13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (5 page)

Both Jefferson and Jackson saw a powerful bank as a corrupting influence that could undermine the proper functioning of a democratic government. While this was not a foregone conclusion—the First Bank had lost its bid for a renewed charter in part because of its political weakness
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—the Bank War gave a hint of the way financial power could be misused for political ends. Jefferson and Jackson did not think the government could control finance; the idea of a modern, technocratic central bank lay beyond their imagination, far in the future. Instead, they feared that powerful, privately owned financial institutions would gain disproportionate influence over the government. Given the choice between the Second Bank and no national bank at all, Jackson chose the latter. As a result, central banking developed slowly and informally in the United States, especially when compared to Europe.
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But even with this handicap, the U.S. economy continued to innovate and grow through the nineteenth century.

Most important, Jackson’s victory ensured that a powerful private bank was not able to install itself in the corridors of political power and use its privileged position to extract profits for itself, inhibit competition, and hamper broader economic development. Perhaps the United States could in any case have avoided the fate suffered during the same period by Mexico or Brazil—where a small elite controlled a concentrated banking sector, with unfortunate economic results—and by many recent emerging markets.
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Had Jackson lost the Bank War, it is possible that the Second Bank might have gradually evolved into a modern central bank without distorting the political system to its own advantage.
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But this was not a risk that Jackson wanted to take, and his populist prejudices against financial elites (and his desire for increased presidential power) ensured that the American financial system would err on the side of fragmentation and decentralization. Although the resulting financial system was vulnerable to macroeconomic shocks, it was generally able to supply the capital needed by a growing business sector, and it did not soon generate a small elite with a dangerous amount of economic and political power.

THE MONEY TRUST

By the late nineteenth century, however, industrialization had created a powerful economic elite that held political power at all levels, with its supporters in substantial control of the Senate, the Republican Party, and the presidency. Seventy years after Jackson, it was time for another confrontation between an independent-minded president and concentrated economic power.

Despite its decentralized financial system, nineteenth-century America had turned out to be a great place to develop new ideas and make money. Americans were among the first to invent or commercialize many new technologies that arose after 1800, building companies based on innovations in agricultural implements, canals, telecommunications, steam power, railroads, chemicals, and other industries. By the end of the nineteenth century, American companies were at the forefront of almost all of the technology-intensive industries that were making it possible to produce more and better goods with fewer and cheaper inputs.
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Finance played a constructive supporting role during this period, providing the crucial connection or “intermediation” between savers on the one hand and people with productive investment opportunities on the other hand.
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Capital continued to flow into productive uses even after the demise of the Second Bank.
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The innovations that changed the economic landscape changed the political landscape as well. Social mobility and the lack of an entrenched aristocracy meant that newly successful companies and industries could gain political representation quickly, at least when compared to European societies. New money could make its way into politics, whether legally or illegally. By the late nineteenth century, the Senate had become known as the “Millionaires’ Club”; buying political support with cash was considered by many to be just an extension of normal business practices.
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Railroad wealth was the most prominent late-nineteenth-century example of the entrance of new money into politics. In the three decades immediately following the Civil War, America was swept by a craze for building new railroads. Fortunes were made and lost and businesses built and destroyed, while long-distance travel became much faster and hauling freight became much cheaper than ever before. The railroad barons and their industrial allies acquired great political power, coming to dominate the Senate by the turn of the century. Two of their strongest allies, Senators Mark Hanna and Nelson Aldrich, were important power brokers in the Republican Party, which controlled the White House for all but eight years from 1869 to 1913 and had a Senate majority for all but two years from 1883 to 1913. Hanna managed William McKinley’s successful 1896 presidential campaign and dominated the Republican Party machine into the Theodore Roosevelt years; Aldrich was one of the most powerful men in the Senate and largely dictated its positions on government regulation of industry and banking.
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Political representation for rising industrial interests is preferable to ossified social structures that restrict innovation and keep new people away from the levers of power.
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Most of the European societies that had such restrictions struggled to keep up with the Industrial Revolution and fell behind their competitors. The United States also turned out much better than Latin American countries, such as Mexico, which started at roughly similar income levels but where elites controlled concentrated banking systems; in some cases a lack of effective corporate governance led to nepotism and insider transactions that took advantage of outside shareholders.
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At the same time, however, the openness of the American political system has always made it possible for the current business elite to use its political power to shift the economic playing field in its favor. Any growing and profitable sector can take this route, from railroads, steel, and automobiles to defense and energy. Each of these industries has used the argument that “what’s good for (fill in the blank) is good for America” in order to obtain preferential tariffs, tax breaks, or subsidies.
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This was the case for the new industrial trusts that emerged late in the nineteenth century.
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These massive agglomerations of economic power were brought on in part by the spread of railways, which created national markets for many goods, making possible economies of scale of previously unheard-of dimensions.
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Consolidation was also a reaction to prolonged economic downturn and perceived overcapacity in some industries. But it stemmed as well from the old-fashioned instincts of successful industrialists, who realized that combining with their competitors (at least the ones they hadn’t been able to wipe out) could give them an effective monopoly, and with it the power to increase prices and profits. The rise of the trusts was a momentous development in American economic history in its own right. But it was also important because it brought concentrated financial power back onto the economic stage.

Standard Oil was an early pioneer of the trusts, followed closely by imitators in other industries. According to historian Thomas McCraw, “in the period 1897–1904 … 4,227 American firms merged into 257 combinations. By 1904, some 318 trusts … were alleged to control two-fifths of the nation’s manufacturing assets.”
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The rise of the trusts depended heavily on investment bankers, who provided the money needed to buy shares and rearrange shareholdings and also offered the social glue necessary to bring disparate industrial interests together. A handful of bankers led by J. P. Morgan played a central role in this rapid transformation of the business landscape, giving Morgan an economic importance unmatched by any financier since Biddle, if not the beginning of the republic.
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Morgan’s empire handled an extraordinary share of the money flowing into American industry—as high as 40 percent of total capital raised at the beginning of the twentieth century.
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In a lightly regulated banking system, industrial concentration led naturally to financial concentration, and J. P. Morgan stepped forward to take the reins of the financial system.

The 1896 election of McKinley as president was welcomed by large corporate interests that feared the alternative—populist crusader William Jennings Bryan. However, they would be less happy with his second-term vice president and successor (after McKinley’s assassination in September 1901), Theodore Roosevelt, who adopted “trust-busting” as a signature policy and made improved supervision of large corporations a major theme of his 1901 State of the Union address.
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(McKinley had begun investigating the trusts, but Roosevelt was the first president to take them on directly.) Roosevelt pushed through major legislation to tighten regulation of the railroads. More important, his Department of Justice pioneered the use of the Sherman Antitrust Act of 1890 to break up large trusts, first taking aim at the Northern Securities Company, a railroad combination engineered by J. P. Morgan among others.
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In 1904, the Supreme Court agreed with the Roosevelt administration and dissolved Northern Securities as “an illegal combination in restraint of interstate commerce.”
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The industrial-finance barons didn’t understand why Roosevelt was so worked up; J. P. Morgan’s response was “If we have done anything wrong, send your man to see my man, and they can fix it up.”
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But Roosevelt, following in the tradition of Jefferson and Jackson, opposed concentrated industrial power for political reasons; he believed that dominant private interests were bad for democracy and for economic prosperity.
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In taking on the trusts, he sought not only to obtain greater economic benefits for consumers (the prevailing modern interpretation of antitrust law), but to safeguard democracy from monied elites and maintain an economic system that was open to new ideas and new businesses. In the process, he helped change the way Americans thought about big business. As Nobel Prize–winning economist George Stigler wrote, “A careful student of the history of economics would have searched long and hard on July 2 of 1890, the day the Sherman Act was signed by President [Benjamin] Harrison, for any economist who had ever recommended the policy of actively combatting collusion or monopolization in the economy at large.”
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After Roosevelt, however, the consensus view became that antitrust law should be used to break up monopolies and prevent abuses of market power.

The Roosevelt administration’s successful prosecution of antitrust cases in the courts led to more cases brought under Presidents William Howard Taft and Woodrow Wilson, including the court-ordered breakup of Standard Oil in 1911. However, these policies did little to disturb the concentration of money and power that had taken place in the financial sector in parallel with the rise of the industrial trusts. The wave of industrial concentration at the end of the nineteenth century was supposed to stabilize individual markets and cushion particular industries against overexpansion and price wars.
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Instead, the interaction between large industrial trusts and their bankers created the backdrop for the worst financial crisis in American history to date, which brought concentrated banking power to the political forefront.

In October 1907, a routine (for the time) attempt to manipulate the price of stock in the United Copper Company by company insiders and their Wall Street banker went awry, triggering a run on banks perceived to be connected to the scheme.
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The panic soon spread to the Knickerbocker Trust Company, one of the largest financial institutions in New York, and then to many other banks in the city. In order to raise cash quickly, banks were forced to sell whatever they could, pushing down asset prices across the board; stock prices also fell as banks cut back on loans to stockbrokers. This is a standard feature of any financial crisis.
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Any bank has deposits that customers can withdraw immediately, while many of its loans (such as mortgages) cannot be called in on demand. As banks stop lending, borrowers are forced to liquidate assets in order to pay off their debts, reducing asset prices even further and creating more pressure on banks. In any banking system, a crisis can be rapidly magnified by this vicious cycle, sometimes called the “financial accelerator.”
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This is the type of crisis that central banks are supposed to prevent; but thanks to Andrew Jackson’s victory in the Bank War, the United States had not developed a central bank. Instead, J. P. Morgan—the man—stepped in to fill the gap. He and his team, led by Benjamin Strong, decided which banks should fail because they were irredeemably insolvent and which should be saved because they only needed some cash to get them through the panic; then they pressured other major financial institutions to join with Morgan in providing loans and deposits to threatened banks in order to ensure their survival. They were brutal in these choices, and their decisions were final. But despite J. P. Morgan’s financial muscle, the private sector could not come up with sufficient funds. The only entity with enough ready money to stabilize the situation was the U.S. government, which deposited $25 million into New York banks to provide the liquidity needed to keep the financial system afloat.
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