Financial History Issue 129 (Spring 2019) | Page 17

Members of the US Congress decided to investigate this unaccountability. They held what became known as the Pujo Hearings, named after Congressman Arsene Pujo of Louisiana, a House Bank- ing and Currency subcommittee inquiry into whether there was a “money trust” in Wall Street. (“Trust” was both a legal and a colloquial term used to connote a concentration of power in any industry that might need to be broken up. A finan- cial trust company like the Knickerbocker Trust, however, was a lightly regulated bank that paid slightly higher deposit rates, but that generally took somewhat more risk with depositors’ money.) The work of this subcommittee resulted in the passage of the 16th Amendment autho- rizing a federal income tax, the Clayton Anti-Trust Act and the Federal Reserve Act establishing a central bank, a bank designed to check the power of J.P. Mor- gan and his colleagues that would—most significantly—be empowered to function as a “lender of last resort.” The establishment of the Federal Reserve sought to banish for eternity those all too conspicuous vultures. By empower- ing an institution to combat bank panics, the government made sure such vultures could never again profit from having “ready money” in times of panic. Early on, its leaders were hesitant. But as the dollar’s link to gold loosened until being cut entirely in 1971, the Federal Reserve became increasingly willing to provide cheap liquidity at any hint of trouble. Federal Reserve officials like to quote the classic principles of central banking promulgated by 19th century British econ- omist Walter Bagehot, who counseled that central bankers should—in times of panic—lend freely against good collateral, but at a high interest rate. Modern cen- tral bankers have certainly mastered the first two of these precepts—lending freely against good collateral (if mortgages are considered “good”)—but the third con- cerning interest rates they seem to ignore entirely. Wall Street watched this and gradu- ally concluded that liquidity does not pay. In the wake of the Lehman bank- ruptcy in 2008, when liquid funds were needed, short-term rates did not spike Bernard Baruch was young and newly rich in 1907. He quietly deposited $1 million into a few strapped but solvent Manhattan banks, and he shipped cash to a distressed copper mining concern in Utah while buying up its common stock. upwards—they declined! Federal Reserve infusions saw to it. The lesson was obvious. What was the point of holding cash for such scarce times if the Fed could print all any bank needed? What large financial institution could afford to tilt against such a policy wind and do other than “borrow short, lend long and hope for the best”? A century of financial gerrymandering has produced a system that simply does not reward risk- aversion in any positive way. The implications of this policy change extend beyond “solving” the liquidity problem of the moment. One is the decline of the currency: The Federal Reserve now manages interest rates to maximize eco- nomic growth and employment, meaning that interest rates are often kept lower than they would be otherwise, which in turn requires the Federal Reserve to create money to bid up the price of government securities and suppress these rates. (The call money rate, for example, has never returned to remotely the levels of October 1907.) All the money and credit creation required has left the US dollar—now a “Federal Reserve Note”—a tiny 2% speck of the gold-backed dollar of 1907, and gradual devaluation (i.e., “inflation target- ing”) is now a governmental goal. The subtle, less visible effect is on the value of, and the potential returns accru- ing to, financial prudence. To illustrate, it helps to recall the actions of a few promi- nent financial figures from those bygone days of 1907. Bernard Baruch was young and newly rich in 1907. He had made a fortune speculating on sugar prices, the end of the Spanish-American War in 1898, and the Northern Pacific ownership tussle and short squeeze of 1901. He was, neverthe- less, a public-spirited man who would later volunteer his services to the govern- ment during the World Wars. The fall of 1907 found him worried about the markets and holding roughly $2 million in cash in safe-deposit boxes. When the panic took hold, he saw his duty to be in shoring up the nation’s financial con- dition. He thought of approaching J.P. Morgan directly with offers of help, but he knew Morgan regarded him as little more than a gambler. Baruch instead quietly deposited $1 million into a few strapped but solvent Manhattan banks, and he shipped cash to a distressed copper min- ing concern in Utah while buying up its common stock. Jesse Livermore was also a newly rich speculator in 1907, but he was somewhat more flamboyant than his contemporary, Baruch. Known around Wall Street as the “Boy Plunger” because of his perennially youthful appearance and his investing style, Livermore was alternately barbari- cally liquid and then bankrupt as his speculative positions waxed and waned. (In Wall Street parlance of the day, to “plunge” was to sink most of one’s assets into a single speculative position.) Octo- ber 1907 found him solidly short the mar- ket, and he was making hundreds of thou- sands of dollars per day in late October when the great man, J.P. Morgan himself, placed a discrete phone call to Livermore asking him to discontinue his shorting of the stock market. Livermore complied, later recalling the significance of Morgan’s request as part of “a day of days for me,” one in which his winnings were tallied in both money and “intangibles.” Henrietta “Hetty” Green was a mon- strously rich private investor in 1907. The sole surviving heiress to a New Bedford, www.MoAF.org  |  Spring 2019  |  FINANCIAL HISTORY  15