Mellon would eventually be accused of having encouraged the market higher out of the crude desire to enlarge his personal fortune. This is unfair. In private, he acknowledged that stocks were in a bubble. But his experience as one of the country’s great financiers convinced him that there was little that the Fed or anyone else could do about it, observing to a fellow member of the Federal Reserve Board, “When the American people change their minds, this speculative orgy will stop but not before.” Having decided that trying to talk the market down was an impossible task and that he would only look foolish when he failed, he waited for the frenzy to burn itself out, saying as little as possible publicly. In March 1929, he did declare that he thought this was a good time for investors to buy bonds, but this was so coy a pronouncement that those few people who paid any attention poked fun at Mellon’s admonition that “gentlemen prefer bonds.”
The irrepressible gentlemen on Capitol Hill were not so reticent. In February and March of 1928, the Senate Committee on Banking and Currency held hearings on brokers’ loans and, from March to May, its House counterpart opened its own investigation into stock market speculation—overall a spectacle somehow both embarrassing and uplifting. It was painful to watch the good senators flailing around trying to understand the workings of a complicated financial system and hurling foolish questions at the expert witnesses. But there was also something admirable as they voiced the outrage of the common man at the absurdities of Wall Street.
The following exchange captures the quality of the discussion and the mood of the Congress. In the middle of the hearings, Senator Earle Mayfield of Texas suddenly has an inspiration: Why not ban all stock trading?
SENATOR MAYFIELD: Well, instead of urging all these various changes in the law, why do you not prohibit gambling in stocks and bonds on the New York Stock Exchange? In that way you could make a short cut to the proposition. Just stop it.
SENATOR BROOKHART: Well, I do not have any objection to doing that. But Senator Couzens, in discussing the thing, said we needed a market—a legitimate market for stocks and bonds.
SENATOR MAYFIELD: Preserve the legitimate market, but cut out the gambling. . . .
SENATOR EDGE: Does the senator from Texas seriously consider passing a bill prohibiting that?
SENATOR MAYFIELD: There are millions of dollars of stocks and bonds sold every day by people who do not own them and have no idea of owning them. Purely gambling on the market.
SENATOR BROOKHART: There is no trouble at all in stopping the gambling. . . . We have a law against poker gambling, and we can have a law against stock gambling.
The discussion during the hearings continued in an attempt to refine the distinction between investing and gambling. Finally, Senator Carter Glass, one of the architects of the Federal Reserve System and secretary of the treasury during the last two years of the Wilson administration, thought he had it figured out. A stock he had bought only the previous January at 108 was now selling on the market at 69. “Now what is that but gambling?” he exclaimed.
It was great theater, put on, according to Time magazine, with that combination of “oratory, ethics and provincialism” at which the U.S. Congress is so good: a reenactment of an old morality play that had divided the republic since its founding—between those, like Hamilton, who believed that great wealth was the reward for taking risks and those, like Jefferson, who believed that prosperity should be the reward for hard work and thrift.
The strongest calls to do something came from senators representing the farm states of the Midwest and the Great Plains: Borah of Idaho, La Follette and Lenroot of Wisconsin, Brookhart of Iowa, Pine of Oklahoma, and Mayfield of Texas. They had their roots in those parts of the country that had always been suspicious of bankers and were ambivalent about the power of money in American life. Their constituents, the farmers, had already been through hard times for most of the decade as commodity prices fell and were now being starved of credit as it was diverted into the stock market. But the senators slowly came to recognize that they would only inflict greater damage upon their people if they pressed for tighter credit to force stock prices down.
And so Congress’s efforts to control speculation yielded little except for some gloriously overheated language. In February 1929, Senator Tom Heflin of Alabama introduced a resolution asking the Federal Reserve Board to control speculation, thundering to the Senate: “Wall Street has become the most notorious gambling center in the whole universe . . . the hotbed and breeding place of the worst form of gambling that ever cursed the country.” The Louisiana State Lottery “slew its hundreds,” he continued, “but the New York State gambling Exchanges slay their hundreds of thousands. . . . The government owes to itself and to its people to put an end to this monstrous evil.”
It was thus left to the Fed to wrestle with the conundrum of how to deflate the stock bubble without crippling the economy. Recognizing that the easing of credit policy in the middle of 1927 had been a mistake, it raised rates from 3.5 percent in February 1928 to 5 percent in July 1928. But just as the stock market began its second leg upward in the middle of 1928, the Fed fell silent and disappeared from view, brutally divided about how to react.
Any further measures to bring the market to earth were bound to inflict collateral damage to the economy, especially on farmers. Moreover, capital had once again begun flowing in from abroad, attracted by the returns on Wall Street. Were the Fed to raise interest rates now, it might well pull in even more gold, possibly even forcing sterling off the gold standard.
Strong was still grappling to the very end with these issues. He was willing to concede that it had been a mistake to delay tightening credit so long in early 1928, thus letting the bull market build up such a head of steam. Nevertheless, in the last weeks before he died, he had begun arguing that the Fed should not tighten any further but step aside in the hope that the frenzy would burn itself out.
Strong’s successor at the New York Fed was George L. Harrison, a forty-two-year-old lawyer, with impeccable establishment credentials. Born in San Francisco, the son of an army colonel, Harrison had had a peripatetic childhood while his father was posted to various forts across the country. He had been lame from childhood as result of a fall and hobbled around with a heavy walking stick. He had gone to Yale, where he had run with “right crowd” and had become a member of Skull and Bones, the elite secret society for seniors that supposedly serves as an entrée into the upper echelons of business and government. His Yale room-mate and close friend was Robert Taft, the son of President William Taft, and they had gone on to Harvard Law School together. Graduating close to the top of his class, Harrison was offered a clerkship on the Supreme Court with Justice Oliver Wendell Holmes, a position in which he would be followed by Harvey Bundy, father of the Bundy brothers, William and McGeorge, and by Alger Hiss, the senior State Department official later accused of being a Soviet spy.
Harrison had joined the Federal Reserve Board as assistant general counsel in 1914 soon after it opened and in 1920 had been persuaded by Strong to come to the New York Fed as his deputy. A scholarly-looking man with a big head of wavy hair, friendly blue eyes, and a warm and genial manner, he was a committed bachelor, lived in a small suite at the Yale Club, and liked to spend his evenings playing poker with his friends. Having been groomed for the job, he was the obvious choice to succeed Strong. He shared his mentor’s international outlook and as the deputy governor responsible for the day-to-day’s dealings with European central banks, he had developed close working relationships with both Norman and Moreau.
Nevertheless, filling Strong’s shoes was a daunting task. As Russell Leffingwell, the Morgan partner, put it, Harrison had the double disadvantage of “being young and new,” while as Strong’s protégé he “had inherited all the antagonisms that poor Ben left behind him.” Harrison also had a very different personality from his predecessor’s. Where Strong was forceful and aggressive, the affable and easygoing Harrison was cautious and diplomatic. Strong had a ter
rible temper and was impatient with incompetence in his subordinates. Harrison by contrast found it hard to fire anyone. There was never much doubt where Strong stood on an issue and he did not shy from confrontation, while Harrison believed in keeping his cards close to his chest.
Strong’s death had left a political vacuum within the system as a whole. The chairman of the Board, Roy Young, who had taken over from Daniel Crissinger in late 1927, was a florid-faced glad-handing banker from Minnesota who loved to regale people with his stories. With Strong dead, Young very consciously set out to reclaim leadership, to reassert Washington’s control over the decision-making process, and in his words, “raise the prestige of the Board within the system.”
A majority of the Board in Washington, among them Young, Miller, and Hamlin, the same governors who had been so strongly in favor of raising interest rates to curb speculation as the bull market built up, had now changed their minds. Fearful that increasing the price of money at this stage would harm the economy without checking the orgy on Wall Street, they now began to press for “direct action” against speculators.
By early 1929, the bubble was not simply a problem for the Fed but for almost every European central bank as well. New York was sucking in capital from abroad at a time when Europe was still very dependent on American money. The weakest links were Germany and the other Central European countries. But the Bank of England was losing gold as well. While in early 1928, it held over $830 million in reserves, the highest since the war, by early 1929, these had fallen below $700 million and were still going down. In the old days, when his gold reserves came under strain, Norman’s first reaction would have been to press his friend Strong to ease Fed policy. Now grimly aware that with Wall Street on a roll, no one would dance to that tune, he thought out a very different strategy.
He arrived in New York on January 27 armed with his new proposal. Meeting with Harrison at the New York Fed, Norman now surprised everyone by arguing for a sharp rise in U.S. rates, possibly by 1 percent, even by 2 percent, taking the discount rate to 7 percent. The Fed should try to break “the spirit of speculation,” “prostrating” the market by a forceful tightening of credit. Once a change in psychology had been achieved, interest rates could be then brought down again and capital flows to Europe would resume. For some reason Norman thought the Fed could pierce the bubble with a surgical incision that would bring it back to earth, without harming the economy. It was a completely absurd idea. Monetary policy does not work like a scalpel but more like a sledgehammer. Norman could neither be sure how high rates would have to go to check the market boom nor predict with any certainty what this would do to the U.S. economy.
Nevertheless, such was his power that Harrison embraced the idea. He did, however, warn Norman that since Strong had died, things had changed within the Fed. The conflict between the Board and the New York Fed had become even greater than in the past. There was now general agreement that the United States was faced with a stock market bubble. But the system was deeply divided about how to respond. While the reserve banks wanted to raise rates, it was now the Board that was resisting, and it had become more aggressive about getting its way. Harrison himself had just emerged from a collision with the Board over issues of jurisdiction, Chairman Young warning him that he and the other Board members did not “any longer intend to be a rubber stamp.” Harrison urged Norman to visit Washington—which he had till now ignored—and begin building a relationship with the Board if he wanted to continue to influence U.S. credit policy.
On February 5, Harrison, fortified by his discussions with Norman, himself went down to Washington and proposed exactly the Norman strategy to Young. He rejected the idea that his old chief, Strong, had been advocating in his last few months—that the Fed should passively sit by and “let the situation go along until it corrects itself.” Instead, he now pressed for “sharp incisive action,” a rise in rates of 1 percent. He had come to the conclusion, as he would put in later, that it would be better “to have the stock market fall out of the tenth story, instead of the twentieth later on.” Once the speculative fever had been broken, rates could be brought down again. The next day, Norman also turned up in Washington, bearing the same message. Members of the Board could not help but remark on the almost sinister influence that he seemed to exert over the New York Fed, originally upon Strong and now upon Harrison. One governor would later comment that Harrison “lived and breathed for Norman.”
While Harrison and Norman were pressing for rate hikes, the Board continued its campaign for direct action. On February 2, it issued a directive to all its member banks that they should not borrow from the Fed “for the purpose of making speculative loans or for the purpose of maintaining speculative loans.” Four days later, it made the directive public. The Dow fell 20 points over the next three days, but quickly recovered and by the end of the week was back at the highs. The market’s attitude was best summarized by an editorial in the Hearst newspapers. “If buying and selling stocks is wrong, the Government should close the Stock Exchange. If not, the Federal Reserve Board should mind its own business.”
Norman left for home in the middle of February shaken by his trip. In the old days, during his visits to the United States, there had been an easy camaraderie and his friend Strong had always exercised a calming influence over him. This time he returned to Britain as anxious as when he had set out. It had been “the hardest time in America that he had ever had,” he reported to his colleagues. He had found the American central bankers paralyzed by indecision; there was “no leader”; within the Federal Reserve System, they were “at odds with one another, drifting and not knowing what to do.” In a circular letter sent to several heads of European central banks, he wrote that he had set off in the hope of getting a clearer view of what was going on in the United States only to return with “an even deeper feeling of confusion and obscurity.”
Meanwhile, back in the United States the struggle between the Board and the New York Fed was intensifying. On February 11, the directors of the New York Fed voted unanimously to raise rates by 1 percent to 6 percent. Harrison called Young in Washington to inform him of the decision, acknowledging the Board’s right to override it. Young asked for time to consider the initiative, but Harrison insisted on a definitive answer that day. After three hours of calls back and forth in which Young unsuccessfully tried to persuade Harrison not to force a showdown, he eventually called to say that the Board had voted to disallow the hike. Over the next three months, the directors in New York voted ten times to raise rates and each time were overridden by Washington.
The Fed was now paralyzed by this standoff between its two principal arms. The Board kept insisting that the right way to deflate the bubble was through “direct action”: credit controls, particularly of brokers’ loans. New York was equally insistent that such a policy could not work, that it was impossible to control the application of credit once it left the doors of the Federal Reserve. Meanwhile, the pace of speculation was accelerating.
It did not help that the Fed seemed incapable of even exerting its control over leading bankers, let alone over the crowd psychology of investors. At the end of March, it was announced that total broker loans had increased to almost $7 billion, and the market swooned. The fear that some drastic action from the Fed to curtail the amount of credit going into the stock market was imminent drove the rate on brokers’ loans to over 20 percent. Instead, Charlie Mitchell of National City Bank, himself a director of the New York Fed, defied the Board by calling a press conference and announcing that his bank would pump an extra $25 million into brokers’ loans to support the stock market. After that, what little credibility the Fed possessed was irretrievably lost.
It is too easy to mock the Fed for entangling itself in a bureaucratic turf feud and fiddling while Rome was burning. Both parties to the debate were in fact right. The Board was undoubtedly correct that with the demand for money on Wall Street so strong, call money averaging over 10 percent, sometimes spiking as h
igh as 20 percent, and speculators counting on gains of 25 percent a year and more, a hike in the Fed’s discount rate from 5 percent to 6 percent or even 7 percent at this stage of the game was going to have almost no effect. To be sure of pricking the bubble would have required raising interest rates higher, perhaps to 10 or 15 percent, which would have caused massive cutbacks in business investment and would have plunged the economy into depression.
But the New York Fed also happened to be right. All the jawboning about reducing credit for speculators proved to be pointless. It did in fact succeed in curbing the amount of money going into brokers’ loans from banks—between early 1928, when the Board first declared war on brokers’ loans, and October 1929, banks cut their loans to brokers from $2.6 billion to $1.9 billion. Meanwhile, other sources of credit—U.S. corporations with excess cash, British stockbrokers, European bankers flush with liquidity, even some Oriental potentates—more than made up for the decline by increasing their funding of brokers’ loans from $1.8 billion to $6.6 billion. It was these players, all of them outside the Fed’s control, who were by far the most important factor supporting leveraged positions in the stock market.
Even Adolph Miller, the most vocal opponent of speculation in general and brokers’ loans in particular, could not resist the temptation to earn 12 percent on his own savings. In 1928, Fed officials discovered that he had invested $300,000 of his own money in the call market through a New York banker, personally helping to feed the very speculation that he so vociferously opposed at the Board.
One is led to the inescapable but unsatisfying conclusion that the bull market of 1929 was so violent and intense and driven by passions so strong that the Fed could do nothing about it. Every official had tried to talk it down. The president was against it, Congress too; even the normally reticent secretary of the treasury had spoken out. But it was remarkable how difficult it was to kill it. All that the Fed could do, it seemed, was to step aside and let the frenzy burn itself out. By trying to stand up to the market and then failing, it simply made itself look as impotent as everybody else.
Lords of Finance Page 33
