A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  Indeed, not only did Winthrop Aldrich agitate for this latter clause, he actually drafted Section 21 of the Senate bill in Glass’s behalf!66

  The Morgans fought back bitterly, William Potter of the Morgan-dominated Guaranty Trust calling Aldrich’s proposal “quite the most disastrous... ever heard from a member of the financial community.” The opposition was to no avail, however, with President Roosevelt personally urging Senator Glass to retain Section 21. As Chernow writes, “This was the coup de grâce for the House of Morgan.”67 J.P. Morgan and Company delayed their final divestment decision, hoping for the passage of Carter Glass’s amendment to the Banking Act of 1935, allowing some securities powers to deposit banks, but Roosevelt delivered the final blow to the Morgans by personally interceding in the House-Senate conference committee to kill the amendment. Upon this defeat, J.P. Morgan and Company made the fateful decision to keep its deposit business and to divest itself of its power center, the investment banking business. The Morgans set up a new Morgan, Stanley and Company to engage in investment banking.68

  It is a tragic irony that Carter Glass and his theoretician H. Parker Willis were lured into this alliance with the Rockefellers and the New Dealers to clobber the Morgans by coercively divorcing commercial and investment banking. Willis, as noted above, was a trenchant critic of the Strong-Morgan credit inflation of the 1920s. Unfortunately, Willis’s “real bills” approach, which led him to oppose the bank credit expansion, also led him to oppose it for the wrong reason. Contrary to Willis, the problem was not that the banks were buying corporate securities or lending money to the stock market; the problem was that the banks were inflating credit, period. But Willis and Glass, starting with the wrong reasoning, came to the wrong solution: to compel the commercial banks to stop purchasing or issuing securities, as a partial means of reaching the ultimate goal—forcing the banks and the Fed to return to the original concept of confining their credit to short-term self-liquidating “real” bills. Hence, the luring of the reluctant Glass and Willis into uncongenial schemes of socializing and cartelizing Wall Street and helping the Rockefellers destroy the Morgans.

  Professor Benston points out that all the provisions of the Banking Act of 1933 helped develop a coherent structure for government cartelization of the banking industry. In the first place, the separation sections, which we have been discussing, helped the commercial bankers get rid of unprofitable securities, and to eliminate the powerful competition of investment bankers for customers’ deposits. As for investment bankers, one-third of them, including J.P. Morgan and Company, hived off that business to stick to deposit banking, leaving the remainder free of their competition. In particular, as we have seen, the Rockefellers rid the commercial banks of unwelcome investment banking competition.

  Other Banking Act provisions reinforced the cartelization. Thus, federal deposit insurance guaranteed all bank deposits, thereby cartelizing the industry and supposedly guaranteeing every bank’s success. The prohibition of bank payment of interest on demand deposits was a particularly cartelizing device, since it “forced” the banks collectively to keep payment of interest to their depositors at zero, policing any competing bank that would have liked to break the cartel by bidding for depositors’ accounts.69

  In addition to all this, the Banking Act of 1933 began the crucial process of stripping away the dominant power of the Federal Reserve Bank of New York (and hence of the Morgans) over the operations of the Federal Reserve System, and of transferring that power to political appointees in Washington. Previously, for example, each Federal Reserve Bank—and therefore the private bankers in that district—had total power over its own open-market operations—and therefore over the movement of bank reserves. In practice, this meant the New York Fed, since open market operations were in U.S. government securities, and the bond market is located in New York. The Banking Act of 1933 began a transfer of power by creating a statutory Federal Open Market Committee (FOMC). The FOMC, however, continued to be in private banker hands, since it consisted of one member from each Federal Reserve District, selected by the board of directors of each Federal Reserve Bank. In practice, these were the governors of each Federal Reserve Bank.

  The new law required that every Federal Reserve bank’s open market operation conform to Federal Reserve Board regulations, but each Federal Reserve bank retained the right to refuse to participate in the FOMC’s recommended open market policies. The result of this hybrid system was that the Federal Reserve Board was ultimately responsible for Fed policy, but it could not initiate open market operations. The Federal Reserve Board could ratify or veto FOMC policies, but those policies had to be initiated by the FOMC. The Federal Open Market Committee, for its part, could initiate open market policies, but it could not execute them; execution remained in the hands of the New York Fed and the Federal Reserve banks. The Federal Reserve banks, for their part, could not initiate open market policies, but could obstruct them by failing to execute them.

  All in all, the Federal Reserve Bank of New York, while losing much of its power over open market operations in the 1933 act, was able to live with the new arrangement. It was more annoyed over a neglected provision of the act, that forbade the New York Fed (or any other Federal Reserve bank) from conducting negotiations with foreign banks—a direct slap at the crucial New York Fed–Morgan role during the 1920s in making arrangements with the Bank of England and other European banks.70

  The demagogic eruption of the Pecora hearings also led to another New Deal 100 Days measure that both revolutionized and cartelized the securities industry and delivered another body blow to the House of Morgan. This was the Securities Act of 1933, passed in May, followed the next year by its more powerful successor, the Securities Exchange Act of June 1934. The first act imposed rigorous and expensive laws and procedures for any new securities issues, allegedly to protect the investing public. Its actual effect was to cartelize the sources of new capital, channeling the supply of savings into firms big enough to bear the substantial costs and freezing out smaller and more risky new capital ventures. Even more directly, the Securities Act cartelized the investment banking industry, keeping out any newer and smaller investment banks that might challenge the established giants. While many investment bankers were unhappy with specific provisions and urged amendments, they were on the whole delighted with the basic thrust of the regulation. Thus, testifying on the bill before the House Commerce Committee, George W. Bovenizer, partner in Kuhn, Loeb and Company, and a venerable Morgan enemy, declared that his firm was

  wholeheartedly in favor of the type of legislation... suggested by the President. We have stood by now for the past 12 years, or more, and have looked on with apprehension as the good name of investment banker has been put into jeopardy... by the actions of some people who should never have been in the business.... I believe that every honest banker today will look with great favor upon the principle of this legislation as the dawn of a new era.71

  The enforcement of the Securities Act was put into the hands of the Federal Trade Commission, since the accession of Roosevelt in left-wing hands, but a new Securities and Exchange Commission created for this purpose was to take over the enforcement powers in July 1934. By that time, however, Congress had passed the Securities Exchange Act of June 1934, greatly expanding the powers of the Securities and Exchange Commission from compulsory registration of new issues to control over the practices of the exchange as well as to compulsory disclosure for existing securities.72

  The securities legislation constituted a body blow to the Morgan empire because the Morgans dominated the New York Stock Exchange, especially through the exchange’s president, Richard Whitney. Whitney, a scion of the prominent Morgan-oriented financial family, was the head of Richard Whitney and Company, the major bond broker for J.P. Morgan and Company. In addition, Richard’s brother George was a senior partner at the House of Morgan, and was Morgan’s man on such important boards as that of General Motors and of the giant Morgan-controlled publi
c utility holding company, the United Corporation. Since Richard Whitney was the leader of fierce opposition to any government regulation of securities and in behalf of laissez-faire, his defeat by the New Dealers, and in particular his later disgrace, tended to discredit his free-market views.73

  It had always been assumed that since the Stock Exchange was a New York institution, it could only be constitutionally regulated by the state of New York, rather than by the federal government. The New Dealers, however, considered states’ rights an absurd obstacle in the path of centralizing the economy, and they treated it accordingly. Moreover, by imposing federal regulation and enforcement, they could at one and the same time dominate and cartelize the securities and investment banking industries, while delivering another body blow to the House of Morgan.

  The two securities acts were written by New Dealers, many of them young and all eager to radicalize and transform American finance. Substantial roles were played by Federal Trade Commission Chairman Huston Thompson, a Washington State populist, and by the venerable New York trial lawyer Samuel Untermyer, scourge of the House of Morgan as chief counsel of the U.S. Senate’s Pujo Committee in 1912, which had then helped to drive J.P. Morgan, Sr., to his grave. But the most important role in drafting and pushing through the securities acts was played by powerful left-liberal theorist, agitator, and shadowy manipulator Felix Frankfurter, a professor at Harvard Law School. An old friend and adviser to Franklin Roosevelt, Frankfurter specialized in seeding his former students and assistants, his “happy hot dogs,” into powerful positions in the federal government. In particular, Frankfurter folded into the New Deal, and into drafting the securities acts, his disciples James M. Landis, Benjamin Cohen, and Thomas “Tommy the Cork” Corcoran. And standing behind Frankfurter, pulling the strings from his Supreme Court bench, was the even more shadowy master manipulator Louis D. Brandeis, Frankfurter’s mentor from Harvard Law School. Brandeis was able to violate judicial ethics systematically while on the Court, by putting Frankfurter on permanent retainer on his secret payroll, and using Frankfurter as his agent in the political realm. Brandeis, who had been powerful in the Wilson administration, had been fiercely anti-Morgan for decades, and was a longtime legal representative for retail users of Morgan railroads and utilities, particularly for the Filine interests of Boston.74, 75

  While the New Deal Left originally wanted security regulation in the hands of the left-dominated Federal Trade Commission (FTC), they were perfectly happy to “compromise” by setting up a specialized Securities and Exchange Commission (SEC). Indeed, Roosevelt cunningly threw a sop to conservatives and moderates by naming his old friend, the Irish-American stock speculator and buccaneer Joseph P. Kennedy, to be chairman of the five-man SEC, while the other commissioners were leftist ideologues from the FTC, including the leading New Dealer writing the legislation, James McCauley Landis. Rounding out the SEC was none other than that scourge of the Morgans and the Wall Street Republicans, Ferdinand Pecora. Landis was to succeed Kennedy when the latter left the SEC chairmanship in 1935.

  While Joseph Kennedy was a bit more conservative than his colleagues, especially on the New Deal assault on public utility holding companies, his life as a speculator successfully bamboozled many moderates who did not realize the extent of Kennedy’s collectivist views. Thus, Kennedy not only enthusiastically endorsed the New Deal, he went beyond it to advocate a general federal incorporation law, as well as the abolition of private investment banking. In addition, during his buccaneering period in the 1920s, he had repeatedly clashed with the Morgan interests. The extent of Kennedy’s collectivism is seen by his assertion, similar to all collectivist planners:

  An organized functioning economy requires a planned economy. The more complex the society the greater the demand for planning. Otherwise there results a haphazard and inefficient method of social control, and in the absence of planning the law of the jungle prevails.76

  Though Kennedy was a buccaneer, he was scarcely the lone ranger. In the late 1920s and the 1930s, Kennedy worked closely with various Hollywood film corporations, particularly those such as Paramount Pictures, dominated by Lehman Brothers.77

  As for Landis, on the other hand, businessmen expecting a socialistic antibusiness force at the helm of the SEC were pleasantly surprised to find Landis a conscious and deliberate creator of governmental cartelization, of a government-business partnership in behalf of “industrial self-government” under the benign aegis of federal regulation. Landis charmed the financial groups by overcoming his personal dislike of bankers, brokers, and accountants in order to include them in his well of support and regulation. Thus, as early as 1934, Landis wrote in the Yearbook of the Encyclopedia Britannica:

  In all its efforts the [Securities and Exchange] Commission has sought and obtained the cooperation not only of the exchanges, but also of brokerage houses, investment bankers, and corporation executives, who in turn recognize that their efforts to improve financial practices are now buttressed by the strong arm of the government.78

  Landis also shrewdly won over the accounting profession, which had been fearful of New Deal attempts to dictate to and penalize the nation’s accountants. Instead, Landis explicitly offered that profession, previously resentful of domination by corporate clients, the opportunity to cartelize and rule the securities roost, under the benevolent aegis of the SEC. As historian Thomas McCraw puts it,

  [I]t struck him [Landis] as far preferable to use their [the accountants’] existing expertise and to make their professional institutions the vehicle of change, rather than attempting to force results with direct government action.79

  As a result, the accounting profession took to Landis and the SEC with alacrity. The American Institute of Accountants quickly formed a Special Committee on Cooperation with the Securities and Exchange Commission, and this group functioned as a permanent liaison with the SEC. A leading scholar of accountancy soon noted that, with the establishment of the SEC policy,

  the control function of accounts takes on a new and quite different form. Instead of being merely a tool of control by business enterprise they become a tool for the control of business enterprise itself.

  In other words, the scholar, D.R. Scott, was noting the wondrous fact that whereas until the SEC, accountants were forced to subordinate themselves to their private business clients on the market, the SEC was enabling accountancy to enter a new era: where accountants could turn the tables by serving the central government to control and dominate their clients.80

  In particular, Landis set up a special accounting subdivision headed by a chief accountant, who quickly became the most important auditing regulator in the United States. The chief accountant happily accepted the charge of driving toward more rigorous audits, cracking down against violators, and setting up compulsory uniform accounting standards. In 1937, the chief accountant began the practice of issuing much-vaunted “Accounting Series Releases,” laying down a network of standardized accounting practices for the profession. Much of the SEC’s power to enforce guidelines was deliberately delegated to the professional associations of accountants, thus further enlisting the organized profession as surrogate cartelists and enforcers.

  One charm the SEC regulations had for the accountants is that the SEC acts required a large number of new financial statements by “an independent public or certified accountant”— provisions that created a welcome substantial increase in the demand for accountants. As a result, while the number of lawyers and physicians in the nation increased by about 71 percent between 1930 and 1970, the number of accountants swelled by no less than 271 percent.81

  Finally, Landis’s shrewd strategy induced the New York and other regional stock exchanges to collaborate and run their own regulation, under the wing, of course, of the federal government. In a series of addresses to the New York Stock Exchange Institute during 1935, Landis called for “self-government” as the crucial principle. Indeed, Landis carefully worked out the SEC rules in a series of negotiations with t
he exchanges. In early 1937, Landis outlined his strategy candidly in a major address. Regulation, Landis noted,

  welded together existing self-regulation and direct control by government. In so doing, it followed lines of institutional development, buttressing existing powers by the force of government, rather than absorbing all authority and power to itself. In so doing, it made the loyalty of the institution to the broad objectives of government a condition of its continued existence, thus building from within as well as imposing from without.82

  James M. Landis left the SEC in alleged triumph in 1938 to attain the coveted post of dean of Harvard Law School.83 He was succeeded as SEC chairman by commission member William O. Douglas, an old friend of Roosevelt’s, who had developed his own network at Yale Law School. Douglas, even more left-wing and anti-Morgan than Landis, felt that Landis had been lax in hounding Morgan’s Richard Whitney out of his post as head of the New York Stock Exchange. Douglas proceeded to pursue this goal with vigor. But even Douglas was no simple antibusiness socialist, preferring to continue cartelization by working with dissident anti-Morgan groups within the stock exchange, led by the Rockefeller-oriented E.A. Pierce. Douglas was particularly able to work with the retail commission brokers, led by young St. Louis stockbroker William McChesney Martin, Jr., who resented the elite floor traders led by Whitney and the Morgans. It was these dissidents who ousted Whitney and took over the stock exchange, and whose tough new disclosure rules unexpectedly turned up the financial irregularities of Richard Whitney, that were to send him to the penitentiary for embezzlement in 1938. As Douglas exclaimed at this stroke of good fortune: “The Stock Exchange was delivered into my hands.”