Lords of Creation

by Frederick Lewis Allen

  But there were other advantages still. One was that a holding company could siphon money out of its operating companies—and so adroitly that a regulating commission could not see it go. For instance, it could charge the operating companies very heavily for the management and engineering services which it undertook on their behalf. How could a state regulating commission tell whether the amounts of money which a local power company spent for management and engineering services were reasonable? It could not examine the books of the holding company which performed these services—for this latter corporation was in no way under its jurisdiction unless it actually sold power itself; in legal theory it was not engaged in the electric power business at all. The holding company was safely beyond the regulating commission’s reach!

  Let us watch this siphon at work. One of the Insull group of companies (the National Electric Power group) had such services performed for it by a concern called the Electric Management and Engineering Corporation. During the period between July 15, 1925, and September 30, 1930, this Electric Management and Engineering Corporation performed services for the operating companies which cost it, in all, a little less than $2,100,000—and it charged over $4,100,000 for them, collecting a profit of 98.8 per cent, neatly sucked out of the various operating companies.

  And perhaps the choicest advantage of all was that a system of holding companies and operating companies could manufacture profits by marking up the values of properties and finding ways in which the mark-ups might appear on their books as profits. One way of doing this was to have the various companies in the system sell properties to each other at rising prices. It was somewhat as if Mr. Jones owned a piano for which he had paid a thousand dollars, and Mrs. Jones owned an Oriental rug for which she had paid a thousand dollars. Presently Mr. Jones sold the piano to his wife for $1500 and she sold the rug to him for $1500, and they declared that it had been a profitable year for them because each of them had made five hundred dollars on the sale of property—despite the fact that the piano and the rug were still right in their living-room and that not a nickel had come in from outside the family! Does this seem to you a curious way of keeping accounts? Perhaps; it is hardly more curious than the method employed from time to time in the Insull system.

  For example, in January, 1928, the Middle West Utilities (one of the Insull holding companies) sold some securities to the National Electric Power (another Insull company, which incidentally it controlled) for over three million dollars more than it had paid for them; and simultaneously—indeed, by the very same agreement—the National Electric Power sold some other securities to the Middle West Utilities for over three million dollars more than it had paid for them. The securities were simply exchanged; they stayed within the family, just as did the Joneses’ piano and rug, and no money had come in from the outside. Yet those two companies chalked up two profits of three million dollars each. And as the Middle West controlled the National Electric Power, and thus had cream-skimming rights over it, the Middle West got not merely its own three millions but the National Electric Power’s three millions too, and chalked up a profit of six millions!

  In defense of such remarkable accounting it could be argued, of course, that the rising prosperity of the electrical business was causing all values to increase, and that this was simply a way of taking due advantage of the swelling wealth of the utility systems. But as Professor W. Z. Ripley pointed out, such revaluations were “paper profits, not real ones at all.” It was unwise to distribute them as dividends; it would be better to “salt them down against an evil day when something may happen to the other side of the ledger.” Furthermore, it was largely because revaluations were constantly going on, in system after system of utilities, that the upward march of market values was so impressive, and that there was thus a shadow of an excuse for the practice. Indeed, the sequence of cause and effect in the operations of these utility systems was circular. Because the holding companies could be made to show big profits, it was easy to raise money to finance them. (It was also, incidentally, easy to persuade public-service commissions that rates could not be lowered; had not the Supreme Court declared it legitimate to claim a fair return, not merely on the original investment, but on what it would cost to reproduce the investment in these days of higher prices?) Because it was so easy to show profits, the stock could be watered and the magnates at the center of things could make much money through financing operations. Because so much money could be made, the systems became more and more ambitious and tried to get hold of more and more operating companies. Because they tried so hard, the market value of electric light plants increased. Therefore there was a plausible excuse for writing up the assets of existing companies. And therefore the systems could be made to show big profits. It was an endless sequence; and it was enough to turn the head of any but the coolest of financiers.

  By 1926 or thereabouts—when Coolidge prosperity was coming richly into flower—Samuel Insult’s head appears to have been pretty thoroughly turned. (His financial head, that is to say; he still remained a brilliant operator of utility plants.) The expansion and elaboration of his pyramid of corporations was now going on at a terrific rate. Already it was seven or eight stories high. In his reckless zeal for the acquisition of new operating companies and water power sites, he was striking some strange bargains—buying paper and textile mills and even a tire-fabric company and a shoe-factory in New England; buying real-estate development companies near Kansas City, and in Texas (one of which was designed to transform Port Isabel, Texas, into “the Venus of the South”). He was paying strange prices; said the president of an electric light company to N. R. Danielian, when asked why he had sold out to Insull: “What in hell would you do if some one came along and offered you three times as much as your company was ever worth?” So curious were some of the Insull investments at this time that it is doubtful if the mad adventure could have gone on long, had it not been possible to mark up values and shuffle investments about among the numerous corporations in the Insull family, and to sell more and more stock at more and more inflated values. Mr. Danielian estimates that Middle West Utilities, which paid good dividends and the stock of which went to 570 in 1929 (that stock which Insull had got 40,000 shares of without charge, back in 1912), would have run at a loss during most of its career if it had had to depend upon the sort of profits which cold-blooded accountants permit to be shown as profits. But investors were greedy and stock-salesmen were operating under high pressure and high profits were being shown all along the line—and the speculative fever was in the air. So the adventure went on.

  To look at a chart of the Insull pyramid as it appeared during those lush days is almost to be persuaded that one is dreaming. Certainly, one thinks, here is corporate capitalism gone mad.

  At the top of the pyramid (as it existed in 1929) was a so-called investment trust known as Insull Utility Investments, Inc. This concern held stock, directly or indirectly, in four others of imposing size: The Public Service Company of Northern Illinois, the Commonwealth Edison Company, the Peoples Gas Light and Coke, and the Middle West Utilities. But the Middle West Utilities was itself the capstone of a lesser pyramid, controlling holding companies which controlled holding companies which in turn controlled other holding companies or operating companies. The system was not symmetrical, neither did it retain its shape for any long space of time; there was a constant shifting of investments going on, a constant passing of properties from hand to hand (often at rising prices); but some notion of its dimensions and complexity may be obtained by following up the lines of control from the bottom to the top in one or two places. For example, as we have already seen in Chapter 7, the Tidewater Power Company (in North Carolina) was controlled by the Seaboard Service Company, which was controlled by the National Public Service Corporation, which was controlled by the National Electric Power Company, which was controlled by the Middle West Utilities. For another example, let us move from North Carolina up into Maine. The little Androscoggin Electric C
ompany in Maine was controlled by the Androscoggin Corporation, which was controlled by the Central Maine Power Company, which was controlled by the New England Public Service Company, which was controlled by the National Electric Power Company, which was controlled by the Middle West Utilities. These are only two instances of the relationships in a pyramid consisting of scores of corporations. And each of the corporations in this vast system had its board of directors, its officers, its investments, its ledgers, its complex system of accounting, its annual reports, its various classes of stock, and its army of minor investors.

  Does this seem complicated enough? One more element of confusion must be noted. The lines of investment and control did not simply run from the top of the system to the bottom, as one might expect. They ran every which way. Sometimes they ran upward. For example:

  When Samuel Insull formed the Corporation Securities Company of Chicago, late in 1929, to try to maintain his control over a system that was already getting out of hand, he arranged that this newest of all his concerns should hold a large block of the stock of Insull Utility Investments, Inc., which he had formed in the previous year to put at the top of his pyramid. At one time “Corps”—as Corporation Securities was known to its intimates—held 28.9 per cent of the stock of Insull Utility Investments. But Insull Utility Investments also owned 12.5 per cent of the stock of “Corps.” Each of these two super-super-super-holding companies thus held a firm grip on the other. Again, at one time “Corps” held a little over ten per cent of the stock of Middle West Utilities, which was a story below it in the pyramid, so to speak; but Middle West also held 1.2 per cent of the stock of “Corps.” In the face of facts like these, one is at a loss for figures of speech which can be applied to the system. A pyramid, was it? But what sort of a pyramid has a lower step partly resting upon the step above it? A family tree, was it? (Financiers often refer to “parent companies.”) But in what sort of a family is the child a part-parent of the father?

  Years afterward, Owen D. Young said that he had to confess to a “feeling of helplessness” when he attempted to understand the tangle of corporations which had grown up under Insull’s sovereignty. “I say it is impossible,” insisted Mr. Young, “for any man to grasp the situation of that vast structure … it was so set up that you could not possibly get an accounting system which would not mislead even the officers themselves.” … He expressed the belief that the intricate relationships “got even beyond the power” of Samuel Insull, “competent as he was, to understand” them. Mr. Young was putting it mildly. When, in 1934, Insull was tried for fraud, the Federal Attorney struggled to find a formula by which he could show the jury that the real value of the stock of “Corps” was not what the Insulls had claimed it to be. On a blackboard in the courtroom he wrote two equations:

  The bewilderment of the twelve good men and true when they looked at those equations was hardly greater than would have been the bewilderment of any man who had tried to discover what Insull was really doing in his endlessly complex financial pyramid-building.

  Yet few people had any doubts, in 1929, of Insull’s ability to understand what he was doing. If there was some conservative questioning in the East, Chicagoans were tempted to ascribe it to jealousy. He seemed to be a miracle-worker. His prestige was colossal. He was chairman of the board of directors of 65 different concerns, and president of eleven others. His wealth was reputedly vast. John Flynn quotes a cynical reporter of those days as saying that it was worth a million dollars to any man to be seen talking to Sam Insull in front of the Continental Bank.

  He had built a great opera building—popularly known, on account of its shape, as “Insull’s Armchair”—in which the new Civic Opera Company which he financed was preparing for its first brilliant season. (Oh, yes, he was a patron of the arts: had he not, among other things, humored his wife’s ambition to return to the stage by spending a quarter of a million or so that she might appear as Lady Teazle in “The School for Scandal”?) High up in this same opera building he had a magnificent apartment, in the central room of which there was a grand piano and also a directors’ table, suggesting the union of finance and its tributary arts. Flynn tells a story of a man’s coming to see Insull in this apartment and wanting to talk to him confidentially, and noting as they conversed that a group of men were talking in an adjoining room, the massive oak door of which stood open; and of his wondering uneasily whether the men were within earshot; and then of his seeing the oak door close as if of its own accord—slowly, noiselessly. And on Insull’s vast estate at Libertyville, the villagers were said to have “built homes on Insull real estate, sent to an Insull school children born in an Insull hospital, used Insull light, cooked with Insull gas, traveled on an Insull road, saved in an Insull bank, and played golf on an Insull golf course.” Great was Samuel Insull.

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  Such, at least was the appearance. In reality, however, the monarch sat somewhat uneasily upon his throne, even in the confident year 1929. He had just formed his penultimate holding company, the Insull Utility Investments; and his purpose in so doing was to secure from investors the sinews not so much of conquest as of defense. His position was vulnerable: much of his system of control depended upon minority holdings of stock, and there was always the danger that someone might seize a part of his corporate domain, as Harriman had sought to seize a part of Hill’s domain in 1901. Insull must not let this happen. He must call the investing public to his aid, to provide money with which he might strengthen his hold on his empire.

  To Insull Utility Investments, this new holding company (or investment trust, as it was somewhat inappropriately called), he transferred nearly all the holdings of his family in Middle West and the other upper companies of his pyramid.

  It is interesting to notice, however, the way in which this transfer was made; for it suggests that even at this moment of insecurity Insull and the men about him had the speculative virus in their veins. He and his family received, in return for the stocks which they transferred, not only a block of preferred stock in the new corporation, but also nearly three quarters of a million common shares valued at $7.54 a share; to say nothing of warrants which entitled him to buy further shares—half a million more of them—at $12 and $15 within the next two years. Presently the stock was listed on the Chicago Stock Exchange. The trading was to begin which would establish a market price for these new holdings of his.

  At the moment when the trading began—on a January morning in 1929—the only shares in existence were those which had been issued to Insull and his family for $7.54 apiece. If any buying and selling were to be done, only the Insulls could do the selling.

  At the opening of the market, that day, there were quantities of bids to buy Insull Utility Investments “at the market”—for speculators were extravagantly eager. Yet at first no stock was to be had. Then it began to come out—at a price, not of $7.54 a share or anything like it, but of $30 a share. Insull’s brokers were taking advantage of the wild demand on the part of speculators to give the Insull family a paper profit of almost exactly 400 per cent. Nor did they let the price lag. They kept buying and selling “to maintain the market”—buying mostly, at first—and the price kept rising. By the end of February it was 46, by the end of July it was 126, and one day in August it actually touched 149¼. Insull salesmen were using these prices as a guide in determining the prices at which they should sell other shares to the public outside the Exchange. Thus the public was buying at prices ten or fifteen times the price at which Insull himself had bought—Insull, who as the head of the company was supposedly the chief representative in its councils of these very investors. As the price soared, the man’s paper profits became enormous. It must have seemed to him as if the secret of wealth unlimited had been discovered.

  Still, however, his grip on his empire was insecure. And if he sold permanently many of the hundreds of thousands of shares which he had acquired at low prices, and thus took his paper profits, it would become still more insecure. So h
e decided to form still another holding company (or investment trust), the Corporation Securities Company of Chicago—“Corps,” as we have already called it. That would draw in still more investors to help him hold the bag from which flowed this mighty stream of potential gold. Were promoters trying to dislodge him from his throne? All he needed to do, it seemed, was to form a new corporation, mark up values again, declare more dividends, and sweep on to victory.

  Then came the panic of October and November, 1929, in which marked-up values collapsed with a tremendous crash.

  To tell the rest of the story of Samuel Insull is to carry ourselves far beyond the seven fat years. We need not do more than summarize very briefly what happened. The financing of his huge collection of corporations had reached the regions of complete unreality. Prices, values, even dividends, had become speculative rather than substantial. And now the ground began to fall away from under them. Company after company found its assets beginning to look more and more dubious; the excuse for handing stocks about at rising prices began to look thinner and thinner; and to make matters worse, as business slackened and the earning power of the operating companies was affected, there began to be, as it were, a deterioration in the quality of the cream on the top of the corporate bottles, that cream upon which the holding companies were vitally dependent for their revenue. Furthermore, a ramifying structure of bank loans and credit had been built upon the speculative values of 1928 and 1929, and as these values sank the Insull credit began to crumble. Yet the system had set for itself a pace of growth and of declared earnings and dividends which it would be very dangerous to slacken, lest public confidence be utterly lost.