The Corner

by Bart Ward

A quick flip through today’s newspapers is likely to lead even the most ardent advocates of free markets to acknowledge that professional standards in the banking and securities industry have eroded considerably over the past five years to a new low. In reality this is not true.

During the last 40 years of the 1800s there were all types of crooked and colorful Wall Street operators that left wakes of busted and broken investors. Jim Fisk was associated with Daniel Drew, known as two of the great robber barons of the time. Drew backed Fisk with his brokerage firm of Fisk & Belden. Fisk teamed up with Drew and Jay Gould in a fight with Cornelius Vanderbilt for the Erie Railroad in 1867. This was known as the Erie War, which ended with a crippled railroad that would not make a profit for over 70 years.

Known as “Barnum of Wall Street” and “Jubilee Jim,” Fisk was one of the giant figures of the Gilded Age. He was known to bribe judges and other government officials.

In 1869 Gould and Fisk made an effort to attempt to corner the gold market. They persuaded President Grant to keep federal gold reserves out of circulation. Over time the two ended up controlling enough of the available supply of gold to bid up the price to record levels. Eventually Grant caught on to the scheme and he had the federal government resume the sale of gold. Prices crashed and the gold panic of 1869 began.

The panic of 1873 was the result of risky loans made by high-flying bankers to major operators of the railroads. When the panic hit and passed one of the worst economic collapses of the 19th century occurred. Approximately 10,000 businesses closed down during the depression that lasted until 1878.

The panic of 1893 created a long drawn out depression in the U.S. This panic was the result of a collapse of the railroad business because of overbuilding and bad financing. What marked this period of overbuilding was the desire by bankers and brokers to sell bonds and stocks to unsuspecting foreign investors. Lines were built that deadened in nowhere land. Many new railroad lines were built right next to already existing lines, making it difficult for the new lines to be profitable. Nevertheless the origination and sales of railroad stocks and bonds made fortunes for many and left others with big losses when the bust hit.

The 1907 panic was one the biggest of all time and has some of the hallmarks of our current problems in the U.S. It led to the Pugo investigations of 1913 headed by Congressman Arsène Pujo. Minnesota congressman Charles Lindbergh Sr. introduced a resolution to begin an investigation of Wall Street and Pugo formed a subcommittee of the House Committee on Banking and Currency. While a number of high profile bankers were accused of wrongdoing, the end game was that the Federal Reserve System was created with the passage of the Sixteenth Amendment in 1913.

The banking and securities industry was plagued by notoriously low standards in the 1920s, ending with the Great Crash of ‘29. This was followed by the U.S. Senate Pecora Investigations in 1932. The Glass-Steagall Act of 1932 split commercial and investment banking. Finally came the creation of the Securities Acts of 1933 and ‘34. The ‘34 act created the Securities & Exchange Commission.

In the 1950s and ‘60s there were many transactions that might well have run afoul of today’s insider-trading laws or notions of fiduciary conduct. By the end of the 1980s, the securities business had been through a period of intense scrutiny and prosecution, and the result was an industry operating under much higher worldwide standards of disclosure, customer protection and fair trading practices than at any other time in history.

In reality, the standards were rising at the same time as the competition was becoming more intense, and it was harder and harder to make a buck the old-fashioned way (by trading in markets with lower standards and larger spreads). As the markets were becoming more efficient, many firms stuck their necks out a bit further and took more risk. Among the risks they took was to focus more on incentive compensation in return for delivered profits, and sometimes to tolerate profits from transactions that might be questionable or worse.

By the early 1990s, following an array of financial scandals, the public perception of the securities industry was near its low again. Professional standards, which incorporate the industry’s reputation for integrity, service, quality and expertise, had been seriously tarnished by criminal proceedings, regulatory complaints, customer litigation and all the publicity that attended them. Trust and confidence in the banking and securities industry once again reached levels not seen since the “orgy of corporate larceny” during the 1920s. No industry can thrive and prosper for long with such a reputation. Public distrust and increased scrutiny and regulation produced a deadening brew of more competition, greater risks, more litigation and increased costs of compliance.

The Dotcom Bust hit at the end of the 1990s speculative bull market, followed (as usual) with a whole host of investigations and new regulations including the Sarbanes Oxley Act of 2002. This speculative bull run in the stock market was peddled by many brokerage firms and venture capitalists of Silicon Valley. From 1995 to 2000, a boom occurred in the stocks of Internet-based companies. Many of which never made any money at all. Plenty of these companies ran out of money and eventually were sold or fell into bankruptcy. Some executives were convicted of fraud and a number of top tier banks and brokerages were fined millions. When the crash hit, there were losses of over $5 trillion in the market value of dotcom companies which stunned investors all over the world.

One of the great challenges to the banking and securities industries is the maintenance of their reputation for high professional standards of conduct while coping with the sea of changes that engulfs the underlying economic base from time to time. But to think that this time is unique and things are the worst that they have ever been, only speaks to one of the great quotes on Wall Street: “The only thing new on Wall Street is unlearned history.”

Quote of the Week: “The price of greatness is responsibility”—Winston Churchill

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