Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (39 page)

No company better exemplified
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the booming economy and provided a better window into the rising stock market than General Motors. It had been founded in 1908 by William Crapo Durant, grandson of H. H. Crapo, the Civil War governor of Michigan. Young Billy Durant grew up in Flint, Michigan, and after dropping out of high school, drifted through a series of nondescript jobs, including grocery boy, drugstore attendant, traveling medicine man, insurance promoter, and tobacco shop manager. The bantam-sized Durant was a natural salesman, charming, soft-spoken but determined, with a winning smile, an infectious attitude of irrepressible
optimism, and an unusual talent for persuading people. After building one of the largest buggy businesses in the country, in 1903 he acquired the Buick Motor Company, one of the several hundred car companies then in America, and during the next eight years steadily acquired a whole series of small automobile firms—among them Oldsmobile, Cadillac, and Pontiac—whose names have become so familiar that they are now almost part of the language.

In 1910, after overexpanding and going too deeply into debt, Durant lost control of General Motors to his bankers. Instead of giving up, the indefatigable Durant went on to form a new car company with Louis Chevrolet, a racing driver, and was so successful that in 1915, he was able to reacquire his old company, General Motors, which had gone public, in a takeover raid. But in 1920, the postwar recession once again found him overextended and he lost control of the company for a second time, on this go-around to the Du Pont family.

When the Du Ponts acquired their stake in General Motors, the company was producing 250,000 cars a year, had just earned some $30 million in profit, and was valued at a little over $200 million. Under its new professional management, General Motors went on to become the most successful company in the country and the darling of Wall Street. By 1925, it was making over 800,000 cars a year, about 25 percent of all those sold in the country and generating over $110 million in profit. Its stock price in those five years quadrupled in value, from around $25 to over $100 a share.

Supported by growing companies such as General Motors, the stock market ballooned into something of a financial behemoth during the Coolidge bull market. By the mid-1920s, about $1 billion was being raised annually for new investments, the number of corporations listed had quintupled, and the total value of stocks had increased from $15 billion in 1913 to over $30 billion in 1925.

Wall Street was not the only beneficiary of the growth in the economy. The buoyant stock market was accompanied
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by a real estate boom in Florida. Since the war, Florida had been swamped by an enormous migration of people attracted by the climate—in five years, the population of Miami
had more than doubled. All the money flooding into the state had driven real estate prices into a frenzy. Lured by brochures, which promised graceful palm trees, golden beaches, sun-kissed skies, and whispering breezes, but somehow omitted to mention the hurricanes and the mangrove swamps, the public began buying land indiscriminately. New developments such as Coral Gables and Hollywood-by-the-Sea sprang up overnight. From Palm Beach to Miami and across to the cities of the Gulf Coast, prices skyrocketed. A strip of land on Palm Beach worth a quarter of a million dollars before the boom was priced, by early 1925, at close to $5 million; vacant lots that had once gone for a few hundred dollars were being sold for as much as $50,000.

Watching other people become rich is not much fun, especially if they do it overnight and without any effort. It was therefore inevitable that all this frenetic activity—the thriving stock market, the new issues, the ballyhoo about a new era, the buying and selling of Florida real estate—provoked a chorus of voices demanding that the Fed do something to stop the “orgy of speculation,” a phrase that would become so commonplace over the next few years as to lose all meaning.

Leading the charge was the ever disputatious Adolph Miller. His hostility to the rise in the stock market rested, like so many of his arguments, upon several misconceptions. There was the erroneous notion that a rising stock market “absorbs” money from the rest of the economy. This is sheer nonsense, because for every buyer of stocks there is a seller and whatever money flows into the stock market flows immediately out.

In the fall of 1925, Miller had also become particularly alarmed by the data on so-called brokers’ loans. These were loans provided by banks to stock brokers who used the money to finance their own inventories of securities or to lend to their own customers to buy equities on margins. Typically such margin investors only paid 20 to 25 percent of the value of stocks with their own money and borrowed the rest. The total volume of such brokers’ loans, which had averaged around $1 billion in the early years of the decade, had suddenly ballooned to $2.2 billion at the end of 1924 and looked likely to reach $3.5 billion by the end of 1925. Miller saw these
loans as a symptom of speculation, and he was firmly convinced that it was somehow more “inflationary” for banks to finance stock market purchases than for them to finance other activities. Again, we now know this to be fallacious—the inflationary consequences of easy credit have much more to do with the total amount the public borrows and very little to do with the purposes for which it does so.

Miller’s campaign was given an added boost one quiet Sunday afternoon in November 1925, when he was sitting in the study of his house on S Street in Washington, going through one of the many Board reports he took home with him, and the doorbell rang. “Before the butler could move
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,” Miller’s neighbor from two doors down pushed his way into the house unannounced, “bounded up the stairs, taking them two at a time,” and barged in, demanding, “Are you as worried about this speculation as I am?”

Miller’s unusually energetic neighbor was none other than the “boy wonder,” Herbert Hoover, secretary of commerce. Hoover, a Quaker orphan from Iowa, was an engineer by profession who had graduated in the very first class from Stanford and had made a fortune in the first decade of the century as a promoter of mining ventures in every corner of the globe—from China to the Transvaal, from Siberia to the Yukon, from the Malay peninsula to Tierra del Fuego. He had come to national prominence by accident as the man in charge of evacuating Americans from Europe in 1914, then as the War Food Administrator in the Wilson administration and as the head of Belgian Relief, “the only man who emerged
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from the ordeal of Paris with an enhanced reputation,” according to Maynard Keynes. Appointed to the cabinet by Harding, he had distinguished himself from his do-nothing colleagues by his superb organizational ability, his belief in himself, and the constant flurry of activity that always surrounded him.

In the fall of 1925, Hoover, not shy about interfering in his cabinet colleagues’ business—Parker Gilbert called him the “Secretary of Commerce
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and the Under-Secretary of all other departments”—decided to launch a campaign against the pervasive atmosphere of speculation that he claimed was infecting the country, from Florida real estate to the stock market.

For both Miller and Hoover, the culprit behind this speculative fever was Benjamin Strong. They believed that his policy of keeping interest rates artificially low to help European currencies was responsible for fueling the incipient bubble. Hoover had once been a prime supporter of American engagement in European affairs following the war, and had counted Strong a good friend. But he was now convinced that the policy of propping up Europe with artificially cheap credit had been taken too far. In his words, Strong had become “a mental annex
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to Europe.”

Like every other financial official at the time, Strong was taken aback by the surprising strength of the stock market and was himself also worried about a potential bubble. His letters to Norman are filled with misgivings about the rise in prices on Wall Street. Though he had a somewhat jaundiced view of the stock market, dominated as it was by its motley crew of outsiders—its plungers and pool operators, all of whom were very much at the bottom of the Wall Street social ladder—he was acutely aware of its power to cause trouble. Stock market crashes and banking panics had always been closely linked in the pre-Fed world and many of the country’s past financial crises had emerged from Wall Street: 1837, 1857, 1896, and 1907. In his early days as a stockbroker, he himself had been a witness firsthand to the crash of 1896, and had been an active participant in restoring order after the panic of 1907.

But as an experienced Wall Street hand, he was quite aware of how difficult it was to identify a market bubble—to distinguish between an advance in stock prices warranted by higher profits and a rise driven purely by market psychology. Almost by definition, there were always people who believed that the market has gone too high—the stock market depended on a diversity of opinion and for every buyer dreaming of riches in 1925, there was a seller who thought the whole thing had gone too far. Strong recognized his own highly fallible judgment about stocks was a very thin reed on which to conduct the country’s monetary policy. Even though his initial reaction was that the market might have gone too far, he asked himself, “May it not be the case
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the world is now entering upon a period
where business developments will follow the recovery of confidence, so long lost as a result of the war? Nobody knows and I will not dare prophesy.” Given so much uncertainty, he was convinced that the Federal Reserve should not try to make itself an arbiter of equity prices.

Moreover, even if he was sure that the market had entered a speculative bubble, he was conscious that the Fed had many other objectives to worry about apart from the level of the market. He feared that if he added yet another goal—preventing stock market bubbles—to the list he would overload the system. Drawing a rather stretched analogy between the Federal Reserve and its various and conflicting objectives for the economy and a family burdened by many children, he ruminated, “Must we accept parenthood
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for every economic development in the country? That is a hard thing for us to do. We would have a large family of children. Every time one of them misbehaved, we might have to spank them all.” He wanted the Fed to focus on stabilizing the overall economy and was reluctant to allow its policies to be dominated by the need to regulate the “affairs of gamblers
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” who thronged the tip of Manhattan.

In Strong’s view, something about the American character—the exuberance, the driving optimism, the naive embrace of fads—lent itself to periods of speculative excess. “It seems a shame
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that the best sort of plans can be handicapped by a speculative orgy,” he mused almost philosophically to Norman at the end of 1925, “and yet the temper of the people of this country is such that these situations cannot be avoided.”

Despite the agitation from Hoover and Miller in late 1925, Strong concluded that with absolutely no signs of domestic inflation, the pound having only just returned to gold and the European currency situation still fragile, this was not the time to tighten credit. For the moment he would just have to ignore the stock market.

Even in combination there was little that Hoover and Miller were able to do to force his hand. As secretary of commerce, Hoover had no remit to interfere in the deliberations of an independent agency like the Fed. Miller was in a minority on the Board. And while the two of them
campaigned to change the Fed’s policy by co-opting allies in Congress, senators and congressmen are rarely informed enough to be persuasive advocates for changes in monetary policy.

It helped Strong enormously that the Fed’s charter had an inherent bias toward inaction. Under the then law, only the reserve banks could initiate changes in policy. While the Board had the power to approve or disapprove such changes, it could not force the reserve banks to act. It was a recipe for the worst sort of stalemate. Checks and balances may work well in politics, but they are a disaster for any organization—the military is one example; central banks are another—required to act quickly and decisively. But in 1925 and 1926, with Hoover and Miller pushing to tighten credit policy, Strong was able to hide behind the Fed’s charter and do nothing.

Nothing illustrates the dilemmas posed for monetary policy by the stock market than the push to tighten in 1925. It turned out that Hoover and Miller had raised a false alarm. There was no bubble. Stock prices took a breather in the spring of 1926, falling by about 10 percent, and then resumed a steady but not yet spectacular rise. By the middle of 1927, the Dow stood at 168. Meanwhile, profits grew strongly and the price-earnings ratio, one measure of market valuation, remained around 11, well below the danger level of 20 that is often considered a sign of overvaluation.
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The Florida real estate bubble burst of its own weightlessness, helped by a devastating hurricane in 1926, and though there was much local disruption, its impact on the national economy was minor. Meanwhile, consumer prices remained almost completely flat.