Lords of Creation

by Frederick Lewis Allen

  To hear some people discuss inflation, one might suppose that the only possible kind of inflation were that which can be brought about by the government through the use of the printing press, printing greenbacks; but banking or credit inflation of the sort described above has been a normal financial process for a very long time and has come about as the joint result of innumerable acts of judgment on the part of thousands of individual bankers as they received deposits and made loans. The money thus manufactured is quite as legal as a dollar bill, as each of us is aware when he pays his bills by check.

  Thus the commercial banker, although he is engaged in private business, is permitted to exercise a public function of high importance. The responsibility which rests upon him is thereby increased. For if he makes imprudent loans or investments he is not only imperiling your deposit and mine, he is also imperiling the quality and stability of a part of the national supply of money.

  We have already noticed in previous chapters of this book how lax, during the early part of the century, were the standards of safety imposed upon the banks. Each state had its own legal requirements, and they were mostly low. The United States set higher requirements for national banks, but a bank was not required to enter the national system if it chose not to do so. Hence there were, in effect, forty-nine systems instead of one. The Federal Reserve System had been superimposed upon this chaotic situation, partly to mobilize reserves for use wherever and whenever they might be suddenly needed, as in a disaster or a panic, and partly to bring the supply of check money under a measure of control. It had been very valuable, during the war and the depression of 1921, as we have seen; so valuable, in fact, that there was a distinct impression in the public mind—and even, to a considerable extent, in the banking mind—that it offered a sure guarantee against disaster. But it did not. Its powers were limited. A vast number of the smaller banks were not Federal Reserve members and were thus beyond its reach, and even the member banks were to a very great degree free to lend and invest money according to their own best judgment.

  It is very illuminating to notice what happened to this unsystematic combination of forty-nine banking systems during the years of boundless financial confidence.

  To some readers who recall vividly the utter breakdown of American banking during the years 1930–1933 it may seem, in misleading retrospect, as if bank failures had been rare in the previous years of affluence. This is far from true; during the years 1923 to 1929, inclusive, bank failures occurred in the United States at an average rate of nearly two a day. During those seven years there were 4,787 failures; and they were well distributed throughout the period. Here are the figures. There were

  648 in 1923

  776 in 1924

  612 in 1925

  956 in 1926

  662 in 1927

  491 in 1928

  and 642 in 1929

  To be sure, during these years not a single big metropolitan bank went under. The victims were small banks, mostly in small towns. The direct cause of the destruction of most of them was the drop in the value of farm land after the agricultural boom which ended in 1920, leaving quantities of farmers with over-mortgaged acres and heavy debts for farm equipment, the payments on which could be met only by selling their crops at inadequate prices. Many other banks went down when the Florida real-estate boom and the widespread boomlets patterned upon it collapsed in 1926 and 1927. Yet they would hardly have perished in such numbers had most of them not been too small or too badly located to diversify their loans properly in the interests of safety, or too incompetently managed and complacently supervised to pursue sound banking policies. The record was disgraceful.

  The city banks did far better. But they were changing character in a significant way. The chief traditional use for the funds deposited in a bank had been in the making of commercial loans: that is, loans to businesses to finance seasonal operations or specific ventures: loans which would be paid off when the goods which had been manufactured or bought with the borrowed money were sold. These short-term commercial loans were constantly being repaid; they did not tie up money over a long period of time, and were thus—if discriminatingly made—considered prudent. During the rising prosperity of the nineteen-twenties one might have expected an increase in the total amount of these commercial loans. Oddly enough, there was virtually none. There did not seem to be a growing demand for them, even when business was boiling. (It was easy to raise money for business by the sale of long-term securities such as bonds or stock; and furthermore, the giants of industry kept large cash reserves and maintained low inventories of goods and were thus able, as it were, to lend themselves most of the money which they needed from time to time.)

  There was nevertheless a large banking inflation; so great was the increase in the amount of check-money manufactured by the banks that Dr. Lauchlin Currie has estimated that the total national supply of money climbed from about 21¾ billions in 1922 to over 26½ billions in 1929—a growth of nearly five billions. And there was also a very large increase in the total of loans and investments by the banks of the country—something like a fifty per cent increase; according to the figures for Federal Reserve member banks only, loans and investments moved upward from a little over 24 billions in 1922 to more than 35½ billions in 1929.

  What accounted for this increase, if not commercial loans? The answer to this question is significant.

  1. Investments in securities: there was a three-billion dollar increase in this item—from seven billions to ten billions.

  2. Loans on securities: that is, loans which, if not paid back, could be made good only by selling the bonds or stock with which they were secured: there was a five-and-a-half-billion-dollar increase in this item—from four and a half billions to ten billions.

  3. And, in minor degree, loans on city real estate (which during the latter part of this period was having a spectacular boom, and in any case could hardly be converted into cash on short notice): this item increased from a little over one billion to over 2¾ billions.

  The significance of these changes is clear. The commercial banks of the country were putting a smaller proportion of their funds than previously into the current financing of business—the traditional use for such funds, and the safest. They were putting a much larger proportion than previously into making—or backing—long-term investments in stocks, bonds, or real estate. Thus they were becoming more dependent, both for the safety of their deposits and for the quality of the money they manufactured, upon the condition of the investment and speculative markets—a fact which was to become distinctly and regrettably evident during the early nineteen-thirties.

  They were also—a fact which was evident at once—becoming good customers for investment bankers who had securities to sell. This fact, coupled with the fact that insurance companies and other financial institutions were expanding rapidly, and the further fact that since the Liberty Loan campaigns more private individuals had become investment-minded than ever before, smoothed the pathway to success for men like Charles E. Mitchell. It is difficult, in matters like this, to distinguish clearly between cause and effect. The fact that the banking inflation was reflected in enlarged investments probably both encouraged Mitchellism and was encouraged by it. In any case it is fair to say that the rise and potency of such a man as Mitchell were characteristic signs of the times.

  THE VAN SWERINGEN BROTHERS

  M. J. (left) and O. P. (right) Van Sweringen, photographed as they came to testify before the Senate Committee in 1933

  CHARLES E. MITCHELL

  (at the right) on his way to testify early in 1933; Max Steuer, his lawyer, accompanies him

  Mitchell was not born to the deep purple of the banking aristocracy. He came from the shabby and unfashionable Boston suburb of Chelsea; went to college at Amherst, but had to earn part of his expenses by teaching public speaking; began his business career as a clerk in the office of the Western Electric Company in Chicago, spent his evenings taking night courses in bookkeeping
and commercial law, rose in a few years to the position of credit manager, developed a shrewd idea for the consolidation of a number of concerns which made telephone switchboards, took this idea to New York, to Oakleigh Thorne, president of the Trust Company of America, and made such an impression upon Thorne that he was asked to join the bank as Thorne’s assistant. That was in 1907—on the eve of the great panic in which the Trust Company of America was to be a storm center. Through the exhausting days and nights of the panic young Mitchell, now barely thirty years old, was at Thorne’s right hand; there were nights when he had to work so late that it was not worth while trying to go home, and he snatched a brief sleep curled up on the floor of the president’s office. Four years later he formed his own investment house. Five years after that—in 1916—he was chosen for the presidency of the National City Company.

  What had brought him so far in such a brief span of years? Inexhaustible energy, a restless imagination, a powerful faculty for concentration; that talent for organizing and stimulating the efforts of other people which we call executive ability; that specialized and commercialized variety of the talent for persuasion which we call salesmanship. Mitchell was a big man physically, solid and broad-shouldered, with a strong face: bold jaw, blunt-ended nose, stern mouth, keen eyes: the face of a man, not of sensibility, but of gross power. He believed in keeping fit—for years he walked every morning the whole seven miles from his house in the east Seventies to the National City Bank. He worked mightily, studying, learning, and not forgetting that social contacts of the right sort can be very valuable to a rising financier. His confident energy galvanized other people. There flowed from him the sort of vital personal force which enables a military commander to rally his men for a successful assault—a force which the accidents of circumstance, in an acquisitive society, directed into rallying bond salesmen. When, like Napoleon upon a hilltop, Mitchell looked down from the windows of the Bankers’ Club upon the field of campaign, he showed his lieutenants not an armed enemy but a host of sales prospects, millions of dollars strong.

  When he took over the management of the National City Company, in 1916, it controlled millions of dollars but its staff consisted of only four people working in a single room. He saw a bright future for it, and began to build up a great sales force. Bruce Barton, than whom there was no more enthusiastic trumpeter of the glories of big business during the nineteen twenties, described the Mitchell method: “Instead of waiting for investors to come, he took young men and women, gave them a course of training in the sale of securities, and sent them out to find the investors. Such methods, pursued with such vigor and on such a scale, were revolutionary.”

  Still the National City Company was a mere appendage of the Bank. Yet there was no other man in the organization who equaled Mitchell in personal force. And so when James A. Stillman had to leave the presidency in 1921, Mitchell assumed direction of the whole vast concern: not merely of the expanding affiliate which sold and traded in securities, but also of the Bank itself, the custodian of other people’s savings, the nourisher of business, the manufacturer of a part of the national supply of money.

  All through the seven fat years Mitchell’s salesmen—by 1929 there were 350 of them, with offices in fifty-eight cities connected with the New York headquarters by means of eleven thousand miles of private wire—were engaged in finding investors and telling them what to do with their savings. Behind these salesmen there was a relentless pressure to get results. Whether or not the sales letters quoted by Julian Sherrod in his Scapegoats were actually sales letters sent out from New York to Mitchell’s men, at least they suggest the spirit in which these men and others like them were exhorted to dispose of their wares. “You cannot stand still in this business—you either go forwards or backwards.” “The trouble with most Security Salesmen has been that in the past three or four years they have been order takers.” “As I see it, you fellows are not Self-Starters.” “… we do want to be absolutely sure that, with the exception of the cubs, we have no one in our sales force but producers.” “I should hate to think there is any man in our sales crowd who would confess to his inability to sell at least some of any issue of either bonds or preferred stock that we think good enough to offer. In fact this would be an impossible situation and, in the interest of all concerned, one which we would not permit to continue.…”

  There were sales contests for these salesmen of stocks and bonds, just as there were sales contests in those days for men who sold vacuum-cleaners and novelties: in one contest which began in September, 1929, just as the prices of securities were about to go over the cliff’s edge into the depression, the National City Company offered $25,000 in prize money and the scoring was done on an elaborate point system—one point for each share of General Mills common stock which they disposed of, 4 points for each share of Missouri-Kansas-Texas 7 per cent preferred stock, and so forth. Under the whip of such incentives, a salesman could hardly be expected to look with a coolly impartial eye upon the disposition of an investor’s savings, or to recommend speculative investments only to business men in close and active touch with the course of the markets. What counted in such a business was results—“and results mean orders.”

  The Barton article on Mitchell from which I have already quoted bore a title which in retrospect seems ironical. It was called—after the hortatory style of the American Magazine’s success stories in that era—“IS THERE ANYTHING HERE THAT OTHER MEN COULDN’T DO?” Apparently there was not. High-powered security salesmanship became widespread.

  Buyers were so easily persuaded and the sale of securities was so lucrative that soon there was a furious competition among investment bankers and the investment affiliates of the big banks to find concerns which were willing to put out bonds or stocks for expansion. The manufacturer did not have to go hat in hand to the bankers to ask their assistance; the bankers came to him, eager to issue securities for him and feed them out to banks and private buyers. And among these bankers the representatives of the security affiliates of the commercial banks were becoming more and more numerous. Mitchellism was becoming contagious. In 1927 the affiliates originated less than one-sixth as much of the volume of security issues as did the private bankers; in 1928 they originated nearly one-third as much; in 1929, nearly four-fifths as much.

  One sort of security which it was very easy to sell was the bonds of foreign states, and here the strenuousness of the competition approached the ridiculous. Young men representing big New York banks camped in Balkan and South American capitals in the frantic hope of inducing the local financial dignitaries to issue bonds. Sometimes these young men were not only ignorant of the language of the country but of its customs and traditions, and even of its political and financial record; and there might be three or four of them maneuvering for a single bond issue, each eager to get ahead of the others by whatever means could be contrived. Small wonder, under the circumstances, that some of this headlong financing did not redound to the credit of the banks which made the loans and sold the bonds, or that it led in due course to the shrinkage of assets of hundreds of American banks and to the impoverishment of thousands of embittered investors.

  Before long some of the more experienced investment bankers became frankly apprehensive of the reckless way in which this foreign financing was being conducted. Said Thomas W. Lamont of the House of Morgan in 1927: “From the point of view of the American investor it is obviously necessary to scan the situation with increasing circumspection and to avoid rash or excessive lending. I have in mind the reports that I have recently heard of American bankers and firms competing on almost a violent scale for the purpose of obtaining loans in various foreign money markets overseas.

  “Naturally it is a tempting thing for certain of the European governments to find a horde of American bankers sitting on their doorsteps offering them money.… That sort of competition tends to insecurity and unsound practice.”

  The House of Morgan had spoken—yet the business went right on. For exam
ple, Mitchell’s own National City Company subsequently sold two issues of Peruvian bonds—despite the fact that memoranda written from time to time by officers of the Company and the Bank during the previous five or six years had stated that “Peru has been careless in the fulfillment of contractual obligations,” and had referred to Peru’s “bad-debt record” as an “adverse moral and political risk.” The Company sold two issues of bonds of the State of Minas Geraes, Brazil, despite the fact that a member of the foreign department of the bank had drawn attention to the “inefficiency and ineptitude” of the officials of the state in connection with previous loans to them, and “the complete ignorance, carelessness, and negligence of the former State officials in respect to external long-term borrowing.” The Peruvian bonds went into default in 1931; the bonds of the State of Minas Geraes, in 1932. Many other extreme examples of foreign lending might be cited; and the number of banking houses involved in them bears witness that “there was not anything here which other men couldn’t do.” The business of selling foreign securities to Americans assumed huge proportions—and by 1934 over a third of the outstanding foreign securities were in default.

  In passing judgment upon such bond issues one must make allowance for the fact that sincere opinions, even within a single institution, may differ upon the merits of any investment issue; and also for the fact that the world depression dragged down into default many foreign bond issues which in the nineteen-twenties would have seemed good risks even to the conservative banker. It is difficult to escape the conclusion, however, that it was all too easy to decide in favor of an issue when other banking houses were also in the market for it and a staff of salesmen all over the country were ready and able to sell almost anything to small banks and private investors.