by Kai Bird
With assets of more than $700 million, the St. Paul reorganization was a major case for the firm. Paul Cravath himself and Swaine took the lead on making all the major decisions. Cravath’s strategy in such reorganizations was promptness: everything depended on getting first in line for the receivership. So, when St. Paul’s management quietly approached Kuhn, Loeb (their bankers) about the need for a receivership, Cravath lawyers immediately began drawing up the papers. Under Swaine’s supervision, McCloy started work on the drafts a full two months before there was any public hint that the St. Paul was going under.25
While McCloy was diligently drawing up the receivership papers and taking various affidavits, the major holders of St. Paul stock and the men who had appointed the company’s board of directors, William and Percy Rockefeller and Ogden Armour, were quietly selling out. In a short time, few of the railroad’s directors had any stock at all in their own company. Theoretically, the numerous small shareholders, owning more than $400 million worth of stock, had a voice in running the company. In practice, however, the board had been self-perpetuating since 1913. The directors’ only allegiance seemed to be to the troubled railroad’s bankers, Kuhn, Loeb and the National City Bank.26
In anticipation of the receivership, Kuhn, Loeb needed a legal device whereby none of the some forty thousand individual investors, scattered all over the country, could attempt to exercise collective control over the reorganized railroad. To this end, McCloy, Swatland, and Douglas drafted an enormously complicated and wordy document. Max Lowenthal, a Senate investigator who later wrote a small book about the case called The Investor Pays, observed that, if an ordinary investor “had attempted to explore the documents, he would have perished in the jungle of impassable words.”27
The document had no table of contents and no index. The language was all but impenetrable; one sentence ran to 2,250 words. Buried throughout the proposed receivership document was this essential fact: in order for any shareholder to participate in the receivership, he must give an unqualified proxy to the bankers. The document also gave the lawyers the right to set a deadline for shareholders to submit their shares in return for certificates in a new company. This put pressure on any shareholders who might wish to challenge the receivership in court. If they lost, and the deadline for agreeing to the Cravath receivership had passed, then they would be ineligible for any compensation at all. In these circumstances, it was not long before the Cravath receivership committee controlled an absolute majority of all shares.
The lawyers made sure that a friendly judge would acquiesce in a Cravath receivership, and a new company was quickly incorporated in Delaware; the newspapers reported the appointment of McCloy as the youngest-ever president of a railroad company, and a photo of him looking very youthful in his army captain’s uniform was published alongside the story.28 Over at Kuhn, Loeb, Buttenwieser referred to the new company as a “dummy corporation.”29
All that remained was for McCloy and Douglas, appointed vice-president of the new entity, to attend the auction of the bankrupt St. Paul. Because the defunct railroad had been incorporated in Butte, Montana, the Cravath lawyers and Kuhn, Loeb bankers had to take the train out west in mid-November 1926.
The New York Times correspondent reported from Chicago, “When the Olympian of the Chicago, Milwaukee & St. Paul Railroad leaves this city at 11 o’clock tomorrow night it will bear a group of bankers, railroad officials and lawyers representing probably a quarter billion dollars in purchasing power.. . . It seems practically certain that the Reorganization Committee backed by Kuhn, Loeb & Co. and the National City Bank will buy in the property.”30
An independent bidder for the property was hardly likely. The only other investment bank capable of handling such large refinancing bonds was the House of Morgan. But in those days the two rivals rarely, if ever, engaged in bidding wars against each other. When rumors were floated in Wall Street that the House of Morgan might back a minority faction of stockholders against the Kuhn, Loeb reorganization, a Morgan official took the trouble to deny the report firmly, explaining that “it would not be fair to Kuhn, Loeb & Co.”31
When McCloy and his party arrived in Butte, there were no other bids at the auction. It was a cold, snowy day when the train pulled into the station. A crowd of Butte citizens were there to greet the luminaries, who included Pierpont V. Davis, vice-president of National City Bank; Jerome J. Hanauer, operating head of Kuhn, Loeb; and Frederick H. Ecker, chairman of the bondholders’ committee formed by the Cravath lawyers. The auction was scheduled to be held on the steps of the station, but the steps were so icy that at the last moment a table was set up just inside. The auction master took twenty-two minutes to read the legal notice of sale, and then he announced that there were no bids other than Kuhn, Loeb’s. A Chicago Daily News reporter wrote, “A festive air pervaded the hearing. The reorganization group were in high spirits and they bubbled over with good feeling as the proceeding continued and no semblance of opposition manifested itself.”32
The trip was a significant financial success for the lawyers and bankers. Kuhn, Loeb and National City Bank billed the reorganized St. Paul railroad $1,044,000 for their banking services. Cravath submitted bills for more than $450,000. Neither McCloy nor Douglas seemed troubled by the roughshod treatment they had accorded the independent stockholders. A few years later, Douglas would write articles attacking the selfishness of Wall Street. But his colleagues, McCloy included, can recall no such qualms on his part at the time. “I don’t remember any ideological interchange between Douglas and me at Cravath,” said McCloy. “We just talked about how to get the day’s business done. How do we get our ducks in a row? What consents do we have to get? Who on the bondholders’ committee is important? Who should we talk to at the banks? Bill Douglas wasn’t the passionate crusader then.”33
Almost immediately the St. Paul reorganization became a popular symbol of Wall Street greed. Complaints were filed with the Interstate Commerce Commission (ICC), and a group of disgruntled stockholders went to court to challenge the high fees paid the bankers and lawyers. For the next five years, Cravath lawyers found themselves hauled before ICC investigators or federal judges to explain their conduct. Swaine defended the high fees he charged St. Paul as an “ordinary business arrangement.” Angry St. Paul stockholders fought the Cravath fees to the Supreme Court. It was not until 1931 that the court, in a five-to-three decision, upheld Cravath’s fees. Justices Stone, Holmes, and Brandeis dissented, charging Cravath with “failure to conform to those elementary standards of fairness and good conscience. . . .” Justice Stone called the fees “wasteful and extravagant” and argued that Cravath’s conduct would serve to undermine the public’s confidence in the railroads.34
His prediction proved correct, for though the ICC ultimately approved Cravath’s reorganization plan as a “lesser evil,” the railroad was back in receivership within a few short years. Even Swaine had to acknowledge that the legal system had failed: “The discussion brought to public attention the artificiality of the consent receivership, the fictitious nature of the railroad foreclosure sale and defects in the conventional procedure which had earlier been pointed out even by counsel criticized in the St. Paul reorganization.”35
Off and on throughout 1926–27, McCloy worked with Swatland, Douglas, Swaine, and others on similar corporate reorganizations. He thrived on the sixteen-hour workdays, and enjoyed “getting our ducks in a row.” His only ambition was to be named a Cravath partner. Not everyone had the physical stamina or patience to endure both the long hours and the often tedious nature of the work. Bill Douglas pined for his beloved Northwest and the outdoors. “I don’t think he ever had his heart wholly in his work,” McCloy remembered. “The work at Cravath was pretty much of a grind.”36 Douglas, in fact, had seen enough of both New York City and corporate law, and had concluded that “the practice of law required predatory qualities.”
When Douglas left the firm in January 1926 for eight months in the West, McCloy remain
ed, content to clock the long hours needed to win a partnership. Despite his long hours, he was not asocial. Quite the contrary, he was one of the most popular associates in the firm.
His circle of acquaintances now included a group of rising young bankers and businessmen who became lifelong friends. In 1925, Cravath managed an offering of $30 million in bonds placed by Brown Brothers in Norway.37 As a consequence of this and other bond business with Brown Brothers, McCloy met Robert Abercrombie Lovett, a Yale graduate of the same age. Lovett’s father, chairman of Union Pacific, was a neighbor of Paul Cravath’s on Long Island. The younger Lovett had spent one year at Harvard Law and then, in the autumn of 1921, decided a legal career was not to his taste; he joined Brown Brothers, a major investment-banking firm, working initially as a “runner.” A tall, handsome young man with a wry sense of humor, Lovett had been born into the kind of privileged class McCloy so respected. At Yale, one of his best friends was F. Trubee Davison, the son of Henry Davison, the J. P. Morgan & Co. partner. While McCloy was learning to ride horses at Plattsburg, Lovett and Davison put together the “Aerial Coast Patrol No. 1,” more popularly known as the “First Yale Unit.” Davison’s father financed the entire operation, and the boys trained in their seaplanes headquartered on the Davison estate at Peacock Point on Long Island.38
They were scoffed at in the newspapers at the time as the “millionaires’ unit.” When Lovett’s and Davison’s seaplane had to make an emergency landing one day in the East River, the two young men calmly went off to have lunch on Davison’s yacht, moored nearby.39
They were not quite the dilettantes they made themselves out to be; when America finally entered the war, Lovett distinguished himself as an expert dive-bomber and came home from Europe with a Navy Cross. By the time McCloy met him in the mid-1920s, Trubee Davison was an assistant secretary of war, supervising the air force in the Coolidge administration. Davison had married Dorothy “Dot” Peabody, daughter of the famous headmaster of Groton. The Davisons were also good friends of Lew and Peggy Douglas in Washington, where Douglas was serving his first term as Arizona’s sole congressman.
Davison took to inviting McCloy out to play tennis on the grass courts at his Peacock Point mansion. McCloy found another tennis partner at Brown Brothers: Henry “Harry” Brunie, an amiable but quiet young investment banker. Brunie was good enough to have played at Wimbledon, and could more often than not beat McCloy. “I was just as good as he was,” claimed McCloy, “but kept my nose to the grindstone [at Cravath] a bit more.”40
Another rich young man in this charmed circle was W. Averell Harriman. A few years earlier, Harriman had inherited Union Pacific from his father, the legendary robber baron Edward H. Harriman. About this time, Cravath handled a $13.5-million securities issue for W. A. Harriman & Co., a small investment bank set up by Harriman after his father’s death. McCloy and Harriman may have met in conjunction with this work, but more likely they were introduced at one of many weekend parties hosted by Lovett or Davison on their Long Island estates. Compared with Lovett, McCloy thought Harriman a lightweight. “Most of the people who worked with Averell on Wall Street,” McCloy recalled years later, “felt he did not pull his weight, and that he was not too bright. . . . He was good-looking, affluent, and very aloof back then, which made him quite a lady’s man. I once attended one of those lavish polo parties and felt out of my milieu. He had an air about him, one that Lovett never sought to affect.”41
McCloy was thrown in with this crowd of young investment bankers because their banking firms needed Cravath’s legal expertise in handling a rising volume of business in European securities. Prior to World War I, most of Cravath’s international work involved representation of European institutional investment in American securities. By 1919, the flow of capital from Europe to America was almost completely reversed. Now American investors were looking for opportunities in European markets, and they turned to Cravath for legal advice. This new business more than replaced that lost from Cravath’s European clients. In 1927, the firm found it profitable to send Chester McClain, a partner in the firm and a good friend of McCloy’s, to open a Paris office.42
McClain was swamped with work, much of which required him to travel throughout the continent. In response to his request for assistance, the firm sent McCloy, who based himself in Milan, where a large number of Italian investment-banking houses were headquartered. Working out of rented living quarters, McCloy was more or less his own boss.
His securities work kept him on the road many months out of the year, traveling throughout Italy, Greece, France, and Germany. On one occasion in late 1928, he was sent to Athens in connection with a $54-million bond issue to finance reclamation work in Struma, Philippi, and Thessaly. Before McCloy had hardly begun to negotiate the legal guarantees attached to the bond, he was stricken with a case of dengue fever that required hospitalization for several weeks; in his eagerness to return to work, McCloy checked out of the hospital long before he had fully recovered. Walking down the cobblestone road leading from the hospital, he encountered a herd of goats entirely blocking the road. He stepped to the side, was pushed up against a wall, stumbled, and fell. “It seemed as if the whole herd of goats passed over me,” he recalled years later. Still delirious, he made his way back to the hospital in a fog.43
A large number of the European bonds McCloy negotiated defaulted within a very few years. In retrospect, Swaine explained, “If, in the light of hindsight, it seems that many such issues were put on the American market without adequate economic justification, it should be remembered that American bankers and investors were being encouraged by the national Administration to invest in the rehabilitation of Europe and the development of Latin America with faith in the future rather than regard for the past.”44
Swaine’s recollection, however, was a little too self-serving. The investment-banking community in New York, led by the House of Morgan and by Kuhn, Loeb, took the lead on these loans, because there was a great deal of money to be made in floating new securities.45 German bonds, for instance, in these years earned a very respectable 7 or 8 percent. The investment bankers who managed such bonds took their fees off the top: thus, of the $1.2 billion in loans to Germany from 1924 to 1930, the bankers earned $50 million in fees alone 46
Many of the securities were risky from the beginning. To be sure, the loans were necessary to rebuild the war-torn European economies. But most of these countries also had large war-loans to pay off, or, in the case of Germany, hefty reparation payments due the Allied governments. Not surprisingly, in order to make their private reconstruction loans more marketable, New York’s investment bankers encouraged leniency on the repayment of this government-to-government debt. Financiers like Otto Kahn, Thomas Lamont, Benjamin Strong, and Paul Warburg urged the U.S. government to forgive the interest for three to five years on the approximately $10 billion the European Allies owed Washington.47
McCloy and a whole generation of New York’s “bankers’ lawyers” came to believe strongly that the war debts and German reparations were both unwise and unfair. He regarded his work on European securities in the 1920s as an almost altruistic private program of war reconstruction. “What took place after World War I was the forerunner of the Marshall Plan,” McCloy remembered. “But back then the rehabilitation of Europe was done in a private capacity. Practically every merchant bank and Wall Street firm, from J. P. Morgan and Brown Brothers on down, was over there picking up loans. We were all very European in our outlook, and our goal was to see it rebuilt.”48
He made a number of trips into Germany in 1927–28 and witnessed the debilitating effects of spiraling inflation and speculation on the economy. His Warburg clients at Kuhn, Loeb still had relatives, not to speak of large financial interests, in Germany. During these years, McCloy assisted in some of the transactions of the Warburg family’s International Acceptance Bank, set up to finance German industries. Paul Warburg himself was continually lobbying U.S. officials to make large-scale loans to Eur
ope.
Anticipating the arguments made two decades later in behalf of the Marshall Plan, Warburg and Kahn raised the specter of the Bolshevist threat to Germany.49 But for the most part they argued that European loans were needed in order to expand free trade. Warburg went so far as to suggest that the United States should throw open its doors to European imports and pay for them with the gold the Allies had used to pay for U.S. war materiel. By assuming the role of “the world’s banker,” he argued, New York would in fact become the world’s financial and commercial center.50
Financial power was indeed shifting in these years from London to New York. A headlong rush for high profits made American bankers extend large loans to shaky European clients. Otto Kahn spoke of the fierce “competition by American bankers for European and foreign issues in general through the two mad years of 1926 and 1928, when, just as in 1929, nothing counted but pieces of paper. . . .”51 Kahn described to Senate investigators in 1933 how dozens of “American bankers sat in half a dozen South and Central American states, or in Balkan states,” engaging in “cutthroat competition, one outbidding the other foolishly, recklessly, to the detriment of the public, compelling him to force bonds on the public at a price which is not determined by the value of that security so much as by his eagerness to get it. . . .”52 Some of Cravath’s clients were more speculative than others. Throughout the 1920s, National City Bank of New York, for instance, was run by the flamboyant and aggressive Charles E. Mitchell. He made a large number of loans to German municipalities and industrial ventures, many of which later defaulted. Arrested in 1933 for tax evasion, Mitchell was represented by Cravath lawyers, who managed to have him acquitted.53
