A quarterly magazine of urban affairs, published by the Manhattan Institute, edited by Brian C. Anderson.
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Two centuries worth of Wall Street highs and lows
6 June 2008
Wall Street: Americas Dream Palace, by Steve Fraser (Yale University Press, 208 pp., $22.00)
Though University of Pennsylvania lecturer Steve Frasers book Wall Street: Americas Dream Palace came out in late April, its blissfully free of discussion about the financial worlds current slow-motion car crash. Yet it still provides the best explanatory framework for understanding the present-day crack-up. Fraser doesnt focus on the arcane details of collateralized debt obligations and credit-default swaps. Instead, he sticks to timeless archetypes. Through four short chaptersone each on Wall Streets ageless aristocrats, heroes, confidence men, and immoraliststhe author reminds us that theres nothing new under the sun, only fancier acronyms.
In his chapter on the American aristocrat, Fraser chronicles Americas enduring ambivalence toward its financial elites, which dates back to the first days of the republic. Thomas Jefferson led a faction suspicious of New Yorker Alexander Hamiltons plans to create the first national debt by issuing bonds to pay back obligations that individual states had incurred during the revolution. Jefferson saw in this plan a malevolent conspiracy to build up a moneyed aristocracy of urban bondholders who, through their financial power over the nation, would be able to control the fledgling government. Looking across the ocean at England, Fraser writes, Jefferson and his sympathizers could easily see how an incestuous relationship between the money men and the central government . . . threatened to make the government the exclusive preserve of the privileged.
Hamilton, the nations first treasury secretary, won this battle, and Americas unique brand of finance was born. Thanks in large part to the financial savvy that Hamilton and his Manhattan brethren embracedalong with Europes declineAmerica was the worlds creditor, not its debtor, by the end of World War I, and New York was the worlds financial capital. As Fraser writes, Rivers of capital from all over the world flowed into New York, the only place it could safely pool without fear of depreciation. Though were no longer the worlds creditor, the dollar is still the worlds reserve currency. But it may not be for much longer, as inept banks have lobbied to win subsidies (via cheap interest rates and dollar devaluation) of their own bad debts. Jefferson, the anti-banker, would be fascinated to learn that in the end, it may be the banking lobbys power that harms the future of American financeforcing Washington to do whats good for big banks today, but bad for the industrys long-term outlook.
The early American experience also teaches us that free markets dont get free by themselves. Hamilton seemed oblivious to the fact that not everyones motives were as noble as his own when it came to the nations finances. After Hamilton warned a close acquaintance, William Duer, against using insider knowledge in gambling on the national debt, Duer and some co-conspirators nevertheless conspired to speculate on the bonds, Fraser relates. Soon they found themselves . . . forced to liquidate their holdings, causing the fledgling market to collapse and its manipulators to flee. . . . Real estate prices collapsed, credit dried up, house building stopped. As Fraser writes, Hamilton had failed to understand that his colleagues were less-public-spirited than he supposed. Hamiltons painful lesson was just the first of innumerable examples over the next two centuries of self-dealing and insider trading, a reminder that investors big and small need regulatory protection that suppresses capitalists worst impulses while encouraging and unleashing the best. Were still learning how difficult it is to establish such protection, despite obvious progress in government efforts to protect the integrity of the financial markets since 1792.
Frasers heroes remind readers of a time when the financial world was mostly on its own. Without the Federal Reserve to protect even seemingly safe depository banks and without regulations mandating considerable disclosure of what went on in corporations, banking customers and corporate shareholders were vulnerable to panics. To calm one such storm in 1907, J. P. Morgan, a government unto himself, publicly persuaded his fellow financiers to put up the money to save institutions that otherwise would have failed, the victims of poor risk calculations and then investor panic. Lest we pine too ardently for the days when Wall Street didnt look to government to bail it out, its worth remembering that Morgan only got so powerful because he hated the free market. He made his profits by impos[ing] law and order on it through aggressive mergers, management tie-ups, and corporate collusions in industrial sectors that today would run afoul of antitrust law.
But Wall Street aristocrats and heroes can easily morph into con men. Richard Whitney, the Depression-era chief of the New York Stock Exchange, was an aristocrat before he turned con man to combat bad debts, resort[ing] to embezzlement and fraud to keep afloat. Charles Mitchell, the head of National City Bank in the same era, was another of these eminent men who had lured thousands of . . . clients into the most dubious of investments. Enrons Jeff Skilling, and now Countrywide Banks Angelo Mozilo, might find such tales a bit too familiar: both were lauded as heroes during their respective market booms and shamed as swindlers afterward.
Frasers chapter on con men is good funfrom a distance, of course. Who today remembers the Great Diamond Hoax of 1872, launched by two rascals who bought a few gems and scattered them around a dirt plot out West? Their scheme suckered jewel expert Charles Tiffany, New York congressman Benjamin Butler, and Rothschild agent August Belmont into believing their tale of a lucrative new mine. Even the sophisticated can fall prey to the lure of something too good to be true. Some of the nations most renowned asset managers are learning this fact anew, having bought opaquely structured, strangely acronymed mortgage-backed securities in the past few years on the premise that they offered high interest rates and low riskan unlikely combination.
Frasers chronicling of good men gone bad and bad men who stayed bad reminds us that in an optimistic economy, the presence of such fraudsters, as well as the hero-worshipping of icons whose feet later to turn out to be made of clay, is perennial. Regulators must ensure that companies disclose as much information as clearly and as often as possible so that frauds and misjudgments can be quickly ferreted out. And these regulations must evolve as markets evolve, just as antibiotics must change to chase mutating bacteria. But even then, surprises will lurk.
Unlike the con man, the immoralist exists largely in his critics imagination. Hes the cartoonish caricature of the financier as parasite, a perception often caught up with dangerous anti-Semitic prejudice. Fraser chronicles how auto giant Henry Ford, who trafficked in anti-Jewish propaganda, publicly worried that Wall Streets profits werent the product of hard work. Instead, he felt, the Street leached away real wealth that originated elsewhere. Suspicion that financiers are stealing the fruits of other peoples toil persists today. Sometimes perfectly well-meaning, its especially acute during periods of economic stress. Witness public fears that hedge-fund managers have pushed up the price of food around the world through their commodities investments, or concerns that buyout firms dont benefit the companies they purchase and retool but only strip them of their profits. Of course, fears of market manipulation are often well-founded, but they are quite distinct from broader concerns that the financial industry in general, and speculators in particular, add no value.
Fraser ends his book by voicing some perplexity. After Enron and its cascading scandals, he writes in a tone of disappointment, Americans still seemed to maintain more faith in markets than in government. Nobody seemed to want a new FDR to institute huge new protections to harness the financial world. No major depression followed the meltdown of the dot.com bubble, further diminishing any sense of urgency about mounting a frontal assault on Wall Streets latest reincarnation as the confidence man, Fraser laments. Until such an emergency arisesif it ever doespublic alarm and readiness for more drastic measures may remain low.
Fraser may be getting his emergency now. Just as his book went to press, the Bear Stearns meltdown occurred and the government unprecedentedly guaranteed investment banks assets to deter their creditors from fleeing. And while middle-class Americans during the dot-com boom had always viewed stocks as a risky investment, tempering the shock of the losses many eventually suffered, few had considered their investments in their houses similarly risky. Real-estate agents and their lending enablers often declared that buying a house was a sure thing. Like those Americans who put their savings in banks before the Depression, todays homeowners are dismayed that safe investments sometimes arent.
But it wasnt the con man or the immoralist who got Wall Street this time. It was rathereven more dangerouslythe bungler. The shock felt by the financial press and the general public today isnt that financial titans proved diabolically clever, but that they were abjectly stupid about shareholders and customers money. Take Charles Prince, formerly of Citigroup, or Stanley ONeal, formerly of Merrill Lynch: neither had any earthly idea of the size and scope of the risks their own firms had taken on.
To see how this latest Wall Street story could end, Fraser should go back to his aristocrat chapter, which contains this fitting epitaph from the Roaring Twenties: During the boom years of the 1920s, the white-shoe world . . . had accepted credit for the nations good fortune and been portrayed as a conclave of wise men. Now, under the new circumstances of economic ruination, that same world was treated as criminally irresponsible, pathetic even, an object not only of censure but of mockery. And there is perhaps nothing more fatal for the life expectancy of an elite than to be viewed as ridiculous.
Nicole Gelinas, a City Journal contributing editor and the Searle Freedom Trust Fellow at the Manhattan Institute, is a Chartered Financial Analyst.