Lords of Creation

by Frederick Lewis Allen

  From Manhattan to Los Angeles there was a bull market in city lots and an aggressive building of skyscrapers. The logic of this movement was that the supply of desirable urban land was limited; few people seemed to realize that the possibility of pushing skyscrapers up to almost any height could pretty successfully defeat this limitation. Anyhow, each city thrust up its cluster of pinnacles at the center—pinnacles which, unlike the prices of common stocks, would not come down again when the impulse that had created them had been frustrated. They stand today where they were built, half-empty reminders of the fact that the speculative spirit of the nineteen-twenties saw its most dazzling future in raising the standard of living, not of the poor, but of the rich, by providing for them loftier and more luxurious offices and more lordly dwellings.

  Possibly the most illuminating way of suggesting the effect upon the commercial banking system of this boom in city real estate, as well as of the boom in stocks, may be to look briefly at an extreme example, an exhibit of the pathology of banking. The failure of the Bank of United States, late in the year 1930, was the largest bank failure which had taken place up to that time in the whole history of the country. It was also the forerunner of further disasters to come. If we put the microscope to this egregious specimen we may see in aggravated form a few of the causes of some of those other disasters.

  The Bank of United States, founded by a Jewish garment manufacturer named Marcus and managed in later years by his son and another garment manufacturer named Singer, had grown rapidly through a series of mergers, acquiring the stock of other banks or exchanging this stock for its own, sometimes at extravagant prices; by the spring of 1929 it had thus become a large institution, with deposits of over two hundred million dollars. Naturally, being an up-and-coming bank, it had a security affiliate; indeed, it had a whole series of affiliated or subsidiary corporations through which the men at the head of the bank might engage in various forms of investment or speculation, with the aid of money lent to these corporations by the legally separate bank: in other words, with the depositors’ money. As M. R. Werner puts it in his account of the adventures of the Bank of United States: “Whenever they needed money for the enterprises in which they indulged, Marcus and Singer pulled corporations out of drawers and borrowed for them. The officers of these corporations were minor officials of the bank, and frequently the same three, Mr. Lip-schutz, Mr. Duffy, and Mr. Rubenstein.” Thus the bankers were ingeniously set free of the annoying restrictions which the laws had thrown about the use of depositors’ money.

  As 1927 gave way to 1928, and 1928 to 1929, these bankers became more and more urgently interested in the market price of the stock of their bank. One reason for this was that their affiliate, the Bankus Corporation, was actively engaged in buying and selling this stock as it rose along with other stocks in the bull market. Another reason was that Marcus and Singer had a syndicate of their own, through which they were personally engaged in pool operations in the stock. Still another reason was that when the Bank of United States absorbed other banks by exchanging its stock for theirs at goodly prices, the former stockholders of these other banks, finding blocks of Bank of United States stock in their hands and noting that the market quotations for it were invitingly high, were under a natural impulse to sell out; and this constant selling tended to depress those quotations, to the embarrassment of the Bankus Corporation and of Marcus and Singer’s personal syndicate. Marcus and Singer therefore became actively interested in distributing the stock of the bank as widely as possible among people who would be unlikely to dump it on the market: in selling it to small depositors and other innocents. But still the price sagged. So the Bankus Corporation went on buying the stock to hold the price up. And it went on borrowing from the Bank to finance these purchases—borrowing the depositors’ money.

  Thus a desperate situation developed: to a greater and greater degree the Bank found itself financing a speculative campaign which could not be successful unless prices continued to rise.

  But this was not all. The men who ran the Bank were not only stock-market minded, they were real-estate minded. Through the various dummy corporations at their disposal, they had been putting the depositors’ money into the financing of ambitious apartment-house projects, mostly along the west side of Central Park, New York. The shining towers which they built adorned the rapidly changing skyline of Manhattan, but as investments they were declared by a bank examiner to have been “based exclusively on optimism instead of good business policies and sound judgment.” Banks, of course, were not supposed to invest in real estate, but that fact did not trouble Marcus and Singer; banks could lend money to corporations, and these corporations could do it. Why lose such a chance to make big money?

  The rest of the story can be very briefly told. After the panic of 1929, the price of Bank of United States stock fell. The money locked up in speculative real-estate ventures could not be extracted. The bank foundered.

  Now it would be grossly unjust to suggest that such reckless adventures were typical of the course of American banking during the fat years. Most American bankers were men of probity, conscious of the gravity of their responsibilities to their depositors. Yet there is no denying that the tendencies shown in exaggerated form in the Bank of United States were sufficiently prevalent to affect the general banking structure.

  Indeed, it may have occurred to the reader as he followed the story of this bank that there was something faintly familiar about some of the elements of it. Rapid expansion through purchases of other banks at high prices: did we not see this happening in California too, when Giannini was in full career? The bank’s affiliate trading in the bank’s own stock: was Mitchell’s National City Company not doing this? Distributing this stock through a vigorous selling campaign: was not Mitchell doing that too?

  Very well; but what about the element of injudicious investment in real estate? That this was a factor in the fortunes of other and less grossly mismanaged commercial banks than the Bank of United States, that there was some truth in the British remark that American bankers did not know the difference between a bill and a mortgage, is suggested, first, by the cold statistics of the increase in loans on city real estate by American banks from a little over one billion dollars in 1922 to over 2¾ billions in 1929. (One must bear in mind, too, the probability that the 1929 figure does not adequately represent the extent to which the commercial banks had become involved in the fortunes of skyscraper office buildings and big apartment houses: for real-estate ventures, as we have noticed, could readily be disguised as loans to construction companies.) The over-indulgence of bankers in real-estate financing is suggested, in the second place, by the experience of the men who examined the banks of the country after the grand smash of 1933: again and again they had to report that the greatest factor of weakness was the prevalence of real-estate paper in the portfolios of banks. And it is suggested, in the third place, by concrete instances such as that of two big banks in Cleveland.

  These two big Cleveland banks were the Union Trust Company and the Guardian Trust Company. In January, 1929, the Union Trust Company had loans outstanding to a total of a little over two hundred and twenty million dollars; and of this total, over seventy-six millions—more than one-third—was in the form of loans on real estate. That was one of the effects of the building boom inspired by the glittering example of the brothers Van Sweringen. As for the Guardian Trust Company, let us turn to the report of the Senate Banking and Currency Committee which investigated the Cleveland collapse: “At the time of the closing of the bank the Guardian Trust Company and its subsidiaries were engaged, besides conducting a banking business, in the operation of an office building, a chain of hotels, a coal mine, and residential and business properties …” The Guardian, incidentally, had several subsidiary corporations which could take over its real-estate investments when these began to look a little questionable for the portfolio of a supposedly conservatively managed bank.

  Speculation in the steel-and-mason
ry pinnacles of urban prosperity was not the exclusive concern of gentlemen like Messrs. Singer and Marcus.

  Another form of speculation in which we have found these gentlemen engaged was personal speculation in the stock of their own bank. To find a parallel to this exploit we do not need to roam the country; we need only regard the exploits of the head of the bank which in 1930 passed the National City Bank in size and thus became the biggest in the country, indeed the biggest in the world: an institution of the most splendid importance, the Chase National Bank.

  The Chairman of the Board of this bank was Albert H. Wiggin. The bank had, of course, a subsidiary, the Chase Securities Corporation, which participated in many trading accounts (otherwise known as stock-market pool operations) in various stocks, including the stock of the Chase National Bank itself. But that is merely mentioned by the way. Albert H. Wiggin likewise participated in such trading accounts—not personally in his own name, but through the medium of one or the other of his private corporations.

  There were few stranger blossoms in the corporate garden than the private corporation. It enabled one to engage in transactions with which one would not care to have one’s personal connection generally known; and it also enabled one to put one’s profits beyond the reach of the income-tax collector. Taxes on corporate profits were not as heavy as upon the upper brackets of personal income, and the profits of one’s private corporation did not have to appear in one’s personal accounts unless or until one chose that the corporation should pay dividends. A variant of this device, also in favor among the rich, was the use of a Canadian corporation. The Canadian income-tax laws happened to differ from those in the United States in that a Canadian corporation which acquired stock need not record this acquisition for tax purposes at the price which it paid for it; it could record it at the going market price. Thus if an American magnate who had a Canadian corporation in his financial stable had bought, say, a thousand shares of Steel for $150,000, and the market price for Steel had gone from 150 to 250, and he wanted to sell and realize a neat profit of $100,000, he could dodge the tax on this profit: by going through the appropriate legal motions he could transfer this stock to his Canadian corporation, record it on the books of the Canadian corporation at $250,000 rather than at the purchase price of $150,000, and let the Canadian corporation sell it for $250,000—showing no profit at all for tax purposes. Albert H. Wiggin had three American private corporations, officered and directed by officers and directors of the Chase National Bank and the Chase Securities Corporation; he also had three Canadian corporations.

  His three American corporations, during the six years 1927–1932, inclusive, made over ten million dollars in transactions in the stock of the Chase National Bank, of which he was the head.

  The man who through the medium of these private corporations, and with the aid of officers and directors of his bank, was engaged in serving his stockholders by buying stock from them cheap and selling it to them dear, and who was incidentally participating in stock-market pools in other stocks, with or without the assistance of officers and directors of the companies whose shares were thus taken in hand: this man was no ex-garment manufacturer from the East Side, no unseasoned novice at banking. He was a man of long financial experience, who had been with the Chase Bank itself for twenty-five years. He was a director of scores of corporations. His power was great. His influence was even greater. As the head of one of the mightiest commercial banks in the country, he bore a very heavy responsibility for the maintenance of sound banking conditions: for seeing that the speculative epidemic did not seriously involve the banking structure of the country to the detriment of depositors, business, and that structure of bank credits which served the country as money. And yet this man, wearing a disguise which might shield him from the tax collectors of the Treasury Department, was playing the market in the shares of his own bank.

  Years afterwards, when the Senate Banking and Currency Committee had called Wiggin before them and had dragged from him these and other damaging admissions, Ferdinand Pecora, counsel to the Committee, asked him what had prompted the Chase Securities Corporation to engage in trading in stocks.

  “I think the times,” said Wiggin.

  “I assume you mean the speculative atmosphere?” asked Pecora.

  “I think perhaps that covers it,” said Wiggin. “There was a great deal of atmosphere. There were a great many people who began to think you did a great injustice to everybody if you did not have equity stocks. It even got to be the custom to think that trust funds—it was a pity to limit them so that they could not invest in equity stocks; that we were doing a great injustice to them. In other words, it was the times.”

  “Did you yield to the temper of the times in that respect?” pursued Pecora.

  “I am afraid so.”

  Let us leave it at that; realizing as we do so that we are setting down the only possible excuse for the speculative spirit which possessed many other men than Albert H. Wiggin, and which, along with the spirit of headlong salesmanship and the spirit of reckless expansion, pervaded the commercial banking system and prepared it for its downfall. “It was the times.”

  Chapter Eleven

  INTO THE STRATOSPHERE

  FOR the investment bankers—those midwives and attending physicians of the corporate world, whose function it was to provide, through the sale of securities to dealers and thus to the general public, the capital which governments and industrial and business concerns needed in order to carry on and to grow—the seven years 1922–1929 were fat indeed. The affiliates of commercial banks were taking some of the business which might otherwise have gone to them, yet there seemed to be enough for all, and the investment banking houses still enjoyed the cream of it.

  They it was who, with the sleepless aid of their corporation lawyers, put into effect many if not most of the devices by which the promoters and organizers of corporations might do as they pleased without interference from the cohorts of the stockholders. During these years an endless stream of new issues of securities poured forth from their offices and were swallowed up by an eager investing public: foreign government bonds, foreign corporation bonds, railroad bonds, industrial bonds, utility bonds, preferred stocks, common stocks. And the stream grew in volume: between 1926 and 1929 the annual total rose from a mere seven billions to more than eleven and a half billions.

  It was a very lucrative business. The profits of those investment bankers who had the prestige and the judgment to negotiate security issues successfully for the giants of industry were huge. Profits measured in terms of hundreds of thousands of dollars on a single issue were commonplace, and sometimes they rose well into the millions. For example, according to the report of the Senate Committee on Banking and Currency, the profits, commissions, and fees which went to Kuhn, Loeb & Co. for marketing securities for the Pennroad Corporation and for other services to this corporation during less than six months in 1929 amounted to about five million eight hundred thousand dollars. And the total profits of the House of Morgan for the year 1929 may be suggested by two recorded facts: first, that the partners paid in Federal taxes for that year a total of about eleven million dollars, and second, that during that year the net worth of J. P. Morgan & Co. and of its Philadelphia ally, Drexel & Co., increased by more than twenty-seven millions.

  What made investment banking lucrative was not simply the opportunity to buy issues of bonds from corporations at, say, a price of ninety-five and sell them to the public at a price of ninety-eight or ninety-nine. (Although on a big issue a three-or-four-point spread could add up to a great deal of money, such a spread was ordinarily not unreasonable in view of the risk involved and the number of banks and bond houses among which the money was divided.) It was also the opportunity to be numbered, again and again, among the insiders who got common stock for very little money when corporations were formed or refinanced. In such operations the practice which Morgan the Elder had pursued when he formed the Steel Corporation had now for a long time
been orthodox.

  Most of the money which a company needed in order to begin business was raised by selling bonds or preferred stock, or both; sometimes all of it was thus raised. The common stock, on the other hand, was not usually distributed in quantity to the general public—at least, not directly. Most of it was issued to the insiders—the promoters, the investment bankers, and their allies—for little or no cash: either handed out along with the preferred stock which these favored gentlemen purchased; or issued to them for “services,” or bought by them at very low prices. (When two or more companies were merged, the common stock of the big corporation which took their place was usually issued in exchange for their stock; but ordinarily this stock too, if one were to trace its previous history, would be found to have had a very inexpensive origin.) Thus these insiders found themselves in a delightfully favorable position: a sort of heads-I-win-a-lot, tails-I-can’t-lose-much position. If the company did badly (which of course very frequently happened) their losses on their common stock were slight. If, on the other hand, it prospered, they were very well off indeed.

  For the shares leaped in value; after being listed on a stock exchange, they were taken up by speculators, often by speculative pools; sooner or later they found their way into the hands of investors; and then such insiders as chose to sell might make handsome profits. (You may remember that when the Steel Corporation was organized, the Morgan syndicate had walked off with a profit of sixty-two and a half millions, of which considerably more than twelve and a half millions had gone to the House of Morgan itself.) It was very advantageous to be in on the ground floor in these operations.

  During the nineteen-twenties the procedure was modified in many ways. For one thing, the eagerness of the general public to buy common stock made it often possible to sell such stock at round prices, even at the outset of a corporation’s career. For another thing, the insiders now sometimes took their special advantage in the form of a new device, the option warrant which entitled them to buy more common stock in the future if they wished. For example, J. P. Morgan & Co., in 1929, were granted a million option warrants to buy United Corporation common stock at $27.50 per share at any time in the future. The amount of money allocated to the purchase of these warrants was one dollar per warrant. Heads-I-win-a-lot, tails-I-can’t-lose-much again. If the stock did not gain in price, they need not exercise these option warrants; if it did, they could exercise them and at once sell the shares at a big profit, or they could sell the option warrants themselves. As a matter of fact, the Morgan firm sold 200,000 of their United Corporation option warrants during 1929 at a profit (based on the above allocated consideration) of over eight million dollars. The rest of the warrants were distributed among the partners of the firm.