War, Debt, Health Care how are they related?

By Melvin J. Howard

Remember that old song War What Is Good For? Absolutely Nothing well that’s not so true at least not when it came to financing it. Bonds what are they in finance a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest. There are many kinds of bonds but for this entry we will be focusing on Government Bonds. One of the first persons to master the bond market was you guessed it Nathan Rothschild. Master of universe at that time, he boasted that he was the arbiter of peace and war, and that the credit of nations depends upon his nod.

Nathan Mayer Rothschild, founder of the London branch of what was, for most of the nineteenth century, the biggest bank in the world. But it was the bond market that made the Rothschild family rich real rich. Lord Rothschild, Nathan's great-great-great-grandson. Said of Nathan he was 'short, fat, obsessive, ex­tremely clever, wholly focused I can't imagine he would have been a very pleasant person to have dealings with.

The Battle of Waterloo was the culmination of more than two decades of intermittent conflict between Britain and France. But it was more than a battle between two armies. It was also a contest between rival financial systems: one, the French, which under Napoleon had come to be based on plunder (the taxation of the conquered); the other, the British, based on debt. Between 1793 and 1815 the British national debt in­creased by a factor of three to more than double the annual output of the UK economy. This increase in the supply of bonds had weighed heavily on the London market.

Now let’s jump to the other side of the Atlantic to another war the Civil war in America and how it was really won. The South's ability to manipulate the bond market depended on one overriding condition that investors should be able to take physical possession of the cotton which underpinned the confederate bonds if the South failed to make its interest payments. Col­lateral is, after all, only good if a creditor can get his hands on it. And that is why the fall of New Orleans was the real turning point in the American Civil War. With the South's main port in Union hands, any investor who wanted to get hold of Southern cotton had to run the Union's naval blockade not once but twice, in and out. Given the North's growing naval power in and around the Mississippi, that was non-starter. If the South had managed to keep New Orleans until the cotton harvest had been offloaded to Europe, they might have been able to sell more cotton bonds in London. The Confederacy had miscalculated. They had turned off the cotton tap, but then wasn’t able to turn it back on. By 1863 the mills of Lancashire England had found new sources of cotton in China, Egypt and India. And now investors were rapidly losing faith in the South's cotton-backed bonds. The consequences for the Confederate economy were disastrous. With its domestic bond market exhausted and only two paltry foreign loans, the Confederate government was forced to print unbacked paper dollars to pay for the war and its other expenses, 1.7 billion dollars' worth in all. Both sides in the Civil War had to print money. But by the end of the war the Union's 'greenback' dollars were still worth about 50 cents in gold, whereas the Confederacy's 'greybacks' were worth just one cent. The situation got worst by the ability of Southern states and municipalities to print paper money of their own.

With ever more paper money chasing ever fewer goods, inflation exploded. Prices in the South rose by around 4,000 per cent during the Civil War. By contrast, prices in the North rose by just 60 per cent. Even before the surrender of the principal Confederate armies in April 1865, the economy of the South was collapsing, with hyperinflation remember this word we will come back to it later. Was the partner of the North in the defeat of the South. Those who had invested in Confederate bonds ended up losing their shirts. The North pledged not to honour the debts of the South. In the end, there had been no option but to finance the Southern war effort by printing money. It would not be the last time in history that an attempt to buck the bond market would end in ruinous inflation and military humiliation. The fate of those who lost their shirts on Confederate bonds was not especially unusual in the nineteenth century. The Confederacy was far from the only state in the Americas to end up dis­appointing its bondholders; it was merely the northernmost de­linquent. South of the Rio Grande, debt defaults and currency depreciations verged on the commonplace. Latin America in the nineteenth century in many ways foreshadowed problems that would become almost universal in the middle of the twentieth century. Partly it was because Latin American republics were among the first to discover that it was relatively painless to default when a substantial proportion of bondholders were foreign. It was no mere accident that the first great Latin Ameri­can debt crisis happened as early as 1816, when Peru, Col­ombia, Chile, Mexico, Guatemala and Argentina all defaulted on loans issued in London just a few years before.

^{But by the later nineteenth century, countries that defaulted on their debts risked economic sanctions, the imposition of foreign con­trol over their finances and even, in at least five cases, military intervention. Defeat itself had a high price. All sides had reassured tax­payers and bondholders that the enemy would pay for the war. Now the bills fell due take Berlin Germany for instance. One way to understand the post-war hyperinflation was a form of state bankruptcy. Those who had bought war bonds had invested in a promise of victory; defeat and revolution represented a national insolvency, the brunt of which necessarily had to be borne by the Germans creditors. At the conference at Versailles, which imposed an unspecified reparations liability on the fledgling Republic the total indemnity was finally fixed in 1921, the Germans found themselves saddled with a huge external debt with a nominal capital value of 132, billion 'gold marks' (pre-war marks), equivalent to more than three times national income. Although not all this new debt was immediately interest-bearing, the scheduled repar­ations payments accounted for more than a third of all hail Hitler’s expenditure in 1921 and 1922.}

Hyperinflation seemed to be the word of the day after the First World War. Austria - as well as the newly independent Hungary and Poland - also suffered comparably bad currency collapses between 1917 and 192.4. In the Russian case, hyperinflation came after the Bolsheviks had defaulted outright on the entire Tsarist debt. Bondholders would suffer similar fates in the aftermath of the Second World War, when Germany, Hungary and Greece all saw their currencies and bond markets collapse. It could be easy to associate hyperinflation with the costs of losing world wars; it would be relatively easy to understand. Yet there is a caveat in more recent times, a number of countries have been driven to default on their debts. Either directly by suspending interest payments, or indirectly by debasing the cur­rency in which the debts are denominated.

There is a slight gamble involved when an investor buys a bond. Part of that gamble is that an upsurge in inflation will not consume the value of the bond's annual interest payments. If inflation goes up to ten per cent and the value of a fixed rate interest is only five, then that basically means that the bond holder is falling behind inflation by five per cent.' As we have seen, the danger that rising inflation poses is that it erodes the purchasing power of both the capital sum invested and the interest payments due. And that is why, at the first whiff of higher inflation, bond prices tend to fall. In 1975, as inflation soared around the world, the bond market made Vegas casino’s look like a pretty safe place to invest your money. At that time when US inflation was surging into double digits, peaking at just fewer than 15 per cent in 1980. That was perhaps the worst bond bear market in history.' To be precise, real annual returns on US government bonds in the 1975 were minus 3 per cent, almost as bad as during the inflationary years of the world wars. Today, only a handful of countries have inflation rates above 10 per cent and only one, Zimbabwe, is afflicted with hyperinflation.'"" But back in 1979 at least seven countries had an annual inflation rate above 50 per cent and more than sixty countries, including Britain and the United States, had inflation in double digits. Among the countries worst affected, none suffered more severe long-term damage than Argentina.

Inflation has come down partly because many of the items we buy, from clothes to computers, have got cheaper as a result of technological innovation and the relocation of production to low-wage economies in Asia. It has also been reduced because of a worldwide transformation in monetary policy, which began with the monetarist-inspired increases in short-term rates imple­mented by the Bank of England and the Federal Reserve in late 1975 and early 1985. Also trade unions have become less powerful. Loss-making state industries have been privatized. But, perhaps most importantly of all, the social con­stituency with an interest in positive real returns on bonds has grown. A rising share of wealth is held in the form of private pension funds and other savings institutions that are required, or at least expected, to hold a high proportion of their assets in the form of government bonds and other fixed income securities. With every passing year, the pro­portion of the population living off the income from such funds goes up, as the share of retirees increases. In a graying society, there is a huge and growing need for fixed income securities, and for low inflation to ensure that the interest they pay retains its purchasing power. As more and more people leave the workforce, recurrent public sector deficits ensure that the bond market will never be short of new bonds to sell. People forget just months before President Bush's election, in September 2000, the National Debt Clock in New York's Times Square was shut down at $5,676,989,904,887 it ran out of room. Bush agreed with the principle of paying down the debt but did not have a committed specific date for eliminating it. That lack of commitment on President Bush’s part was a tale tale sign of things to come. When Bush entered the White House, his administration ran a budget deficit in seven out of eight years. The federal debt has increased from $5 trillion to more than $10 trillion when Bush left office the national debt now stands at over 11 ½ trillion dollars. That is why it is so imperative to pass health reform with out it we are on a collision course to debt hell.

An estimated $2.26 trillion was spent on health care in the United States, or $7,439 per person. Health care costs are rising faster than wages or inflation, and the health share of GDP is expected to continue its upward trend, reaching 19.5 percent of GDP by 2017. As a proportion of GDP, government health care spending in the United States is larger than in most other large western countries. On top of that, there is substantial expenditure paid from private insurance. A recent study found that medical expenditure was the cause for 60% of all personal bankruptcy in the United States. According to Dr. David Himmelstein of Harvard University who helped author the study, "Unless you're Warren Buffett, your family is just one serious illness away from bankruptcy for middle-class Americans, health insurance offers little protection.

The US spends more on health care per capita than any other UN member nation. It also spends a greater fraction of its national budget on health care than Canada, Germany, France, or Japan, In 2004 the US spent $6,102USD per person on health care, 92.7% more than any other G8 country, and 19.9% more than Luxembourg, which, after the US, had the highest spending in the Organisation for Economic Co-operation and Development (OECD). Now I know most Republicans would rather not see our country crushed by a depression just to prove an ideological point or to try to thwart President Obama’s domestic agenda. If that is the case it is distressing and malice for this reform is too important to be playing politics with at this time. But history tells me that is exactly what is going on. Extreme conservatives fought recovery in the last depression, and Roosevelt did not spend enough to get us out of it. It took World War II to provide the excuse for the enormous deficits that finally jolted the economy out of depression and into overdrive. You might ask yourself why borrow and spend i.e. Economic Stimulus? Let me give you an illustration why. Money flows in circles: you get paid; you spend it, and the store pays someone else, who spends at another store. But what if everyone spent 90% and saved 10% in the bank? The circular flow of money would dwindle away to nothing, all the money would end up in the bank, the stores would shut down and we'd all be out of work and broke.

So in summary what we did was ask Captain President Obama to take over the Titanic when it was just about to hit the iceberg while the other Captain President flew off in the sunset. Now we all are asking Captain President Obama to save us from this financial calamity. Which I have the utmost confidence he will but to judge him after six months in office please get real!

The U.S. finished as the world economic super power now that’s just downright ridicules!

The News of my demise are greatly overstated!

By Melvin J. Howard

This past 4^th of July I wanted to recap on where we were economically this time last year. Countries from every stripe were wondering is the US done being an economic super power who could blame them the outlook was bleak. The debt was continually climbing to be exact; the Debt now stands at $11,033,157,578,669.78. Divide it by the U.S. population that comes up to over $36,000 in debt for every man, woman and child in the U.S. Between a couple of wars and hundred of billions of dollars of stimulus money well lets just say that would tend to leave your wallet a little emptier. Heck even the Chinese who holds about a trillion dollars invested in U.S. Treasury notes, said they wanted some guarantee. They were even calling for a new global currency. But China rest assured there is no need to worry and here is why you see I take the opposite route not because of sentimental value but of cold hard facts. I became a student of history specifically financial history. I am still bullish on U.S. debt and here is why all the data I collected dating back over a century was telling me otherwise. The U.S. has always had some hick- up along the way of prosperity but it always comes back. So now let go back to that reminder that I wrote last year I titled it. The US finished as the world economic super power I would think again!

As I study more and more about banking the US in particular I am amazed at where it started to where it is today. From a colony of rag tag framers and merchants to the most competitive, creative and complicated financial and banking system in the world. I also want to note that it was not just the farmers and merchants that built early America. Slave labour had a lot to do with America’s fight to stand on its own independent of Britain. Slave Labour or human capital is what we call it today cannot be discounted. Congress has finally apologized for slavery I guess better late then never. So let’s move on although there have been some bank failures in the past and some recently. The alternative would be 3 or 4 banks to choose from to do all your banking. Can you imagine America without choices? Lets face it we want choices like 31 flavours it is in our blood. America's central bank (ie, government-controlled money & banking system) was instituted purportedly to protect the public from the "anarchy" of free banking. Money & banking were the most free from 1936 (when President Andrew Jackson ended Federal involvement in banking) to 1862 (when Congress mandated that fiat greenbacks be accepted as legal tender to finance the Civil War -- but without prohibiting the use of gold or silver). The National Bank Act of 1863 required all banks to collateralize their bank notes with government securities. Private coinage was outlawed in 1864. Otherwise, from 1836 to 1913 banking remained under state jurisdiction, with over half of states allowing free banking. Prices remained stable during this period -- in sharp contrast to the steep inflation produced under central banking in the period after 1913.

Representatives for the American central bank say that there were bank failures in the United States prior to the Federal Reserve System. This is true where business is freely practiced, poorly run or poorly located businesses will fail. Free markets mean rapid progress through trial-and-error, rather than the stiflingly slow progress (or regress) of a controlled economy. But bank failures were far fewer under free (or semi-free) banking than under central banking. The ratio of capital to loans in American banks went from 40.5% in 1836 to 55.1% in 1842, falling to 41.3% in 1862, to 17% in 1913 and to 5.6% in 1989. In New York State, which had the largest, most free banking system, bank failures from 1838 to 1863 were less than one-third of 1% per year, on average (with customers receiving an average 75 cents on the dollar in the failures). By contrast, under central banking the rate of bank failures in the 1920s was in excess of 2% per year. And in the 1930-1933 period about one-third of all US banks failed. Depositors lost more money in the first 20 years of central banking than had been lost in the 75 years before central banking. Bank failure rate declined after 1934 when the institution of Federal deposit insurance effectively created a welfare system for bankers, allowing federal money to bail-out poorly managed banks thereby underwriting inefficiency and encouraging risk-taking.

The Federal Reserve Act of 1913 established the Federal Reserve System (headed by the Federal Reserve Board) as the central bank of the United States (affectionately known as "the Fed"). Of course, this move was touted as the creation of high-minded oversight for money & banking that would rise above the petty interest of the market place. Conveniently, the Fed doubled the money supply during World War I to finance the war effort.

The inflation wrought by wartime government spending in Europe was far more severe than that in the United States particularly in Germany, where a postage stamp for local delivery cost 100 billion marks in 1923. The inflationary crisis in Germany undoubtedly made people desperate for a New Deal from a "high-minded" leader like Hitler, who had no trouble rising above the petty interests of peoples who would be free. As has been mentioned, Roosevelt's New Deal made the possession of gold punishable by imprisonment for American citizens.

The Federal Reserve Act of 1913 forced all banks in the United States to become part of the Federal Reserve System. This meant that their reserves (for fractional reserve banking) had to be demand deposits at the Fed. US Dollars became Federal Reserve Notes, backed (fractionally) by gold. The fractional reserves of gold held by the Fed were "backing" for the fractional reserves of Federal Reserve notes (amount dictated by the Fed) for the member banks. The system was so "successful" that in the period from 1921 to 1933 more than half of the 30,000 US banks went of business. In 1938 the Fed doubled the reserve requirements for member banks from 10% to 20%, an economic shock treatment that led to disastrous credit liquidation.

Outlawing gold for American citizens was only half the battle for a truly fiat currency, however. As long as dollars went abroad, foreign governments could demand gold for the dollars. But central bankers in foreign countries were all engaged in the same struggle for independence from the discipline of the gold standard that the Fed was attempting. Once freed from the gold standard in the 1970s, the Fed could back-up its reserves by printing as much money as it liked.

The Fed controls money supply not so much by the amount of money it prints, but by the amount of reserves created in the banking system and the fractional reserve requirement dictated by the Fed. After 1980 the fractional reserve requirement was gradually lowered from 14% to 10%, which increased the money supply considerably. Reserve requirements for nonpersonal time deposits and CDs were eliminated entirely in 1990.

The Fed is currently not changing reserve requirements as a means to implement monetary policy. Nor do changes in the discount rate have a significant impact on money supply. Currently, the key to the Fed's control of money supply and interest rates is through its open market operations, ie, buying and selling of US government debt instruments (bonds, T-bills, etc.) through Primary Dealers. (Just over 20 Primary Dealers are authorized to buy & sell with the Fed, including Goldman Sachs and Morgan Stanley.) The buying or selling can be either permanent or temporarily through repurchase agreements or reverse repurchase agreements. For example, the Fed could increase money supply by buying $1 billion of US government bonds. The Fed writes a check to a bond dealer for $1 billion from the Federal Reserve Bank of New York and then the bond dealer deposits the check from the Fed with a commercial bank.

But a check from the Fed does not "clear" the way other checks do. The check creates a deposit at the Federal Reserve Bank, increasing the commercial bank's reserves by $1 billion. The Fed has spent no money it has simply written a check creating $1 billion in new money. But with a fractional reserve policy of 10%, the commercial bank is now able to make $9 billion in new loans. Thus, the $1 billion purchase by the Fed has increased money supply in the economy while helping supporting the market price of the government's bonds. Unlike the obvious inflation of printing money -- which only enriches the Treasury Department inflation through credit-expansion (lowering interest rates) enriches the Treasury from the $1 billion from the bond sale, enriches the Fed by the interest collected on the bonds, and enriches the commercial bank by the interest collected on the additional loanable funds. The purchase also ensures that the government benefits disproportionately from the new money, while others (such as pensioner's living on fixed income) are harmed disproportionately by being the last to experience the inflationary effects.

The main tools the Fed has for control of money supply & interest rates are the fed funds rate and the discount rate. In a free market, interest rates are determined by the supply & demand for savings. In contemporary regulated economies, central bankers have considerable influence on interest rate through control of money & banking. When the Fed sells government securities it decreases the supply of money (loanable reserves), whichincreases interest rates (the fed funds rate). When the Fed buys government securities it increases the supply of money (loanable reserves), which decreases interest rates. The Fed indirectly controls the fed funds rate by buying or selling bonds to achieve the desired rate.

Fed funds is another name money loaned or borrowed to maintain the Fed's mandated level of bank reserves, the deposits a bank has with its regional Federal Reserve Bank plus cash in the vault. The fed funds rate is the rate at which banks make short-term (usually only overnight) loans to each other to meet reserve requirements. The loans are made on a private financial market called the federal funds market.

On any given day a bank may have more or less reserves than its required amount. Banks with excess reserves can loan to banks having a deficiency (fed funds are exempt from reserve requirements). The lending bank instructs the Federal Reserve Bank to charge its own account and credit the account of the borrowing bank a transaction to be reversed the next day. No physical delivery occurs, the exchange is made through the Fed's electronic network, the "Fed Wire".

The fed funds rate is the shortest of short-term interest rates and is the US short-term benchmark. The most common fed funds instrument is an overnight, unsecured load between two financial institutions (commercial banks, savings banks, savings & loan associations or credit unions) on the basis of an oral agreement. When banks borrow heavily on the fed funds market, the fed funds rate will rise unless the Fed adds new reserves. The Fed tries to keep the fed funds rate within a narrow band (50 basis-points or less) through buying & selling of government securities. The Fed will continue buying or selling in a trial-and-error fashion until its desired fed funds rate is achieved.

The discount rate is the rate the Fed charges banks to borrow money from the Fed. The Fed can directlycontrol discount rate. When rates are changed, the fed funds rate and the discount rate are almost invariably both increased or decreased by the same amount at the same time. [The Fed sets a new discount rate and targets a new fed funds rate -- the latter typically being 50 basis points (ie, 0.5%) higher.] The Fed discourages banks from direct borrowing by imposing costly and time-consuming procedures, including scrutinization of the bank's creditworthiness offsetting the cost advantage of direct borrowing and making the Fed the "lender of last resort". Unlike fed funds, reserves borrowed through the discount window require collateral, and the borrowing can only be done for "approved" reasons. Attempts to use the discount window frequently will cause the Fed discount officer to refuse the loans.

The open market policies of the Fed are decided by the Federal Open Market Committee (FOMC), which includes all 7 members of the Board of Governors plus five of the twelve Presidents of the district Feds who serve one-year terms on a rotating basis. The Governors are appointed by the US President for a 14-year term (subject to US Senate confirmation). Because open market operations are administered through the Federal Reserve Board of New York, the President of that district bank is a permanent FOMC member, with the title of Vice-Chairman. The FOMC meets 8 times per year under the Chairman to decide on interest rates. Banks will invariably increase or decrease their prime interest rates (ie, interest rates charged by commercial banks to their most credit-worthy customers) in lockstep with increases or decreases in fed funds rate & discount rate. Mortgage rates, bond interest and other forms of interest charge follow -- although long-term interest rates tend to be more independent and subject to market forces.

The control of interest rates & money supply are powerful tools of economic regulation in a purportedly free economy. In a free economy interest rates are the "price of money" -- and that price is determined by market forces (supply & demand). Price-fixing of interest rates by autocrats invariably results dislocation from the market price -- and shocks the economy every time the change is made or anticipated. The autocrats on the FOMC undoubtedly enjoy the fawning attention of the media hanging on their every word in an attempt to second-guess the next action -- but price-fixing always misallocates market resources.

The FOMC meets in secret and only issues vague summaries of its meetings six weeks after they occur. When Alan Greenspan was Chairman his disdain for market forces has been immortalized in his description of stock market activity as "irrational exuberance". However, Mr. Greenspan may well be the least autocratic (and most pro-market) member of the Fed at the time. The tentacles of the US financial system are found all over the world including debtor nations through the IMF. No the US is not done being an economic super power not buy a long shot.

What's Your Seven Deadly Sin?

Lets examine one of them Greed 

By Melvin J. Howard

The seven deadly sins did not come from the bible as a lot of people think they did. They came from a list of transgressions identified by Evagrius of Pontus in the 4^th century and then by John of Cassius in the 6^th century. Gregory the Great then formulated the now traditional seven deadly sins. The sins were ranked by increasing severity, and judged to be the greatest offences to the soul and the root of all other sins. Pride, Greed, Lust, Envy, Gluttony, Anger and Sloth it all equals vice. That many of us are so guilty of since the beginning of time till now. If you want to know what got us in the current economic malaise you have no further then to look at these seven deadly sins.

A major topic of conversation in the late nineteenth and early twentieth centuries were bankers, especially J. P. Morgan and his son Jack (J. P. Morgan Jr.). After the panic of 1893, it became clear that Morgan was able to exercise a power far in excess of his private position on Wall Street. But true to his nature, J.P. exercised that power and then receded from public view. As far as the press and the reading public were concerned, the principles of Jeffersonian democracy were still safe in turn-of-the-century America. State influence in private affairs was still at a minimum despite the formation of some regulatory agencies such as the Interstate Commerce Commission. The America of Thoreau, where good government remains in the background, was still inviolate, or so it appeared. But behind this facade of private trust capitalism was a fragile financial structure. To many panics occoured and when they did they underlined the frailty of a system driven largely by private enterprise. What was extraordinary about the first panic of the twentieth century was that it appeared to be a replay of those that had occurred so many times before on Wall Street. During the panics of 1857, 1869, 1873, and 1893, Wall Street had to come to its own rescue. Strong financial firms bailed out the weaker while allowing others to fail. Government was not much help. Traditionally, when a white knight appeared to help others by bailing them out or by helping the government with it’s financing, the rewards were minimal and the risks could be great. The anti-Wall Street contingent was quick to charge financiers with lining their own pockets at the expense of the public, as Pierpont Morgan had witnessed more than once. After Jay Cooke had beaten Drexel and Company into second place in investment banking in Philadelphia, his unravelling came quickly when the Northern Pacific bankrupted him. It was natural that anyone who stepped into the breach caused by the lack of strong central government power should make sure there was something in it for them.

The profits made by bailing out the Treasury in 1894 were criticized but well earned. But it became clear that an emerging economic power could not leave its lender-of-last-resort functions to Wall Street. Even if the banking community looked after its own in reasonable fashion the conspiracy theorists would always rant about the concentration of economic power at the corner of Broad and Wall. One of the more disparaging nicknames hung on Wall Street's lapel was destined to last for decades. In the wake of the oil, steel, and tobacco trusts the so called "money trust," the lofty Wall Street group that controlled the financial system, were allocating credit at whim. This would prove a difficult characterization that would not be shaken off easily. During the panic of 1900’s" the notion would only pick up additional credence.

The stock market was approaching bubble like proportions in 1900’s. In 1901 the price of the Northern Pacific rose to over thousand dollars per share as J. P. Morgan bid the price up in an attempt to stop Jacob Schiff and Harriman from gaining a majority control. Subsequent market collapse piqued the anger of the New York pres-brought denunciations raining down on the heads of the trusts. The market had also been hard hit by speculation. In that plunge the share price of US Steel had dropped from the mid-fifties to less than ten dollars a bubble again began to expand and prices rose. The lack of a central bank became increasingly worrisome to almost all market operators. If the market fell, many banks would undoubtedly follow suit since they integrally involved in the market as either underwriters or investors. This-included the trust banks, a group of institutions separate from the commercial and investment banks. Trust banks were administrators of private family funds, money invested on behalf of estates, wills, and the like.  Many of them made loans to market speculators, taking securities as collateral. If stocks fell, the trust bank would be severely hurt, as would their investors. Without a central bank no one would loan them money if a depositor's run developed they would need cash to prop up their positions under duress.

Wall Street began to recognize the problem, and the heads of banks wanted to assemble a pool of money to be used as a standby if it developed. They also had a substantial stake in the trust business. 7 years earlier, many of the New York banks had pooled their money and founded their own trust, the Bankers Trust Company, later to become a Morgan partner. Any vulnerability in the group was bound to have severe repercussions up and down the Street most had anticipated, the reaction came on March 13, 1907, when the market began to fall. The press was full of stories about bankers and deliberate attempts to make the market fall. Politicians, notably Roosevelt, also blamed the current economic concentration in the country. The next six months saw the market steadily erode. Then, on October 21, a run developed on the Knickerbocker Trust Company of New York. Depositors lined up in front of the bank's head­quarters on the site of the future Empire State Building to demand their funds. Many of them were unsuccessful. The bank closed the next day af­ter an auditor found that its funds were depleted beyond hope. The bank's president, Charles Barney, shot himself several weeks later, prompting some of the bank's outstanding depositors to commit suicide as well.

After the Knickerbocker failure, the Wall Street community, led by J. P. Morgan, put together a rescue package designed to prop up the other trust institutions. Morgan, Jacob Schiff of Kuhn Loeb, George Baker of the First National Bank, and James Stillman of the National City Bank banded together to ensure that the banking system remained intact. Schiff especially had been an advocate of banking reform for some time he thought banking was conducted to be nothing short of disgraceful. After the Knickerbocker failed, this group stepped in to prevent others from doing so. They met in New York with President Roosevelt's secretary of the Treasury, George Cortelyou, who provided them with Treasury funds of $25 million to keep the system from collaps­ing. The money was deposited in the national banks in New York with the intent of adding funds to a system sorely in need of more liquidity. It was the job of the large New York banks to apply the funds as they saw fit to prevent further panic and runs by depositors. In many ways the act was an extraordinary gesture Roosevelt had faith in Morgan. The Treasury of the largest emerging economy in the world had to transfer funds to private bankers in order to prevent a financial collapse. More than one detractor claimed that those bankers had orchestrated most of the panics themselves in order to make speculative profits. The panic of 1907 was nothing short of a massive conspiracy designed to ingratiate Wall Street to Washington and make more than a few dollars in the process. Many pointed to the profits made by the Morgan syndicate in the previous panic. One of the strongest proponents of the conspiracy theory was Senator Robert La Follette of Wisconsin. Described as one of the few U.S. senators who was not a million one who had not bought his seat. There was little doubt that Morgan would enhance his own reputation in the financial sector if it could be saved, but the handwriting was on the wall. Those favoring a central bank would now win the day, but it would still take several years to work out the details. After bailing out both the banking system and the NYSE, Morgan whom was deified in the press, was now being referred to as "our savior." He was portrayed now as having saved the country from the excesses of speculation. He was also portrayed as being above the common excesses of foreign traders and minor-league capitalists, all of whom were hell-bent on making a dollar regardless of the consequences. But Senator La Folier took a different tack. He suspected the Wall Street banking interest manipulating the crisis to their advantage from the very beginning. Pointing to the fiasco at the Knickerbocker Trust and the subsequent bail out of the Trust Company of America, La Follette presented a very different interpretation from that generally accepted. He blamed the run on Knickerbocker and the Trust Company on enemies of Charles Barr who wanted to ruin him. Morgan's reputation was only enhanced by a rescue package put together for New York city the depression and unemployment caused by ten months of market slide and bank failures had forced the city's back to the financial wall. The mayor appealed to Morgan, who agreed to underwrite a bond issue for New York for the required amount: $30 million. The 6 percent bond issue was successful, and finally, after several difficult months, the panic began to abate. Morgan was seen as the savior of the banking system, the stock exchange, and New York City all at the same time. So what is the ruling here was it Greed by J.P. Morgan and his associate bankers that brought down the financial system in the 1900’s. Was it also the same Greed that led him to help the US Treasury to restore confidence in the banking system? I make no verdict I am merely acting as camera recording events in time. Did Greed cause the crack in this current global financial system perhaps? But also did Greed build some of the great empires of the past? It is a philosophical question that may not have a black and white answer.   

 

J P Morgan The Go To Guy For The Government, GE, AT&T And Others

                

SOME OF THE WELL KNOWN COMPANIES TODAY STARTED AS TRUSTS AND J P. MORGAN FINANCED THEM

By Melvin J. Howard

Some of the well-known trusts of the period included the telephone monopoly named the American Telephone and Telegraph Company (AT&T) after 1889. The communications leviathan is normally associated with Alexan­der Graham Bell, the founder of the company, although it was run by Gar­diner Greene Hubbard and later by Theodore Vail. The Edison Illuminating Company, founded by Thomas Edison but managed by several staff members including Samuel Insull, eventually became the General Electric Company. Tobacco came under a virtual monopoly when James Buchanan Duke integrated tobacco farming, processing, and distribution under the aegis of the American Tobacco Company. The ingenuity displayed by these entrepreneurs lay in their abilities to understand the structure and potential markets of their businesses. In the process of consolidation, much of their competition was either absorbed or driven out of business. In this respect, American business had not changed markedly since the period prior to the Civil War, but the stakes had become larger as the American market grew. But one important factor distinguished some of these enterprises. Some were more capital-intensive than others and needed more investment funds to support expansion, and when they did they attracted Wall Street financiers. That attraction would be central to American development in the late nineteenth century, there were no better examples than the General Electric Company and AT&T. Both Edison and Bell had quickly become American legends for their dis­coveries, but neither was particularly good at managing or expanding his business.

From the very beginning, both relied heavily on professional managers and outside financing. Neither man would become as wealthy as those who assisted them and put the deals together. Bell/AT&T entered an alliance syndicate of bankers headed by J. P. Morgan to provide fresh funding Bell himself was by then out of the picture. By 1881 he was divorced from Bell companies except for a small shareholding. Thomas Edison was a more active participant in his own course. For a short time he was a partner in Pope, Edison Company, an engineering firm that pursued patents and products such electric ticker tape, which helped revolutionize stock exchange reports. When the firm was bought out in 1870, Edison used his share of the its to open a laboratory in Menlo Park, New Jersey, so he could purchased inventions. Edison was helped big time by J. P. Morgan, who provided funds for an experimental power station located at Pearl Street, adjacent to the Wall Street district. 

Morgan continued to support Edison and would be instrumental in forging the General Electric Company out of Edison’s original company. During this period of entrepreneurship and invention, modern investment projects requiring capital that investment bankers could pick and choose which ones they would support. But investment banking was still limited by the amounts of capital it could provide for new and established companies. Even the large banks such as Morgan, Kidder, Peabody, or Kuhn Loeb could not afford to provide all the capital their clients needed so they began to use syndicates more and more. New issues of stocks and bonds were now regularly being sold to groups of banks, which would then sell them to the public. The banker who constructed the deal in the first instance was known as the lead underwriter and became the manager of the deal. Whichever bank assumed this position was able to dictate to the company needing funds, as well as to the rest of Wall Street. For the fifty-year period between 1880 and 1930, that position indisputably belonged to Morgan and Company he headed until 1913 by Pierpont Morgan.

His Influence Spreads

The last two decades of the nineteenth century also were Wall Street’s first golden age. The number of listings on the stock exchange increased by leaps and bounds it just had its first million-share day in 1885. The investment banking syndicates became fixtures on Wall Street through which bankers would purchase large blocks of new securities from companies then sell them to investors. The power and influence of the investment bankers continued to grow. The influential houses such as Morgan, Kidder, Lehman Brothers gained in stature, and many became better known than their client companies. The well-known bankers became the thread holding together many of the various parts of American industry. But many were not content with being just intermediaries. They became active in trust creation and consolidating power in their own right. The dependence upon foreign capital was still very evident in the nineteenth century. The United States was still a debtor nation, more to foreigners than it earned from them. By the beginning 1890s, this dependence became particularly clear when foreign investors began to panic over the gold-silver debates that had been waged in the United States since the Special Resumption Act of 1879. In 1890 the Sherman legislation was passed, as the Sherman Silver Act of which required the Treasury to buy a specific amount of silver in each deal in order to maintain its price. This was Congress’s bowing to the western mining states. Silver was used mostly for coins and for backing silver certificates. However, many people saw little use for it, and much of it returned to Treasury vaults shortly after being placed in circulation. Politically, maintaining a silver policy smacked in the face to many of trying to please two masters backing two metals currency rather than one. The clear preference was for gold, but politics intervened on behalf of silver.

Unsure of the Americans’ devotion to gold as the single standard, which was the base for the dollar; foreign investors began to sell American securites en masse. They had read of the fiery, eloquent speeches of Y Jennings Bryan in favor of silver. Such populism only added to their insecurity, which in turn caused an outflow of gold from the country. With in a short time the panic of 1893 began, underscoring the Americans’ continued reliance upon foreign investors. But the usually reliable banks investors had become more wary of foreign investment. In 1890 the venerable Baring Brothers failed and had to be bailed out by other banks. The bank’s chairman had overextended the family-run firm buying an excessive amount of Argentinean and Uruguayan securities when both of these markets collapsed, Baring followed soon after. 

Panic bode well for American securities in the long run but made British investors nervous about foreign investments in general. The gold reserve of the United States had fallen to low levels before revenue losses created by protective tariffs and increased bonus to war veterans. When the reserves fell below $100 million, previously considered an acceptable level, investors became uneasy and began selling securities. In February 1893 the NYSE witnessed its busiest day ever 1.5 million shares were traded and over $6 million worth of bond s sold. By April only about one-quarter of the money in circulation was backed by gold reserves. In May the NYSE index dropped to an all time low behind massive selling of securities, wiping out many traders in the process. Railroad stocks were particularly hard hit. As a result, President Cleveland asked Congress to repeal the Sherman Silver Act of 1893 in an attempt to shore up reserves and restore order in the financial system. Morgan's position in finance was central to the heart of corporate America.

Advising corporations had been good business for investment bankers since the early days of the railroads. But Morgan's influence spread to include trusts and holding companies. In this respect his bank had no peers, and his ability to be at the center of the financial universe earned him begrudging respect during his tenure at the helm of his bank, but he was more feared than considered a colleague by other financiers. His personal yachts, all somewhat arrogantly dubbed the Corsair, suggested to some critics that investment banking and brigandage were one and the same activity. His haughtiness and authoritarian nature became legendary, but he did win the confidence of the U.S. Treasury, a relationship that was to endure for decade’s and is still evident today. But in terms of stock trading, he always kept on the banking side of the street rather than the speculative side. He preferred to use brokers when necessary and did not consider himself one of their members. Morgan's influence on the creation of corporate America was as strong as that of many inventors and entrepreneurs that owned their own businesses. In the nineteenth and early twentieth centuries, he had a dom­inant position in railroads, life insurance, steel, and electricity, in addition to banking. Of all of his activities, his role in the formation of the U.S. Steel Corporation and the General Electric Company were perhaps the largest feathers in his hat. In both cases, as in many others, all he brought to the table was financial advice. Thomas Edison and Andrew Carnegie had already laid the groundwork for these two companies. Edison's early enterprises had relied upon loans from Morgan since the time of the experimental power stations on Pearl Street. Morgan and his partners were also minority shareholders in Edison General Electric. The company remained relatively small until the 1880s, with sales remaining below a million dollars per year.

The light bulb was not to be the future of the electric industry. How it would be powered and where electrical power would originate were the more important issues that would turn the industry into a battleground. Electricity production was about to become a important issue in American politics that would last for the next fifty years. In the early 1880s, one of Edison's avid supporters was an erstwhile railroad baron. After the debacle in which he was forced into personal bankruptcy, he returned to his native Germany for six years before reemerging in New York in 1886. When he returned, he had financial support of several large German banks and was intent on forging a worldwide electrical cartel. One of his first targets was the Edison Company. But in order to capture it, he would need the blessing of Morgan. Edison himself was no longer interested in the business, he returned to tinkering and inventing. Villard and Morgan formed an alliance that effectively bought out Edison and the principals of Edison Electric, for several million dollars. Edison himself got $1.75 million, while the others received $1 million between them. One of those receiving a small amount was Edison's chief lieutenant, Samuel Insull, a young Briton, which helped the inventor organize the company. Insull went on to become a president and member of the board of the new company along with his son, while Villard became president. The money offered by Morgan and Villard was too much to resist, especially for the inventor. "Mr. Insul and Edison were afraid they might get into trouble for lack of money. . . . therefore they concluded it was better to be sure than to be sorry," Edison wrote. Explains his reasons for accepting the offer. But Villard's fortunes were not to remain on the rise for long. The Edison General Electric Company prospered under Insul by cutting costs; he was able to trim the operation while increasing profits from year to year. It became the most profitable of the three major electrics companies, the others being the Westinghouse Company under General Westinghouse and the Thompson-Houston Electric Company. Westinghouse was the smaller of the two competitors, possessing an alternative product (alternating current rather than the direct current of Edison what proved to be a nasty battle between Edison and Westinghouse. The companies set out to prove that its respective product was the safer for electrical voltage. One of the products of that campaign was the introduction of the electric chair as a means of execution, adding a macabre sub-plot.

A corporate battle between two innovative companies. However, Westinghouse had better engineering skills than Edison Electric, and a merger would be out of the question. So Villard arranged a merger whereby Edison would take over the larger Thompson-Houston. Morgan had ideas of his own, however. Arranging a counter deal v. the executives of Thompson-Houston, Morgan turned Villard's deal on its head. There is no doubt that Morgan was at the center of America’s early industrial expansion. So it is today that JP. Morgan has been the go to guy for the US Goverment for a very long time. My guess is that will continue for a very long time to come. I don't see J P. Morgan has a villian as most people portrayed him he bailed out the Govement with little or no profit coming to him. He had the smarts the courage and the vision to understand if one industry went down it could take all the rest with it.

 

 

 

The Goverment And Wall Street Best Friends Forever Or BFF

The Government And Wall Street Go Way Back

By Melvin J. Howard

No matter what the sentiment is right now about Wall Street the fact is the Government needs Wall Street and Wall Street needs the Government and that is not going to change anytime soon. It all started back in the 1700’s when most of America's riches were based upon land the more you had the richer you were. The new young world provided more than just space for the land-starved Europeans. The millions of undeveloped acres were too hard to resist. Success was limited only by lack of imagination. Trading with the Europeans and with the Indians, manufacturing basic staples, and ship transportation all had been pursued successfully by some of the country's oldest, and newest, entrepreneurs. The businessman providing these services was adding value to other goods and services for a society that was hardly self-sufficient at the time. Making money was smiled upon almost expected as long as a few basic rules were followed. Others had to benefit as well from entrepreneurship. Borrowing money to become successful in business was becoming popular because it was reconized that captialisme could be practiced in some cases.

Between independence and the Civil War, land played the pivotal role in American investments and dreams. The vast areas of the country and its seemingly never-ending territories provided untold opportunities for Americans and Europeans alike. They represented everything the Old World could no longer offer—opportunity, space to grow, and investment possibilities. The idea certainly never lost its allure. When early entrepre­neurs borrowed large sums of money, it was often to purchase land in the hope of selling it to someone else at a profit. This American ideology was never forgotten. Its role as the pivotal part of the American Dream is still used today. Although in this current market some would disagree.

At the time of American independence, land was viewed less for home-ownership than for productive purposes. England had already been stripped bare of many natural resources, and new lands were sought to provide a new supply. Much land was also needed to provide the new crop craved by both Europeans and Americans—tobacco. The desire to own property had also been deeply ingrained in the European and English people. Africans who were slaves at the time also wanted their share of land but it was against the law of that time. Hence the saying 40 acres and a mule that was promised after slavery was outlawed. Owning land has been deeply embedded in American culture since the start of the revolution.

But the market place was hardly efficient as those of Britian and Holland. Basic institions were still lacking. The new U.S. Treasury Department was not instituted until six months after George Washington was sworn in as president in 1789. Another institution the new country lacked was an organized stock exchang a manufacturing country would not develop quickly or well. Exchanges were needed so that investors could become familiar with companies and their products. Only when the merchants began turning their attention to providing money for new ventures did the idea of trading shares and bonds become more attractive. A market for these sorts of intangible assets had already existed in Europe for about a hundred years, but the idea was slow in cross­ing the Atlantic.

The European stock exchanges, or bourses, as they were called, were established in the seventeenth century as places where governments could sell their own loans (bonds) and the large mercantile trading companies could raise fresh cash for their overseas adventures. The Dutch developed their bourses first, as early as 1611, with the English following about seventy five years later. Besides trading commodities vital to the developing mercantilist trade, both bourses began to actively trade new concepts in financing shares or loans and bonds Governments and the early trading companies began to look upon private investors as sources of capital. Borrowing from investors were safer, for more than one British government had run into trouble by over­taxing its citizens. Investors warmed to the idea of share ownership be­cause it limited their risk in an enterprise to the amount actually invested in it. Although the partnership form of control was far from outdated, the new corporate concept began to take hold.

After the Revolutionary War, the new American federal government immediately found itself in delicate financial straits, complicating matter-considerably. The first Congress met in New York City in 1789. The new government assumed all the war debts of the former colonies and the Continental Congress. Unfortunately, it had little actual revenue if the new Republic did not honour its existing debt progress would be difficult for new creditors would not be found easily. As a result, the U.S. government borrowed $80 million in New York by issu­ing federal government bonds. Necessity became the mother of invention and the American capital markets, however humble, were born. The major competition for money came from basic industries and financial institutions that were quickly establishing themselves in the new country. Most of these institutions were American versions of British trad­ing companies and financial institutions well known in the colonies before the war. Merchants, traders, and investors trusted these companies more than they did governments. As a result, the rate of interest paid to the new government had to be fairly high to compensate, but buyers’ did not provide strong demand for the new bonds. After having shaken off the chains of British colonial domination, the entrepreneurs and merchant in New York, Boston, and Philadelphia were not particularly keen to loan money to another government, especially one as untested as the new federal government, which did not yet even have a permanent home. As a result, many of the new government bond issues were only partly sold. The three major cities that were home of American capitalism in its infancy back then. Philadelphia was home of the first actual stock exchange, Boston continued as a shipping center, and New York was the rapidly emerging center for financial services such as insurance and banking. Although the government bonds were sold in all three places and other major cities such as Baltimore and Charleston as well, New York developed the first active market for trading bonds and the shares of emerging companies. Local merchants and traders would gather at various locations in lower Manhattan, around Wall Street, along a barricade built by Pete Stuyvesant in 1653 to protect the early Dutch settlers from the local Indians. There they congregated to buy and sell shares and loans (bonds). From there securities business quickly grew, the traders divided their-selves into two classes—auctioneers and dealers. Auctioneers set the prices, while dealers traded among themselves and with the auctioneers.

This early form of trading set a precedent that would become embedded in American market practice for the next two hundred years. The only problem was that the auctioneers were in the habit of rigging the price of the securities.

The new market conducted at the side of the street and in coffeehouses were crude approximation of the European stock exchanges that had existed for some time. The London and Antwerp stock exchanges were quite advanced in raising capital and trading shares and bonds for governments and the early mercantilist trading companies. The exchanges developed primarily because both countries were the birthplaces of modern capitalism. Equally, the British and the Dutch exported much capital abroad, in hope of reaping profits from overseas this was possible and necssary because both had excess domestic capacity and money and were anxious to find new areas of profit. And many years before the American Revolution, both had already had their share of financial scandal, the South Sea bubble and tulip speculation being two of the more noteworthy. These early scandals had proved that sharp dealings and rampant speculation could seriously diminish the en­thusiasm of private investors, who were vital for the development of industral capitalism antics of an early speculator made raising money difficult in the middle and late 1790s. In essence the American financial system adopted from the Dutch and British system an inherent flaw. That is ultimately bubbles will form to cause havoc in the economy. Boom and bust cycles will always exists unless a new formula is found.  In March 1792 a local New York merchant speculator named William Duer became overextended in his curbside dealings, and many of his speculative positons collapsed having financed them with borrowed money, he was quickly prosecuted and sent to debtors' prison. 

A member of a prominent English family with extensive holdings in the West Indies. Duer permanently settled in his adopted country in 1773, becoming sympathetic with the colonists' grievence against Britain. Well acquainted with New York society, he quickly began to hold positions of importance. He was a New York judge, and a signer of the Articles of Con­federation. He was also secretary to the Board of the Treasury, a position that made him privy to the inner workings of American finance in the late 1780s. Having developed a keen knowledge of international finance, he was intent upon opening a New York bank capable of rivaling the great British and Dutch merchant banking houses of the time.

 THE EARLY BANKERS

The early investment bankers came from humble origins. More than one had begun his career as a merchant, selling hardware and household goods from the back of a horse-drawn carriage. Usually these merchants would borrow money to buy their inventories and would repay the loan when they returned from their travels (the origin of the term •working capital, which has endured to the present). Many merchants quickly realized that the individuals or small banks loaning them money worked less hard than they did selling their wares on the road. That prompted many of them to try their hand at the banking business, and many small merchant bankers set up shop, especially during the travails of the Second Bank of the United States.

The banking profession that many entered was still a far cry from the investment banking business as it is understood today. Prior to the Civil War, anyone who loaned money to a company by buying its bonds was considered a financier to the company. The same was true of stockholders. Many of the new bankers simply bought bonds from a company when they were first issued and either held them as investments or arranged to sell them to other financial institutions for a small fee. This was a crude form of underwriting but not the same type that would emerge later in the cen­tury, when syndicates of investment banks would pool funds and buy entire issue from companies with the intention of reselling to other investors. New securities before the Civil War had dozens of initial investors ranging from the larger New York and Philadelphia banks down to the small two-man operations that remained in business for only a short time.

In the 1830s, many new investment houses emerged to help investors trade shares and foreign exchange and raise capital for new companies and entrepreneurs. Nathaniel Prime, one of the early members of the stock exchange as well as John Eliot Thayer established a similar operation in Boston, which later would become Kidder, Peabody and Company. While all performed essentially the same operations, the merchants turned bankers were very similar to their British merchant banking counterparts since they became bankers in order to serve themselves and other merchants. The brokers and other finance people who turned to banking forged strong connections between what is known today as commercial banking (taking deposits and making loans) and investment banking (underwriting securities), especially by loaning depositors' funds to the early securities markets.

Many merchant bankers appeared in New York, migrating from other areas where they had initially found some success. Merchant bankers had a distinct edge over commercial bankers that would play an important role in American economic history for the next hundred years. Private merchant bankers, using their own capital as a base for their operations, were not required to have a state charter and as a result did not have to make their financial positions public. Successful private bankers would be able to develop considerable financial power without outside scrutiny since they were not accountable to anyone other than their clients. In the early days of American finance this helped them keep above the states' rights arguments that surrounded much of the banking industry and also kept them out of the money printing controversy since private bankers did not issue their own notes.The nature of private banking attracted foreign firms eager to do business legendary N. M. Rothschild (originally a German firm) of London established an American connection through an agent, August Belmont, who in turn established August Belmont and Company in order to represent the Rothschilds in North America. The Rothschilds had already established a legendary reputation for shrewdness. Most of the financial world already knew of their acumen in using carrier pigeons to inform them of Wellingtong. The Rothschilds legendary banking name, rival that of the Medici in the annals of European finance.

 ENTER THE HOUSE OF MORGAN

One of the major financiers at the time was Winslow, Lanier and Company, founded in New York City in 1849 by James F. Lanier. It acted as paying agent and transfer agent for many companies, especially the railroad merchant bankers simply took positions in securities and acted as passive investors or short-term traders. One innovation that the company introduced to railway bonds was selling by sealed bids a technique that was used by the treasury for the previous twenty years, partly in response to criticisms about being too close to the large merchants who had helped sell the War of 1812 issues. But perhaps one of the most important firms of all to apper before the civil war was that of George Peabody and Company founded by an American living in London in 1851. The firm was better known for Peabody's partner, Junius Spencer Morgan, who was recruited by Peabody from Boston. Junius's son, John Pierpont Morgan, or J. P.. who would become probably the best-known banker of the early twentieth century, was just a schoolboy when his father worked for the London firm. Junius changed the name of the firm to J. S. Morgan and Company when Peabody retired, marking the beginning of the extraordinary influence that Morgan, his son, and grandson would hold over American finance for the next ninety years. The Morgan firm, later to become a full-fledged do­mestic American bank, would continue to specialize in funnelling foreign capital to the United States for well over a century. Although American in origin, the Peabody and (later) Morgan firms were still considered foreign because of their locations but were never the less a considerable amount of foreign capital from Europe to the United States. By the 1840s, foreign capital was heavely invested in American Treasury bonds, municipal bonds, and the stock and bonds of the rapidly expanding railways. But not all of the newly established houses were American. Many were established by German Jewish merchants and quickly became embedded as major forces in the merchant banking business.

The Lazard brothers of New Orleans formed Lazard Freres in 1832 and quickly used their European connections to establish a base outside the United States as well. Marcus Goldman, another Bavarian Jew, established Goldman Sachs and Company in 1869. One of the firm's specialties was trading in commercial paper, a market the United States sorely lacked in the period prior to the Civil War. The absence of such a market had con­tributed to the many business downturns and panics that occurred before the war. Goldman came to dominate the commercial paper market.

The Jewish firms specialized in the usual merchant banking business, and many opened branch operations in Germany and other European investors. By doing so, they changed the complexion of American creditors, who for many years had been predominantly British. They keep to themselves socially. Usually, the top job at a firm was passed on only to a relative or to a son-in-law, ensuring a line of succession when the patriarch died or retired. But despite their separation from the purely "Yankee" houses in the securities business, these firms became central members of New York society by virtue of their influence and far-reaching business connections.

The Jewish banking houses shared an essential element with the /Yankee houses that proved indispensable on Wall Street. All were enthusiasti­cally bullish on the economic prospects for the United States and sold that bullishness to foreign and domestic investors alike. Long before securities analysis became popular, they touted the relative safety of the United States from invasion and stressed the vast resources of the country, many of which were still being uncovered, as their own success demonstrated. So here we are everybody pointing fingers when as history has told us that both Wall Street and the Government have to work together to save the nation from financial ruin. Only this time its global!!!!!!!! But lets face it nobody ever paid attention in history class. 

 

 

 

Financial Duress In History Then And Now

 

 

Time Space and Money are relative time being the common denominator.

By Melvin J. Howard

As I have researched the history of the world’s financial collapses I am wondering why are we so surprised about the current financial upheaval we find ourselves in today. We can go back in  history to find out this pattern has a way of repeating itself time and time again. Usually the response has been the same change in government, policy and new financial regulations. Senate hearings followed by prosecutions. Example lets look at the deteriorating state of the nation between 1929 and 1931. National income declined by over 30 percent, savings 50 percent, unemployment rose fivefold to almost 16 percent of the labor force housing starts came to an abrupt halt. Wall Street fell on hard times too, although nobody cared if bankers were jumping from their office windows. Market turnover fell by half, new issues of corporate securities fell by "5 percent, and broker's loans, once so popular, collapsed. Companies once rushed to loan money to the stock market literally disappeared, leav­ing only the banks in their wake. A significant shift occurred in the voting population as a result. The Republicans lost their majority in Congress and the Democrats seized the presidency in the 1932 election.

In 1930 individuals witnessed the largest banking meltdown in American history done by the failure of the Bank of United States to both depositors and the banking community was inestimable ironically, both in name and in scope, the bank was the epitome of what was wrong with the American financial system at the time. Despite its name, the Bank of United States was simply a local New York bank that had been taking advantage of immigrants in New York's garment district.

The bank had over sixty branches and numerous affiliates. It was a member of the Federal Reserve but did not have access to any fed funds late in 1930 because it was already insolvent when its problems came to light. Most of its business was retail and it had a large number of recent immigrants, both Italian and Jewish, among its depositors. The less informed were easily mislead by the operation, which displayed a large array of members of the Justice Department in the foyer of its head office. Many of the deposits were used to make purchases of their own stock, running up the price before selling at a profit. When the stock market would not always bid a high price, they sold their stock to their affiliate companies, cashing out at the bank's expense. Then came the crash, and the fall in prices wiped out their stock value, including the loans they had made to themselves in the process sound familiar?

The New York banking authorities attempted a somewhat late rescue but was unsuccessful. Attempting to cobble together a rescue package of $30 million, the New York banking superintendent, Joseph Broderick, approached Wall Street banks. The Wall Street contingent appeared to have little interest in propping up a retail bank. After Governor Franklin Roosevelt ordered the bank closed, it was dis­covered that some four hundred thousand depositors had lost over $300 million. Some of the money eventually was recovered by depositors be- cause the New York bank clearinghouse put up some funds to reimburse depositors. Con­gress had not yet created federal deposit insurance yet.

Critics contended that Morgan and the Wall Street crowd could have saved the bank without much trouble. They pointed to the fact that the Wall Street firms had just banded together to bail out Kidder, Peabody, a firm that had been left short of funds after some precipitous withdrawals caused by nervous foreign depositors who withdrew funds because of the depression. The government of Italy and the Bank for International Settelments pulled out funds, leaving the old-line firm tottering on the edge. But bankers looked less favorably upon a retail bank, especially one run by outsiders that catered to immigrants. The failure of the Bank of United States was the largest in American history until that date. The heads of the bank were sent to prison, and the Superintendent was indicted for not acting quickly enough to close the bank. This would create an impact that could not have been foreseen. The public, naturally distrusting banks, be­gan to withdraw funds from banks around the country. The great "money hoard" had begun.

The floodgate had been opened other banking frauds were coming to light. The Union Industrial Bank of Flint, Michigan, had been systematically looted by its employees over the previous years. They used the funds to play the markets, and lost. But the largest banking failure was the straw that broke the camel's back for the country's banking system. As far as the public was concerned, the banks were no longer safe. And the saviors of the past were nowhere to be seen. There was no J. P. Morgan Sr. to step into the breach and hold things steady. The system had become too large to be supported by private bankers. Individuals were not able to save the stock market. There was no reason to believe they could actually save the banking system either.

Herbert Hoover tried to put things right. His plans to rescue the economy began in 1931. True to his style of consen­sus politics, he called to the White House twenty-five prominent bankers, including Thomas Lament and George Whitney of J. P. Morgan, Albert lggin of Chase, and Charles Mitchell of National City. Hoover's plan was to forge an alliance between his administration and the banks in order to bail out the economy by creating a national credit pool, to be called the National Credit Corporation. The idea was to ask each bank to contribute 52 million for the rescue pool; the bankers, however, had different ideas. Despite the growing depression, they looked upon the credit pool as a bad idea, lacking collateral as well as a potential for profit. Some rejected Hoover outright, with little discussion. Others would pay lip service to the idea but put up no money, dooming the plan to failure. It would not be the first time in the 1930s that banks would turn a cold shoulder to Washington. Stung by the bankers' rejection, Hoover proposed that a government agency be established to provide the credit. Congress created the Reconstruction Finance Corporation (RFC) in December 1931. Before it was all finished, other agencies would be created to solve financial problems  that wall turned its back upon.

Originally, the RFC was endowed with $500 million in capital and was meant to make loans to banks and other financial institutions, as well as other industries in need of funds. While its aims were noteworthy, being a publicly funded institution did not always aid its objectives. RFC loans was to lead to much further trouble for both Hoover and the banking system. The Democratic Speaker of the House was ordered to keep the list of institutions that received loans from the RFC secret so that short seller would not be attracted to them. Also, he was concerned that a public list of RFC loans would cause a run by depositors who might get wind of the loan and panic. Banks would receive discreet loans from the RFC without upsetting its customers this was particularly important because bank customers were withdrawing large sums of cash from those banks that were still solvent, hoarding currency instead of leaving it with institution they did not trust. Stories about the Bank of United States and a dozen of others had made depositors wary. The lack of funds available to banks for lending caused a severe decline in the amount of money on hand, called "the Great Contraction" by Milton Friedman.

Americans withdrew 6 Billion dollars before before Roosevelt restored stability to the banking system a year later. Ironically, fear of banks made less money available, which only contributed to the lack of business activity. Secrecy seemed to be the best method to ensure some order however some political connections came home to haunt Hoover almost immediately, destroying his plans. Garner quickly reversed his position concerning RFC loans, and a few months later the agency was required to publicize its list of borrowers on a monthly basis. Bank runs and failures occurred at an alarming rate. Hoover claimed that Garner was acting irresponsibly, causing bank failure the political climate was becoming more acrimonious than ever. It was clear that Hoover's proposals did not go far enough to satisfy opinion that was building against his philosophy of government sound familiar?

One of the early RFC loans was a $90-million facility extended to the Central Republic Bank of Chicago, headed by Charles Dawes. The loan represented almost 20 percent of the RFC's available capital at the time. Howls of protest arose in Congress, with cries of political favoritism heard everywhere. Lost in the melee was the fact that the directors of the RFC were chosen from both parties, so obviously Democrats had voted in favor of the loan along with the Republicans. One of them was Texan Jesse Jones, who would lead the RFC under Roosevelt. Jones later explained how the loan came about in the first place. The RFC advanced the funds to prevent the Dawes bank from failing, although it was solvent, fearing a run on other banks if it did not. In the end, the loan proved profitable to the RFC, which managed to earn $10 million in interest in the several years it was outstanding.

Other RFC loans were made to both large and small banks, but the majority of its loans designated for financial institutions went to the major money center banks. The loans made to railroads also smacked of political favoritism. More than half of the original railroad loans were made to groups headed by Morgan and the Van Sweringen brothers, the two Cleveland railroad barons who had been closely involved with Morgan since World War I. They had put together the Alleghany Corporation, controlling several railroads, including the Missouri Pacific. Within two years, the corporation would be bankrupt. Ironically, the RFC loans made to it were used to pay back loans due to bankers, a ploy that distinctly violated RFC guidelines money was owed to J. P. Morgan and Company. Harry Truman, then a senator from Missouri, later likened Morgan and the Van Sweringens to the railway bandits of the previous century. He claimed that twentieth-century bankers were more harmful to the railways than Jesse James had ever been.

During 1931 Hoover began his crusade against short selling. Believmr that the practice was destroying the economy, he began to exhort the commodities futures exchanges and the stock exchanges to control the bears. Many corporate leaders from small companies also urged him to put a stop to the practice entirely. Their point was quickly adoptee Hoover urged the exchanges to make less stock available for lending so that short sellers would not be able to borrow shares to cover their short positions. Officials at the NYSE listened to his protests in the late winter of 1932 but did little in the way of meaningful reform despite the fact that Hoover threatened to regulate the exchanges if corrective measures were not forthcoming. Hoover remarked "individuals who use the facilirties of the Exchange for such purposes are not contributing to the recovey of theUnited States. Speculators had been earning strong trading profits by selling agricultural products short, correctly assuming that prices would fall.

The depression was creating havoc among farmers. Prices for their goods were falling so quickly that within a year it would no longer make sense for many crops to be harvested. Short sellers detected the trend and hoped to profit by the drop in prices across the board.

The central part of Hoover's conspiracy theory came to light in 1932. Secretary of the Treasury Ogden Mills and Eugene Meyer of the Federal Reserve Board planned to use open market operations stimulate the banks and the market to have the Fed buy government securities in the open market. By doing so, the Fed would inject badly needed cash into the financial system. The banks would then use that cash to make loans in an effort to give the economy a much-needed boost. Hoover was in favor of the plan. This did not work bankers knew what was coming and adjusted their prices accordingly. And the added funds did not do much good in the banking system because business activity was slowing down and demand for loans was not strong to begin with. So begin the slew of Senate hearings.

The most damning practice uncovered was the activity of specialists (those who made markets on the floor of the exchanges). Be­cause of their central location and functions, specialists were able to control some stocks on the exchanges had over a third of their volume traded by their specialists for their own accounts. Thus the specialists were in a privileged position to see prices before executing for the public and would often act for themselves before filling an order from the public be­ing executed through a floor broker.

But ironically, it was not the activities of brokers that would cause the greatest sensation during the hearings. The subsequent activities of in came Ferdinand Pecora he took over the reins of the committee. Crash stories and brokers' manipulations were essentially general news, but when individual bankers were connected with the dismal economic conditions, the stories took on a more personal note. Those revelations would make them the most hated professional group in the country.

Bond Defaults

Stocks were not the only major casualties of the crash. Many of the corpo­rate and foreign bonds sold to an unwary public as safe investments turned out to be extremely risky. Another reason for the public's wrath against bankers was that 1932 was a banner year for bond defaults, which were de­stroying many savers' investments and weakening the banking system even further. In their great rush to "manufacture" securities, the bond underwriters often overlooked some very basic facts when bringing new issues to market. These oversights created as much trouble for them in the long run as the market crash itself. Foreign bonds sold to American investors were some of the main ca­sualties of the post crash period. Most were bought not by large institu­tions but by small investors.

Now lets fast-forward to 2009 we need to resist the temptation to create regulations that slow American business to a crawl. There is no such thing as no risk the idea that we can achieve rewards while forbidding risk is stupid the notion that all rewards had been achieved without assuming risk is a joke. We should put an eventual stop to the bailout safety net. You run your bank into the ground you don't get bailed out, you get taken over and If you have been caught with your hand in the cookie jar you get prosecuted.

The world is not coming to an end and the sky is not falling. Things will turn out in the end. This financial shift will probably spell the end of several venerable American financial institutions. And we might be better off. This is a great opportunity there are great companies that are suddenly within reach the market is holding a fire sale and I’m buying. If you are unsure just look at the history that is your market indicator if you look close this is not new. It’s just different a different Scenario.

 

Maybe we should put some foxes back in henhouse?

 

Sometimes the very same people that got you into a mess are the very same people you need to get you out.

By Melvin J. Howard

 

As President Barack Obama deals with financial reforms and stress test for banks it got me thinking. Why not put some foxes back in the hen house it worked for FDR when he appointed Joe P. Kennedy the father of the late great President John F. Kennedy as the first Chairman of the SEC. Everybody thought FDR lost his marbles but FDR countered whom better to know where all the dead bodies are. As  bankers discuss isolating toxic assets and the Obama administration pressing banks to resume lending. "The president emphasizing that Wall Street needs Main Street and that Main Street needs Wall Street. So lets go down memory lane and see what FDR did. FDR had a very good reason for wanting to involve Joe Kennedy in his first administration. Kennedy had helped him get elected.

In 1932, FDR was attempting to prevent a deadlocked convention. Kennedy aligned himself with the powerful Bernard Baruch. Kennedy, equally wealthy spoke with the loud voice of money. Kennedy contributed $50,000 of his own to FDR's campaign, and helped raised another $200,000. As told it FDR wanted to ignore them but couldn't. FDR listened to them about their concerns, even if he had his own serious reservations.

Kennedy approached William Randolph Hearst to say that a deadlocked convention may pick Newton Baker, a man detested by Hearst. Hearst then convinced John Nance Garner to give his delegates to FDR. In those days that ensured that Garner would be selected vice presidential job instead.

So FDR defeated Herbert Hoover in a landslide and began to work on his New Deal. Joe Kennedy wanted to be Treasury Secretary. But Roosevelt put the breaks on car. But he did have something else in mind for Kennedy. In FDR's New Deal he created four regulatory bodies: National Labor Relations Board, Civil Aeronautics Authority, Federal Communications Commission, and the Securities and Exchange Commission.

The SEC was created by an act of Congress on June 6, 1934 for the purpose of protecting the public and investors against malpractice in the financial markets. While Wall Street was not exactly jumping up and down of the coming regulation, but Congress was set on changing the Street as it was an easy target for the Crash and the Depression which followed are we connecting the dots yet? Commenting on the creation of the SEC, Texas congressman (and future Speaker) Sam Rayburn admitted he didn't know whether the legislation passed so readily because it was so good or so incomprehensible. In his book "Freedom From Fear," historian David Kennedy summed  it up like this on the importance of the SEC: "For all the complexity of its enabling legislation, the power of the SEC resided principally in just two provisions, both of them ingeniously simple. The first mandated detailed information, such as balance sheets, profit and loss statements, and the names and compensation of corporate officers, about firms whose securities were publicly traded. The second required verification of that information by independent auditors using standardized accounting procedures. At a stroke, those measures ended the monopoly of the Morgans and their like on investment information. Wall Street was now saturated with data that were relevant, accessible, and comparable across firms and transactions. The SEC's regulations unarguably imposed new reporting requirements on businesses. They also gave a huge boost to the status of the accounting profession. But they hardly constituted a wholesale assault on the theory or practice of free- market capitalism. All to the contrary, the SEC's regulations dramatically improved the economic efficiency of the financial markets by making buy and sell decisions well-informed decisions, provided that the contracting parties consulted the data now so copiously available. This was less the reform than it was the rationalization of capitalism. "So the SEC prohibited the "pools" and other devices used by the likes of Kennedy to amass their fortunes. While manipulation of the markets was still possible, there were now risks as it is today. Did I ever tell you the one about a penny stock company I invested in but that's another story. 

Meanwhile, FDR decided he had to do something with Kennedy so he chose to name him the first commissioner of the SEC. Joseph Kennedy was appointed to oversee the very activities he had participated in. FDR was initially accused of selling out to Wall Street. But FDR argued that Kennedy was the right choice since he was the only one with intimate knowledge of the very acts that the SEC was set up to prevent. It was a classic case of the fox guarding the henhouse. When Joe first started he was given a job with the venerable Boston stock brokerage firm Hayden, Stone and Company, after Mayor Fitzgerald Joe's father promised to swing business to the firm if they hired his son-in-law. Galen Stone, a friend of Joe's father-in-law, taught his protégé how to make huge sums of money off investors by trading on inside information. I am not making any judgement calls here because back then the practice of using inside information was not illegal. Joe was a business man he was out to make money his distrust for institutions and the prejudices he faced for being catholic I am sure drove him to become a success. People and their prejudices are so ridicules and stupid it makes no sense I have gone through it myself in the early part of my career so I understand. What Joe did was it ethical maybe maybe not there was no law at the time. Did Joe use his contacts and influence to gain an advantage? Why sure he did just like all the robber barrons before him. It still happens today because of privileged positions how many times have you had advice to take advantage of a loophole now before it closes can I get a show of hands.

Besides using inside information, Joe made a ton through what were known as stock pools. This was a way of manipulating the market by forming a syndicate and arranging for the members to trade stock back and forth. By bidding the price of the stock higher, the pool members created the appearance that the public was bidding up the price. In fact, the syndicate members retained the profits, and when the trading public bit by joining the action, the syndicate members sold out, leaving the public with losses. Joe called the practice "advertising" the stock.

By 1930 Joe had seen the Depression coming, and as Black Tuesday approached, Joe liquidated his longer-term investments while continuing to make money on the declining market by selling short. 

Selling Short - Usually an investor purchases stock and later sells it, earning a profit if the stock has gone up. Selling short reverses the process. The investor who believes the price of a stock will go down borrows stock - say at $10 a share - from a broker for a fee. If the price falls to $8, he buys new shares at the lower price of $8 and gives them back to the broker to replace the shares he borrowed at $10. He then gets to keep the $2 difference as his profit. By selling short, Joe made sums estimated at more than $1 million dollars by forcing prices down. The fact that the market was unregulated was largely responsible for the crash. Salesmen had made wild claims to a gullible public. Stock pools were defrauded legitimate investors. Reporters and columnists had acted as accomplices for companies peddling stocks in return for payoffs. 

Considerably richer because of his short selling, Joe Kennedy had sold off his Wall Street holdings before the bottom dropped out of the stock market. He then waited to pick up the pieces. Joe Kennedy's wealth was now estimated at over $100 million. Some of you might say that's not how he made all of his money. Maybe but I am only focusing on his appointment as Chairman of the SEC. 

The crash set off a worldwide financial panic and depression that would last for years. By 1932, 12 million Americans were jobless. Governments responded with strict tariff restrictions that dried up world trade. In Germany, where 5.6 million people were out of work, the depression contributed to the rise of Adolph Hitler.

As one of his first official duties, Kennedy delivered a national radio address: "We of the SEC do not regard ourselves as coroners sitting on the corpse of financial enterprise...We do not start with the belief that every enterprise is crooked and that those behind it are crooks. "Wall Street breathed a little easier. After all, regulation did not always mean prosecution. Joe Kennedy proved to be a highly effective leader of the SEC. And, while he stayed in the position only one year (leaving to pursue other interests), it was a crucial one as far as establishing the credibility of the organization.

Historian John Steele Gordon described his reign: "Kennedy knew where the bodies were buried. But he regarded his job to be not only to restore the confidence of the country in Wall Street, but, equally important, to restore the confidence of Wall Street in the American economy and government. Kennedy's first priority was to end the 'strike of capital,' in which the great Wall Street banks, and innumerable small ones, shell-shocked alike, were refusing to underwrite new issues of securities and to lend money, no matter how good the collateral or how solid the project." Eventually, Wall Street and the country recovered. Kennedy quickly established himself as a fair-minded, yet tough, leader. He set up the procedures for investigating and prosecuting misdeeds by investment bankers and brokers and for all this, his place in financial history is secure. Joe also took steps to protect his fortune and the future of his children and their mother. That information will costs extra that is what I get paid for.