Lords of Finance_ The Bankers Who Broke the World Part 11

PART FOUR.

REAPING ANOTHER WHIRLWIND.

1928-33.

16. INTO THE VORTEX.

1928-29.

At particular times a great deal of stupid people have a great deal of stupid money. . . . At intervals . . . . the money of these people-the blind capital, as we call it, of the country-is particularly large and craving; it seeks for someone to devour it, and there is a "plethora"; it finds someone, and there is "speculation"; it is devoured, and there is "panic."

-WALTER BAGEHOT

THE GREAT BEAR of Wall Street legend, Jesse Livermore, once observed that "stocks could be beat, but that no one could beat the stock market." By that he meant that while it was possible to predict the factors that caused any given stock to rise or fall, the overall market was driven by the ebb and flow of confidence, a force so intangible and elusive that it was not readily discernible to most people. There would be no better evidence of this than the stock market bubble of the late 1920s and the crash that followed it.42 The bubble began, like all such bubbles, with a conventional bull market, firmly rooted in economic reality and led by the growth of profits. From 1922 to 1927, profits went up 75 percent and the market rose commensurately with them. Not every stock went up in the rise. From the very start, the 1920s market had been as bifurcated as the underlying economy-the "old economy" of textiles, coal, and railroads struggling, as coal lost out to oil and electricity, and the new business of trucking bypa.s.sing the railways while the "new economy" of automobiles and radio and consumer appliances grew exponentially. Of the thousand or so companies listed on the New York Stock Exchange, as many went down as went up.

The first signs that other, more psychological, factors might be at play emerged in the middle of 1927 with the Fed easing after the Long Island meeting. The dynamic between market prices and earnings seemed to change. During the second half of the year, despite a weakening in profits, the Dow leaped from 150 to around 200, a rise of about 30 percent. It was still not clear that this was a bubble, for it was possible to argue that the fall in earnings was temporary-a consequence of the modest recession a.s.sociated with Ford's shutdown to retool for the change from the Model T to the Model A-and that stocks were being unusually prescient in antic.i.p.ating a rebound in earnings the following year. The market was still well behaved, rising steadily with only a few stumbles, and without the slightly crazed erratic moves and frenetic trading that were to come.

It was in the early summer of 1928, with the Dow at around 200, that the market truly seemed to break free of its anchor to economic reality and began its flight into the outer reaches of make-believe. During the next fifteen months, the Dow went from 200 to a peak of 380, almost doubling in value.

That it was so obviously a bubble was apparent not simply from the fact that stock prices were now rising out of all proportion to the rise in corporate earnings-for while stock values were doubling, profits maintained their steady advance of 10 percent per year. The market displayed every cla.s.sic symptom of a mania: the progressive narrowing in the number of stocks going up, the nationwide fascination with the activities of Wall Street, the faddish invocations of a new era, the suspension of every conventional standard of financial rationality, and the rabble enlistment of an army of amateur and ill-informed speculators betting on the basis of rumors and tip sheets.

FIGURE 5.

By 1929, anywhere from two to three million households, one out of every ten in the country, had money invested in and were engaged with the market. Trading stocks had become more than a national pastime-it had become a national obsession. These punters were derisively described by professionals like Jesse Livermore as "minnows." But while the bubble lasted, it was the people who were the least informed who were the ones making the most money. As the New York Times New York Times described it, "The old-timers, who usually play the market by note, are behind the times and wrong," while the "new crop of speculators who play entirely by ear are right." described it, "The old-timers, who usually play the market by note, are behind the times and wrong," while the "new crop of speculators who play entirely by ear are right."

The city that was most obsessed was New York, although Detroit, home to so many newly enriched "motor millionaires," came a close second, followed by two other new-money towns, Miami and Palm Beach. The infatuation with the market took over the life of New York City, sucking everything into its maw. As Claud c.o.c.kburn, a British journalist newly arrived in America, observed, "You could talk about Prohibition, or Hemingway, or air conditioning, or music, or horses, but in the end you had to talk about the stock market, and that was when the conversation became serious." Anyone trying to throw doubt on the reality of this Promised Land found himself being attacked as if he had blasphemed about a religious faith or love of country.

As the crowd piling into the market grew, brokerage house offices more than doubled-from 700 in 1925 to over 1,600 in 1929-mushrooming across the country into such places as Steubenville, Ohio; Independence, Kansas; Amarillo, Texas; Gastonia, North Carolina; Storm Lake, Iowa; Chickasha, Oklahoma, and Shabbona, Illinois. These "board rooms" became subst.i.tutes for the bars shut down by Prohibition-the same swing doors, darkened windows, and smoke-filled rooms furnished with mahogany chairs and packed with all sorts of nondescript folk from every walk of life hanging around to follow the projected ticker tape flickering on the big screen at the front of the office. The grail was to discover the next General Motors, which had risen twentyfold during the decade, or the next RCA, which had gone up seventyfold. The newspapers were full of articles about amateur investors who had made fortunes overnight.

The old crowd on Wall Street had a rule that a bull market was not in full stampede until it was being played by "bootblacks, household servants, and clerks." By the spring of 1928, every type of person was opening a brokerage account-according to one contemporary account, "school teachers, seamstresses, barbers, machinists, necktie salesmen, gas fitters, motormen, family cooks, and lexicographers." Bernard Baruch, the stock speculator who had settled down to a life of respectability as a presidential adviser, reminisced, "Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day's financial news as he worked with rag and polish. An old beggar, who regularly patrolled the street in front of my office, now gave me tips-and I suppose spent the money, I and others gave him, in the market. My cook had a brokerage account."

The stock p.r.o.nouncements of shoeshine boys would become forever immortalized as the emblematic symbol of the excesses of that period. Most famously, Joseph Kennedy decided to sell completely out of the market when in July 1929, having already liquidated a large portion of his portfolio, he was accosted by a particularly enthusiastic s...o...b..ack on a trip downtown to Wall Street, who insisted on feeding him some inside tips. "When the time comes that a shoeshine boy knows as much as I do about what is going on in the stock market," concluded Kennedy, "it's time for me to get out."

About a third of the new speculators were female. Articles on investing regularly appeared in women's magazines. Indeed, the seminal manifesto of the time, "Everyone Ought to Be Rich" originally appeared in the August 1929 Ladies' Home Journal. Ladies' Home Journal. Its author, John J. Raskob, recently treasurer of General Motors, now sponsor of the Empire State Building then in its planning stages, made the case that anyone who invested $15 a month and reinvested the dividends would have a fortune of $80,000 after twenty years. Its author, John J. Raskob, recently treasurer of General Motors, now sponsor of the Empire State Building then in its planning stages, made the case that anyone who invested $15 a month and reinvested the dividends would have a fortune of $80,000 after twenty years.

Initially, Wall Street, always a bastion of misogyny, dismissed the new cla.s.s of speculatrices as "hard losers and naggers . . . stubborn as mules, suspicious as serpents and absolutely h.e.l.l bent to have their own way." Even the New York Times New York Times had to have its chuckle about some of the characteristics of these novices-their memory lapses, their superst.i.tions, their gullibility. But women soon became so important to the market that brokerage houses opened up special offices on the Upper East Side on Fifth or Madison or on Broadway in the West Seventies to cater specifically to this ever more substantial clientele. had to have its chuckle about some of the characteristics of these novices-their memory lapses, their superst.i.tions, their gullibility. But women soon became so important to the market that brokerage houses opened up special offices on the Upper East Side on Fifth or Madison or on Broadway in the West Seventies to cater specifically to this ever more substantial clientele.

The new folk heroes of the market were the pool operators, a band of professional speculators a.n.a.logous to the hedge fund managers of today. They were typically outsiders, despised by the Wall Street establishment, who acc.u.mulated their fortunes-though they would soon enough lose them-by betting on stocks with their own and their friends' money. The seven Fisher brothers who had sold their automobile body company to General Motors for $200 million ran such an enterprise, as did Arthur Cutten, an old hard-of-hearing commodity trader from the Chicago wheat pits; Jesse Livermore, the great bear trader; and Kennedy, who had made his first million investing in the stock of the Hertz Yellow Cab Company and was now making his profits as an investor in the movie industry.

Biggest of them all was Billy Durant, who became the cheerleader for the bull market. Operating from a high-floor office at the corner of Broadway and Fifty-seventh, the exiled creator of General Motors now specialized in ramping stocks-acquiring large blocks in secret, eventually publicizing his positions to drive the price high, then off-loading them as a sadly unsuspecting public piled in. He traded so frequently and in such large amounts that he had to use twenty different brokers, his commissions just to one of whom amounted to $4 million a year. When he went to Europe, his transatlantic phone bills alone were said to be $25,000 a week.

On Wall Street, opinion about the markets was as always split. Charles E. Mitch.e.l.l, head of the National City, the largest bank in the country, was nicknamed "Sunshine Charlie" for his infectious optimism. He was the carnival salesman of American banking, who had transformed his firm into a giant machine for selling stocks. Paul Warburg, one of the wise men of American banking, the intellectual father of the Federal Reserve System, kept predicting that it would all end in disaster, issuing his most powerful jeremiad on March 8, 1929: "History, which has a painful way of repeating itself, has taught us that speculative overexpansion invariably ends in over-contraction and distress." If the "debauch" on the stock market and the "orgies of unrestrained speculations" continued, he warned, the ultimate collapse in stocks would bring about "a general depression involving the entire country." He was promptly accused of "sandbagging American prosperity."

Even within the same firm opinions were divided. At Morgans, Thomas Lamont was a believer in the New Era. Russell Leffingwell, a former a.s.sistant secretary of the treasury, who had become a partner in 1923, blamed the bubble on Norman and Strong. In March 1929, on the very same day that Warburg issued his ominous p.r.o.nouncement, Leffingwell predicted to Lamont, "Monty and Ben sowed the wind. I expect we shall have to reap the whirlwind. . . . I think we are going to have a world credit crisis."

The financial press was as much at odds as the men they covered. While the Journal of Commerce Journal of Commerce and the and the Commercial and Financial Chronicle Commercial and Financial Chronicle hammered away at the "speculative orgy," the hammered away at the "speculative orgy," the Wall Street Journal Wall Street Journal kept the faith, insisting that, "There are many underlying reasons why the size of the market should be many times what it was a decade ago." There was much editorial head shaking in the mainstream newspapers. Alexander Dana Noyes, the bespectacled, professorial financial editor of the kept the faith, insisting that, "There are many underlying reasons why the size of the market should be many times what it was a decade ago." There was much editorial head shaking in the mainstream newspapers. Alexander Dana Noyes, the bespectacled, professorial financial editor of the New York Times New York Times, who had been watching the market for forty years, warned that "stock speculation has reached an exceedingly dangerous stage," while the Washington Post Washington Post editorialized that "thousands of buyers of stocks are in for serious losses." editorialized that "thousands of buyers of stocks are in for serious losses."

The New York Daily Mirror New York Daily Mirror, by contrast, was so transported by its vision of the future that it was unable to restrain its soaring flight of rhetoric: The prevailing bull market is just America's bet that she won't stop expanding, that big ideas aren't petering out, that ambition isn't tiring in the wings, that tomorrow is twitching with growth pains. Graph hounds, chart wavers and statistic quoters may shout their pens hoa.r.s.e with contrary sentiment-financial Jeremiahs may rave of days of doom, but these minority reports are drowned by the hurrahing ticker tape and the swish of skyrocketing securities. We're gambling on continued prosperity, full employment, and undiminished spending capacity-on freight loadings, automobile output, radio expansion-on aviation development, crop yields, beef prices-on mail order sales and sound retailing.

It was from Washington that the bull market faced its greatest hostility. Every senior financial official in the government thought that stocks were now in a speculative bubble-everyone, that is, except the president, Calvin Coolidge. For some reason unfathomable even to members of his own administration, Silent Cal seemed blithely unconcerned about developments on Wall Street. In February 1929, as he prepared to leave the White House, he declared that stocks were "cheap at current prices" and conditions absolutely sound, probably just to irritate his successor, Herbert Hoover.

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 circ.u.mspect. 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 emile Moreau, who could not help noticing that Mellon seemed almost bored during their discussions and "displayed some life 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 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 p.r.o.nouncement 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 embarra.s.sing 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 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 pa.s.sing 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 gambling. . . . 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 Gla.s.s, 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 Time magazine, with that combination of "oratory, ethics and provincialism" 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. magazine, with that combination of "oratory, ethics and provincialism" 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 const.i.tuents, 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 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.

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.

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. Nevertheless, in the last weeks 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 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 entree 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 cla.s.s, 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 a.s.sistant 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," while as Strong's protege 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, Young very consciously set out to reclaim leadership, to rea.s.sert Washington's control over the decision-making process, and in his words, "raise the prestige 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.

Nevertheless, such was his power that Harrison embraced the idea. He did, however, warn Norman that since Strong had died, things had changed within the Fed. The conflict between the Board and the New York Fed had become even greater than in the past. There was now general agreement that the United States was faced with a stock market bubble. But the system was deeply divided about how to respond. While the reserve banks wanted to raise rates, it was now the Board that was resisting, and it had become more aggressive about getting its way. Harrison himself had just emerged from a collision with the Board over issues of jurisdiction, Chairman Young warning him that he and the other Board members did not "any longer intend to be a rubber stamp." Harrison urged Norman to visit Washington-which he had till now ignored-and begin building a relationship with the Board if he wanted to continue to influence U.S. credit policy.

On February 5, Harrison, fortified by his discussions with Norman, himself went down to Washington and proposed exactly the Norman strategy to Young. He rejected the idea that his old chief, Strong, had been advocating in his last few months-that the Fed should pa.s.sively sit by and "let the situation go along until it corrects itself." Instead, he now pressed for "sharp incisive action," a rise in rates of 1 percent. He had come to the conclusion, as he would put in later, that it would be better "to have the stock market fall out of the tenth story, instead of the twentieth later on." Once the speculative fever had been broken, rates could be brought down again. The next day, Norman also turned up in Washington, bearing the same message. Members of the Board could not help but remark on the almost sinister influence that he seemed to exert over the New York Fed, originally upon Strong and now upon Harrison. One governor would later comment that Harrison "lived and breathed for Norman."

While Harrison and Norman were pressing for rate hikes, the Board continued its campaign for direct action. On February 2, it issued a directive to all its member banks that they should not borrow from the Fed "for the purpose of making speculative loans or for the purpose of maintaining speculative loans." Four days later, it made the directive public. The Dow fell 20 points over the next three days, but quickly recovered and by the end of the week was back at the highs. The market's att.i.tude was best summarized by an editorial in the Hearst newspapers. "If buying and selling stocks is wrong, the Government should close the Stock Exchange. If not, the Federal Reserve Board should mind its own business."

Norman left for home in the middle of February shaken by his trip. In the old days, during his visits to the United States, there had been an easy camaraderie and his friend Strong had always exercised a calming influence over him. This time he returned to Britain as anxious as when he had set out. It had been "the hardest time in America that he had ever had," he reported to his colleagues. He had found the American central bankers paralyzed by indecision; there was "no leader"; within the Federal Reserve System, they were "at odds with one another, drifting and not knowing what to do." In a circular letter sent to several heads of European central banks, he wrote that he had set off in the hope of getting a clearer view of what was going on in the United States only to return with "an even deeper feeling of confusion and obscurity."

Meanwhile, back in the United States the struggle between the Board and the New York Fed was intensifying. On February 11, the directors of the New York Fed voted unanimously to raise rates by 1 percent to 6 percent. Harrison called Young in Washington to inform him of the decision, acknowledging the Board's right to override it. Young asked for time to consider the initiative, but Harrison insisted on a definitive answer that day. After three hours of calls back and forth in which Young unsuccessfully tried to persuade Harrison not to force a showdown, he eventually called to say that the Board had voted to disallow the hike. Over the next three months, the directors in New York voted ten times to raise rates and each time were overridden by Washington.

The Fed was now paralyzed by this standoff between its two princ.i.p.al arms. The Board kept insisting that the right way to deflate the bubble was through "direct action": credit controls, particularly of brokers' loans. New York was equally insistent that such a policy could not work, that it was impossible to control the application of credit once it left the doors of the Federal Reserve. Meanwhile, the pace of speculation was accelerating.

It did not help that the Fed seemed incapable of even exerting its control over leading bankers, let alone over the crowd psychology of investors. At the end of March, it was announced that total broker loans had increased to almost $7 billion, and the market swooned. The fear that some drastic action from the Fed to curtail the amount of credit going into the stock market was imminent drove the rate on brokers' loans to over 20 percent. Instead, Charlie Mitch.e.l.l of National City Bank, himself a director of the New York Fed, defied the Board by calling a press conference and announcing that his bank would pump an extra $25 million into brokers' loans to support the stock market. After that, what little credibility the Fed possessed was irretrievably lost.

It is too easy to mock the Fed for entangling itself in a bureaucratic turf feud and fiddling while Rome was burning. Both parties to the debate were in fact right. The Board was undoubtedly correct that with the demand for money on Wall Street so strong, call money averaging over 10 percent, sometimes spiking as high as 20 percent, and speculators counting on gains of 25 percent a year and more, a hike in the Fed's discount rate from 5 percent to 6 percent or even 7 percent at this stage of the game was going to have almost no effect. To be sure of p.r.i.c.king the bubble would have required raising interest rates higher, perhaps to 10 or 15 percent, which would have caused ma.s.sive cutbacks in business investment and would have plunged the economy into depression.

But the New York Fed also happened to be right. All the jawboning about reducing credit for speculators proved to be pointless. It did in fact succeed in curbing the amount of money going into brokers' loans from banks-between early 1928, when the Board first declared war on brokers' loans, and October 1929, banks cut their loans to brokers from $2.6 billion to $1.9 billion. Meanwhile, other sources of credit-U.S. corporations with excess cash, British stockbrokers, European bankers flush with liquidity, even some Oriental potentates-more than made up for the decline by increasing their funding of brokers' loans from $1.8 billion to $6.6 billion. It was these players, all of them outside the Fed's control, who were by far the most important factor supporting leveraged positions in the stock market.

Even Adolph Miller, the most vocal opponent of speculation in general and brokers' loans in particular, could not resist the temptation to earn 12 percent on his own savings. In 1928, Fed officials discovered that he had invested $300,000 of his own money in the call market through a New York banker, personally helping to feed the very speculation that he so vociferously opposed at the Board.

One is led to the inescapable but unsatisfying conclusion that the bull market of 1929 was so violent and intense and driven by pa.s.sions so strong that the Fed could do nothing about it. Every official had tried to talk it down. The president was against it, Congress too; even the normally reticent secretary of the treasury had spoken out. But it was remarkable how difficult it was to kill it. All that the Fed could do, it seemed, was to step aside and let the frenzy burn itself out. By trying to stand up to the market and then failing, it simply made itself look as impotent as everybody else.

PERHAPS THE MOST perverse consequence of the bubble was that by the strange mechanics of international money, it helped to tip Germany over the edge into recession. For five years, hordes of American bankers had descended on Berlin to press loans upon German companies and munic.i.p.alities. However much Schacht had tried to wean his country from this dependence on foreign capital, there was little he was able to do about it. Over the five years between 1924 and 1928, Germany borrowed some $600 million a year, of which half went to reparations, the remainder to sustain the rebound in consumption after the years of austerity.

In fact, Germany's appet.i.te for foreign exchange was so great that even the deluge of long-term loans from U.S. bankers was not enough, and it was forced to supplement this with short-term borrowings in international markets closer to home. Out of the total of $3 billion for which German inst.i.tutions signed up in those years, a little less than $2 billion came in the form of stable long-term loans. But more than $1 billion was "hot money," short-term deposits attracted to German banks by high interest rates-7 percent in Berlin compared to 5 percent in New York-and subject to being pulled at any time. In late 1928, as the U.S. stock market kept climbing and call money rates on Wall Street skyrocketed, American bankers mesmerized by the phenomenal returns at home suddenly stopped coming to Berlin.

It was the combination of the drying up of foreign credit due to high interest rates induced by the U.S. stock bubble and the residual lack of confidence among German businessmen following Schacht's ill-fated strike against the stock market in 1927 that drove Germany into recession in early 1929. Moreover, as long-term American loans stopped, Germany was forced to rely more and more on hot money, some raised from London, but much from by French banks, then flush with all the excess gold that had been sucked into their country. Germany therefore found itself slipping into recession just as its foreign position was becoming increasingly vulnerable. A British Treasury official, recalling how much money France had pumped into Russia before the war, could not help remarking with cynical detachment, "The French have always had a sure instinct for investing in bankrupt countries."

The collapse in foreign loans and the recession could not have come at a worse time for Germany. Under the Dawes Plan schedule, Germany was to have fully recovered by now, and was due to ramp up its reparations payments in 1929 to the full $625 million a year, about 5 percent of its GDP. This would not have been an intolerable burden by historical standards. But Schacht, for that matter most of the German leadership, had always been resolute that with its new const.i.tution still fragile, its body politic still divided, its people still bitter over the defeat, and its middle cla.s.ses decimated by the ravages of the inflation years, Germany simply could not pay this amount.

As 1929 and the scheduled rise in payments approached, Schacht was of two minds about what to do. He often spoke about simply waiting for the economic crash that so many financial experts were predicting. It was a common view in Britain, held, for example, by Frederick Leith-Ross, the top Treasury official responsible for reparations, that the world was headed for a ma.s.sive payments crisis in which several European countries would default on their debts, setting the stage for a general restructuring of all international commitments arising from the war. Europe could then wipe the slate clean of both reparations and war debts and start over again. Occasionally, Schacht even talked almost too glibly about provoking such an upheaval himself.

The alternative was to reopen negotiations before the jury-rigged payments system broke down. During the Long Island central bankers' meeting of 1927, Schacht had made enough of a stir about Germany's foreign debt problem as to convince Strong and Norman that something had to be done soon, to the point that Strong in turn pressed Agent-General Seymour Parker Gilbert to strike a deal before the whole thing blew up in their faces.

Gilbert, effectively Allied economic proconsul for Germany for the last four years, was even then all of thirty-six years old. A precocious genius, he had graduated from Rutgers at the age of nineteen, from Harvard Law School at twenty-two, had become one of the four a.s.sistant secretaries at the U.S. Treasury at the age of twenty-five, and been promoted to under-secretary, the second most powerful official in the department at the age of twenty-eight. In 1924, at the tender age of thirty-two he had been appointed agent-general for reparations, responsible for managing Germany's payments, and most important, for deciding how much it could afford to transfer into dollars every year. In the hands of this tall, shy, boyish, sandy-haired young man from New Jersey lay the immediate fate of the world's third largest economy.

There was little doubt that they were very capable hands. Reserved, bookish, and taciturn, Gilbert was uncomfortable around people, speaking "with a mixture of awkwardness and arrogance, mumbling the words so that one could hardly understand his English." But his intellectual power and capacity for work were legendary. At the Treasury, he had usually been at his desk till two or three o'clock in the morning, seven days a week. Living in Berlin for five years, he did not socialize, never learned German, did "nothing but work without interruption," according to the German finance minister, Heinrich Kohler. "No theater, no concert, no other cultural events intruded into his life...."

That so young an American should have such enormous sway over the life of their country was greatly resented by most Germans. Government officials also suspected the staff in his office of being espionage agents, sent to report on Germany's attempts to cheat on the limitations imposed on its armed forces by the Versailles Treaty. In February 1928, a right-wing group staged a mock coronation attended by ten thousand people in which Gilbert's effigy was crowned "the new German Kaiser who rules with a top hat for a crown and a coupon clipper for scepter." Schacht, always attuned to the locus of power, was one of the few German officials to befriend Gilbert.

Apart from his power to determine transfer payments, Gilbert's most potent weapon was his annual report. Generally viewed as the best independent a.s.sessment of Germany's economic policy and overall situation, it was always eagerly awaited by Germany's creditors. Though successive ministers of finance may have resented being lectured for overspending by this absurdly young whippersnapper of an American, no German politician dared challenge him because of the influence he carried abroad.

In his 1927 report released in December, Gilbert declared that the time had come for Germany to take control over her own economic destiny "on her own responsibility without foreign supervision and without transfer protection." Germany should be told once and for all exactly how much she owed and for how long. Moreover, the transfer protection clause embodied in the Dawes Plan, while useful in 1924 for restarting foreign lending, was now creating its own perverse incentives-what we now refer to as moral hazard. By providing an escape clause in the event of a payments crunch, the plan encouraged foreign bankers to be too cavalier in their lending and allowed Germany to be too lax about the consequences of acc.u.mulating so much debt "without the normal incentive to do things and carry through reforms that would clearly be in the country's own interests." Though Gilbert thus announced his intention of working himself out of one of the most powerful economic positions in the world, it did help that he had just received the highly lucrative offer to join J. P. Morgan & Co. as a partner.

There were many on the British side, and even among the Germans, who thought that it was still premature for a final reckoning. The bitterness between France and Germany had yet to subside; more time was needed until the German economy had truly revived before the amount of foreign payments it could sustain could definitively be settled.

By late 1928, however, Gilbert had been successful in persuading the Allies to convene a conference in Paris in February 1929 to do just that. He had even convinced the powers in Berlin that though the current situation-no new foreign loans coming in, large debts to nervous French depositors in German banks, and rising domestic unemployment-did not provide the ideal backdrop against which to reopen negotiations, it was best to try to strike a deal now while at least the rest of the world was booming.

Gilbert and the German leadership, Schacht included, were operating, however, from two completely different a.s.sumptions about what such a deal might look like. During his campaign to get a new round of negotiations started, the Allies had very explicitly told Gilbert that any further concessions would have to be small. Receipts from Germany had to cover payments on war debts to the United States and provide France and Belgium something beyond this to cover some of the costs of reconstruction. The lowest figure that the Allies could concede was an aggregate payment of $500 million a year. In his enthusiasm to get the parties to the table, Gilbert convinced himself and told everyone on the Allied side that the Germans would be willing to accept such a settlement as the price for getting France out of the Rhineland and regaining economic sovereignty.

Meanwhile, Schacht believed that American bankers had now committed so much money to Germany-they had provided some $1.5 billion of the $3 billion it had borrowed-that they represented an effective lobby for reduction and would bring enough political pressure on the creditor governments for Germany to swing a settlement of $250 million a year. Schacht, having by now broken with the German Democratic Party (DDP), which he had helped found, was beginning to flirt with the right-wing reactionaries of the DNVP, the German Nationalist People Party. At one point, he even bragged to his new friends that he could get reparations below $200 million a year. Gilbert tried his best to disabuse the Germans of such excessive optimism and they in turn tried to convince him that Germany "was dancing on a volcano" and could not afford $500 million a year. But the two parties ended up talking past each other.

Thus as the delegations began to descend on Paris in February 1929 for yet one more summit devoted to reparations, none of the partic.i.p.ants realized how wide the chasm of disagreement between the various sides remained. It came as an ill omen when, just as the conference convened, a ma.s.sive cold front descended across Europe, bringing with it the coldest temperatures for almost a century. Temperatures in Berlin fell to their lowest level in two hundred years; in Silesia it was 49 degrees below zero, the coldest day since records had begun in 1690. Europe was icebound. Across the continent, trains were immobilized, ships lay frozen in the Baltic and on the Danube, and many rural communities, particularly in Eastern Europe, faced actual famine. The newspapers carried chilling reports evoking the Dark Ages, of packs of starving wolves attacking isolated villages in Albania and Romania and of a whole band of gypsies found frozen to death in Poland.

The German delegation, weighed down with twenty-seven boxes of files, arrived by train from Berlin on February 8. Paris had escaped the worst of the cold-the temperature was only 10 degrees below zero. Nevertheless, the city authorities had lined the streets with braziers. But for all the chill, in contrast to Central and Eastern Europe, the French capital was visibly booming. The local economy, fueled by soaring exports, high savings, and large capital inflows, was expanding at 9 percent a year, making it the fastest growing major country. In the last two years, the French stock market had enjoyed the best performance in the world, beating even Wall Street's-having gone up 150 percent since the end of 1926, while the Dow had risen 100 percent. With the good times had come a renewed self-confidence, even arrogance, and this being Paris, scandals. As the delegates arrived, the city was still abuzz with L'Affaire Hanau.

Marthe Hanau was a forty-two-year-old divorcee who in 1925 had started a stock tip sheet, La Gazette du Franc La Gazette du Franc. By 1928, she had a following of hundreds of thousands of investors. Taking advantage of the gullibility and cupidity of the small-town savers who were her clients-local priests, retired soldiers, schoolteachers, and shopkeepers-she promoted stocks that were often little more than paper companies. When her success brought her to the attention of the authorities, Hanau, nicknamed by the press "La Grande Catherine de Finance," kept investigators at bay by bribing politicians. The archbishop of Paris was one of her clients. But eventually her extravagance-she always traveled in a convoy of two limousines, in case one of them broke down; regularly splurged $100,000 on diamonds; and periodically spent the weekend at the Monte Carlo gaming tables-caught up with her. In December 1928, she was arrested and forced into bankruptcy, owing $25 million dollars. Now in prison, she was awaiting trial threatening to name names.43 The Germans were put up at the Royal Monceau, a new luxury hotel near the Arc de Triomphe, and furnished with four new limousines by Mercedes-Benz for the duration. This was the first conference at which they felt themselves treated as equals rather than as the enemy. They were even invited to the opening lunch at the Banque de France on Sat.u.r.day, February 9, hosted by the head of the French delegation, emile Moreau. Representing the United States were Owen Young and Jack Morgan, with Thomas Lamont as Morgan's alternate; from Britain came Sir Josiah Stamp, one of the original members of the Reparations Commission of 1921, and Lord Revelstoke, one of the five peers in the Barings family and chairman of the bank; the industrialist Alberto Pirelli, one of the richest men in Italy, and the banker emile Francqui, the richest man in Belgium, represented their countries. Also attending was a delegation from j.a.pan. It was a reunion for many of the men, who like Young and Stamp, had been on the Dawes negotiating teams.

Over a six-course lunch-Huitres d'Ostend washed down with a 1921 Chablis, Homard a l'Americain with a 1919 Pouilly, Roti de Venaison accompanied by an 1881 Chateau Rothschild, Faisans Lucullus with a 1921 Clos de Vougeot, Salade d'Asperge with a 1910 Chateau d'Yquem, a 1910 Grand Fine Champagne with desserts, and finally a bottle of the 1820 Cognac Napoleon over coffee-the delegates selected Owen Young, with his perfect diplomatic skills, as their chairman.

On February 11, the Young Conference-as it would come to be called but was for the moment referred to as the Second Dawes Conference-opened in the Blue Room at the Hotel George V. During the previous decade Paris had been the scene of so many international gatherings that every other grand hotel-the Crillon on the Place de la Concorde, the Bristol on the Rue Saint Honore, the Majestic on the Avenue Kleber, and the Astoria on the Champs-elysees-carried in its faded corridors and meeting rooms the echoes of some gathering of statesmen that had ended in acrimony. It seemed only fitting, a sort of rite of pa.s.sage, for the George V only recently opened for business to host this new meeting before it could claim its place in the ranks as a true Parisian hotel-de-luxe hotel-de-luxe.

On the second day, seated around the horseshoe table, Schacht made his opening offer-$250 million a year for the next thirty-seven years. Moreau conveyed to Young that France would accept nothing less than $600 million a year for the full sixty-two years and might even demand as much as $1 billion. Young was shocked at the huge gap between the main protagonists. Being the consummate financial diplomat, and recognizing that a premature discussion of numbers on reparations would merely lead to an early breakdown in negotiations, he arranged for all the delegates to be tied up in subcommittees for the next six weeks talking around the subject, while he used the time in back-channel shuttle diplomacy between the Germans and the French.

As the conference stretched into its sixth week, a sour and cynical mood began to pervade its halls. Lord Revelstoke complained in his diary that the sessions were "lengthy, tiresome and far from satisfactory. Schacht resumes his most negative att.i.tude, is unhelpful to the last degree." One of the journalists present described Schacht, storming out of meetings with threats to abort the talks, as "a vehement, intolerant man; excitable and dogmatic; . . . the most tactless, the most aggressive and the most irascible person I ever have seen in public life." He alienated all the other delegates with his "tantrums and exhibitionism." Revelstoke thought that with his "hatchet, Teuton face and burly neck and badly fitting collar" he looked like a "sea lion at the Zoo."

Moreau by contrast sat there obstinate and ill-tempered, his mouth shut, Revelstoke observed, "like a steel trap when Schacht pleads poverty and inability to pay." As Moreau watched the Germans become more isolated, he tried to keep quiet and let them dig their own graves. But eventually, unable to restrain himself, he exploded and publicly accused Schacht of negotiating in bad faith. Jack Morgan, bored with the sort of details he generally left to underlings and shaken by his one attempt to try to reason with Schacht, left for a cruise on his yacht around the Adriatic and the Aegean with the archbishop of Canterbury, complaining that, "If h.e.l.l is anything like Paris and an International Conference combined, it has many terrors and I shall try to avoid them."

The German delegates found the atmosphere in Paris menacing. They were not being paranoid. The French secret police were tapping their phones. All communications with their government had to be conducted by courier or by cipher telegrams, with each of the twenty-eight partic.i.p.ants a.s.signed a code name. The three senior representatives, Schacht included, took turns traveling back to Berlin by train every two weeks in order to brief the cabinet.