2. The general process of concentration made for irresponsibility of management, because again and again the power which men wielded far outreached their personal stake in the enterprises which they controlled. It must be remembered that the right to form a corporation, with limited liability for those who conduct it, is not a natural right of man, or even a very ancient right of property. It is a privilege extended by the state, under restrictions which have traditionally been designed to assure a responsible exercise of this privilege. The utmost pains were taken, when the corporation was a comparative novelty, to make sure that those who put money into it were protected, that the directors whom they chose were subject to their control and could do nothing contrary to their wishes; and also, on the other hand, that owners and directors alike were under restrictions as to the sort of businesses in which they could engage and were otherwise limited in power and scope. By the nineteen-twenties, however, it was possible to organize a corporation whose charter permitted it to do almost anything; it was possible for the management to act without the stockholders’ consent on vital matters, even to enjoy opportunities to make money at the stockholders’ expense, and to do all this without the financial risk which attends ordinary ownership. So complex were these financial structures, furthermore, that nothing less than a battery of accountants and investigators could find out whether the insiders had or had not lived up to their trust. Power without responsibility is dangerous. The men who occupied such favored positions would have had to be extraordinarily disinterested never to take advantage of their opportunities to profit at the expense of others, and extraordinarily far-seeing as well as disinterested not to engage in operations which would add to the instability of the national economy.
3. Finally, the concentration of so much power in a few hands had virtually the effect of setting apart a special economic class—a class of insiders, of economic rulers, almost as far removed, in opportunity and interest, from the ordinary stockholders—the proxy-signers—as the office executives were removed from the day laborers.
Here we must be very careful with our definitions. If we speak of the insiders as forming a class, we must not imply that it was a recognized class—consciously recognized either by itself or by most other people as possessing a well-marked identity of interest—or that it was a homogeneous or hereditary or exclusive class. Some of the members of it inherited their power, others rose from the ranks and seized it. They were scattered all over the country, though a large proportion of them—probably as many as half—were in Wall Street.
Nor must even Wall Street be thought of as representing anything like a united front. There were fierce divergencies of opinion there. There were men wielding large power in Wall Street who had never met one another. No man spoke to the financiers with such authority during the seven fat years as the elder Morgan had spoken to them a generation before; the voice of the House of Morgan, while it was listened to with deep respect not unmixed with fear, did not now call the tune so definitely as it once had. Indeed, so abundant were the opportunities now open to this class, so easy was it for men of inordinate ambition to carve out for themselves new principalities, that discipline was largely lost. Here was no firm hierarchy, no well-organized general staff for the forces of finance and industry, but rather a confusion of powers.
But enough of such generalizations and reflections. Let us turn to drama. Let us watch some of these insiders as they use the privileges and devices which we have been analyzing. Only if we do this can we fully realize what an age of financial wonders was that span of years from 1922 to 1929.
Chapter Nine
BUILDING THE PYRAMIDS
IN THE year 1878, when Benjamin Disraeli was prime minister of England, there lived in London a humble young clerk named Samuel Insull. His father was an impecunious clergyman. His mother kept for a time “Insull’s Temperance Hotel.” Young Samuel himself was a stenographer in an auctioneer’s office, where his wages had begun at five shillings a week.
Fifty-one years later, Samuel Insull had become the most powerful man in Chicago. His system of public-utility holding companies controlled several hundred electric light and power plants and gas plants and other properties scattered from Maine to Texas and Oklahoma. At his own (subsequent) estimate he was worth one hundred and seventy million dollars. Few men in the country wielded a mightier or more pervasive influence. He seemed to have reached the pinnacle of financial fortune.
Five more years passed, and Samuel Insull had become a fugitive from justice, rocking across the Mediterranean in a dingy little Greek steamboat in the futile hope of finding somewhere a refuge from the police.
It has been the fate of few men to rise so high from such simple beginnings, and then to fall again so sickeningly. But the career of Samuel Insull is interesting not merely because of its extraordinary contrasts, but also because of the way in which it illustrates the possible effects of an almost unrestrained use of some of the financial devices which had been developing in the United States since the turn of the century and which flourished riotously in the nineteen-twenties.
The fact that Insull came to grief and was at last brought to trial on a charge of fraud has seemed to set him widely apart from other financiers of his time: has made him, in the public mind, one of the chief scapegoats for the financial follies of those days. It must be remembered, however, that the operations upon which the charge of fraud was based were not undertaken until his pyramid was already toppling about his ears; and that the structure of that pyramid was not essentially different in most respects from the structure of some other pyramids which fell less resoundingly or even remained intact. (Indeed, some of the devices which characterized the Insull financing were found in even more exaggerated form elsewhere.) The chief reason for citing the Insull empire as the prime example of the technic of pyramiding in the public-utility field is that it has been more thoroughly illuminated by the spotlight of publicity than any other, and that the sequence of events which led to its collapse reveals with singularly dramatic force the temptations to which pyramiders were subject and the results of succumbing to those temptations. There are no doubt other Americans who might have said, as they read of Insull’s humiliating flight from the Piraeus in that dingy Greek boat in the early days of 1934, “There, but for the grace of God, go I.”
Samuel Insull’s early career seems to have been ready-made for the use of a modern Horatio Alger. To be sure, luck played a large part in its early phases. The nineteen-year-old English stenographer had read with admiration about the inventions of young Thomas Edison, and had even written a paper on Edison for a little literary society. Shortly afterward he lost his job in the auctioneer’s office where he had been employed. Looking for another job, he answered a newspaper advertisement—and discovered to his rapture that the man who had inserted it was the London manager for Edison’s fledgling enterprises! He got this job—as a stenographer—and showed so much more than mere stenographic ability that when Edison himself needed a secretary he cabled to England for young Insull, who thus found himself at the great inventor’s very right hand and close to the center of what was to prove to be a vast industry.
Luck had thus far showered its favors upon him; during the next twenty or thirty years, however, it played a smaller part in his rise than sheer ability and knowledge combined with furious determination. While he was still in his twenties he became an important figure in the business management of the Edison companies. In his thirties he became the president of Edison’s electric light company in Chicago. He managed it brilliantly and soundly, and it absorbed rival companies one by one, until in his forties he had achieved a monopoly of the electric-light business in the city.
He was coming on very fast, this young Anglo-American, and his progress was creditable. You might not have enjoyed his companionship particularly, for like other young men of his time whose overwhelming ambition was to get on in the world, he seemed to live for business; but he was sober, hard-working, and extrao
rdinarily competent. Flynn describes him at this period as “a rugged, thick-set Briton, radiating self-assurance and power, with an iron jaw under a cushion of fresh, pink skin.” He knew the business of producing and distributing electricity in every detail, he was almost a genius at organization, and the contributions which he made to the development of the electrical industry were undeniably very valuable. He realized the great advantages of mass-production. He realized that if the most were to be made of them, it was essential for local electric companies to be monopolies. And he also realized—as many men did not—how necessary it was, to the industry as well as to the public, that rates should be lowered as the consumption of electricity expanded and the production of it became more efficient. Indeed, he even welcomed governmental regulation. Said he once, “If there is anything wrong with my business, I want to know it. And the best way for me to know it is to have a public official who has the right to look into my affairs, in a position so he can employ the highest class of talent to help him.” In fact, Insull once went so far as to say—at a time when the idea of government interference, as sponsored by Theodore Roosevelt and Robert LaFollette, was filling the business community with dismay—that if public regulation failed, public ownership would be necessary.
Insull’s domain was soon to expand, and with it, his ideas. In 1905 he began to acquire electric light and power plants outside the Chicago area, making an investment in two small concerns on the Ohio River. In 1912—when he was still in his early fifties—he formed the Middle West Utilities Company to raise more capital for his acquisitions, and his career entered a new phase.
For he organized this Middle West company in such a way that when he had been fully reimbursed for the properties which he had turned over to it, he was fifty thousand common shares to the good. The operation was performed as follows: Insull sold his properties to the new-born Middle West for $330,000. The company then issued to him—or, if you prefer, he issued to himself, for he was president of the company—40,000 shares of preferred stock and 60,000 shares of common stock. For these he paid $3,600,000. This was such a good bargain with the company which he himself headed that he was able to sell the preferred shares and 10,000 of the common shares to the public for $3,600,000—enough to repay him for his investment—and still have 50,000 shares of common left, for which he thus had to pay nothing! And he had control of the new company.
It was a perfectly characteristic job of stock-watering—reminiscent in some ways of the formation of the Steel Corporation and of other financing operations which we have witnessed. It could be defended on the ground that these common shares which Insull acquired would be of no value unless by excellent management he increased profits, in which case his efficiency would be largely rewarded. But it was perhaps too instructive a lesson in how to make money in the utility business. The big money was made in selling stock to the public for more than you had had to pay for it (or, to put it another way, in selling the stock of your own company to yourself for less than its potential market value.) To do this, you had of course to put a high—if not actually extravagant—valuation upon the property which the stock represented, and to paint a rosy picture of possible earnings. And to make good on this picture, you had to provide the earnings. Ordinarily, the operation was one which could not soon be repeated without disastrous results: even in a rapidly growing industry, it usually took time for earnings to catch up with expectations. But possibly ways of finding them—or seeming to find them—could be discovered.
Wrote George Savile, first Marquis of Halifax, in the seventeenth century: “A Cunning Minister will engage his Master to begin with a small wrong step, which will insensibly engage him in a great one. A man that hath the Patience to go by steps, may deceive one much wiser than himself.” Samuel Insull was taking his first steps in the new finance.
The early steps, however, were short ones. In the next few years Insull acquired or formed many new companies in various parts of the Middle West, but his most impressive advance in power and prestige was in Chicago itself. The war came and Insull, as the biggest man in Chicago business, became chairman of Governor Lowden’s State Council of Defense, which had charge of various war activities in Illinois. The local gas company was in difficulties, and he was asked to save it, and did. He combined the local traction companies and restored them to comparative economic health. By the beginning of the seven fat years his organizing ability had become a legend.
He was now in his early sixties. He still worked furiously; usually he reached his desk well before eight o’clock in the morning. If you had met him outside of business, you would probably have been charmed by the range of his knowledge, by his capacity for taking a personal interest in your affairs, no matter how busy he was, and by the disarming gentleness which his brown eyes could assume. He was generous with his millions. He did not forget his friends. As a knickerbockered country squire at Libertyville he could be mellow affability itself. Yet in business affairs he was dictatorial and ruthless.
His will seemed to dominate the affairs of the city of Chicago. Apparently he was quite complacent about the political corruption of the city; he and his henchmen aided both political parties. Among the beneficiaries of his generosity was the chairman of the commission which ruled upon utility rates and utility financing in the State of Illinois, and the contributions were made in cash—envelopes stuffed with bills. “When you want the money, come and get it,” said Insull to the political agent who collected such largesse, according to the agent’s subsequent testimony. Englishman though Insull was by birth and early loyalty, he did not seem to mind supporting Big Bill Thompson, whose expressed ambition was to “bust King George on the snoot.” Business was business, and politicians could be useful. Insull was feared; by some who had felt his ruthlessness he was hated; yet he was also mightily respected for his actual prowess as an executive and his supposed prowess as a financier.
It was during the seven fat years that Insull’s steps in the new finance became reckless. The lucrative possibilities of holding-company pyramiding had been discovered in many quarters, and several big systems of electric-light and power companies were growing with astonishing rapidity. The competition among them became furious. There was the Electric Bond and Share system, the biggest of all, built up by a brilliant financier, S. Z. Mitchell, as an offshoot of the General Electric Company. There were also the Byllesby system, the Cities Service system, the Associated Gas and Electric system, the American Waterworks and Electric system, and many others. These systems were engaged, seemingly, in a race to see which one of them could buy up the greatest number of local electric light companies. They were spawning new holding companies and super-holding companies to widen and consolidate their control. Securities were easy to sell, for to the investing public the prospects of the electric-light industry were incredibly dazzling. With confidence unbounded, Insull expanded his system. He sought to have the biggest empire of all.
We must pause now for a word of explanation. How could the electric light and power business be so lucrative? The local companies—being monopolies—were regulated by the states, were they not? They were supposed to lower their rates as business expanded and efficiency increased, rather than to pile up huge profits, were they not? What, then, was the great advantage in buying up these companies so lavishly?
There are several answers to this question. One was that a holding company which controlled a number of operating companies was able to provide them with good management, to command better engineering ability than they could afford individually, to save money by mass-purchasing, by consolidating income-tax returns, and otherwise, and to secure them new capital on better terms than they could command individually. Another reason was that the business was expanding so rapidly and gaining in efficiency so rapidly—partly as a result of the very competition of which we have been speaking—that often profits could grow even if rates were lowered. Another reason was that political pressure could sometimes succeed in keeping rates from
being lowered; a legislator who wanted to lower them could be made to seem a destructive radical, an enemy of the business man; or else perhaps he could be bought.
Still another reason was that a holding company was something like a cream-separating machine, which skimmed off the richest of the profits when these were increasing. Ordinarily the holding company held only the common stock of the operating companies, or part of it, leaving the bonds and preferred stock in the hands of the general public. If we think of the earnings which went to pay interest on the bonds and dividends on the preferred stock as resembling the milk in a bottle, and the further earnings which went to pay dividends on the common stock as the cream at the top, we can see how advantageous it was to skim the cream from ten or twenty bottles: one inch more of cream in each bottle, and the cream-separators would find their haul growing out of all proportion. (Conversely, of course, the cream-separating business would languish if the cows gave a poorer quality of milk—but that is the sort of thing which does not occur to investors in boom times.)
By piling holding companies on top of one another, one could still further increase the richness of one’s cream. For just as the bondholders and preferred stockholders of the operating companies got the milk of profits, and the common stockholders got the cream (if there was any), so the bondholders and preferred stockholders of the holding companies (which we have likened to cream-separators) got the ordinary cream, and the common stockholders got the extra-heavy cream at the very top (if there was any). To own the common stock of a super-holding company might be to get the best of the extra-heavy cream, skimmed, as it were, from forty or fifty bottles (again, if there was any).
Lords of Creation Page 26
