After The Fall: Saving Capitalism From Wall Street—and Washington

by Nicole Gelinas

Wall Street: America’s Dream Palace, by Steve Fraser (Yale University Press, 208 pp., $22.00)

Though University of Pennsylvania lecturer Steve Fraser’s book Wall Street: America’s Dream Palace came out in late April, it’s blissfully free of discussion about the financial world’s current slow-motion car crash. Yet it still provides the best explanatory framework for understanding the present-day crack-up. Fraser doesn’t focus on the arcane details of collateralized debt obligations and credit-default swaps. Instead, he sticks to timeless archetypes. Through four short chapters—one each on Wall Street’s ageless “aristocrats,” “heroes,” “confidence men,” and “immoralists”—the author reminds us that there’s nothing new under the sun, only fancier acronyms.

In his chapter on the American “aristocrat,” Fraser chronicles America’s 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 Hamilton’s 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 nation’s first treasury secretary, won this battle, and America’s unique brand of finance was born. Thanks in large part to the financial savvy that Hamilton and his Manhattan brethren embraced—along with Europe’s decline—America was the world’s creditor, not its debtor, by the end of World War I, and New York was the world’s 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 we’re no longer the world’s creditor, the dollar is still the world’s 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 lobby’s power that harms the future of American finance—forcing Washington to do what’s good for big banks today, but bad for the industry’s long-term outlook.

The early American experience also teaches us that free markets don’t get free by themselves. Hamilton seemed oblivious to the fact that not everyone’s motives were as noble as his own when it came to the nation’s 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.” Hamilton’s 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. We’re 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.

Fraser’s “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 didn’t look to government to bail it out, it’s 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.” Enron’s Jeff Skilling, and now Countrywide Bank’s 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.

Fraser’s chapter on con men is good fun—from 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 nation’s 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 risk—an unlikely combination.

Fraser’s 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. He’s 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 Street’s profits weren’t “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 people’s toil persists today. Sometimes perfectly well-meaning, it’s 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 don’t 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 Street’s latest reincarnation as the confidence man,” Fraser laments. “Until such an emergency arises—if it ever does—public 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, today’s homeowners are dismayed that “safe” investments sometimes aren’t.

But it wasn’t the con man or the immoralist who got Wall Street this time. It was rather—even more dangerously—the bungler. The shock felt by the financial press and the general public today isn’t 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 O’Neal, 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 nation’s 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.