Lords of Creation

by Frederick Lewis Allen

  He regards with pleasure the presentation to his son, Samuel Insull, Jr. (on the left), of an award for being the young man who did “the greatest service to Chicago in 1931”(raising money for unemployment relief). This picture was taken shortly before the final collapse of the Insull system

  INSULL AT THE BOTTOM Passing through the gates of the Cook County Jail at the time of his trial

  Insull was caught in a speculator’s trap. Retreat was impossible. He could only go on; and he went on—showing profits and paying dividends. Long after the panic, the salesmen of Insull securities were still selling stocks to the little investors who were considered more likely to hold them than the big investors. Wrote Frank R. Evers, secretary of the unit which distributed shares, “The success of our business has lain in our getting the small fellow to buy.” And again,… “my experience with these big buyers has been that they sell out on the least turn of the market.” There was a note of unintentional irony in a letter from Halsey, Stuart & Co., Insull’s bankers, in 1931, to a woman investor, suggesting that she buy Corporation Securities shares in place of her United States Government bonds; they explained to her that on account of the demand for Government bonds on the part of banks, the market for them was “artificially stimulated to a great extent.” All this time Insull’s brokers were stimulating the market for the shares of Insull’s corporations by buying and selling in the hope of holding up prices.

  The hope was vain. The undertow of liquidation was too strong. The brokers bought more shares of Insull Utility Investments than they sold—but still the price sagged. Alas for Insull’s mighty paper profit: it was of little use to him now. Eaton, a Cleveland financier, had accumulated a big block of Insull stock and said (so the story goes) that he would throw it on the market if Insull did not buy it at his lofty price. Insull bought; he did not dare risk the effect of a new torrent of selling upon his price structure.

  Yet gradually that structure, rotten as it was with speculative values, succumbed. Insull did not desert it; he believed in its validity. He and those about him borrowed frantically, putting up stock as collateral. As the margins of safety behind these loans diminished, the bankers called for more collateral, and the Insulls had to find it wherever they could. The credit of company after company suffered in this desperate defensive campaign. Nor did the slow processes of collapse bear down upon the Insull companies alone. Investors by the thousand were affected; banks were affected; other corporations were affected. These corporations were tied by a thousand strands to other parts of the American economy. Insull had not been building his pyramid in a vacuum. He did not, could not in the nature of things, go down to defeat alone.

  At last the day of doom arrived: the day when Owen D. Young and a group of New York bankers confronted Insull in Young’s office and told him that surrender was inevitable. The meeting took place on April 8, 1932—two and a half years after the panic.

  “Does this mean a receivership?” asked Insull, when Young, after a private discussion with the bankers, crossed the room to explain that they regarded the situation as hopeless.

  “Yes, Mr. Insull, I’m afraid it does.”

  A witness of that scene has testified that Insull seemed to be in a state of collapse. “I wish my time on earth had already come,” he said.

  But it had not. Investigation, flight, indictment, refuge in Greece, capture, and trial in Chicago were still to come—grimly underscoring the tragic conclusion of a financial adventure in which a brilliant career had been wrecked, and American investors had lost nearly three-quarters of a billion dollars, and the economic system of the whole country had been gravely shaken.

  3

  None of the other public utility pyramids combined in such lavish measure as Insull’s the qualities of immense size, immense complexity, reckless expansion, and speculative management. Yet some of the peculiarities of some of these other systems deserve a passing mention, if only to suggest that Insull was not in all respects unique.

  Take, for example, the matter of complexity. Anybody who tries to study these public utility systems as they rose during the heydey of the pyramid-builders is constantly baffled, not merely by the intricate relationships between the holding companies, but by the similarity of their names. At this writing the Federal Trade Commission’s investigations of American utilities are recorded in no less than seventy-one good-sized volumes. Pick up any one of these volumes, and you are in a jungle of confusion: there are so many dozens of corporations whose names sound much alike that even the best memory is baffled to recall which is which. And sometimes it almost seems as if the confusion must have been deliberate.

  Suppose, for example, you wished to discover the exact status of an operating company, and traced its control to the Associated Electric Company, only to find that this was controlled by the Associated Gas and Electric Corporation, which was controlled by the Associated Gas & Electric Company, which was controlled by the Associated Securities Corporation, which was controlled by the Associated Gas & Electric Properties. Suppose you found, in this same system, both a Rochester Central Power Corporation (of New York) and a Rochester Central Power Corporation (of Delaware). Or two separate concerns which were known respectively as Mohawk Valley Company and The Mohawk Valley Company (only the definite article in the name of the latter concern distinguishing it from the former). Would you not wonder what legitimate purpose there could be behind such a bewildering method of nomenclature?

  Suppose you found many corporations which were separate legal entities and had officers and directors, ledgers, minute-books, and stock outstanding, but no employees. A Federal Trade Commission examiner, Charles Nodder, said that this was true of most of the sub-holding companies in the Associated system. Suppose you found a company as large as the Standard Gas & Electric, with assets of one hundred and ninety million dollars at the end of 1929, getting along with no payroll at all and being managed by a subsidiary corporation. Would you not wonder what had become of corporate responsibility in a case like that?

  Or let us consider the matter of personal responsibility for corporate affairs. Presumably one may expect that when a man’s name is connected with a company, he is able to give it some substantial personal attention. With all due respect to E. P. Summerson, secretary of Electric Bond & Share, one may reasonably ask how much personal attention he could give to the companies with which he was associated. At one time there were 240 of them, according to a report made to the House Interstate and Foreign Commerce Committee by Walter M. W. Splawn in 1934. Nor was Mr. Summerson alone in his multiplicity of duties. Another man was connected with 212 companies; three other men were connected with between 175 and 200 each.

  So many, many corporations—and so many species of securities! Here we run into another tangle of confusion. Prior preference stock, preferred stock, cumulative preferred stock, common stock, Class B common, common stock with warrants—and sometimes warrants with the most complicated conditions of exercise: even to understand the financial status of a single one of these corporations might tax the mind of a practiced accountant. To take one example only, the investor who in 1929 decided to put his money into the Associated Gas & Electric Company (not the Corporation, or the Properties, but the Company) had no less than twenty different classes of securities to choose between—including, if you please, an issue of bonds due to be retired on the first of January in the year 2875. (There’s long term debt for you! One takes off one’s hat to the assurance of men who borrow money with a solemn promise to pay it back at a date more distant in the future than the Norman Conquest is distant in the past—presumably on the assumption that even at that remote time their subsidiaries will still be operating electric-light plants in American towns.)

  The Insull system was by no means alone in marking up values, though not often did companies in other systems resort to the over-simple practice of classing as income their profits on inter-company transactions. According to N. R. Danielian, the inflation in value of the assets in t
wenty holding-company systems amounted to a total of at least $839,000,000, and probably a good deal more.

  And how about the imposition of service charges? We found, you may recall, a company in the Insull system which supervised operating companies and performed other services for it at a profit of 98.8 per cent. But we also find—according to Professor Buchanan’s analysis—the Southeastern Power & Light Company supervising at a profit of 95 per cent on the cost of its services during the three years 1925–27 inclusive, and the American Gas & Electric Company supervising and performing other services at a profit of 73.3 per cent. Besides such handsome takings the 50.8 per cent service profit of Electric Bond and Share from 1908 to 1929 looks moderate (although for the year 1927 the Federal Trade Commission calculated its profit on cost to be at least 106 per cent); and the failure of the North American Company to impose any service charges at all seems positively quixotic.

  In most systems the services for which these goodly fees were charged were of course substantial and valuable; but there was always the temptation to take the payment and then slight the services. Here is a bit of testimony before the New York Public Service Commission with regard to the management fees collected from an operating company in the Associated Gas and Electric system:

  Q. Did the J. G. White Management Corporation perform any services or do anything for the New York State Railways to your knowledge, and if so what, during the time this contract was in effect?

  A. Nothing that was helpful. They did advance the money, but it was not helpful, and a few other things, but nothing helpful.

  Q. What did they do outside of this advance of money?

  A. Called up on the telephone occasionally and asked different information, and so forth.

  Q. Did they ever send any one there to advise you or assist in management or operation of the road?

  A. No, sir.

  It is not necessary here to dwell upon the wildly extravagant prices paid by some of these other systems for properties when the competition in expansion was at its height; or upon the opportunities which insiders had to speculate in the stocks which represented these properties while negotiations were in progress; or upon the equally extravagant heights to which the stocks of the upper companies in pyramid after pyramid leaped in 1928 and 1929, often with the aid of persons close to the management who personally profited by this inflation.

  Nor is it necessary to make more than a passing reference to the political pressure exerted by some utility systems and their friends to prevent the new status quo from being disturbed. (Do you recall the letter written by State Senator Warren T. Thayer of New York early in 1927 to a vice-president of the Associated Gas and Electric Company, in which he said, “I hope my work during the past session was satisfactory to your company, not so much for the new legislation enacted, but from the fact that many detrimental bills which were introduced we were able to kill in my committee”?) Nor do we need to waste time over the “educational” campaigns financed by utility magnates to assure the public that they were intent only upon service to the public, and that the widespread ownership of shares of their companies by consumers constituted a striking exhibit of local economic self-government in the best American tradition. (When Professor Ripley suggested that in view of the vanishing rights of stockholders, governmental supervision of corporate affairs might be necessary, a vice-president of the Empire State Gas and Electric Association charged him with uttering “the kind of propaganda on which demagoguery and communism feed.”)

  What does perhaps need emphasis is that the pyramiding of utility companies was essentially a new device, lavishly resorted to during the seven fat years, which bestowed upon a few aggressive insiders an immense and unseasoned power subject to grave abuses. These insiders did on the whole a splendid job with their physical properties: there is no denying that. They gave the public effective service, and their high-tension lines, marching over hill and dale, linked the individual properties together with fine engineering skill. But the price which they charged was heavy. The siphoning of money out of operating companies hurt the consumer, who had to pay more than he should on his electric-light bill or his gas bill because the monopoly which furnished him with these services, and which (because it was a monopoly) was supposedly regulated in his interest by a state commission, was vouching for “expenses” of operation which permitted large profits (invisible to the state commission) for those higher up. The optimistic bookkeeping and inflationary financing of some of these systems hurt the investor, who bought speculative securities often without the least notion that they were speculative. And—more important still—the whole process of inflating values and hopes put the general economic system of the country to a prodigious strain, since this process directly or indirectly committed not only individuals but corporations and banks and other institutions to the expectation of exaggerated if not actually indefensible revenues.

  Inordinate profits do not come out of thin air. They come out of the consumer, or the worker, or the investor, or the future. It was the innocent delusion of the American public during the seven fat years that inordinate profits can come out of thin air. Pyramiding, and the financial expedients to which it almost irresistibly led in a time of overwhelming confidence, took inordinate profits out of the consumer, the investor, and the future—often including, of course, the insiders’ own future, as Samuel Insull subsequently discovered.

  4

  It is in young and rapidly expanding industries, like the electric light and power industry, that one expects to find daring financial devices flourishing. Not so in industries which have reached a comfortable middle age. The railroads had sown their financial wild oats long since, in the days of Gould and Fisk; they had reached their powerful maturity at the turn of the century, when Morgan and Harriman were in the saddle; by the nineteen-twenties they seemed to have accepted the limitations of circumstance and of advancing age, and they were living on a strict diet of regulation, subject to the doctor’s orders of the Interstate Commerce Commission. It was anomalous, therefore, that one of the most remarkable financial pyramids of the seven fat years should have been built on a foundation of railroads.

  Perhaps this anomaly may be partly explained by the fact that the two men who designed this pyramid were themselves young, and that they rose by way of real-estate promotion. The speculative sub-divider, after all, is a sort of belated and misplaced pioneer: the man who buys a tract of pasture land and turns it into a thriving suburb knows what it is to stake everything on a vision of the future, to take a long chance and subdue the earth. Let him turn to railroading and he may not be content with accepting the common lot.

  These two young men were the Van Sweringen brothers of Cleveland, upon whom had been bestowed the singular names of Oris Paxton and Mantis James. They were not twins by birth, for O. P. Van Sweringen was two years older than M. J.; but they were twins by choice. They lived together, worked together, planned together; bachelors both, they were almost inseparable; they even slept in twin beds. Each knew everything the other did. They were almost like two halves of a single personality. And they had a joint and very remarkable career.

  They began life in simple circumstances. (It is interesting, by the way, to note how many of the skyrockets of finance in the nineteen-twenties shot up from what might be called the lower-middle class.) Neither of the Van Sweringens went beyond the eighth grade in school. Oris got his start as an office boy, then as a clerk. But they were ambitious, and studied in the evenings. By the time Oris was twenty-one and Mantis was nineteen they were in the real-estate business.

  Pretty soon they began to buy and lay out and sell land on a rural plateau east of the city of Cleveland. Their operating methods were novel, their plans were far-reaching and well-devised, and they were fortunate enough to anticipate that trend toward the suburbs which was to become such a significant factor in the expansion of American cities. When the Van Sweringens were still in their early thirties, Shaker Heights, the development whi
ch they had so skilfully and ambitiously engineered, was becoming a thriving suburb.

  The brothers were doing extraordinarily well for themselves and for Cleveland, but still one would never have dreamed that they would become railroad magnates. The transformation was effected almost by blind chance. They needed better transportation service from the heart of Cleveland out to the suburb of Shaker Heights than the leisurely street-car lines would afford. They decided to build a high-speed electric line. Looking for a suitable place for a terminal in the city, they found themselves barred by the conflicting plans of the New York, Chicago and St. Louis Railroad—generally known as the Nickel Plate—for a freight terminal. The Nickel Plate was owned by the New York Central, but—providentially for them—the Interstate Commerce Commission wanted the Central to sell it. The Van Sweringens decided to buy it themselves, and to use its property and its right of way in Cleveland both for their own original purposes and for its purposes.

  But how to buy it? The price was eight and a half million dollars for the controlling shares, and the most that they themselves and their immediate associates could rake together was a million.

  Perhaps you have already guessed the answer. They formed a holding company.

  We need not go into the details of this transaction. All it is necessary to say is that the Van Sweringens sold enough preferred stock in their holding company to cover the first payment on their purchase, and thus to get control of the Nickel Plate without losing control of their Cleveland terminal properties. Of course they still had a lot of money to pay; everything depended upon whether they could get good earnings out of the Nickel Plate railroad line. But they were shrewd enough to select, as president of the road, one of the ablest operating men in the country, one J. J. Bernet. Soon Bernet was doing wonders with it—transforming it from a second-rate, run-down line into a successful one. In 1916 it had earned a little over six per cent on its common stock. In 1920 it earned over ten per cent; in 1921, over twenty-five per cent.