These earnings created such a cheerful prospect for the Nickel Plate Securities Corporation that the Van Sweringens were now able to issue more preferred stock, pay off most of their debt to the New York Central, and begin the purchase, on the installment plan, of three more small railroads. By this time they were no longer mere real-estate men of Cleveland; they were big railroad men too, and a new and exalted ambition was growing in their minds.
During the war the railroads had been under the direction of the Federal Government. The advantages of combining railroad resources and operating facilities had been so apparent that when the roads were returned to their private owners, the government had encouraged them to group themselves into a number of big systems, subject to the approval of the Interstate Commerce Commission. Just how this grouping was to be effected was a problem. In the East, for example, big systems would naturally be built up about strong roads like the New York Central, the Pennsylvania, and the Baltimore and Ohio, which might buy up other lines or merge with them. Such. purchases and mergers, however, were easier to talk about than to accomplish; for rivalry was intense, railroad presidents and directors could be very obstinate in their independence, stock-market speculators were avid, and a small road which might be sought after by two or three big systems could become a tempting speculative prize in the Street. There were destined to be years of conferences and bickerings, while railroad presidents tried to come to agreement on the redrawing of the railroad map—with an uneasy or eager eye, meanwhile, upon the stock-market quotations. In the early years of these conferences, nobody seemed to think seriously of the possibilities of a major railroad system built up about the Nickel Plate, which ran only from Buffalo to Chicago and until recently had been a single-track, down-at-theheels line. The Van Sweringens, however, were thinking of it very seriously. And they thought of it in terms of holding companies laid one upon another.
They were now in their early forties—two nice-looking, boyish young men; sturdy, round-headed, low-voiced, attractive; shy young men, who kept to themselves, seemed to care nothing for social life despite their growing wealth; who did not smoke or drink, did not believe that the road to success ran by way of the golf-links, took no vacations and seldom a day off, but were always working, whether in their adjoining offices or in their private suite at the Cleveland Hotel, or at their suburban farm, Daisy Hill, a few miles outside the city. To Clevelanders their names were already potent, seldom as they were recognized on the street; to the general American public they were completely unknown. But the seven fat years had begun—the great era of holding-company expansion—and they were soon to be heard from.
In 1925, the year when Coolidge succeeded Harding as President, the Van Sweringens bought the so-called Huntington interest in the Chesapeake and Ohio road—only a fifteen per cent interest, as it happened, but large enough to permit them to name the directors if the other owners were acquiescent. The Morgan partners had been watching them, liked their hard-working earnestness, raised no barrier to their purchase, and continued to watch them with approval. It took more than seven million dollars to make this purchase, but the brothers collected it by selling new bonds of the Nickel Plate road, and by borrowing. During the next two years they bought the Pere Marquette and also a large interest in the Erie, borrowing again to make the latter purchase. Old George F. Baker was the largest stockholder and the most powerful factor in the counsels of the Erie, and his opposition would have been fatal to their plans, but he too, like the Morgan partners, regarded them with a friendly eye. The story is that when they came to see him he asked them only two questions: did they work hard and did they sleep well? Satisfied with their answers, he let them buy the necessary stock to take over the direction of the Erie.
With such formidable allies in Wall Street as the House of Morgan and George F. Baker, the Van Sweringens saw the pathway to fortune lying clear before them. They went on buying railroads. But their purchases required money—lots of it—and they must have this money on terms which would not permit their sovereignty to be disputed. They got it by forming more and more holding companies: very big ones: layer upon layer of holding companies.
Incredible indeed, by 1929, seemed the achievement of these two young men. Thirteen years before, as a result of trying to build a rapid-transit line from Shaker Heights into Cleveland, they had put a million dollars into purchasing the control of the rickety Nickel Plate; and now, with the mighty House of Morgan as a potent ally, they were masters of a great system reaching from Chicago to the Atlantic Coast; a system with thousands of miles of track, over a hundred thousand employees, and assets in the neighborhood of two billion dollars. Until 1929, this great system had not spread beyond the Mississippi, but now the Alleghany Corporation—their biggest holding company—was purchasing stock in the Missouri Pacific, and thus was expanding the Van Sweringens’ sphere of influence all the way to the Mexican border.
As a mere detail of their campaign of conquest and expansion they were rebuilding the whole central part of their native city. Their subsidiary corporations in Cleveland had been putting hundreds of millions of dollars into a vast and splendid urban real-estate project: railroad terminals, huge office buildings, a hotel, a seven-hundred-foot tower. They were multi-millionaires, too; for pyramiding could be very profitable if the pyramiders and their top holding companies transferred blocks of stock to new holding companies at rising prices. On some of their transactions their profits mounted into the tens of millions.
Not only in Cleveland but in Wall Street, too, the name Van Sweringen had now become magical. Yet the brothers themselves remained as modest and self-effacing as ever. They appeared in public as little as possible. When a great dinner was held to celebrate the opening of their new Union Terminal, they stayed away from it. They refused to have a New York office; when they visited New York, they had their papers bundled up and taken from their private car to a hotel. They preferred the quiet of their Cleveland offices or of their Daisy Hill farm, where a private telephone operator took care of the urgent long-distance calls which came in from all over the country as they spun their web of power.
The foundation of the Van Sweringens’ glittering success, in railroading as in real-estate speculation, was undeniably sound. Their railroads were well run, as Shaker Heights had been well planned. Bernet, their best operating man, had followed the focus of their interest in efficient management from the Nickel Plate to the Erie, and from the Erie to the Chesapeake and Ohio, and each of these roads had responded to his magic touch. But on this solid foundation of operating skill they had raised an immense financial pyramid built of debt and of hope.
At the top of this pyramid sat O. P. and M. J. Van Sweringen themselves. On the step below them was the Vaness Company. The second step from the top consisted of the General Securities Corporation. On the step below the General Securities, and controlled by it, was the Alleghany Corporation, which in turn (another step down) controlled the Chesapeake Corporation and the Nickel Plate, and was acquiring control of the Missouri Pacific. We now descend to the fifth step from the top. The Nickel Plate controlled the Wheeling and Lake Erie; the Chesapeake Corporation controlled the Chesapeake and Ohio; and this company in turn controlled (the sixth step from the top) the Hocking Valley and (with the assistance of the Alleghany Corporation) the Pere Marquette and the Erie.
There could be no more perfect example of the technic of remote control through pyramiding than this system. For example, according to the figures published by Berle and Means, the financial interest of the Van Sweringens themselves in the General Securities Corporation (as of April 30, 1930) was 51.8 per cent; in the Alleghany it was 8.6 per cent; in the Chesapeake Corporation it had dwindled to a mere 4.1 per cent; in the Chesapeake and Ohio, to less than one per cent; in the Hocking Valley to the ridiculous figure of one-quarter of one per cent—and yet with this minute personal financial stake in the Hocking Valley, the men at Daisy Hill were the arbiters of its destiny, so astutely had they managed t
o pile holding company on holding company, and to induce the public to join with them in investing in each.
A very persuasive structure, this pyramid; so persuasive that the Morgan partners, far from looking askance at it as they looked askance at the unwieldy Insull pyramid and some of the other financial structures of the day, were hopefully engaged in selling building-blocks in certain parts of it to all and sundry. Yet it had its peculiarities, and these peculiarities had their wide economic consequences.
For one thing, the Van Sweringens and their companies were always borrowing largely from the banks: each new offensive in their campaign involved them in new debts. For another thing, the formation of each new holding company meant the issue of bonds or preferred shares which were dependent upon common-stock earnings.
In short, here was the old cream-separating business all over again; what you were buying, when you took an Alleghany Corporation bond, was a first call on a cream-separating machine which in turn was partly dependent on another cream-separating machine. This fact was significant from your point of view as an investor; but it was even more significant from another point of view. It meant that the Van Sweringens had locked themselves into a situation where their railroads had to earn common-stock dividends—even on stock which had once been considered speculative—or the huge debt structure which had been built upon the hope of these dividends would come crashing down in bankruptcy.
Meanwhile, in the city of Cleveland, the Van Sweringens’ spectacular real-estate operations had involved their local companies in debts to the banks, and had also encouraged a general boom in urban real-estate, thereby involving the Cleveland banks in all sorts of investments and loans based on speculative valuations. Though the shy, soft-spoken men from Daisy Hill were quite unlike Samuel Insull, their operations, and the operations which their dazzling career had suggested to others, had woven speculative values, as his had, deeply into the economic fabric.
Then came October and November, 1929, and—worse than that—the decline in values in the fall of 1930, and the slow avalanche of 1931 and 1932. An ugly time for borrowers; and for lenders too.
Not all the things which were done in those years of collapse make agreeable reading. Debt had hitherto weighed lightly upon the Van Sweringens; now its burden was terrific. They had to have money. One of their closest associates was the president of one of the Cleveland banks, the Union Trust. The Van Sweringens had borrowed so heavily from this bank that at last an unsecured loan to one of their companies was refused at the main office—but the president gave his oral approval and the loan was made. By 1930 they were so deeply obligated to the Cleveland banks that they could raise no more money there—in quantity, at least—and they had to borrow nearly forty million dollars from J. P. Morgan & Company. The Morgans required sound collateral, and it was vital to the Van Sweringens to remain in their good graces. Thereupon—to quote the words of the Senate Banking and Currency Committee—“substantially all of the collateral having any market value which was pledged with the Union Trust Company was released from the Cleveland loans and turned over to the Van Sweringens to hypothecate against the loans from J. P. Morgan & Company.” New York must be served, even if others suffered.
Again, the Missouri Pacific Railroad, which the Van Sweringens now controlled, was under terrific compulsion to show good earnings, not only for its own sake but for the sake of the Alleghany Corporation, which as we have seen had a big stake in its fortunes. The Missouri Pacific reported as income the dividends which it received from a subsidiary to which it was lending money at the time—the money going to the subsidiary in the form of loans and returning in the form of dividends. And it also took profits on transactions in its own stock between two of its subsidiaries—an improvement company and a motor-bus company!—thereby reminding observers of the old grand-piano-and-Oriental-rug game which had worked so neatly in the Insull system.
But enough of such examples. The twistings and turnings of men in the grip of circumstance are not always pleasant to watch. It is enough to set down the facts of the situation as they stood in 1935.
The two biggest banks in Cleveland had crashed—ruined by their adventures in real estate and their other financial expeditions during the years of indiscretion, and by their frantic attempts to stave off failure during the years of reckoning. (It might almost be said that the Van Sweringen influence had found Cleveland a city of brick and wood, and had left it a city of marble—and of bad debts.) The Missouri Pacific road had gone into a trusteeship under the bankruptcy legislation of 1933. The Alleghany Corporation, unable to pay the interest on one of its issues of bonds, was negotiating a difficult capital readjustment. As for the Van Sweringens themselves, they still were in command of the railroads over which they had assumed dominion, but their stock was pledged as collateral against huge loans; if they were still afloat upon the sea of debt, it was because the lifelines of credit to which they clung were held at the other end by the strong hands of the Morgans and their banking allies. There were few people, any longer, who regarded the great Van Sweringen pyramid as one of the seven wonders of the financial world.
I have before me a photograph of the two brothers as they appeared when they came before the Senate Banking Committee for investigation in June of 1933. They are boys no longer, in that photograph, but elderly-looking men, solid and gray-haired, with old eyes.
Chapter Ten
BANKERS, SALESMEN, AND SPECULATORS
ONE day in 1915 or 1916 Charles Edwin Mitchell and Bruce Barton were standing together by a window in the Bankers’ Club in New York, looking down upon the city. Said Mitchell:
“Every once in a while one of our bond men comes into my office and tells me he can’t find any bond buyers. When that happens I don’t argue with him. I say, ‘Get your hat and come out to lunch.’ Then I bring him up here and stand him in front of one of these windows. ‘Look down there,’ I say. ‘There are six million people with incomes that aggregate thousands of millions of dollars. They are just waiting for someone to come and tell them what to do with their savings. Take a good look, eat a good lunch, and then go down and tell them.’”
Those remarks of Mitchell’s—I quote them from a magazine article by Barton—were laden with implications of which Mitchell himself was then unaware. To be sure, they were made some time before he became one of the mightiest powers in American banking. They were made before his fortieth birthday; at just about the time when he was invited to leave his own investment-selling concern and become the president of the National City Company, the National City Bank’s security affiliate: the Siamese twin by means of which it was able to trade in securities without incurring the displeasure of the law. Old James Stillman, though he was living mostly in Europe and was failing in health, was then the power behind the bank, and Frank Vanderlip was its active head. The future still hid what was to come in the next few years: the death of Stillman in 1918; the falling-out between Vanderlip and the directors of the bank in 1919, which was to thrust young James A. Stillman into the presidency; and, after young Stillman in turn was thrust out in 1921, the selection of Mitchell as the new president.
The remarks were significant because they revealed the nature of Mitchell’s indisputable talents, because the selection of a man of such talents as the chief executive of the richest bank in the United States foreshadowed a change in the spirit of American banking, and because the influence of Mitchell in the financial world of the nineteen-twenties was to give impetus to that change.
Mitchell was a salesman.
To understand clearly what it meant to have the spirit of salesmanship invade commercial banking, one must remind oneself of a few very elementary facts. In the first place, a bank—a commercial bank, that is to say, as distinguished from an investment banking house, which is quite a different thing—is a custodian of your money and mine, charged by law and still more by honor with the duty of lending or investing that money prudently, so that you and I will not suffer loss. In the second
place, the bank, as lender and investor of our money, is a nourisher and stimulator of business. And in the third place, the bank is more than a custodian and lender of money: it is a manufacturer of money. Only a small proportion of the funds in use in the country—somewhere between a fifth and a tenth of them in normal times—are currency; the rest are check money, manufactured by the banks; and not by the banks as a group, but by individual banks wherever they may be from Maine to California.
The process of manufacture may be illustrated by the following over-simplified example. Suppose you deposit a thousand dollars in the Middletown National Bank. This amount, minus what the bank holds as a reserve for safety—say ten per cent of it—is thereupon available for lending. Now suppose I come in and want to borrow from the bank. Nine hundred dollars of the thousand which you deposited is available to be lent to me. The bank lends it. But it does not hand it over to me in cash. The bank chalks up a credit of nine hundred dollars beside my name: those nine hundred dollars become a deposit to my account. Thus the total deposits in the bank are increased by nine hundred dollars; and thus, miraculously, the bank has more money available for lending—not the whole sum which was written opposite my name, for a part of this sum must be held as a reserve, but say eight hundred dollars of it. Now suppose our neighbor Mr. Jones comes in and wants to borrow. The bank can lend him eight hundred dollars, credit this sum to his account, and thus have, say, seven hundred dollars more to lend to Mr. Robinson. And so the process continues; not to the bitter end, of course, for each time you or I draw a check we thereby reduce the total amount of money which the bank can lend; but far enough to make the amount of check money in the country from five to ten times as great as the amount of currency. The example here given, it must be remembered, is over-simplified. In practice no single loan would go through the process outlined above. But it substantially dramatizes a development which actually would involve many banks and thousands of depositors.
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