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.
