Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (45 page)

The new president was so well known to be a fervent opponent of the speculation on Wall Street that in the week of his nomination to the Republican candidacy, the stock market had gone down 7 percent. Like all of Washington, he faced a quandary. While he believed that the market was now living in a world of fantasy, the underlying economy was healthy and doing well. It was almost impossible to craft his comments in such a way as to talk the stock market back to earth without at the same time damaging the economy and laying himself open to accusations of undermining the American dream.

He therefore felt compelled to be extremely circumspect. In the spring of 1929, he did invite the editors of the nation’s largest newspapers to Washington to enlist them against the perils of speculation; he sent Henry Robinson, president of the First Security National Bank of Los Angeles, as his personal envoy to Wall Street to warn that the market was unsound; and he continued to press his friend Adolph Miller for the Federal Reserve Board to use its armory of measures to deflate the bubble. All to little avail.

At the Treasury Department, Andrew Mellon was even less successful. By 1929, he had served under three presidents and was being hailed as the “best Treasury Secretary since Alexander Hamilton.” Gloomy and gaunt, he was an unlikely figure to have presided over a decade of such economic
exuberance. The truth was that most of his public achievements were a matter of luck. In 1921 he had inherited an economy still on the vestiges of a war footing. The peace dividend allowed him to slash public spending almost in half, while at the same time cutting income taxes and paying down the national debt from $24 billion to $16 billion. In international finance, he had left all currency matters to Benjamin Strong. Similarly, though he was a member of the Federal Reserve Board, he usually absented himself from its deliberations; most of the Fed’s achievements in monetary policy were Strong’s. What contribution the United States had made to solving the problem of reparations was largely the work of private businessmen, such as Dawes and Young. Mellon could claim to have played a key role in restructuring the Allied war debts. But the British part of the deal had been unusually harsh, only agreed to by a Britain eager to resume its place as the linchpin of the gold standard. Even now, the French had yet to ratify their settlement.

The emotionally crippled Mellon, long divorced from his wife and now estranged from his children, seemed to find his main solace in obsessively collecting works of art. By the late 1920s, his avocation had come to dominate his life and he had become oddly disengaged in his role as treasury secretary. For example, when he quite coincidently turned up in Paris in the middle of the French currency crisis in September 1926, he was received by the desperate Émile Moreau, who could not help noticing that Mellon seemed almost bored during their discussions and “displayed some life
⁴⁸⁵
only in front of the Fragonard” that hung on Moreau’s office wall.

Mellon would eventually be accused of having encouraged the market higher out of the crude desire to enlarge his personal fortune. This is unfair. In private, he acknowledged that stocks were in a bubble. But his experience as one of the country’s great financiers convinced him that there was little that the Fed or anyone else could do about it, observing to a fellow member of the Federal Reserve Board, “When the American people
⁴⁸⁶
change their minds, this speculative orgy will stop but not before.” Having decided that trying to talk the market down was an impossible task and that he would only look foolish when he failed, he waited for the frenzy
to burn itself out, saying as little as possible publicly. In March 1929, he did declare that he thought this was a good time for investors to buy bonds, but this was so coy a pronouncement that those few people who paid any attention poked fun at Mellon’s admonition that “gentlemen prefer bonds.”

The irrepressible gentlemen on Capitol Hill were not so reticent. In February and March of 1928, the Senate Committee on Banking and Currency held hearings on brokers’ loans and, from March to May, its House counterpart opened its own investigation into stock market speculation—overall a spectacle somehow both embarrassing and uplifting. It was painful to watch the good senators flailing around trying to understand the workings of a complicated financial system and hurling foolish questions at the expert witnesses. But there was also something admirable as they voiced the outrage of the common man at the absurdities of Wall Street.

The following exchange
⁴⁸⁷
captures the quality of the discussion and the mood of the Congress. In the middle of the hearings, Senator Earle Mayfield of Texas suddenly has an inspiration: Why not ban all stock trading?

SENATOR MAYFIELD
: Well, instead of urging all these various changes in the law, why do you not prohibit gambling in stocks and bonds on the New York Stock Exchange? In that way you could make a short cut to the proposition. Just stop it.

SENATOR BROOKHART
: Well, I do not have any objection to doing that. But Senator Couzens, in discussing the thing, said we needed a market—a legitimate market for stocks and bonds.

SENATOR MAYFIELD
: Preserve the legitimate market, but cut out the gambling. . . .

SENATOR EDGE
: Does the senator from Texas seriously consider passing a bill prohibiting that?

SENATOR MAYFIELD
: There are millions of dollars of stocks and bonds sold every day by people who do not own them and have no idea of owning them. Purely gambling on the market.

SENATOR BROOKHART
: There is no trouble at all in stopping the gam bling. . . . We have a law against poker gambling, and we can have a law against stock gambling.

The discussion during the hearings continued in an attempt to refine the distinction between investing and gambling. Finally, Senator Carter Glass, one of the architects of the Federal Reserve System and secretary of the treasury during the last two years of the Wilson administration, thought he had it figured out. A stock he had bought only the previous January at 108 was now selling on the market at 69. “Now what is that but gambling?” he exclaimed.

It was great theater, put on, according to
Time
magazine, with that combination of “oratory, ethics and provincialism
⁴⁸⁸
” at which the U.S. Congress is so good: a reenactment of an old morality play that had divided the republic since its founding—between those, like Hamilton, who believed that great wealth was the reward for taking risks and those, like Jefferson, who believed that prosperity should be the reward for hard work and thrift.

The strongest calls to do something came from senators representing the farm states of the Midwest and the Great Plains: Borah of Idaho, La Follette and Lenroot of Wisconsin, Brookhart of Iowa, Pine of Oklahoma, and Mayfield of Texas. They had their roots in those parts of the country that had always been suspicious of bankers and were ambivalent about the power of money in American life. Their constituents, the farmers, had already been through hard times for most of the decade as commodity prices fell and were now being starved of credit as it was diverted into the stock market. But the senators slowly came to recognize that they would only inflict greater damage upon their people if they pressed for tighter credit to force stock prices down.

And so Congress’s efforts to control speculation yielded little except for some gloriously overheated language. In February 1929, Senator Tom Heflin of Alabama introduced a resolution asking the Federal Reserve Board to control speculation, thundering to the Senate: “Wall Street has become
⁴⁸⁹
the most notorious gambling center in the whole universe . . . the hotbed and breeding place of the worst form of gambling that ever cursed the country.” The Louisiana State Lottery “slew its hundreds,” he continued, “but the New York State gambling Exchanges slay their hundreds of thousands. . . . The government owes to itself and to its people to put an end to this monstrous evil.”

It was thus left to the Fed to wrestle with the conundrum of how to deflate the stock bubble without crippling the economy. Recognizing that the easing of credit policy in the middle of 1927 had been a mistake, it raised rates from 3.5 percent in February 1928 to 5 percent in July 1928. But just as the stock market began its second leg upward in the middle of 1928, the Fed fell silent and disappeared from view, brutally divided about how to react.
⁴⁸⁹

Any further measures to bring the market to earth were bound to inflict collateral damage to the economy, especially on farmers. Moreover, capital had once again begun flowing in from abroad, attracted by the returns on Wall Street. Were the Fed to raise interest rates now, it might well pull in even more gold, possibly even forcing sterling off the gold standard.
⁴⁸⁹

Strong was still grappling to the very end with these issues. He was willing to concede that it had been a mistake to delay tightening credit so long in early 1928, thus letting the bull market build up such a head of steam.
⁴⁸⁹
Nevertheless, in the last weeks
⁴⁹⁰
before he died, he had begun arguing that the Fed should not tighten any further but step aside in the hope that the frenzy would burn itself out.

Strong’s successor
⁴⁹¹
at the New York Fed was George L. Harrison, a forty-two-year-old lawyer, with impeccable establishment credentials. Born in San Francisco, the son of an army colonel, Harrison had had a peripatetic childhood while his father was posted to various forts across the country. He had been lame from childhood as result of a fall and hobbled around with a heavy walking stick. He had gone to Yale, where he had run with “right crowd” and had become a member of Skull and Bones, the elite secret society for seniors that supposedly serves as an entrée into the upper echelons of business and government. His Yale
room-mate and close friend was Robert Taft, the son of President William Taft, and they had gone on to Harvard Law School together. Graduating close to the top of his class, Harrison was offered a clerkship on the Supreme Court with Justice Oliver Wendell Holmes, a position in which he would be followed by Harvey Bundy, father of the Bundy brothers, William and McGeorge, and by Alger Hiss, the senior State Department official later accused of being a Soviet spy.

Harrison had joined the Federal Reserve Board as assistant general counsel in 1914 soon after it opened and in 1920 had been persuaded by Strong to come to the New York Fed as his deputy. A scholarly-looking man with a big head of wavy hair, friendly blue eyes, and a warm and genial manner, he was a committed bachelor, lived in a small suite at the Yale Club, and liked to spend his evenings playing poker with his friends. Having been groomed for the job, he was the obvious choice to succeed Strong. He shared his mentor’s international outlook and as the deputy governor responsible for the day-to-day’s dealings with European central banks, he had developed close working relationships with both Norman and Moreau.

Nevertheless, filling Strong’s shoes was a daunting task. As Russell Leffingwell, the Morgan partner, put it, Harrison had the double disadvantage of “being young and new
⁴⁹²
,” while as Strong’s protégé he “had inherited all the antagonisms that poor Ben left behind him.” Harrison also had a very different personality from his predecessor’s. Where Strong was forceful and aggressive, the affable and easygoing Harrison was cautious and diplomatic. Strong had a terrible temper and was impatient with incompetence in his subordinates. Harrison by contrast found it hard to fire anyone. There was never much doubt where Strong stood on an issue and he did not shy from confrontation, while Harrison believed in keeping his cards close to his chest.

Strong’s death had left a political vacuum within the system as a whole. The chairman of the Board, Roy Young, who had taken over from Daniel Crissinger in late 1927, was a florid-faced glad-handing banker from Minnesota who loved to regale people with his stories. With Strong dead
⁴⁹³
,
Young very consciously set out to reclaim leadership, to reassert Washington’s control over the decision-making process, and in his words, “raise the prestige
⁴⁹⁴
of the Board within the system.”

A majority of the Board in Washington, among them Young, Miller, and Hamlin, the same governors who had been so strongly in favor of raising interest rates to curb speculation as the bull market built up, had now changed their minds. Fearful that increasing the price of money at this stage would harm the economy without checking the orgy on Wall Street, they now began to press for “direct action” against speculators.

By early 1929, the bubble was not simply a problem for the Fed but for almost every European central bank as well. New York was sucking in capital from abroad at a time when Europe was still very dependent on American money. The weakest links were Germany and the other Central European countries. But the Bank of England was losing gold as well. While in early 1928, it held over $830 million in reserves, the highest since the war, by early 1929, these had fallen below $700 million and were still going down. In the old days, when his gold reserves came under strain, Norman’s first reaction would have been to press his friend Strong to ease Fed policy. Now grimly aware that with Wall Street on a roll, no one would dance to that tune, he thought out a very different strategy.

He arrived in New York on January 27 armed with his new proposal. Meeting with Harrison at the New York Fed, Norman now surprised everyone by arguing for a sharp rise in U.S. rates, possibly by 1 percent, even by 2 percent, taking the discount rate to 7 percent. The Fed should try to break “the spirit of speculation,” “prostrating” the market by a forceful tightening of credit. Once a change in psychology had been achieved, interest rates could be then brought down again and capital flows to Europe would resume. For some reason Norman thought the Fed could pierce the bubble with a surgical incision that would bring it back to earth, without harming the economy. It was a completely absurd idea. Monetary policy does not work like a scalpel but more like a sledgehammer. Norman could neither be sure how high rates would have to go to check the market boom nor predict with any certainty what this would do to the U.S. economy.