It was a grave problem, however, that in the event of failing earnings and values, leverage would work fully as powerfully in reverse. All income and value, and in practice more, would be absorbed by the outer debt and preferred shares; for the originating company there would remain literally—very literally—nothing. But of this in 1929 no one, or not many, thought; a rising market combined with the managerial and investment genius of the men who built these structures made any such concern seem irrelevant in the extreme.
Here the parallel: after fifty-seven years investment trusts, called closed-end funds, are now coming back into fashion, although still, I would judge, in a rather modest way as compared with 1929. The more exciting parallel is in the rediscovery of leverage. Leverage is again working its wonders. Not in utility pyramids: these in their full 1929 manifestation are forbidden by law. And the great investment houses, to be sure, still raise capital for new and expanding enterprises. But that is not where the present interest and excitement lie. These lie in the wave of corporate takeovers, mergers, and acquisitions and the leveraged buy-outs. And in the bank loans and bond issues, not excluding the junk bonds, that are arranged to finance these operations.
The common feature of all these activities is the creation of debt. In 1985 alone some $139 billion dollars' worth of mergers and acquisitions was financed, much of it with new borrowing. More, it would appear, was so financed last year. Some $100 billion in admittedly perilous junk bonds (rarely has a name been more of a warning) was issued to more than adequately trusting investors. This debt has a first claim on earnings; in its intractable way, it will absorb all earnings (and claim more) at some astringent time in the future.
That time will come. Greatly admired for the energy and ingenuity it now and recently has displayed, this development (the mergers and their resulting debt), to be adequately but not unduly blunt, will eventually be regarded as no less insane than the utility and railroad pyramiding and the investment-trust explosion of the 1920s.
Ever since the Compagnie d'Occident of John Law (which was formed to search for the highly exiguous gold deposits of Louisiana); since the wonderful exfoliation of enterprises of the South Sea Bubble; since the outbreak of investment enthusiasm in Britain in the 1820s (a company "to drain the Red Sea with a view to recovering the treasure abandoned by the Egyptians after the crossing of the Jews"); and on down to the 1929 investment trusts, the offshore funds and Bernard Cornfeld, and yet on to Penn Square and the Latin American loans—nothing has been more remarkable than the susceptibility of the investing public to financial illusion and the like-mindedness of the most reputable of bankers, investment bankers, brokers, and free-lance financial geniuses. Nor is the reason far to seek. Nothing so gives the illusion of intelligence as personal association with large sums of money.
It is, alas, an illusion. The mergers, acquisitions, takeovers, leveraged buy- outs, their presumed contribution to economic success and market values, and the burden of debt that they incur are the current form of that illusion. They will one day—again, no one can say when—be so recognized. A fall in earnings will render the debt burden insupportable. A minor literature will marvel at the earlier retreat from reality, as is now the case with the Penn Square fiasco and the loans to Latin America.
The third parallel between present and past, which will be vividly and also painfully revealed, concerns one of the great constants of capitalism. That is its tendency to single out for the most ostentatious punishment those on whom it once seemed to lavish its greatest gifts.
In the years before the 1929 crash the system accorded fortune and prestige to a greatly featured croup of men—to Arthur W. Cutten, M. J. Meehan, Bernard E. ("Sell'em Ben") Smith, and Harry F. Sinclair, all market operators of major distinction; also to Charles E. Mitchell, the head of the National City Bank as it then was, and Albert Wiggin, the head of the Chase National Bank, both deeply involved in the market on their own behalf; to Ivar Kreuger, the Match King, international financier (and sometime forger of government bonds); and to Richard Whitney, soon to become president of the New York Stock Exchange and its most uncompromising public defender.
All suffered a fearful fall after the crash. Called before a congressional committee, Cutten, Meehan, and Sinclair all had grave lapses of memory. Mitchell and Wiggin, the great bankers, were both sacked; Mitchell went through long and tedious proceedings for alleged income-tax evasion, and the large pension Wiggin had thoughtfully arranged for himself was revoked. Ivar Kreuger went out one day in Paris, bought a gun, and shot himself. Harry Sinclair eventually went to jail, and so, for embezzlement, did Richard Whitney. Whitney's passage into Sing Sing, in dignified, dark-vested attire, wearing, it has been said, the Porcellian pig of his Harvard club, was one of the more widely circulated news portraits of the time.
The young professionals now engaged in much-admired and no less publicized trading, merger takeover, buy-back, and other deals, as they are called, will one day, we can be sadly sure, suffer a broadly similar fate. Some will go to jail; some are already on the way, for vending, buying, and using inside information. Given the exceptionally oblique line between legitimate and much-praised financial knowledge and wrongfully obtained and much-condemned inside information, more are known to be at risk. But for most the more mundane prospect is unemployment and professional obloquy, and for some, personal insolvency. Expensive apartments will become available on the upper East Side of Manhattan; there will be property transfers in the Hamptons. David Stockman, said by the press to have a car sent out for him to Connecticut each morning by his employer, may end up taking the train.
S. C. Gwynne, a young onetime banker, tells in his excellent book Selling Money of his services in the late seventies and early eighties to the international division of Cleveland Trust, now AmeriTrust, a relatively conservative player on the world scene. He journeyed from Manila to Algiers and Riyadh in search of loans. It was a time of admiring reference to the recycling of funds on deposit from the OPEC countries to the capital-hungry lands. And he tells us that
by December 31, 1982, more than $200 million in loans would be in trouble in Mexico, Brazil, Venezuela, Poland, and the Philippines.... By 1984, thirteen of the seventeen officers who had staffed the [international] division in 1980 would be gone, and Ben Bailey, [the] deputy manager, and most of the members of the senior credit committee that approved the foreign loans would take early retirements.
The end for those in the present play will come when either recession or a tight- money crunch to arrest inflation makes the debt load they have so confidently created no longer tolerable. Then there will be threats of default and bankruptcy, a drastic contraction in operations, no bonuses, a trimming of pay and payrolls, and numerous very, very early retirements. And from many who did not themselves foresee the result, there will be a heavy-handed condemnation of the failure to see that this would be the result. For those who engage in trading operations at the investment houses the day of reckoning could be when the market goes down seemingly without limit. Then will be rediscovered the oldest rule of Wall Street: financial genius is before the fall.
The final parallel with 1929 is a more general one; it has broadly to do with tax reduction and investment incentives. In the Coolidge years, as noted, Andrew Mellon reduced taxes on the affluent. The declared purpose was to stimulate the economy; more precise reference to saving, investment, and economic growth was for the future. The unannounced purpose was, as ever, to lessen the tax bite on the most bitten. By the summer of 1929 the economy was, nonetheless, stagnant—even in slight recession. (To this, rather than to the built-in inevitabilities of speculation, some economists looking for deeper substance later attributed the crash.) There is every likelihood that a very large part of the enhanced personal revenues from the tax reduction simply went into the stock market, rather than into real capital formation or even improved consumer demand.
So again now. Funds have been flowing into the stock market to be absorbed by the deals aforementioned or the cost of making them. Some, perhaps much, of this money—no one, to be sure, knows how much—is from the supply-side tax reductions. Real capital spending is currently flat, even declining—a depressing fact.
From the mergers, acquisitions, and buy-backs, it is now reasonably well agreed, comes no increase at all in industrial competence. The young men who serve in the great investment houses render no service to investment decisions, product innovation, production, automation, or labor relations in the companies whose securities they shuffle. They have no real concern with such matters. They do float some issues for new ventures or expanded operations; one concedes this while noting again how dismal is the present showing on real capital investment. Mostly their operations absorb savings into an inherently sterile activity.
History may not repeat itself, but some of its lessons are inescapable. One is that in the world of high and confident finance little is ever really new. The controlling fact is not the tendency to brilliant invention; the controlling fact is the shortness of the public memory, especially when it contends with a euphoric desire to forget.