The Days Of Boom And Bust

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During the twenties the balance was maintained by making new foreign loans. Their promotion was profitable to domestic investment houses. And when the supply of honest and competent foreign borrowers ran out, dishonest, incompetent, or fanciful borrowers were invited to borrow and, on occasion, bribed to do so. In 1927 Juan Leguia, the son of the then dictator of Peru, was paid $450,000 by the National City Company and J. & W. Seligman for his services in promoting a $50,000,000 loan to Peru which these houses marketed. Americans lost and the Peruvians didn’t gain appreciably. Other Latin American republics got equally dubious loans by equally dubious devices. And, for reasons that now tax the imagination, so did a large n timber of German cities and municipalities. Obviously, once investors awoke to the character of these loans or there was any other shock to confidence, they would no longer be made. There would be nothing with which to pay the old loans. Given this arithmetic, there would be either a sharp reduction in exports or a wholesale default on the outstanding loans, or more likely both. Wheat and cotton farmers and others who depended on exports would suffer. So would those who owned the bonds. The buying power of both would be reduced. These consequences were freely predicted at the time.

The second weakness of the economy was the large-scale corporate thimblerigging that was going on. This took a variety of forms, of which by far the most common was the organization of corporations to hold stock in yet other corporations, which in turn held stock in yet other corporations. In the case of the railroads and the utilities, the purpose of this pyramid of holding companies was to obtain control of a very large number of operating companies with a very small investment in the ultimate holding company. A $100,000,000 electric utility, of which the capitalization was represented half by bonds and hall by common stock, could be controlled with an investment of a little over $25,000,000—the value of just over half the common stock. Were a company then formed with the same capital structure to hold this $25,000,000 worth of common stock, it could be controlled with an investment of $6,250,000. On the next round the amount required would be less than $2,000,000. That $2,000,000 would still control the entire $100,000,000 edifice. By the end of the twenties, holding-company structures six or eight tiers high were a commonplace. Some of them—the utility pyramids of Insull and Associated Gas & Electric, and the railroad pyramid of the Van Sweringens—were marvelously complex, it is unlikely that anyone fully understood them or could.

In other cases companies were organized to hold securities in other companies in order to manufacture more securities to sell to the public. This was true of the great investment trusts. During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts—Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.

This corporate insanity was also highly visible. So was the damage. The pyramids would last only so long as earnings of the company at the bottom were secure. If anything happened to the dividends of the underlying company, there woidd be trouble, for upstream companies had issued bonds (or in practice sometimes preferred stock) against the dividends on the stock of the downstream companies. Once the earnings stopped, the bonds would go into default or the preferred stock would take over and the pyramid would collapse. Such a collapse would h;ivc a bad effect not only on die orderly prosecution of business and investment by the operating companies but also on confidence, investment, and spending by the community at large. The likelihood was increased because in any number of cities—Cleveland, Detroit, and Chicago were notable examples—the banks were deeply committed to these pyramids or had fallen under the control of the pyramiders.

Finally, and most evident of all, there was the stock market boom. Month after month and year after year the great bull market of the twenties roared on. Sometimes there were setbacks, but more often there were fantastic forward surges. In May of 1921 the New York Times industrials stood at 106; by the end of the year they were 134; by the end of 1925 they were up to 181. In 1927 the advance began in earnest—to 245 by the end of that year and on to 331 by the end of 1928. There were some setbacks in early 1929, but then came the fantastic summer explosion when in a matter of three months the averages went up another 110 points. This was the most frantic summer in our financial history. By its end, stock prices had nearly quadrupled as compared with four years earlier. Transactions on the New York Stock Exchange regularly ran to 5,000,000 or more shares a day. Radio Corporation of America went to 573¾ (adjusted) without ever having paid a dividend. Only the hopelessly eccentric, so it seemed, held securities for their income. What counted was the increase in capital values.