum of money at the end of the defined period. Under an endowment policy, the face amount of the policy was paid to the insured at the end of the endowment period or to beneficiaries in the event of death before the endowment period ended. Whole life and endowment policies provided for a surrender value, which

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was the amount of money that the insurance company would pay the policyholder upon surrender of the policy. The loan value of the policy was the amount that the company would loan on the policy, which was usually equal to its cash or surrender value. Interest had to be paid on any loans under the policy since the loans were the companys reserves and not the property of the policyholder. Policies had nonforfeiture provisions that let the policyholder utilize the borrowing or surrender value of the policy to pay premiums. For many years, insurance companies had paid their beneficiaries under whole life policies when the insured reached ninety-six, even if they were not dead. This was considered to be the limit on life for actuarial purposes. One recipient of this largess was John D. Rockefeller Sr., who reached that milestone in 1935. Prior to World War II, life and casualty insurance generally operated separately. Casualty companies specialized in certain areas such as fire insurance. In 1940, accident and health insurance was still considered a sideline of the insurance companies. Annuities were another matter. They had an uncertain prospect before the stock market crash of 1929, but became a growing business during the depression. About $11 million in annuity premiums was received by the insurance companies in 1904, but that amount was not reached again until 1916. From 1916, annuity premiums steadily increased, and insurance companies were writing annuity contracts on a large-scale basis by 1927. In 1930, $90 million of annuity premiums was received, and then annuity premiums began to skyrocket. The number of annuities being sold increased heavily in 1933. There were about 300,000 fixed annuity contracts in the United States by then. Total annuity premiums in 1935 exceeded all premiums from 1866 to 1927. By 1937, the premium income from annuity contracts was $1.7 billion. Reserves for annuity contracts rose from some $400 million in 1929 to $2.6 billion in 1938. The principal forms of annuities during the depression were immediate annuities and deferred annuities. Under an immediate annuity, payments to the annuitant began immediately after the contract was purchased. The annuity was usually paid for by the purchaser in a lump sum. Deferred annuities provided for payments to commence after a stated period of time and were purchased by periodic premiums during the deferral period. The single premium annuity, which was paid for as a lump sum even if benefits were deferred, was another product sold by insurance companies. Despite their growth, annuities were viewed as a problem child of the insurance business because of changing longevity and other factors. From 1933 to 1938, the insurance companies held conferences at the offices of Dr. Arthur Hunter, chief actuary and vice president of the New York Life Insurance Co., in order to establish a uniform program for annuity rates. Other matters considered at these conferences included the desirability of participating annuities that provided an investment return to the beneficiary, limitations on the amount of single premium annuities, cash refunds, and installment and

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temporary annuities. The meetings were also used to establish uniform policy terms and ratesthat is, price fixing. The assets of life insurance companies increased by over 800 percent between 1906 and 1938. The reserves of the insurance companies increased to an extent that they had national implications for investment and capital flows. The investment policies and practices of the legal reserve life insurance companies admittedly influence practically every phase of this countrys economic life.76 The largest insurance companies in the United States had some $28 billion dollars to invest between 1929 and 1938. Most of their investments involved securities, then mortgages, policy loans, and real estate. Life insurance companies held about 2 percent of their assets in industrial and other bonds in 1930. They held 24 percent in railroad and public utility bonds. Government securities took substantial portions of life insurance company investments. In 1937, the twenty-six largest insurance companies owned over 11 percent of the long-term debt of the United States government, as well as large percentages of long-term private debt and well over $1.5 billion of real estate. Insurance Industry Investments The large life insurance companies had over $10 million to invest each day. Yet they invested only small amounts in equity securities. The great bulk of the insurance companies investments in securities was bonds rather than stocks. TNEC found in 1940 that the increasing amount of reserves being accumulated by the life insurance companies was in effect sterilizing the savings funds received and preventing them from flowing into new enterprises or undertakings where the element of venture or risk is present. Thus the small businessman or average industrialist is denied access to this more important capital reservoir.77 The insurance companies were trying to make their investments riskless. In fact, their demand for bonds was making corporate investments even more risky because this placed increased pressure on companies to issue more debt, unbalancing debt-to-equity ratios. Further, the bidding by insurance companies for the supply of bonds was driving interest rates down and reducing the rate of return for the insurance companies. TNEC noted that the emphasis on bond investment by the insurance companies could bring difficulties [u]nless the life insurance companies can find methods by which the funds flowing from their control will become available as equity for the stimulation of new enterprises and accessible to the smalland medium-sized businessmen.78 The committee thought that insurance companies should increase their investments in common stocks in order that industrial enterprise may not become overburdened with debt.79 The insurance companies, however, were restricted in their ability to buy common stocks by state insurance laws adopted in the wake of the Armstrong investigation. Moreover, the insurance companies had come to accept these restrictions and

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were willing to accept a lower return on their investment because their assets were at less risk. The insurance companies happily boasted that their safety record was without parallel, notwithstanding the worst depression in modern history. They noted that their avoidance of equity investments had prevented the insurance industry from being devastated by the stock market crash of 1929. Happily the disaster which might otherwise have occurred was avoided.80 Industry Abuses There were other concerns. During the 1930s, the Travelers Insurance Company was borrowing heavily from two banks that it owned or controlled. This created a conflict of interest with the banks. Travelers was then the seventh largest life insurance company and the largest nonmutual company. The agency system for insurance sales was encountering problems. Although the agents were effective in spreading insurance throughout the country, they often indulged in overzealous claims and high-pressure sales that were deplorable. The agents usually worked under the supervision of a general agent or branch manager, the general agency being the most important method for insurance sales. The general agent hired and fired agents in his territory. He received a commission for sales by his agents, but was also financially responsible for any expenses incurred by his agency. Sales contests were used by general agents to increase business, encouraging high-pressure sales tactics. Agents were given canned sales speeches to make to customers, with set sales pitches to respond to customer concerns or objections. The agent was told how to break down sales resistance and apply sales pressure, how to modulate his voice and when to smile.81 In selling life insurance, agents were told to back the hearse up to the door.82 Sometimes insurance was oversold. One family held forty-four insurance policies in 1938, forty of them industrial policies. The family was spending about 55 percent of its income on these policies. Insurance companies took great care to keep policyholders from allowing their insurance policies to lapse. After all, the lapsed policy meant a loss of premium. One company sent the following warning to policyholders:
I am a lapsed policy. A widows tears have stained my withered surface. I am only a scrap of paper consigned to the trash heap where I now belong. Once I was a living contract. I was proud of my ability to guarantee my owners wife a regular income should she have to go on without him. I represented comfort and security for his family. I was guaranteed estate free from taxes and administrative costs. But something happened. The money from my premium was used for other things much less important. And then came Death. Suddenly and unexpectedly it took my owner away. Its swiftness stunned his family, and when they turned to me for help they found me as I am todaya lapsed policy.83

The Chartered Life Underwriters began examinations in 1928 as a way to instill professionalism into the industry. The states also began to regulate sales

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practices more closely, if not more effectively. Even with abuses, the insurance industry would continue to escape federal regulation. Efforts were made between 1915 and 1917 to create a national health insurance program, but such schemes were rejected. The American alternative to socialized medicine had its foundations in 1929 when Justin Ford Kimball created a prepaid hospital plan. It became the model for Blue Cross and Blue Shield. Kimballs plan was sold to Dallas schoolteachers. Even before Kimball, prepaid medical care was supplied by company doctors in mining and mill towns. Small groups had previously experimented with similar plans. By 1932, some 670,000 Americans were covered by industrial fixed-payment medical service plans. The so-called Blue Plan for health insurance was offered on a not-for-profit basis but involved only local groups until the 1960s, when a strengthened national organization tried to bring the various Blue Plans together.

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Chapter 5 War and the Rebuilding of Finance

1 World War II and Finance

The outbreak of war in Europe in 1939 caused a 23 percent drop in the Dow Jones Industrial Average over a two-week period. Grain prices fell when European markets were closed as the conflict widened. Commodity prices bounced like yo-yos, and the smart money was rushing into wheat.1 Those effects were short-lived. The war in Europe increased demand for wheat, corn, and cotton, all of which were in surplus supply in the United States. Industrial growth was resuming and would expand rapidly as war requirements increased. The gross national product (GNP) in the United States would double between 1939 and 1945, and per capita income would increase by more than 40 percent. Industry in the United States was operating at record levels even before Pearl Harbor. Defense spending increased from about $1.3 billion in 1939 to over $6 billion in 1941. Unemployment dropped from over 14 percent in 1940 to just under 3 percent in 1941. Still, there was a long way to go in reaching a goal of economic security. In 1940, half of all men and two-thirds of the women who were employed earned less than $1,000 per year. Only 48,000 taxpayers in a population of 132 million earned more than $2,500 per year. Thirty-one percent of American homes did not have running water or an indoor toilet. Fifty-eight percent had no central heating. War Preparation The Roosevelt administration created a phalanx of new agencies to deal with war preparations. A War Resources Board was established in 1939. Led by the former head of the United States Steel Corporation, this agencys brief was to prepare the country for mobilization in the event that war spread to our shores. The Office of Emergency Management and the National Defense Advisory Commission were established in 1940 to assist in defense planning. The Reconstruction Finance Corporation (RFC) was given broad powers in 1940 to assist in this mobilization of Americas defense industries. Turning from fighting the depression to preparing for war, the RFC created the Metals
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Reserve Company to stockpile metals and to make metal purchases around the world. It would later finance scrap metal drives across the United States. The RFC created a Defense Plan Corporation, a Rubber Reserve Corporation, and a Defense Supplies Corporation, all of which were assigned tasks to help the defense effort. The RFC announced in 1940 that it would be assisting banks in making loans for defense plant construction. Initially, the RFC agreed to assume 75 percent of secured loans made by banks for defense work. That participation was increased to 90 percent after the attack on Pearl Harbor. In the summer of 1941, the RFC loaned $50 million to the Amtorg Trading Corporation in order to facilitate a commercial transaction by the Soviets. An Airlines Credit Corporation was created by the federal government to finance airlines in Latin America that would compete with the influence being exercised by German and Italian airlines. President Roosevelt established the Supply, Priorities and Allocations Board (SPAB), charged with allocating supplies among competing defense and domestic needs. SPAB was headed by Donald Nelson of Sears, Roebuck. After Pearl Harbor, SPAB became the War Production Board. A Controlled Materials Plan was created to establish priorities for strategic materials. An Office of Price Administration and Civilian Supply was operating in 1941, advocating price, wage, and rent control legislation. The Office for Production Management (OPM) replaced the National Defense Advisory Commission in 1941. It was headed by W.S. Knudsen of General Motors, but he had to share power with a labor representative, Sidney Hillman. After Pearl Harbor, the RFC created the United States Commercial Company (USCC) to act as a counterpart to the United Kingdom Commercial Corporation. The USCC spent some $2 billion to purchase supplies abroad in neutral countries. A part of its purchasing program was designed to deny the Germans essential supplies such as wolfram (i.e., tungsten), which was used to harden steel. In one novel and eccentric scheme, the USCC purchased sausage casings from Turkey in order to deny the Germans their favorite food. The Office of Economic Warfare assumed the operations of the USCC in 1943. The Small Business Act was passed in May of 1942. It created a capital fund of $150 million to finance conversion of small plants to wartime production. President Roosevelt, setting aside his war against big business, announced in March of 1942 that pending antitrust suits that would interfere with war production were to be dropped and that such suits would be avoided during the war. The Office of War Mobilization, which was opened in 1943 and headed by James S. Byrnes, superseded SPAB and was assigned the mission of allocating resources between the military and civilian sectors. The Petroleum Reserves Corporation was created by the RFC in 1943. It was soon transferred to the Office of Economic Warfare, which was charged with the responsibility for acquiring oil concessions in Saudi Arabia. The RFC chartered the War Damage Corporation to insure properties from attack by the enemy in the United States. Although there was no charge for that protection

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initially, premiums were imposed later in the war. The National Service Life Insurance Act was adopted in 1940 to provide insurance for men and women in the military. This became the largest single life insurance operation in history.2 Separately, New York created the first state guaranty association for life and health insurance in 1941. A Defense Plant Corporation (DPC) was created by the Roosevelt administration. It advanced over $300 million to General Motors to build airplane engines. Another $170 million was put into other defense plants. Among other things, the DPC helped finance construction of the Big Inch and the Little Big Inch pipelines from Texas to the East Coast, which greatly aided the war effort. It also bought and sold gasoline and raw silk for parachutes and even financed the armys post exchange (PX) system, which replaced the sutlers of the Civil War era. But a $12 million investment by the DPC to finance hemp production as a substitute for rope supplies from the Philippines was a failure. In total, the Defense Plant Corporation would spend over $9 billion. The alphabet soup of agencies increased many times during the war to include such agencies as the Office of Censorship, the Office of Civilian Defense, the Office of the Coordinator of Inter-American Affairs, the Office of Defense Health and Welfare Services, and the Office of Emergency Management. Some expenditures were not well publicized. The Manhattan Project that developed the atomic bomb employed 150,000 individuals, expended more than $2 billion, and built gargantuan facilities in complete secrecy. Effects of the War in Europe American gold stocks increased by some $4 billion when war broke out in Europe. This was because England and France were purchasing materials from the United States with gold. Some $8.5 billion in gold was moved from New York to Fort Knox in 1941 as American gold stocks increased. The transfer brought the total value of gold held in Fort Knox to $14 billion. Many nations sent their excess gold stocks to the United States for safekeeping. By March of 1941, Fort Knox held an estimated 50 percent of all the gold in the world. Even the president could not resist taking a peek at this hoard. He journeyed to Fort Knox in April of 1943. Documents from the governments archives were moved to the gold vault for safekeeping, including the Declaration of Independence, the Constitution, and the Gettysburg Address. Because copper was in shortage, excess silver stocks were used as a substitute in electrical installations in defense plants. Some 13,000 tons of silver were shipped from West Point to Oak Ridge to be used as a substitute for copper in the Manhattan Project. Over $60 million of silver was shipped in trains to California for use in defense electrical work. In May of 1943, the Senate Silver Committee approved a proposal to lease 5 million ounces of silver to Great Britain. A plan to lend 1 million ounces monthly to England was rejected because silver supplies were being depleted by other demands.

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British investors were selling large amounts of American securities at the outbreak of the war. As in World War I, the British government required its citizens to surrender their American securities as a means to raise funds for the war effort. In January of 1941, British agents in New York were selling American securities at the rate of $10 million per week. By that year, the British government had sold over $1.5 billion of American corporate and government securities. J.P. Morgan & Co. arranged for the sale of many of those securities in America. This selling pressure drove market prices down, and the RFC took action to ease the pressure on the market from these sales by making loans to foreign governments. In one instance, the RFC loaned $40 million on Brown & Williamson Tobacco Company stocks held by the British government. This obviated the need for selling those securities into the market. Soon, the RFC had loaned $425 million to the United Kingdom. An interest rate of 3 percent was charged for these loans. Lend-Lease The Neutrality Act of 1937 required cash-and-carry for purchases of goods in America. This meant that the purchase of war materials by belligerents had to be made in cash and the goods had to be carried away from American ports in the belligerents own ships. The cash-and-carry provisions of the Neutrality Act prevented credit being extended from the United States Treasury or from private bankers in the United States, which was quite different from the situation in World War I. These constraints required President Roosevelt to demand cash in payment for goods from Great Britain before Congress began loosening those restrictions. Roosevelt sent a United States naval ship to Cape Town, South Africa, to collect $50 million in British gold reserves. Churchill described this act as having the aspect of a sheriff collecting the last assets of a helpless debtor. There was cause for his concern. Britains reserves were proving inadequate to support its defense purchases. Roosevelt arranged in September of 1940 for the exchange of a group of outmoded destroyers for British naval bases. In January of 1941, Roosevelt sought passage of legislation that would allow him to transfer war material to Great Britain without requiring immediate payment for those shipments. This unique financing tool was the lend-lease program, which was instituted in March of 1941. Roosevelt used the symbolism of a garden hose to explain to the American people why it was necessary to loan the British war materials that would be used to defeat the Nazi menace. Under his proposed lend-lease program, any unused materials were to be returned to the United States after the war. President Roosevelt described the lend-lease program as follows:
Now what I am trying to do is to eliminate the dollar sign . . . the silly foolish old dollar sign. All right! . . . Suppose my neighbors house catches fire, and I have a length of garden hose four or five hundred feet away. If he can take my garden hose and connect it up with his hydrant, I may help him to put out his fire. Now what do

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I do? I dont say to him before that operation, Neighbor, my garden hose cost me $15; you have to pay me $15 for it. What is the transaction that goes on? I dont want $15, I want my garden hose back after the fire is over. . . . In other words if you lend certain munitions and get the munitions back at the end of the war, . . you are all right.

The Lend-Lease Act was funded with an initial appropriation of $7 billion. Eventually, $60 billion was spent under this program. A total of thirty-eight countries received lend-lease assistance, but England received the bulk of itsome $27 billion. Winston Churchill described lend-lease as the most unsordid act in the history of any nation. Ironically, the first lend-lease shipment to England included 900,000 feet of fire hose. The United States made gold purchase agreements with the Soviet Union in 1942 for over $60 million to finance the sale of war materials. The Soviet Union was a beneficiary of lend-lease, receiving some $10 billion in aid under that program.
By 1944, the United States had shipped to Russia over 5,000 tanks and tank destroyers, almost 200,000 trucks, 36,000 jeeps, almost 30,000 other military vehicles, large numbers of freight cars and locomotives, 850,000 miles of telephone wire, 275,000 field telephones, some 7 million pairs of boots, 2.6 million tons of food and 800,000 tons of wheat. The United States supplied the Soviet Union with two-thirds of the motor vehicles and one-half of the planes being used by the Soviets in the war. In 1943, over 5,000 fighter planes were sent to Russia by the United States. In total, almost 9,000 planes were sent to Russia. The allies, mostly America, provided the Soviets with cloth for 3 million uniforms, and $3 billion worth of machinery, including several complete factories.3

Commodity Trading The Secretary of Agriculture required the commodity exchanges to set price limits on grain futures in May of 1940. These limits sought to retard declines in prices. Such action was thought necessary because wheat prices in Chicago had fallen after Germany invaded France. Unlike other catastrophes, Pearl Harbor did not disrupt the commodity markets. On the evening of Sunday, December 7, 1941, the Commodity Exchange Authority (CEA) called exchange officials and asked them to take whatever actions they thought would be necessary to deal with that crisis. Some commodities hit their price limits when trading opened, and ceilings were imposed on other commodities, but then prices stabilized. The CEA later sought to restrict speculative commodity trading by imposing price ceilings on futures transactions and by having the exchanges increase margin requirements. The exchanges were asked to report to the CEA on measures to prevent excessive speculation as a result of the war. Later, the Secretary of Agriculture asked that futures trading in grain futures be suspended when prices reached specified levels. The exchanges agreed to this request. Ceiling prices were placed on corn in January of 1943, and the Mercantile

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Exchange in Kansas City suspended its futures trading on June 15, 1943, as a result of price controls. The ceiling prices resulted in black market trading, tie-in sales, and reciprocal trade practices that were designed to avoid or evade those ceilings. As other commodities were added to those with ceiling prices, they too became the subject of black market practices. Trading was suspended in lard, soybeans, cottonseed meal, and soybean meal because of shortages. Soybean oil, butter, and tallow stopped trading for a time, and there was little trading in corn. Rye was not subject to price controls during World War II, and it became a target of speculation by Daniel F. Rice, the leader of a group that included the General Foods Corporation. They controlled 12 million bushels of rye, which was almost 90 percent of the deliverable supply. The War Food Administration charged General Foods Corporation and five members of the Chicago Board of Trade, including its former president, with cornering and manipulating the rye market. Those respondents were suspended from trading in the futures markets, but the case was later dismissed by a federal court. It was found that the defendants activities had been designed to stabilize prices rather than to manipulate them. It was later claimed, however, that Rice had been actually been attempting to corner the market and that he buried the corpse by using congressional influence to sell rye abroad.4 The CEA brought charges against other traders for manipulating the wool tops market during the war. Prices for butter and eggs were set during World War II by the Office of Price Administration (OPA). Trading was conducted on the exchanges in those commodities up to their support levels. The CEA was given authority to conduct investigations for the Navy Department during the war to determine if there were illegal foreign holdings in commercial houses and whether trading was occurring by foreign nationals through blocked accounts. The CEA took surveys for the Office of Price Administration and examined the markets for unwarranted trading that could affect prices adversely. Financial Effects of the War Before World War II, Dutch administrative offices had issued bearer certificates against shares of American corporations that were held in the name of the Dutch office. The bearer certificates were then traded on the Amsterdam Stock Exchange. Delivery of the underlying American securities could be obtained in New York upon surrender of the Dutch certificates. Difficulties arose in trading these securities when the Netherlands was occupied by the Germans and restrictions were imposed on the assets of that country. Oddly, the bombing of Pearl Harbor did not cause a very sharp reaction in the stock market. The Dow Jones Industrial Average dropped some four points after that attack, less than 4 percent of the average. The Dow drifted down to just under 93 by April of 1942, but it then began a recovery. The NYSE delisted securities of corporations in those countries against whom war was declared

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in 1941. The NYSE also lost its leader to the war when William McChesney Martin, the president of the NYSE, joined the army. The manufacture of private automobiles was stopped in 1942. Automobile production gave way to the assembly of war machines. This resulted in a $1.5 billion drop in outstanding automobile loans. Credit unions were hurt after the Fed passed Regulation W, which restricted consumer credit. This regulation set minimum and maximum amounts for down payments on consumer goods. Food supplies were another problem. The War Food Administration was created in 1943 to assume overall responsibility for the distribution of food in America. Food and scarce commodities were rationed for consumers. Sugar and coffee were in particularly short supply during the war, as surplus turned to want. OPA was given responsibility for rationing and price controls. OPA set rent ceilings, and it worked with the Department of Agriculture to set farm prices. OPA also established meatless days and distributed ration books and tokens that the public could use to purchase items. The ration books restricted purchases of specific commodities. For example, War Ration Book Number 2 rationed canned goods and meat. War Ration Book Number 3 added additional commodities and clothing to those being rationed. A number of professional counterfeiters were counterfeiting ration coupons. Ceiling prices for consumer goods were set at the highest price charged for goods in March of 1942. Some citizens avoided these controls and a massive black market was soon operating. Despite rationing and competing war demands, food production in the United States increased during the war. Government Finance The federal government intervened throughout the economy as the war progressed. It guaranteed loans to small companies in order to provide them with working capital. After Pearl Harbor, the Fed and the Treasury agreed to support the price of long-term Treasury bonds in order to keep their yield from rising above 2.5 percent. This was designed to reduce government financing costs. The Fed set the three-month Treasury bill rate at 0.37 percent. Longterm United State government bonds were returning an average of 2.3 percent at the end of the war. The Fed was able to maintain interest rates at such artificially low levels by purchasing government bonds in the market whenever their prices fell. Government bond dealers agreed to limit price changes in government bonds to one quarter point per day. This was intended to stabilize the market. The reduction in government interest rates carried over into the private money markets. The prime rate was about 1.5 percent during World War II. The reduction of interest rates as a result of government intervention brought about refunding of higher-paying loans on a large scale that grew in volume as interest rates continued their decline. The Fed was starting to show some signs of independence. It recommended several measures to curb inflation in 1941; the Fed wanted to end the presidents power to devalue the dollar.

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During the war, the United States Mint produced zinc-coated steel pennies to reduce demand on copper. The Emergency Coinage Act allowed for other wartime shortages. Silver nickels were used instead of actual nickel because nickel was needed for the war effort. Coins were made from used shell casings in 1945. The government sold savings stamps in small denominations that ranged from ten cents to five dollars. Some $1.7 billion of these stamps were issued during the war, many of which were exchanged for savings bonds. The Treasury Department was offering Series A through D bonds between March of 1935 and May of 1941. It began selling tax savings notes in August of 1941. These instruments paid interest and could be used to save for tax payments. Treasury notes paid a coupon rate and matured in from one to five years. Treasury bonds that matured between five and twenty-five years were sold. These instruments paid a coupon rate and were callable after a specified period of time. For example, a bond maturing in ten years could be called in eight years. The federal government began issuing Series E United States government bonds in May of 1941. These were nontransferable appreciation bonds that were sold to individuals. The amount that could be purchased was limited to $3,750 per person. They were sold in denominations of $25, $50, $100, $500, and $1,000. These bonds were actually an early form of zero coupon bond. They sold on a discount basis and did not pay a coupon interest rate. The bonds matured in ten years and were discounted by 25 percent. Series E bonds were redeemable on demand after sixty days. The redemption price varied depending on the length that the bonds were held. These bonds yielded about 2.9 percent if held to maturity. Series F appreciation bonds were another fundraising measure employed by the Treasury. These bonds matured in twelve years and returned 2.53 percent interest. Series F bonds were sold at 75 percent of their face amount. They were redeemable on demand after six months. These bonds could be purchased by anyone except commercial banks. The amount that any one investor could purchase was limited to $100,000. Their denominations varied from $100 to $10,000. The Series G bond was another security offered by the government to raise funds. These were current income, registered, nontransferable bonds sold in denominations ranging from $100 to $10,000. The Series G bonds matured in twelve years and paid a rate of 2.5 percent. They were redeemable before maturity. The NYSE focused its efforts on selling government bonds during World War II, and war bonds were sold by the banks. Chase National Bank noted that commercial banks throughout the land, answering a new call, are offering their serviceswithout compensation properto further the sale of United States Defense Bonds.5 Some of the certificates issued by the War Finance Committee for loans were decorated with Walt Disney characters. War bonds were sold on the basis of patriotism, rather than their rate of return. The bonds were promoted by cinema newsreels and widespread advertisements that were often paid for by corporate sponsors. Bond drives were another means used to

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sell these loans to the public. Movie actors and war heroes were used in those drives. In one sixteen-hour program on September 21, 1943, singer Kate Smith sold $40 million of war bonds. Newspaper advertisements urged Americans not to cash their war bonds. They were told that soldiers were sacrificing their lives and that cashing war bonds was unpatriotic. People were able to borrow against their government bonds in order to purchase additional bonds. Auctions of scarce goods were held to attract war bond sales. There was criticism, however, that these auctions were being used as a black market. It was claimed that rich individuals were able to obtain nylon hose, hams, Scotch whisky, and cigarettes in those auctions, while people with lower incomes had to do without. War Loans Eight major defense loans were floated by the federal government during World War II. They included seven War Loans and a Victory Loan. Banks participated in the first two of those loans. News of the Bataan death march, which had been withheld by the federal government for two years, was announced on the eve of the Fourth War Loan in 1944. Sales nearly doubled. The Fifth War Loan drive sought to raise $16 billion in 1944. It was needed. War spending was reaching $6 billion a month in April of 1943. In the first three months of 1944, war costs exceeded $23 billion. Americas total war expenditures would be twice the amount spent during the previous 150 years in the United States. War production in the United States was double that of the Axis powers (Germany, Italy, and Japan). The Sixth War Loan sought to raise $14 billion in 1944. The Seventh War Loan began in May of 1945. Included in the issue were 2.5 percent bonds that were to mature in 1972. A Wall Street broker-dealer pledged to sell $1 billion of the Seventh War Loan, which was used to build B-29 bombers. Although minuscule in terms of todays economy, the amount of the bond sales during World War II was staggering when viewed in the context of a deflated economy recovering from the deepest and longest depression in its history. Government bond sales during World War II totaled over $150 billion. The Treasury sold over $5 billion in securities in one five-day period in December of 1942. The total amount of the Series E through G bonds that were outstanding at the end of the war exceeded $45 billion. Wartime Taxes Merchant shipping tonnage was increased dramatically after Pearl Harbor and soon outstripped losses from Nazi U-boats. One hundred warships were completed in the first five months of 1943. A total of 2,742 Liberty ships were built during World War II. Production in other areas grew equally fast. Three times as many artillery pieces were produced in May [1943] as in all the 18

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months of the first World War.6 Franklin Roosevelt had been met with skepticism in May of 1940 when he declared that he wanted America to produce 50,000 planes a year. Just over 2,000 planes had been produced in the prior year. As it turned out, the president had actually understated the production capabilities of American industry. On June 1, 1943, the United States announced the completed production of 100,000 war planes. Some 300,000 more airplanes would be added to that number before the war ended. The Ford Motor Company was producing one bomber each hour at its Willow Run factory. Another firm benefiting from the growth of the economy during the war was the International Business Machines company. It had revenues of almost $120 million in 1945. By June 30, 1945, the cost of World War II had exceeded $1 trillion. Almost one-third of that amount was contributed by the United States. Annual defense expenditures were over $80 billion by that year. Government spending tripled between 1941 and 1942, growing to over $300 billion between 1941 and 1945. The national debt of the United States stood at less than $60 billion in 1940 and was largely the result of New Deal social programs. That deficit increased to over $250 billion in 1945. The deficit was met principally by borrowing money from the public and the banks. Beginning in 1940, tax measures were adopted that increased income tax rates so that these enormous bills could be paid. Dividends had to be reported to the government, and estate and gift taxes were increased. At war end, tax rates were as much as 91 percent for individuals with incomes over $200,000. To make sure there were not too many of those individuals, salaries were limited to a maximum of $25,000 annually in 1942. The Revenue Act of 1942 established an excess profits tax. Contractors had their books audited and any excess profits had to be given to the government. Corporate rates on other income were raised to 40 percent, and a 5 percent surcharge called a victory tax was added. By 1942, government taxes were taking two out of every three dollars earned by corporations. Corporate tax payments increased to over $16.4 billion by 1945. The number of individuals paying income taxes and filing returns increased from about 4 million in 1939 to over 40 million in 1945. Congress adopted a withholding requirement on wages and salaries in order to speed tax payments. The Current Tax Payment Act of 1943 required withholding on employees wages, and quarterly tax payments were mandated for individuals who were not on salary. This pay-as-you-go withholding was a new concept for American taxpayers. This scheme was fostered by Beardsley Ruml, who had served as treasurer of R.H. Macy & Co. and chairman of the New York Federal Reserve Bank. Ruml knew that customers did not like big bills and that they preferred installment payments. Ruml believed that having employers collect taxes for the government would avoid the political problem of requiring taxpayers to write large checks from their own accounts for taxes. Taxpayers were further encouraged to pay taxes by Irving Berlin, who was commissioned to write a song entitled I Paid My Income Tax Today. It

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appealed to the patriotism of Americans to support the war effort by paying their taxes. About 45 percent of the over $300 billion spent on the war was paid from taxes. Employee health benefit plans were aided in 1942 by the Stabilization Act, which restricted wage increases but permitted employee benefits such as health insurance. Pension fund assets increased by over 400 percent in the 1940s. This growth was further spurred by wage increases and tax breaks for pension fund contributions. Such benefits were exempted from wartime wage freezes. Increased numbers of women were brought into the workforce as the war progressed. The number of employed women increased by some 6 million during the war. In 1943, as the result of wartime shortages in personnel, Helen Hanzelin became the first woman to work on the floor of the NYSE in its 150year history. Many more women were hired on the NYSE floor as the war continued. In London, women were allowed on the trading floor during World War II, but they were discreetly veiled behind a screen.7 After the war, the women on the floor of the NYSE were replaced by men. Women would not return to the floor for more than twenty years. Securities Markets The headquarters of the SEC was moved from Washington, D.C., to Philadelphia during World War II because the SEC was deemed a nonessential agency. With no important role during the war, the SEC faced opposition as a result of a resurgence of the Republican Party, which opposed government regulation. Many of the SECs best staff members departed, as well as several commissioners. The SEC did propose regulations requiring broker-dealers to file annual financial reports in 1942. The agency had modified its net capital requirements in 1939 for brokerage firms by reducing the minimum aggregate indebtedness to capital ratio from 2,000 to 1,500 percent. Restrictions had been placed on the amount broker-dealers could borrow on customer securities in 1941. The SEC voted to abolish floor trading on the exchanges in 1945. The SEC was particularly concerned with those traders activities on the NYSE. However, the SEC had to withdraw that proposal under political pressure. The NYSE announced during the war that it would allow floor trading in inactive stocks and units of less than a round lot. This was done in order to compete with the over-the-counter market and was a reflection of the fact that stock market activity was light throughout World War II. In 1939, average daily trading volume on the New York Stock Exchange had been less than 1 million shares. That volume dropped to 751,000 shares in 1940 and then to 455,000 shares in 1942. Broker loans were reduced to less than $500 million in 1942. The Dow Jones Industrial Average was still below one hundred in April of 1942. In 1942, a NYSE seat sold at the lowest price in the twentieth century$17,000. On March 1, 1943, Bodell & Co. announced that it was suspending its retail securities business as a result of wartime conditions.

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In May of 1943, the president of the NYSE, Emil Schram, declared that securities markets in the United States would be greatly expanded after the war by the listing of securities of foreign corporations that would be formed by American investment bankers. In the meantime, the underwriting business was slow as stock offerings dwindled. Goldman Sachs capital in 1944 was less than $7 million. J.S. Bache & Co., which had been formed before the turn of the century, changed its name to Bache & Co. after its founder died in 1944. An even greater financial giant died the year before. Jack Morgan was seventy-five at the time of his death. In 1942, J.P. Morgan & Co. sold its shares to the public for the first time. Federal tax policies were claimed to have eliminated the individual investor from the market. The result was the increased use of private placements of securities offerings with insurance companies and savings banks. Although diminished, some underwriting activity continued. In July of 1943, Kidder, Peabody & Co. sold $250,000 in Pennsylvania Railroad general mortgage series C, 3.75 percent bonds that would mature in April of 1970. The bonds were legal investments for savings banks and trust funds in New York State. Merrill Lynch, Pierce, Fenner & Beane, the firm of Hemphill, Noyes & Co., and others were joint underwriters in a 100,000-share offering of the First National Bank of Portland, Oregon, in 1943. Salomon Bros. & Hutzler underwrote first mortgage bonds for the Pennsylvania Electric Company. Bear, Stearns & Co. was an underwriter in an offering of $25 million of Central Power and Light Company first mortgage bonds that were paying just over 3 percent. The American Tobacco Company floated a $100 million securities issue in 1942. In 1943, the Pennsylvania Railroad had over 200,000 stockholders who had an average holding of about sixty-three shares. Otis & Co. sued the Pennsylvania Railroad in 1944, claiming that the railroad had improperly sold bonds to Kuhn, Loeb & Co. at a price of one hundred, even though Otis & Co. had offered 102. It was claimed that this was a breach of duty to the shareholders, which included Otis & Co. Wertheim & Co. was selling securities for Corning Glass Works, Mohawk Rubber Co., and H.H. Robertson Co. in 1945. An underwriting syndicate composed of several leading investment firms, including Shields & Co., Tucker, Anthony & Co., and Reynolds & Co., conducted an $18 million offering of Texas Electric Service Company first mortgage bonds in 1945 that paid 2.75 percent interest and were due in 1975. Kitchen & Murphy was a member of the Chicago Stock Exchange. Banking Activity The Industrial Advances Act was passed in 1944. That legislation allowed banks to make five-year loans to businesses and to discount those loans to the Fed. The banks remained liable for up to 20 percent of any loss so discounted. This did not generate very many loans. Nevertheless, the banks were providing a great deal of commercial credit to war manufacturers. RCA obtained a

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$60 million, three-year credit from the Bankers Trust Company and a syndicate of thirty-four other banks in 1942. Emerson Electric Company received $30 million in credit from another banking syndicate. Sunray Oil engaged in a private placement for $4.5 million in five-year notes with a group of commercial banks and insurance companies in August of 1942. Eastman, Dillon & Co. handled this transaction. A group of twenty-three commercial banks made a $75 million credit available to Seagrams in February of 1944 to provide working capital and to allow the company to purchase Frankfort Distilleries. In August of 1945, Standard Oil Company of New Jersey arranged a $50 million loan from a group of banks at an interest rate of 1.75 percent, a rate believed to be the lowest ever set for industrial bank borrowing.8 Mutual savings banks held deposits of almost $12 billion in 1944. These institutions operated in seventeen states and had over 15 million depositors. About 4,000 branch offices of commercial banks were conducting business in 1945. The Federal Deposit Insurance Corporation announced in 1945 that fewer banking difficulties were recorded during the war than at any time in the nations history.9 Banks were acting as underwriters in municipal securities offerings since they were not barred from that activity by the bank laws of the 1930s. President Roosevelt authorized so-called Regulation V loans that were guaranteed by the Federal Reserve banks and made through banks, the RFC, and other financial institutions in order to finance government contracts. Term loans had become popular in the 1940s. Previously, ninety-day, self-liquidating loans . . . had long been the bread and butter of banking.10 In practice, the ninety-day loans had acted as long-term loans because they were simply rolled over for borrowers until liquidated. The National City Bank required corporations receiving loans to maintain compensating balances at the bank. This had the effect of reducing the amount of the loan and increasing its cost. A new business of the banks during World War II was the safekeeping of war bonds. International finance was curbed during World War II, but the groundwork had already been laid for postwar expansion. The National City Bank had over forty branches in Latin America alone when war broke out. The Chase National Bank loaned the federal government over $8 billion during the war. This did not prevent the government from accusing Chase of releasing funds during the war to blocked accounts that the government thought were doing business with Germany in industrial diamonds. The bank was acquitted after a trial. In the meantime, Chase lost its position as the countrys premier bank. It fell behind the Bank of America and the National City Bank. The Bank of America became the largest commercial bank in the world in October of 1945, with some $5 billion in assets. Insurance Business Between 1932 and the end of World War II, accumulated savings through life insurance companies constituted the largest single form of institutional sav-

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ings. However, that trend was changing. Other institutions such as S&Ls and mutual savings banks and mutual funds were providing competition. The insurance industry faced other challenges. In 1944, the Supreme Court held in United States v. South-Eastern Underwriters Association that insurance companies were subject to the antitrust laws.11 In that case, two hundred insurance companies were held to have violated the Sherman Antitrust Act by forming the South-Eastern Underwriters Association to control the fire insurance business and by discriminating and retaliating against insurance companies that were not members of their association. After the Supreme Courts decision, insurance companies became concerned that they would not be able to pool their loss statistics and to jointly compute actuarially sound premiums. The states were concerned that the antitrust laws would preempt state regulation. Some insurance companies refused to comply with state insurance laws on that ground. Congress responded to those concerns by passing the McCarran-Ferguson Act in 1945 to grant the insurance companies immunity from federal antitrust laws to the extent that the companies were regulated by state law. This almost completely exempted the insurance industry from federal regulation. This approach was diametrically different from that taken in the securities industry, where the federal government shared control with the states but had the overriding authority for regulation. Only in future years, when insurance companies started selling securities like products, would there be an effort to reassert federal control. Another force in the insurance industry appeared during World War II with the creation of the Kaiser Permanente Health Plan, offered by Kaiser Steel. It would become a troubled model for health care in America as the century closed.

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2 After the War

Demobilization The approaching victory in Europe raised concerns that, once the war ended, massive unemployment would recur in the United States. Forecasts of the number of people who would be made redundant by a return to peace ranged as high as 18 million. There were grounds for those concerns. Some 12 million soldiers and wartime employees were to be demobilized, and the employment of millions of others in the production of war materials would be ended. Although those figures caused visions of another depression to loom large, there was another side of the coin that created conflicting concerns. Savings rates had increased dramatically during World War II, reaching a level of some 25 percent of national income. In 1944, Americans saved $35.9 billion. In 1940, they had only been able to save $4.2 billion. These increased savings, and pent-up war demand, posed a danger that another speculative bubble would arise once wartime controls on the economy were lifted. Government policy was initially based on the assumption that depression would be the most likely effect of peace. The Revenue Act of 1945 reduced taxes in order to pump more funds into the economy. Excess profits taxes and the capital stock tax were dropped. The Employment Act of 1946 went even further by establishing a national policy of promoting maximum employment, production, and purchasing power. This legislation created the Presidents Council of Economic Advisors, which was directed to report on the state of the economy each year. The governments fear of a renewed depression seemed justified at first. Some 12 million people who had paid taxes in 1945 were taken off the tax rolls in 1946 as war production shut down. The number of business failures had dropped substantially during the war, but rose quickly when the war concluded. The RFC was allowed to resume private sector lending as the war ended. A number of the loans made by the RFC during this period went into default, which suggested another economic decline. Several railroads, includ269

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ing the New Haven, Missouri Pacific, Rock Island, St. Louis Southwestern, St. LouisSan Francisco, International Great Northern, and Gulf Coast Lines, went into bankruptcy in 1946. Postwar Boom These events caused the economy to contract briefly in 1946, but it then began to surge as the savings of the American public and its returning soldiers were pumped into the economy. Spending was furthered by the dropping of the restraints on consumption imposed by the war. Most price controls ended in June of 1946, but Congress extended some restrictions, including those on beef. Ranchers then withheld animals from the market until the controls were lifted. Wartime restrictions were eased on retail charge accounts and single payment loans, as well as installment purchases. Controls were maintained on credit for automobiles, radios, and household appliances, but consumer spending for those items and furniture still rose by 80 percent in 1946. This demand helped push up consumer prices by over one-third over the next two years. Businesses began to increase their spending to meet consumer demands, which further fueled inflation. The Committee for Economic Development was formed during World War II by business groups who advocated that the government incur deficits in order to moderate the effects of economic downturns. Their leader was Herbert Stein, who would later become the chairman of President Richard Nixons Council of Economic Advisors. Although there was concern that left-wingers would dominate President Harry Trumans first Council of Economic Advisors, the economists on that panel were advising the president that inflation was posing a threat to prosperity. The council was right to be concerned. Prices increased by more than 200 percent during the 1940s. Between June 1946 and December 1947, wholesale prices rose by some 45 percent. Prices were increasing at a rate of 14 percent annually in 1947. By then, inflation had cut purchasing power in half from that of 1939. In August of 1947, Congress issued a joint resolution that authorized the Fed to resume controls on consumer credit. A sharp increase in installment credit resulted in another joint resolution seeking further controls over consumer credit. The Fed then readopted Regulation W, which had been used to impose credit controls during the war, but it was only temporary. Controls on installment purchases were ended in November of 1948. Other controls were dropped in June of 1949, but Congressman Wright Patman of Texas was still seeking to extend the maximum time for installment purchases for automobiles from eighteen months to twenty-four months in 1949. Speculation Resumes Continuing inflation soon raised government fears that another speculative bubble was developing, such as that experienced in the 1920s. The Dow Jones

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Industrial Average was at 142 on D-day, June 6, 1944. It reached 152.83 on January 1, 1945. One year later it had risen to 192.65. Margin requirements on stock transactions had been reduced to 40 percent from 55 percent in November of 1937. To forestall speculation, the Fed increased margin requirements for securities to 50 percent on February 2, 1945. Five months later, on July 5, 1945, the Fed increased those requirements to 75 percent. On January 21, 1946, the Fed raised stock margins once again, this time to 100 percent. The Dow Jones Industrial Average went to 212.50 before it plunged to 163.12. The market drop was blamed on the Fed, and the Feds action in raising margins enraged the NYSE. Its president, Emil Schram, sought, unsuccessfully, to have Congress restrict the power of the Fed to set margins. Schram charged that the margin increases had only diverted speculation into commodities and real estate. Congressman Adolph Sabath demanded an investigation of the break in stock prices, but the SEC concluded that the market drop was not caused by manipulation. The SEC did require broker-dealers to file reports on their financial condition in 1946. The SEC stated that this was a precautionary measure taken as a result of the recent decline in the market. Speculators did indeed turn to the futures markets. Commodity futures trading enjoyed record volume after the war. That trading was stated by the CEA to be the result of excessive speculation. Commodity speculators initially focused on the cotton futures market, where the lifting of price ceilings on cotton resulted in large price increases. On October 31, 1946, cotton futures increased by $10 a bale. The stock market rallied when the commodity market jumped, but cotton prices collapsed in the following month when small speculators trading on margin were forced to liquidate. This rise and fall in prices was said to have constituted one of the largest price movements in the history of the cotton markets. That price break was accelerated by the sales of the positions of large speculators. The principal culprit in this affair was Thomas Jordan. His speculation led to a worldwide crash in the commodities markets. The resulting panic caused the temporary closing of the New York, Chicago, and New Orleans Cotton exchanges. Chester Bowles, the head of the OPA, required margins for new speculative cotton futures to be $50 a bale after the market collapse. Before the OPA action, margin requirements on the futures exchanges where cotton was traded ranged from $5 to $15. Speculation in the futures markets continued, reaching a tremendous volume in 1947. In February and March of 1947, unusual speculative activities occurred in the Chicago wheat futures market. One speculator had sold short some 1 million bushels of July wheat and made a large profit. Corn prices increased thirty cents a bushel in August of 1947. On September 30, 1947, the Secretary of Agriculture complained that margin requirements on the Chicago, Kansas City, and Minneapolis exchanges were inadequate to control speculative excesses. The CEA sought increases of margin to 25 percent. Two of the exchanges agreed to that request. Later in 1947, the CEA again asked the exchanges to increase their margins to one-third of the futures contract

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price. The exchanges increased their margins slightly but not to that level. President Truman, who kept a sign on his desk reminding everyone that the buck stops here, announced that gambling in grain was contributing to higher food prices. He charged that 90 percent of corn futures accounts were speculative. The president demanded an increase in margins to one-third of contract prices, as requested by the Secretary of Agriculture. If that increase was not forthcoming, the president threatened to have the government curb the amount of trading that could be engaged in by individuals in the markets. The exchanges then agreed to increase their margins. The CEA discovered that the Dairymens League Cooperatives Association of New York was manipulating spot butter prices in 1947 in order to increase fluid milk prices, which were set on the basis of grade A butter prices under the Agricultural Marketing Act. The league had bought 97 percent of the butter sold on the exchange during a five-day period in order to peg prices at eighty-four cents. After the league stopped trading, prices dropped to seventy-four cents. Another manipulation occurred in the December 1947 egg futures contract on the Chicago Mercantile Exchange. A wave of grain speculation in September of 1947 caused President Truman to further criticize speculators who were gambling in grain. The president stated that grain prices should not be subject to the greed of speculators who gamble on what may lie ahead in our commodity markets. These charges were made in the first televised broadcast from the White House. The Truman administration made public the names of traders holding more than two million bushels of futures contracts. The Secretary of Agriculture released a list of 711 large traders in the futures markets, thus embarrassing many of those individuals. Trumans Attacks on Speculators Harry Truman continued his attacks against the speculators in the presidential election campaign of 1948. Like Franklin Roosevelt, he was running against the money changers. Truman charged that commodity traders were merchants of human misery. These charges irritated Trumans political opponents, and they responded with their own accusations. Harold Stassen claimed that Truman administration officials were using inside information on government policies to profit in the futures markets. Congress then passed a joint resolution requiring the publication of the names of the traders, which the CEA had refused to divulge. The names of Ed Pauley, Harry Trumans personal physician, and General Wallace Graham, a Truman crony, were on that list. Pauley confessed that he had made almost $1 million in three years of trading on the futures markets. He denied using any inside information, but resigned from office. Wallace Graham claimed initially that he had lost his socks in trading commodity futures but later admitted he made a $6,000 profit on an investment of $5,700.12 He was engaging in these speculations at the time that Truman was denouncing the grain speculators.

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A select committee of Congress found in 1948 that confidential government information had been used to profit from commodity futures transactions. A leak of government buying policies was used to speculate in lard. Two former highly placed government officials were trading in that commodity. Unusual trading in lard by a small company in southern Indiana was uncovered. The Indiana company had begun to trade lard while the government was considering its purchasing program. This company had never traded before, but made a profit of $62,000 on these transactions. The select committee believed that this fortuitous one-time profit was due to inside information. Congress also found a premature disclosure of the governments decision to increase its fats and oils allocation for export in 1947. This information was leaked to an employee of the Institute of Shortening Manufacturers a day before the official release of this information. The committee could not determine whether that official traded on the information, but lard prices did increase before the announcement of the governments purchases. Another congressional investigation that examined transactions in commodities between July of 1946 and June of 1948 found other problems. A large number of nonresident aliens were trading in the markets, apparently because of special tax advantagesthat is, they were not required to pay taxes on their profits. President Roosevelt had recommended in April of 1937 that government employees should be prohibited from commodities speculation, but his warning was ignored. Congress found that between 1946 and 1948 some 900 government employees were trading in the futures markets, including about 100 employees who were trading in wheat. One clerk in the Navy Department was speculating in 1.7 million bushels of wheat, 285,000 bushels of corn, 720,000 bushels of oats, 50,000 bushels of rye, 270,000 pounds of lard, 1.5 million pounds of cottonseed oil, 35,500 bales of cotton, and forty-eight carloads of eggs. The employees salary was about $3,300 per year, while the value of the commodities in which she was trading exceeded $10 million. This employee realized substantial profits. The deputy petroleum administrator, who later became the assistant to the Secretary of the Army, traded large amounts of wheat, corn, oats, barley, lard, cottonseed oil, and cotton. Four members of his family were trading as well. An employee in the Interior Department who was serving as petroleum coordinator was trading in large amounts of wheat, corn, oats, cottonseed oil, eggs, and cotton. The wife of an attorney in the General Accounting Office was a large trader in wheat, corn, oats, lard, and cotton. An IRS employee was trading large amounts of wheat, corn, oats, and rye. An officer in the United States Army and members of his family were trading sizable amounts of those commodities and lard, cotton, and eggs. The congressional committee estimated that the federal employees who were engaged in speculative commodity trading received a net profit of $10 to $20 million.

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Expanded Trading The Chicago Mercantile Exchange added livestock and frozen meat futures to its contracts in 1947. The New York Mercantile Exchange had begun trading futures in potatoes before the assault on Pearl Harbor. Volume in that contract was slow during the war years but grew substantially in 1946. Thereafter, potatoes became the most important commodity traded on the New York Mercantile Exchange. That exchange began trading in onion futures in 1946. Onions had been added to the Chicago Mercantile Exchange in September of 1942. Those two commodities, potatoes and onions, would in future years be prime targets for speculators and manipulations. Problems continued in the futures markets. On August 31, 1948, hide futures prices dropped on the New York Commodity Exchange. Concern was expressed that Argentina would be exporting large numbers of hides into the United States at reduced prices. A sharp drop in wool top prices occurred in March of 1949. A large break in grain prices occurred in February of 1949. It was caused by liquidation of a group of small traders accounts when the market began to drop. A subsequent investigation by the CEA concluded that, [w]hen people enter a speculative market with only a small part of the total value of the commodity put up as margin, the tendency is to acquire the largest position possible with the funds at hand. With any considerable decline in prices, traders of limited financial resources are forced to withdraw from the marketor be sold out. When this happens to a substantial number of traders a further sharp break in prices is the inevitable result.13 In 1949, the Department of Agriculture published a study of trading by small speculators in grain futures between 1924 and 1932. Most nonprofessional traders were long in the market rather than shortthat is, they were buying instead of selling. The study found that the majority of small speculators lost money in grain futures. Their net losses were some six times their net profits. The principal reason for those losses was the small speculators characteristic hesitation in closing out loss positions. These traders failed to cut their losses and let their profits run. Instead, they did just the opposite.14 A bright side to this picture did exist. Farm income rose substantially in the 1940s, tripling in one five-year period in the 1940s. As a result, farmers were able to substantially reduce their mortgage debt during World War II. The export of 1.2 billion bushels of wheat from the United States between July of 1946 and June of 1948 was found to have caused scarcity and high prices for grains and feed stocks, which was beneficial for farmers, if not for consumers. Congress was seeking parity for farmers crops after World War II. Parity was a price that theoretically gave farmers what they had received for their crops between 1909 and 1914, as adjusted by inflation. Federal wheat loans were still being offered by the government. In 1945, those loans were based on wheat as security with a value of $1.38 a bushel. In that year, the government had to extend its 1944 loans on all wheat because it was unable to

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accept delivery, having neither the transportation nor storage space. Silver returned to Congress as an inflationary tool. Legislation passed in 1946 required the Treasury to buy silver at ninety and a half cents an ounce and allowed the Treasury to sell the silver that it owned. This legislation increased the price of silver by 27 percent. It was hoped that this would stimulate the production of that metal. The Treasury was selling silver to industrial users at ninety-one cents an ounce in August of 1946. The government continued to change its priorities, as inflation and speculation replaced fears of depression. The life of the RFC was extended in July of 1947, but the operations of the agency were greatly restricted. The RFC was allowed to make loans to businesses and financial institutions only when there was reasonable assurance that the loans would be repaid and when credit could not be obtained on reasonable terms from other sources. The RFC was authorized to make emergency loans in response to disasters. The RFC seemed to have difficulty fulfilling a meaningful role under those restrictions. Among other things, it was planning to loan $2 million to finance Washingtons sesquicentennial celebration in 1949. A congressional report issued in 1951 was critical of the RFC, claiming that its loans were being made through favoritism and improper influence. The IMF International finance and trade were receiving attention. An International Monetary and Financial Conference was held at Bretton Woods, New Hampshire, in 1944. Attended by forty-four nations, the conference adopted the Bretton Woods Agreement, which would be the basis for international monetary stabilization over the next several years. This plan had actually been formulated in debates before the conference between economist John Maynard Keynes in England and Harry Dexter White, Assistant Secretary at the United States Treasury and a secret agent of the Soviet Union. Keynes had advocated an International Clearing Union that would have more centrally controlled currencies around the world while White sought a more limited stabilization fund. Whites effort to create a new international monetary system at the Bretton Woods conference was strongly opposed by the American banking community. At the center of this new world order was the International Monetary Fund (IMF), which was to act as an international monetary authority that would stabilize currency exchange rates among members. The plan was to have subscribing nations set a par value for their currencies and to maintain that value within one percentage point. Par values were to be changed only after approval by the IMF. The Bretton Woods Agreement designated the dollar as the benchmark for exchange rates. This meant that participating currencies were exchangeable at set ratios (par) to the American dollar. The entire plan was backed by a U.S. promise to pay for its dollars in gold at $35 per ounce. This restriction

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was intended to keep the United States from inflating the dollar, and it meant that the dollar was backed by gold. This arrangement placed most of the world back on a gold standard. The United States had plenty of gold to back its dollars, since it held over 60 percent of the worlds gold reserves after the war. The IMF was given authority to protect its members from temporary deficiencies in their hard currency reserves that would affect their ability to maintain their currency at par. The IMF provided this protection by making short-term loans to member countries with deficits in their balance of payments. The amounts of these loans were set by quotas. A countrys quota in the IMF was based on the countrys national income, world trade, and other factors. Not everyone joined the IMF. The Soviet Union attended the meeting at Bretton Woods, but failed to become a member of the IMF. A National Advisory Council on International Monetary and Financial Problems, composed of several cabinet members and the chairman of the Fed as well as the chairman of the Export-Import Bank, was designated as being responsible for monitoring the activities of the IMF for the United States. In October of 1946, the head of the IMF conceded that it would be some time before currency exchange rates could be stabilized among countries. This proved to be true in setting par values for other currencies against the dollar. Italy did not set its par value until 1960. The IMF was unable to save Britains economy. That country was being subjected to socialist experiments in nationalization that Winston Churchill called a murderous theme. The Bank of England was nationalized in 1946, and other industries followed. The United States authorized an Anglo-American Loan Agreement, which provided $3.75 billion to Great Britain to alleviate its postwar deficits and balance of payments. Despite this loan, the United Kingdom had to suspend convertibility of the British pound on August 20, 1947. Great Britain did not make the British pound sterling convertible again until 1958. England was complaining in 1947 about the strict controls placed by the IMF on the use of the proceeds from IMF loans and the limitations on the amount that any one nation could borrow. This would be a common complaint by other countries seeking IMF assistance in future years. In the event, Englands situation continued to deteriorate. In 1949, it announced a massive devaluation of the pound, from 4.03 to 2.80 dollars. Britain and Canada were the largest sellers of United States securities after the war. A wave of securities selling generated from France, Holland, and Sweden occurred in the United States in 1947 when those countries began pressuring their citizens to liquidate U.S. securities. In November of 1947, the French government shipped eighty tons of gold to the United States in exchange for dollars. By then, the pegging of the price of gold to $35 an ounce and rising inflation had made mining gold unprofitable. Another institution that evolved from the Bretton Woods meeting was the World Bank, which was initially known as the International Bank for Reconstruction and Development. The bank was funded by sales of stock to sub-

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scribing nations based on their share of world trade. The United States was the largest contributor to the IMF and the World Bank. The World Bank sought to aid developing nations by making loans to help those countries build up their infrastructure. The bank sold bonds on the world market in order to raise funds for those activities. In September of 1948, the World Bank staff studied the feasibility of selling World Bank bonds for dollars abroad, as well as for other hard currencies. The idea behind selling World Bank obligations in Europe is to get Europeans who are hiding gold and U.S. dollars and securities, to use them to buy World Bank bonds.15 GATT The Atlantic Charter announced by Winston Churchill and Franklin Roosevelt during World War II sought a commitment to free trade. The conference at Bretton Woods laid the groundwork for the creation of an international body that would work to prevent a recurrence of the events of the 1930s, in which trade restrictions and high tariffs virtually stopped international trade and fueled the worldwide depression. The General Agreement on Tariffs and Trade (GATT) was entered into by some twenty-three nations in 1947. This arrangement sought to extend international cooperation beyond exchange rates and into the center of international trade. The goal of GATT was to remove barriers that would restrict trade. Under GATT, subscribing members were required to extend most favored nation status to each other. This meant that no GATT member could be given more favorable tariffs than any other member. That doctrine was not a new concept. Thomas Jefferson had advocated such an approach in 1785. As he wrote to James Monroe:
I would say to every nation on earth, by treaty, your people shall trade freely with us, and ours with you, paying no more than the most favored nation, in order to put an end to the right of individual states, acting by fits and starts, to interrupt our commerce or to embroil us with any nation.

Existing tariffs were to be frozen under GATT and then reduced or eliminated through multilateral trade negotiations. GATT proposed the creation of an international trade organization to administer this program. Although the United States refused to join that organization, it did subscribe to the GATT concept of lowering duties and nontariff barriers through multilateral negotiations. The Marshall Plan International trade was given a boost on another front. Secretary of State George Marshall advocated the creation of what became known as the Marshall Plan at a commencement address at Harvard University in 1947. The Marshall Plan, or European Recovery Plan, as it was officially known, would become a four-year plan to provide grants and loans for the recovery of Europe. Marshall wanted the European countries to stabilize their currencies and lower their

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trade barriers. Marshall Plan funds were being distributed by 1948. Congress initially authorized $5 billion for this program, but that amount would eventually swell to $16 billion. This was the equivalent of over $90 billion at modern prices. The Marshall Plan by all accounts was a success. The Marshall Plan countries saw their industrial production rise almost 40 percent between 1948 and 1952. Operation Bird Dog came to light in June of 1948. This was a plan in which new currency for Germany was printed in the United States and shipped secretly to Frankfurt, where it was exchanged for outstanding reichsmarks. The new currency was the deutsche mark, which would become one of the strongest currencies in the world until its replacement by the euro at the end of the century. In the other former war front, American authorities under General Douglas MacArthur seized several Japanese financial institutions and ordered their liquidation. The Bank of Japan was allowed to reopen, but General MacArthur became the financial czar of Japan. He would attempt to introduce American laws and ideals, including American securities laws, into the financial structure of Japan. Those concepts would be given their own Japanese interpretation. Joseph Dodge, a banker from Detroit, aided MacArthur in rebuilding the Japanese economy, which was racked by hyperinflation. Dodge sought to stabilize the economy and set it on the road to prosperity. It was unclear what effect he had, but an economic miracle did occur in Japan between 1950 and 1970. During that period, Japan experienced growth rates in excess of 10 percent.16 Japan was given large grants and loans by the United States in order to speed its recovery. The United States also assumed a large portion of the financial burden for Japans defense, as well as that of Europe and the rest of the free world. Banking Operations Some problems were encountered by the American government in disposing of surplus war materials. Among other things, the government had some 17,000 surplus homing pigeons on its hands. Fortunes were made in the acquisition of tankers and ships that became surplus at the close of the war. Aristotle Onassis, the Greek shipping magnate, expanded his fleet with those ships and with the aid of financing from the First National City Bank. The loans were financed by the cash that was generated from the ships. This was a novel form of financing at the time. Banking was becoming more international. The Chase National Bank and other banks began financing shipments through letters of credit under the European Cooperation Administration Program. That credit totaled over $2 billion. The Chase had offices in Tientsin and Shanghai, China, but it was forced to close those offices when the Communists took over. A Chase staff member was held hostage for five years over a claim by the Chinese government concerning assets held by the bank.

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Over 10,000 people viewed the exhibit of money on display at the Chase National Bank in 1946. Over 60,000 items represented every period of coinage and every government that had issued money. The display included a one-trillion-mark coin from Germany that had been issued after World War I. A five-million-drachma bill from Greece that had been printed in 1944 was a reflection of the inflation in that country. Among the other items were fourteenth-century Ming dynasty money and a $10,000 Federal Reserve note (the largest denomination bill was limited to $100 in 1945). One coin from Yap weighed over 175 pounds. It was said to be worth 10,000 coconuts. Also included in the exhibit were a check written on the Chase National Bank for $225 million, which was the largest check ever written to date on that bank, and another check for one cent made out to Helen Keller in Braille. Some 2,500 types of scrip currencies that had been issued by states and municipal governments in the 1930s, as well as some buckskin bills, filled other display cases. This collection was later donated to the Smithsonian museum in Washington, D.C. The Chase National Bank began making consumer installment loans in 1946. The National City Bank and the Manufacturers Trust had been making such loans for some time. A retail banking device available to small investors at the end of the war was the savings account that compounded interest. Chase was paying interest on savings accounts with balances of more than $5 and less than $2,500. The interest on larger accounts, up to $25,000, was 0.25 percent. The Bankers Trust Company began to expand its retail business after the war through no-minimum-balance checking accounts, Christmas club accounts, and installment loans for consumer goods. Previously, Bankers Trust had asked a corporate customer to remove its account because it had drawn three checks in a month against its $1,000,000 balance.17 Bankers Trust was experimenting with ways to automate its check processing services. It used something called card checks for customers and for corporate dividend payments. The Chemical Bank and Trust Company was offering a fiscal agency account in March of 1947, which would allow the banks trust department to assist you in all of your investment problems.18 Credit Cards Installment credit was up sharply in July of 1948, but there was a drop of over $120 million in charge accounts in that same month. Credit card historian Lewis Mandell traces the credit card back to retail establishments with credit programs in 1914. Department stores issued credit cards or courtesy cards to customers for credit transactions before World War II. In 1940, Gimbels offered store charge cards that allowed revolving credit and assessed interest charges on outstanding balances. Restaurants were also using charge cards. These cards were limited to a particular store or chain. Credit cards were also employed by oil companies and large chain stores. Oil company credit card sales accounted for more than 8 percent of gaso-

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line sales by one oil company prior to the war and gas rationing. Thousands of motorists carried the handy card. With it, they charged purchases of gasoline, motor oil, tires and other accessories at filling stations.19 Collections for the credit cards were somewhat primitive. The motorist would sign for the purchase at the gas station. The gas station operator would turn the charge slip over to the oil company truck driver, who would forward it to the central accounting office of the oil company. The oil company would add the individual slips and mail the customer a bill at the end of the month. Defaults were about one-half of one percent of charges. This was about the same default rate as for department store credit purchases. Oil companies would often honor each others credit cards. A universal air travel credit card was created in 1948. This arrangement allowed travelers to purchase a credit card for a stated amount of travel. There were three types of air travel cards. One type allowed travel in a particular territory, such as North America. Another card provided for international travel, and still another card was a controlled card that was designed to conform with currency restrictions in certain countries on the amount of money that could be used on foreign travel. The Fed asked Congress for authority to regulate bank holding companies in May of 1946. The Fed wanted those companies to rid themselves of nonbanking subsidiaries unless their business was otherwise in the public interest. That power would not be granted for another ten years. In June of 1945, Secretary of the Treasury Henry Morgenthau Jr. ordered financial institutions, including banks, broker-dealers, and commodity brokers, to make monthly reports to the Treasury on unusual transactions involving $1,000 in currency in denominations of $50 or higher, or $10,000 or more of currency in any denominations. This order was the predecessor to the modern Bank Secrecy Act and money laundering prohibitions. Initially, it was designed to catch tax evaders. The Fed began reporting monthly data on currency, demand deposits, and time deposits in the 1940s. Credit unions were holding assets of over $360 million of deposits immediately after the war. Tremendous growth occurred in the S&Ls during World War II. In the five years after the war, these institutions nearly doubled in value. About $140 billion of deposits was held by commercial banks in 1946. Another $8 billion was held by S&Ls. By October of 1947, some commercial banks were loaned up, which meant that they were not interested in extending further loans to businesses. Loan demand was high because companies were borrowing rather than floating equity issues to obtain additional capital. Interest on commercial loans was about 1.75 percent on October 1, 1947. Insurance Companies The insurance companies advanced large amounts of financing to American industry after World War II. The Equitable Insurance Company provided $100

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million to Gulf Oil, $90 million to R.J. Reynolds Tobacco, and $40 million to TransWorld Airlines, as well as large investments in railroads. Equitable also began offering leaseback financing to railroads and shopping centers. It became one of the largest private lenders of farm and residential loans. Prior to World War II, most farm mortgages were five- or ten-year loans, but Equitable began offering longer terms through arrangements with banks in which the banks took the shorter loan terms and Equitable took longer terms from twenty to thirty years. Equitable began taking farm mortgage business away from the government land banks because of its more flexible financing terms. Equitable began offering a program called Assured Home Ownership Mortgage, in which a mortgage was issued at rates below those offered by commercial banks, provided that the home purchaser bought a life insurance policy for the amount of the mortgage. The insurance policy guaranteed payment of the loan. Financing Resumes State and municipal governments were subject to increased expenditures following World War II, particularly for education. This caused them to seek additional funds from the financial markets, and the states adopted numerous taxes, including sales taxes and income taxes. Fixed income securities issued by states and municipalities did not pay particularly high returns in 1946. State of Arkansas highway refunding bonds yielded as little as 1.20 percent. San Antonio, Texas, independent school district bonds paid 1.30 percent. City of San Francisco bonds were priced to yield 1.55 percent in 1946. Underwritings were increasing. It was a rare week in 1946 when Wall Street underwriters werent called upon to distribute $100 million or more of new securities.20 Willys-Overland Motors offered some 150,000 shares of $4.50 cumulative preferred stock, series A, at a price of $100 per share. Kuhn, Loeb & Co. and E.H. Rollins & Sons were the underwriters. Hilton Hotels Corporation offered 350,000 shares of common stock at a price of $17.50 per share. The Consolidated Edison Company of New York offered refunding mortgage bonds that paid .625 percent interest in April of 1947. They were due to mature in April of 1977. The underwriters included Hornblower & Weeks, W.E. Hutton & Co., Eastman, Dillon & Co., Blyth & Co., and Stone & Webster Securities Corp. On November 1, 1946, American Telephone & Telegraph Company announced an issue of 2.75 percent convertible debentures that were due on December 15, 1961. Subscription warrants were being offered when, as, and if issued. Northwest Airlines was offered 4.60 percent cumulative preferred stock in 1947. Underwriters included Auchincloss, Parker & Redpath, Kidder, Peabody & Co., Paine Webber, Jackson & Curtis, and A.M. Kidder & Co. On October 2, 1947, New England Telephone & Telegraph Company announced the issuance of $40 million of thirty-five-year 3 percent debentures.

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The underwriters included Otis & Co., Inc., Gregory & Son, Weeden & Co., Reynolds & Co., Wertheim & Co., Hallgarten & Co., and Francis I. du Pont & Co. On April 1, 1948, Blair & Co. and Gregory & Son were among the underwriters that offered thirty-year, 3 percent first mortgage bonds of the Ohio Power Company. The First Boston Corporation and Mellon Securities Corporation merged with each other in August of 1946. Halsey, Stuart & Co. was still headquartered in Chicago in 1947. It was conducting a broad range of underwriting for municipalities, railroads, and public utilities. Among other things, Halsey, Stuart won the bidding on a $10 million equipment trust certificate offering in 1948 by the Pennsylvania Railroad. Salomon Bros. & Hutzler was an underwriter for over $13 million in new bond issues in November of 1947. Other leading underwriters were Harriman Ripley & Co., Goldman Sachs & Co., Lehman Bros., A.G. Becker & Co., Drexel & Co., Kuhn, Loeb & Co., and Kidder, Peabody & Co. Harriman, Ripley & Co. was underwriting City of Raleigh, North Carolina, public improvement bonds in 1948. The rates on these bonds varied from 2 to 2.5 percent, depending on their maturity. The amount of the offering was $225,000. Blyth & Co. celebrated its thirty-fifth anniversary in 1949. It had offices in twenty-five cities. Charles E. Mitchell was still the firms chairman. Hornblower & Weeks, established in 1888, was becoming a leading firm. The New York Hanseatic Corporation was selling United States government securities, and bonds for utilities, railroads, and industrial companies, as well as stocks. It offered foreign external and internal securities. J.F. Reilly & Co. in New York had an open telephone line to Boston and direct wires to Chicago and Los Angeles. The company was a member of the New York Security Dealers Association. Goodbody & Co. offered copper stocks. Rambo, Keen, Close & Kerner in Philadelphia dealt in corporate and municipal securities. Mitchell Hutchins & Co. in Chicago sold stocks, bonds, commodities, and unlisted securities. It was a member of the NYSE as well as several commodity exchanges. A.G. Becker & Co. offered shares of Gardner-Denver Company cumulative preferred stock. Charles Merrill had stated in 1940 that he wanted to bring Wall Street to Main Street. That program began in earnest after the war. In 1945, Merrill Lynch, Pierce, Fenner & Beane established a school for returning veterans. They were trained to become stockbrokers in a six-month program and were then sent to branch offices where they worked. The firm published pamphlets teaching the public how to invest, including discussion of such things as hedging and how to read a finance report. Merrill Lynch ran an advertisement in the New York Times in 1948 called What Everybody Ought To Know About This Stock And Bond Business. In 1947, Merrill Lynch conducted 10 percent of the transactions executed on the NYSE. The firm had eighty-one partners who shared profits of about $1.8 million. This was about $22,000 each. By 1950, Merrill Lynch was the largest brokerage firm in the country.

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The Kaiser-Frazier Corporation easily sold an issue of stock for over $50 million in order to create a new automobile company. It tried unsuccessfully to make a stock offering in 1948 for $10 million of common stock. That offering fell through after the underwriters refused to conduct it. Several years later, the SEC conducted an investigation to determine whether one of the underwriters, Otis & Co., had committed fraud in order to evade its obligations under the underwriting agreement. Preston Tucker raised over $20 million after World War II to finance the production of his Tucker automobile. Tucker announced that he would raise more money by selling radios, seat covers, and other automobile accessories for $270 a set to prospective automobile buyers. They would then be given priority for cars that came off the assembly line. The SEC began an investigation to determine whether this offer was a security issue that had to be registered under the federal securities laws and sold under a prospectus. Tuckers difficulties with the government would be the subject of a 1988 Francis Ford Coppola film entitled Tucker: The Man and His Dream. The American Hide and Leather Company was still paying a quarterly dividend for its shareholders in 1949. Textron, Inc., which was founded in 1944 by Royal Little, a former parachute maker, began a program of diversification in 1948. This was said to be the first conglomerate. In January of 1949, Howard Hughes, on his way to attaining fame as an eccentric billionaire recluse, announced that he had declined an offer from Dillon, Read & Co. to purchase Hughes Tool Co. Over $3 billion was invested in mutual funds in 1945. The Keystone Custodian Funds offered certificates of participation in investment companies that were placing their capital in bonds, preferred stocks, and common stocks. These funds were sponsored by the Keystone Company of Boston. Shares of the Scudder, Stevens & Clark Fund were being sold from Boston. Investors Diversified Services (IDS) had organized and promoted three investment companies starting in 1939. By 1949, those investment companies had assets of over $150 million. IDS was selling installment certificates in 1948. At that time, there were outstanding about $273 million of such certificates. Government and Finance The capital gains tax in the United States in 1947 was 25 percent for capital assets held more than six months. Legislation in 1947 and 1948 that sought to reduce taxes was vetoed by President Truman, but a tax cut was approved over his veto by Congress in 1948. Unemployment levels in the United States were at 3.8 percent in 1948. The GI Bill that was passed in June of 1948 guaranteed returning military personnel loans up to $2,000 and provided $500 a year for college tuition plus $75 per month for living expenses. This financing was sufficient to allow more than 2 million veterans to attend college and

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graduate schools. The total cost of the program was about $14 billion. The Housing Act of 1949 sought to better the lives of workers by increasing home ownership during the national housing shortage that followed World War II. Despite Trumans antibusiness policies, a number of financiers were heavily involved in his administration. They included W. Averell Harriman, the Commerce Secretary; Robert A. Lovett, the Under Secretary of State, who had come from Brown Brothers, Harriman & Co.; and Defense Secretary James V. Forrestal, a member of Dillon, Read & Co. The presence of these financiers in his administration did not inhibit Trumans presidential campaign of 1948, which was liberally spiced with attacks on Wall Streeters. Truman called them bloodsuckers. The stock market responded by dropping after Truman was elected. A recession began in November of 1948 and extended into 1949. On February 1, 1947, margins were reduced to 75 percent by the Fed in order to encourage the markets. Help appeared to be needed. NYSE seats were being sold for $68,000 in 1948, down from their high of $625,000 in 1929. But there was room for hope. Over 2 million shares traded on March 22, 1948. On March 31, 1948, almost 600,000 shares were traded in one hour on the NYSE. At that time, the exchange was experiencing an employee strike. The Dow Jones Industrial Average stood at 177.20 on April 1, 1948. Securities Trading and Information The regional exchanges were growing. The Detroit Stock Exchange granted unlisted trading privileges to the Dow Chemical Company. The Los Angeles Stock Exchange granted unlisted trading privileges to the American Telephone & Telegraph Companys convertible debentures in 1948. The Philadelphia Stock Exchange established a clearing system that guaranteed performance on all trades. This made it unnecessary for market participants to assess the credit risk of each individual trader.21 The Philadelphia and Baltimore exchanges consolidated in 1949. The Washington Stock Exchange would join those exchanges in 1953. The Midwest Stock Exchange was created by a merger in 1949 of the Chicago Stock Exchange, the Cleveland Stock Exchange, the MinneapolisSt. Paul Stock Exchange, and the St. Louis Stock Exchange. The New Orleans Stock Exchange would be added to that group in 1960. The Wall Street Journal began a Southwest edition in 1948, supplementing the Pacific Coast edition that had been published since 1929. Dow Jones printed an index of forty bonds and a railroad average of railroad shares in 1950. The Wall Street Journal listed stock option sales for ninety-day options. These options were for 100 shares and covered several securities, including Atchison, Topeka & Santa Fe. The puts and calls on the stock of that railroad were selling for $400 for a ninety-day option. Options were being sold on B&O preferred, New York Central, Illinois

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Central, M.K.T. preferred, Northern Pacific, Southern Pacific, Southern Railway, Alleghany preferred, Bethlehem Steel, Jones & Laughlin Steel, and others. Special calls were offered by Filer, Schmidt & Co., a member of the Put and Call Brokers and Dealers Association, on several stocks, including Hudson Motors, U.S. Rubber, Aluminum Co., and J.I. Case. In 1948, for as little as $137.50 a speculator may buy a call, i.e., a 30-day option to buy one hundred shares of stock prevailing on the day he bought the call.22 Short sales were discouraged by higher tax rates on short-term profits. Short-term rates were up to 82 percent, while long-term capital gains were only 25 percent.

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3 Korea and the War on the Investment Bankers

On March 30, 1949, the Federal Reserve Board lowered margin requirements from 75 to 50 percent. This either presaged or triggered a bull market that began in June of 1949 and lasted for eight years. During that period, the Dow Jones Industrial Average increased from 160 to over 700. The North Korean invasion of South Korea on June 25, 1950, added fuel to this boom, sparking frenzied trading in the futures markets. During a five-week period between June 25 and July 28, 1950, there were substantial increases in commodity prices. A speculator who purchased just before the Korean episode and deposited the minimum margin could have cashed in 5 weeks later on July 28 with an approximately 450 percent profit on lard, 300 percent on cottonseed oil, 300 percent on soybeans, 150 percent on cotton or wool tops, and a comparatively modest 100 percent on the relatively sluggish wheat futures.23 President Truman reacted with anger to the commodity speculators. He sought legislation to restrict futures trading. Senator Hubert Humphrey of Minnesota supported this request, contending that the president should have the authority to crack down on commodity speculators. That legislation was not adopted, however, because the futures exchanges agreed to limit speculation by increasing margin requirements. Speculation Speculation continued. Stock market prices bounced up and down with developments in Korea. Senator Joseph McCarthy of Wisconsin was among those seeking the opportunity to reap large profits. He was using campaign contributions to trade soybean futures. Newspaper columnist Drew Pearson charged that Senators Happy Chandler from Kentucky, Pappy ODaniel of Texas, and Scott Lucas from Illinois were profiting from grain speculations even while the president was decrying such activities. On August 10, 1950, after the invasion of South Korea, the CEA found that a Chinese group of uncertain identity was trading in futures contracts and causing prices to in286

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crease rapidly. There were thirty-one Chinese accounts that collectively held futures contracts covering some 3 million bushels of soybeans. The number of those accounts began to increase. Eventually, forty-nine separate accounts with Chinese connections were trading soybeans. Prices of that commodity skyrocketed from $2.20 to $3.45 a bushel. Commodity futures prices soared again in November of 1950. Rubber experienced particularly strong gains. The country began to mobilize to deal with the crisis in Korea. But enthusiasm for the conflict, such as that found at the outbreak of World War II, was wanting. The Truman administration had difficulty in filling positions in several governmental bodies that had been set up to place the economy back on a war footing after the Korean War began. These agencies included an Economic Stabilization Agency and a Minerals and Energy Administration. A National Production Authority was setting priorities for materials. Over $150 billion was appropriated for the Korean War. The Revenue Act of 1950 raised personal and corporate tax rates to pay for those expenditures. The House Ways and Means Committee proposed a 10 percent withholding tax on corporate dividends. To prevent consumer spending and credit demands from increasing prices and diverting capital from the war effort, the Defense Production Act of 1950 authorized the Fed to control consumer and home mortgage credit. In September of 1950, the Fed required a 15 percent down payment on installment sales of appliances. The balance had to be paid within eighteen months. Furniture required a minimum 10 percent down payment and a maximum of eighteen months to pay. The director of the Office of Price Stabilization set price ceilings on consumer goodsclothing, shoes, housewares, and furniture as well as other merchandise and meat. A Wage Stabilization Board was freezing wages and salaries in 1951. Almost 50 million shares were traded on the NYSE in April of 1950. Especially large trading volume would occur some time later when China announced that it would exchange prisoners with the United Nations. Stock margins were increased by the Fed back to 75 percent in January of 1951, up from 50 percent. On March 12, 1951, the Fed adopted a Credit Restraint Program that sought to limit lending by financial institutions in order to check inflation. The Fed issued a statement of principles, which discouraged loans for speculative investments, acquisitions, and mergers, which the Fed viewed as nonproductive. The effectiveness of these restrictions was questionable. More importantly, the Fed increased its discount rate. This laid the groundwork for the Feds actions in future years, when inflation was again posing a threat to the economy. Truman seized the steel mills in 1952 in response to a nationwide strike of steel workers that was threatening the war effort. The Supreme Court held that the presidents action was improper.24 In the meantime, Truman was fighting what appeared to be a losing battle with inflation. Inflation abated, however, as the conflict wound down. Price controls and credit restraints were lifted. A speculative boom in potato futures markets occurred after the Korean conflict ended in July 1953. Prices thereafter collapsed. The regional exchanges

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continued their operations in the 1950s. The Midwest Stock Exchange proved to be successful in its first years. The Chicago Board of Trade stopped trading securities in 1952, but continued its registration as a national securities exchange. The Philadelphia, Baltimore, and Washington stock exchanges consolidated in 1953. Other exchanges included the San Francisco Mining Exchange and the Salt Lake Stock Exchange. Insurance Programs After the Korean War, the United States government stopped its life insurance program and provided an indemnity of $10,000 for dependents of members of the armed services. The Federal Trade Commission adopted rules relating to the advertising of mail order insurance in 1950. Those rules were authorized under an exception to the McCarran-Ferguson Act. New York, after forty-five years of prohibition, allowed insurance companies to purchase common stock in 1951.25 Seven years later, New York added a leeway clause that authorized up to 2 percent of assets to be used for investments that were not otherwise specifically permitted by the statutes. This allowed insurance companies to engage in nontraditional investments. A New Money Trust Hunt Another attack on the money trust was under way. Again, the target was the investment bankers. While chairman of the SEC, William O. Douglas had urged that competitive bidding should be required for the securities issues of public utility companies. The SEC had sought to impose such a requirement on public utility companies, but its implementation was delayed until after World War II. The first public utility issue to use that bidding process was the New York State Electric and Gas Corporation. There was much difficulty with the process. The SEC tried to extend the competitive bidding process to all underwritings, not just those of public utilities. It had used the Temporary National Economic Committee as a forum to espouse that cause, but World War II interrupted that effort. Competitive bidding for underwritings never became popular. However, the government did require railroad trust certificates to be put to auction, as were many municipal security issues. The Justice Department announced in 1944 that price-fixing clauses found in many underwriting agreements violated the Sherman Antitrust Act. This news was a shock to the investment bankers. The Justice Departments announcement appeared to be a guise for requiring competitive bidding. The Justice Department took no affirmative action on this claim until 1947, when it filed a massive antitrust suit against seventeen investment banking firms and the Investment Bankers Association. The government claimed that the underwriters had conspired to allocate the underwriting business. The seventeen firms named as defendants included Morgan Stanley & Co., Kidder,

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Peabody & Co., Goldman Sachs & Co., White Weld & Co., Read Dillon & Co., Drexel & Co., the First Boston Corporation, Smith Barney & Co., Kuhn, Loeb & Co., Lehman Brothers, and Blyth & Co. Some investment banking firms believed themselves to be slighted because they were not included in the Justice Departments complaint. Among those who were not included, but who had large underwriting participations, were Merrill Lynch, Pierce, Fenner & Beane, the firm of Halsey, Stuart & Co., and Salomon Bros. & Hutzler. The complaint in United States v. Morgan charged that the principal investment banking firms had engaged in a conspiracy since about 1915 to eliminate competition and to monopolize the underwriting business.26 According to the government, the investment bankers developed a system whereby they became the traditional banker to specific large corporations. This historical position allegedly entitled them to receive all future underwriting business of those companies. In addition, if an investment banker merely participated in an underwriting, it claimed to have a historical position that would entitle it to participate on substantially similar terms in future underwriting syndicates. The government contended that investment banking firms recognized a mutual obligation to exchange participations in underwritings. The government charged that the Investment Bankers Association violated the antitrust laws by discrediting the use of competitive bidding, private placements, and agency sales as underwriting methods. This claim was later dropped, but the government persisted in its contention that the investment bankers were engaged in anticompetitive activities, including fixing the offering price of securities, setting prices and discounts to dealers, and quoting penalties on brokers whose securities had to be repurchased by the dealers because their allotment had not sold. The trial in the Morgan case began in 1950 and lasted for over two years. The record of the proceedings exceeded 100,000 pages. United States District Court Judge Harold R. Medina filed a lengthy opinion that dismissed the case in 1953. He found the governments case to be without merit. The judge rejected the governments historical position claims, and he found no conspiracy to impede competition or to violate the antitrust laws. Judge Medinas decision, ridiculing many of the charges in the complaint, was, if anything, a paean to the investment bankers. The judge stated that it would be difficult to exaggerate the importance of investment banking to the national economy.27 He pointed out that the vast industrial growth of the United States had been facilitated by the raising of capital through underwriters. Judge Medina found that adequate financing of the needs of American industry is the life blood without which many if not most of these parts of the great machine of business would cease to function in a healthy, normal fashion.28 Although the government charged that the underwriters had started their monopoly with the Anglo-French loan of 1915, Judge Medina noted that the underwriting system had its roots in the latter part of the nineteenth century. He also found that price maintenance had been used by underwriters in the 1890s in order to avoid having large issues depress securities

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prices. The judge concluded that price maintenance during underwritings was often necessary in order to make the distribution possible within a reasonable period of time. Underwritings The decision in the Morgan case ended government attacks on the investment bankers for a time. Walter Sachs of Goldman Sachs stated that after the Medina trial, the skies really cleared for the first time in years.29 Underwritings continued even while the Morgan case was underway. In January of 1950, American Telephone sold $200 million of long-term debentures through an underwriting syndicate of over 100 firms that was managed by Morgan Stanley & Co. In September of 1950, Van Alstyne, Noel & Co. made a private placement of notes totaling $1.25 million for Drewrys Limited U.S.A. First International Securities Co. offered 500,000 shares of American-Canadian Uranium Co. stock in October of 1950. Amott, Baker & Co. acted as a broker to place short-term funds held by trustees with federal S&Ls. The firm noted that principal being invested would be fully insured by the Federal Savings & Loan Insurance Corporation (FSLIC). The firm stated that it could place amounts of $5,000 to $500,000 among various S&Ls with current annual dividends of 3 percent. Such brokers would cause a crisis in the banking industry in future decades. A new issue of 100,000 shares of the Ultrasonic Corporation was underwritten by Coffin, Betz & Co. in October of 1951. McDonald & Co. acted as underwriter for Scott & Fetzer Company in the offering of 64,000 shares of common stock in 1953. The Liberty Loan Corporation, a finance company, offered 115,000 of its shares in 1952 at a price of $15 per share. Among the underwriters were Edward D. Jones & Co. and Blair, Rollins & Co. In July of 1952, Auchincloss, Parker & Redpath offered warrants that provided the right to purchase the common stock of the Bettinger Corporation. Two warrants entitled the purchaser to obtain one share of common stock at $5 per share and were exercisable between August 1, 1953, and July 31, 1955. F. Eberstadt & Co. offered 5 percent promissory notes of the Walter E. Heller & Co. together with warrants to purchase common stock. Lazard Frres & Co. offered warrants for Magma Copper Company capital stock shares. The Equitable Securities Corporation purchased unsubscribed shares of the Union Planters National Bank of Memphis. Goldman Sachs & Co. made a private placement of $3.6 million, 3.5 percent promissory notes for the Manhattan Shirt Company in 1951. Those notes were due on August 15, 1966. Ford Motor Company stock was sold publicly for the first time in 1956 when the Ford Foundation sold 20 percent of its stock. Goldman Sachs was the lead underwriter for this offering, which totaled $650 million. There were 722 firms involved in this underwriting. Municipal finance was growing in importance. The Wall Street Journal maintained

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an index of tax exempt municipal bonds in 1950. New York City was, once again, experiencing fiscal problems. The city had the second largest budget in the country in 1951, second only to the federal government. In September of 1951, Davidson County, Tennessee, offered school building bonds that were priced to yield 1 to 1.8 percent, depending on their maturity. Among the members of the underwriting syndicate were John Nuveen & Co. and Paine, Webber, Jackson & Curtis. The City of Detroit offered $3 million of series K public utility bonds in 1951. Among the underwriters were Ira Haupt & Co., Laidlaw & Co., and J.G. White & Co. In September of 1950, Cook County, Illinois, offered 2.25 percent tax anticipation warrants. The warrants were to be redeemed from receipts of a corporate fund tax levy and a highway fund tax. The State of Colorado made an offering of turnpike revenue bonds totaling over $6 million in 1950. Members of the underwriting group included W.E. Hutton & Co., Tucker, Anthony & Co., and Piper, Jaffray & Hopwood. Glore, Forgan & Co. and others acted as underwriters for a $6 million City of Cleveland series of first mortgage revenue bonds in 1953. The General State Authority of Pennsylvania issued $40 million of third series serial bonds in 1952. The syndicate group in the underwriting was comprised of some fifty firms, including Smith Barney & Co., Hemphill, Noyes, Graham, Parsons & Co., and the Lee Higginson Corporation. Over 4,000 broker-dealers were operating in the United States. Singer, Deane & Scribner was a member of the NYSE and the Pittsburgh Stock Exchange and a New York Curb Exchange associate. Kidder, Peabody & Co. added Alfred J. Stalker to its Dealer Relations Department in 1950. Glore, Forgan & Co. acted as underwriter with Alexander Brown & Sons in December of that year. Iowa Electric Light and Power Company offered 4.80 percent cumulative preferred stock and 925,000 shares of common stock. The underwriting syndicate included Quail & Co., Alex Brown & Sons, Smith Barney & Co., and F.S. Moseley & Co. E.F. Hutton & Co. was one of the underwriters for a $15 million offering by the Ohio Power Company in November of 1951. Japanese securities were offered in the United States to financial institutions by Carl Marks & Co. Bache & Co. was the underwriter of 5,000 shares of Sattlers, Inc., common stock in July of 1953. Francis I. du Pont & Co. and others acted as underwriters for a $15 million offering by the Indiana & Michigan Electric Company. Victory Loan 2s (a reference to their interest rates) were being traded in 1953 (Vic 2s). Foreign bonds were traded. These included Greek 6s and Japan stamped 5s. Investment quality corporate bonds were trading. The RFC issued tax exempt bonds in 1953. Federal funds were being offered at 2 percent. Merrill Lynch rented a Manhattan armory and put on a how to invest show. This became the basis for the information center that operated for many years in New Yorks Grand Central station. Pandick Press was printing registrations, prospectuses, proxies, and other materials required under the federal securities laws. Business was good for printers and

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underwriters. The number of securities offerings in 1951 exceeded those offered in 1929 for the first time. Stock Trading Over 5,000 over-the-counter issues were being traded at the outbreak of the Korean conflict. The New York Curb Market changed its name to the American Stock Exchange (AMEX) in 1953. The AMEX proposed the creation of investment clubs in the 1950s as a way of spurring stock ownership, but its listings were sometimes dubious. Over 100 Canadian corporations were listed on the AMEX. Most of these companies had earning deficits of one or more years in duration. A NYSE seat was selling for $51,000 in 1950. NYSE firms then had over 1,600 branch offices that employed some 10,000 account executives. In 1952, the NYSE stopped trading on Saturdays and reduced its daily hours, trading only from 10:00 A.M. to 3:30 P.M. The NYSE permitted its member firms to incorporate in 1953. The first brokerage firm to do so was Woodcock, Hess & Co. The investment banking firm of A.G. Becker & Co. became a corporation in 1953. Many other broker-dealers followed their lead. In total, about 28 percent of broker-dealers were incorporated in 1950. Ten years later, over 40 percent would be incorporated. By 1998, every large brokerdealer except Goldman Sachs had incorporated, and it finally succumbed to corporate status in 1999. Only 4.2 percent of the population in the United States owned stocks in 1949. Eighty-two percent of families had life insurance. Twenty-one percent had annuities and pensions and almost 42 percent held United States savings bonds. At that time, 69 percent of American families with incomes over $3,000 opposed investments in common stocks. In 1952, the NYSE had the Brookings Institution conduct a study of stock market investors to see if their numbers were increasing. The study found that over 6.5 million individuals owned shares in publicly owned corporations. Another 2 million individuals held stock in privately held companies. There were some 30,000 millionaires in America in 1952, but many of the individual shareholders were of moderate means. Several efforts were made to increase individual stock ownership. The banks had, for some time, used the Quimby plan, which allowed individual customers to buy stock through the bank. The bank held the shares. The NYSE and its president, George Keith Funston, began promoting stock ownership by individuals in 1953. The NYSE conducted an advertising program called Own Your Share of American Business and hired the puppet show of Kukla, Fran, and Ollie to promote stock investments. The NYSE advocated the use of a Monthly Investment Plan (MIP), in which investors of moderate means would invest a small amount monthly, as an alternative to a mutual fund. MIP investors were to save a minimum of $40 per month through a special account established at a NYSE member firm. The securities purchased by MIP participants were selected by their brokers. Customers could

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purchase fractional shares when they made their periodic payments and could dollar cost average their purchases over extended time periods. Over 13,500 MIP accounts were opened in the first twelve weeks after the announcement of this program, principally by individuals who had never purchased stock before. By 1961, over $200 million was held in MIP accounts. Nevertheless, MIP accounts did not effectively compete with the mutual funds. Among other things, the commissions on MIP accounts were considerably higher than those on mutual funds. Securities margin requirements were reduced back to 50 percent in February of 1953. Even so, volume on the NYSE declined to less than 1 million shares on April 28, 1953. Stock prices dropped sharply on August 31, 1953, but then began a strong upward movement. Between September of 1953 and January of 1955, stock prices, as measured by one index, increased by 50 percent. The NYSE experienced its last day with trading volume of less than 1 million shares in October of 1953. Although there was a recession in 1954, the Dow Jones Industrial Average exceeded its 1929 high for the first time on November 17, 1954. The Standard & Poors 500 Index of common stocks rose by 50 percent in that year. The stock market would rise almost continuously between September 1953 and January 1955, causing concern that another speculative bubble was building. On January 4, 1955, the Fed increased margin requirements. An investigation by the Senate Banking and Currency Committee in 1955 sought to determine whether the market boom presaged another stock market crash. Harvard professor John Kenneth Galbraith was among those predicting doom. But Congress found little cause for alarm, and no new federal legislation was passed. The bull market in 1955 brought huge paper profits to executives of many a U.S. corporation.30 These profits were generated in compensation programs as a result of stock options given to those individuals. Frank Stanton, the president of Columbia Broadcasting System, was holding options worth some $4.5 million in February of 1955. The number of individual shareholders in America rose to 8.6 million in 1956. New Issues A Harvard law professor, Louis Loss, helped prepare a uniform state securities law in the 1950s. It was adopted by more than thirty states. Regulation was needed. A burst of trading in penny stocks, many of which involved uranium companies, occurred in the 1950s. Uranium stocks were popular because of the expanded application of atomic energy. That speculative frenzy was followed by a high technology boom. Two high-tech stocks were Transitron and Texas Instruments. Many new securities issues underwritten in the 1950s were hot issues that would rise quickly in value over their offering price and subside just as fast. Numerous securities salesmen were working only on a part-time basis and had little supervision or training. Even

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Merrill Lynch salespersons were overselling stock, particularly the Aquafilter Corporation, which offered a water filter for cigarettes. Merger activity picked up between 1946 and 1956. Proxy fights became a regular occurrence in the 1950s. The participants often hired professional publicists such as David Carr, who had worked for the newspaper columnist Drew Pearson. One of the biggest proxy fights of all time was over Loews, Inc. The battle involved two factions seeking control of the corporation. This fight nearly stopped production of the movie Ben Hur. In another proxy fight, Louis Wolfson attempted to take over Montgomery Ward. He was pitted against Sewell Avery. Wolfson had built one of the first conglomerates, which operated under the umbrella of Merritt-Chapman & Scott. The institutions that owned large amounts of Montgomery Ward stock refused to back Wolfson, but they demanded that Avery resign. An early corporate raider appeared in the form of Thomas Mellon Evans, who acquired control of H.K. Porter Co. and then used it to pursue other conquests, including the Crane Company and Westinghouse Air Brake. In total, he acquired control of more than eighty companies. Other raiders included Robert R. Young, Charles Green, and Art Landa. The corporate gadfly appeared in the 1950s. These individuals opposed management actions at large corporations that they thought were not beneficial to small shareholders. Their leaders were Lewis and John Gilbert. The Gilberts and their relatives held small amounts of stock in some 800 corporations, which entitled them to attend shareholders meetings. The Gilberts attended as many as 200 corporate meetings a year. In total, the Gilberts were present at some 2,000 annual corporate meetings. Though [a]lmost always out voted, they are seldom out talked, and never out shouted.31 Benjamin Javits was promoting the United Shareholders of America in the 1950s. His organization sought favorable economic legislation. Another gadfly was Wilma Soss, who had founded the Fed