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WALL STREET: How It
Works and for Whom, by Doug Henwood (Verso, 372 pp)
Anybody who ever entrusts his or her money to Wall Street should remember Daniel
Drew’s handkerchief. Drew, an illiterate cattle driver turned short seller,
became the treasurer of the Erie Railroad in 1857. In the cattle business,
Drew’s specialty had been to nearly starve the beasts in his charge and then
give them lots of water just before delivering them so that they appeared to
have the fullness and sheen of health. With Erie, a company whose balance sheet
was just as watery as his cows, he tried a new trick. Drew paid a visit to a New
York club where the brokers congregated. It was a hot day, and Drew took out a
handkerchief to mop his brow. A piece of paper popped out of his pocket that he
pretended not to see. After Drew left, the traders seized the scrap; it
contained plenty of bullish information about Erie. The stock soared, and Drew
began to sell the shares. As the news about Drew’s scheme emerged, the price
dropped precipitously, allowing him to buy the shares back for a pittance and
lock in a tidy profit.
Other doyens of the Erie Railroad included Jay "Mephistopheles" Gould, who
defrauded so many investors that he had to walk home with a bodyguard, and James
"Jubilee Jim" Fisk, who was eventually shot by his mistress’ lover (to the
relief of many). Indeed, a quick glance at Wall Street’s ancestry makes Woody
Allen’s definition of the modern stockbroker as "somebody who takes your money
and invests it until it’s all gone" seems like a sign of progress.
Wall Street’s villains may be of some concern to investors. But they also
provide the makings of a wonderful book. There have been plenty of colorful
histories about Hollywood and a few about Silicon Valley – though neither of
those centers has occupied such central roles in American history as the
southern tip of Manhattan. Surely Wall Street, the heart of the most impressive
economy on the globe, deserves its own chronicler too?
Charles Geisst’s "Wall Street, " the first history of this piece of real estate,
answers the call. But his book is a frustrating affair because it is duller than
it need have been. Geisst’s decision to make Wall Street’s relationship with
government the central theme of this book is a little like deciding to examine
Hollywood through the prism of the Los Angeles City Council. Intriguing rascals
such as Drew force their way into the story, but Geisst gives the impression
that he would much rather deal with something more serious, like the Glass-Steagall
Act. A professor at Manhattan’s College of Business, Geisst divides Wall
Street’s history into four parts: the chaotic early years from 1790, when the
new American government issued its first bonds, to the Civil War; the era of
robber barons that lasted until the crash of 1929; the subsequent bout of
depression and regulation that did not really end until 1954; and then the long
recovery sparked by the Eisenhower boom. Inevitably the first two parts, which
are the most lawless, are also the most interesting.
Wall Street was so named because it ran alongside a barricade erected by Peter
Stuyvesant to protect the early settlers from the wilds of Manhattan. In the
18th century, the street and the coffeehouses around it became a trading place
for investors. At that time, most American private sector wealth was tied up in
land. The biggest borrower in the New World was the young (and distrusted)
American government, and its chief source of investment was Britain. This
emerging market’s first big crash involved an old Etonian named William Duer,
who was a friend of both Alexander Hamilton and George Washington. In 1792, Duer,
who had amassed enormous wealth through exploiting his political contacts and
engaging in curbside speculation, over-borrowed, and the market turned against
him. Panic set in as traders struggled to collect their debts. Much was made of
Duer’s iniquitous British nationality and of the extravagance of his wife, Lady
Kitty (the Duers famously served 15 types of wine at dinner). He died in a
debtors prison in 1799.
The Duer case set the tone for the next century: shady dealings, amazing booms
and busts, political noises just off stage, ostentatious (though not entirely
respectable) wealth and, above all, the importance of foreigners. British and
Dutch investors held about half the Treasury’s securities in 1803. The British
tactfully sold up just before they burned down the White House in 1814, but
soon, despite recurrent protests about America being a "nation of Swindlers, "
they were back again. It was fairly normal for British investors to own more
than half the debt of a state government or most of the stock in a new railroad.
Many of America’s investment banks, including the house of Morgan and what
became Kidder Peabody, were started in London. (The Bank of the United States
was ostensibly abolished on the grounds that the majority of stockholders were
foreign nationals. WFI Editor)
The most successful people on Wall Street were businessmen who had already made
a great deal of money elsewhere, such as John Jacob Astor, whose first fortune
came from the fur business. But by the mid-19th century, Wall Street had become
more central to the nation’s financial life. To men such as J. P. Morgan and
Cornelius Vanderbilt, Wall Street, bear raids and money trusts were essential
parts of business life; indeed it was largely thanks to their mastery of Wall
Street’s methods that they were able to corner such large areas of the American
economy. Yet even as the robber barons grew rich, public resentment mounted
against a system that left 5% of the population controlling more than 90% of the
wealth. Spurred on by Populists such as Louis Brandeis, one congressional
committee condemned Morgan and his fellow bankers for controlling 341
directorships in 112 companies with total assets of $22 billion. After the crash
in 1929, anger against Wall Street boiled over, particularly once it became
known that stockbrokers had earned $2.4 billion in commissions and interest from
1928 to 1933.
Geisst does a good job of describing how the regulatory noose gradually
tightened around Wall Street’s plump neck. But with each new law, his story
lags. The final part of his book, which deals with the 1980s and 1990s, is
especially flat. He says nothing new about a period with which most of his
readers will be very familiar, and the characters fade away. Michael Milken
appears almost as if he were a statistic: Surely the bewigged creator and
dictator of the junk bond market who as a young man went to work early in the
morning with a miner’s lamp strapped to his head so that he could read brokers’
reports is worth some description? Traders and corporate raiders like Ivan
Boesky and Henry Kravis could also have been brought to life. (It is also
interesting that the megalithic Savings and Loans collapse during the 1980s --
which was partially attributable to the junk bond market -- is completely
skipped over, even though it represented the biggest financial corruption
scandal in the history of the republic. WFI Editor)
Above all, it is strange to treat the decadent, internationally minded Wall
Street of the 1980s and 1990s as part of the same era that began with the rather
staid Eisenhower boom. The forces of globalization, technology and popular
capitalism (particularly the mutual fund industry) have changed the financial
services industry forever. Brokers must now make their livings in an age of
cheap Internet trading, indexed funds and harsh quarterly reviews of their
performance, all of which make their business harder to perform. Geisst’s
regulators look even more out of the picture, unable to control markets where
money whizzes around the world in a matter of seconds. Indeed, in many ways,
Wall Street is entering uncharted waters, where its history is only a partial
guide to its future. From this point of view, there is an argument for reading
no more than the first two-thirds of "Wall Street" and then turning to Doug
Henwood’s book, which has the same title but is a theoretical broadside, not a
history. Henwood, the editor of Left Business Observer, would seem to be a
living oxymoron: a socialist who is fascinated by finance. In fact, the same
could be said of Karl Marx. The main difference is that Henwood has a sense of
humor (one has to admire anybody who includes, among the various blurbs on the
back of his book, the following comment from Norman Pearlstine, the former
executive editor of the Wall Street Journal: "You are scum… It’s tragic that you
exist.")
At its best, Henwood’s book fits into the category of scholarly contrarianism.
American firms, he points out, actually retired $700 billion more in stock than
they issued in 1981-96, and most corporate investment comes from internal funds.
So how can Wall Street claim its raison d’etre is to raise money for new firms?
He correctly criticizes the slavish financial press and takes some potshots at
right-wing economists like Michael Jensen while trying to argue that John
Maynard Keynes deserves a second look. In fact, his book only has one real
fault: He is just, well, wrong. All the evidence seems to point to the fact that
good old red-blooded Anglo-Saxon capitalism, for all its excesses and
inefficiencies, actually seems to work much better than any of the alternatives.
Dismissing Henwood as an amusing irritant will doubtless comfort the partners at
Goldman, Sachs. Yet they would do well to consider one recurring theme of his
book and Geisst’s: Wall Street tends to go too far. Inequality in America is on
the increase. The downsizing that Wall Street has so applauded over the last
decade has created a much wider class of malcontents than did previous waves of
restructuring. The middle managers who lost their jobs bitterly resent the huge
pay packets being given out to those who orchestrated their downfall. As this
generation of Daniel Drews is "limoed" back home to their penthouses on Fifth
Avenue, they should wonder how the next generation will cope with the bitter
harvest that they have sown.
F. I. A. S. C. O.: Blood in the Water on Wall Street, by Frank Partnoy (W. W.
Norton, 252 pp)
(Review by Nicholas Von Hoffman, author of numerous books, including "Capitalist
Fools: Tales of American Business, From Carnegie to Forbes to the Milken Gang.")
Of the four financial market books under review here, the one to go long on, as
the security traders say, is "F.I.A.S.C.O." This is a book that should be
getting considerably more attention than it has gotten to date. In a society
transfixed by and dependent on the movement of the markets, you fail to read "F.I.A.S.C.O."
at your own peril. Frank Partnoy has stocked his work with a nice sampling of
the brawling obscene quotas and frothy-mouthed maniacs who have become standard
in Wall Street books since the publication of Michael Lewis’ entertaining
"Liar’s Poker." Indeed, the title of Partnoy’s book, which is chiefly devoted to
the quasi-criminal goings-on at Morgan Stanley, doesn’t refer to some great
financial mess-ups but to the initials of the Fixed Income Annual Sporting Clays
Outing, an event at which a gang of happy rogues from the company get snockered
on alcohol and their egos as they blast away at clay pigeons with their 12-gauge
shotguns. It’s a harmless day in the country, and from reading this book, one
gets the sense that it may be the only activity at Morgan Stanley which is.
"F.I.A.S.C.O.’s" merrymakers are the men and women who trade in derivatives at
the investment bank, which has epitomized white shoe probity and propriety for
most of this century. If Partnoy has it anywhere close to being right, you may
substitute "probity" with "piracy." Partnoy, a professor of law at the
University of San Diego with additional degrees in economics and mathematics,
probably does have it right. He worked at Morgan Stanley, inventing derivatives
and selling them out of the New York headquarters and in Tokyo. Moreover,
Partnoy has the skill to explain financial exotica so that a reader with none of
his brains or training can understand what’s being said without needing Tylenol.
Even for those only mildly interested in finance, there is reason to read "F.I.A.S.C.O."
The annual trade in derivatives is estimated to be $55 trillion, or "double the
value of all U.S. stocks and more than 10 times the entire U.S. national debt."
As the ratepayers (taxpayers?) of Orange County (California) learned to their
chagrin, losing at the game of derivatives doesn’t affect only the high rollers
of finance. Often to their regret, San Diego and San Bernardino counties and the
California Public Employees Retirement System have played the derivatives game,
as have Proctor & Gamble, Dell Computers and Mead Corp. Gains and losses affect
pensions, taxes, dividends, lay-offs and hirings. (To say nothing of public
services, some of which are vital. WFI Editor)
Partnoy explains that one form of derivatives, called equity swaps, is used by
many companies and very rich individuals to avoid paying capital gains tax, or
any tax for that matter, on profits from the sale of securities. Hence, Partnoy
writes, "There was no longer any need for wealthy shareholders to lobby
politicians to repeal the capital gains tax; for a few, investment banks offered
a top-secret individualized do-it-yourself capital gains tax repeal. In recent
years, the capital gains taxes from wealthy individuals in the U.S. have been
close to zero, in large part because of Equity Swaps." (It makes one wonder why
the Republicans keep up their incessant hullabaloo on the subject, unless it is
to keep people from learning about what is actually going on).
Unlike the easily recognized and understandable stocks and bonds, derivatives
are financial instruments in which the word "derivative" never appears.
Typically, they will have names like Dollarized Yield Curve Notes, Discrete
Payoff Bull Notes, Constant Maturity Treasury Floaters, Prime-LIBOR (London
Interbank Offering Rate, if that helps), Floating Rate Notes, Oil Linked Notes,
Real Return Bond Strips and hundreds more. Few of them are exactly alike, so
that you cannot assume that if you understand Constant Maturity Treasury
Floaters you will have any idea how a Brady Income Government Security works.
Without the training of a Partnoy and the correct statistical model on your
computer, it is impossible to understand what these various instruments are
worth, how much risk they entail or how much they may yield day to day or week
to week. Partnoy writes that they are frequently designed to obfuscate, confuse
and conceal. Sometimes it is Morgan Stanley and/or its competitors who invent
derivatives that, he says, are put together so that the people buying them
really don’t know what they’re buying. Sometimes they are designed to conceal
information from regulatory authorities, creditors or shareholders. These
insecurities are often so complicated that the rating agencies can’t penetrate
their contents.
"[The Orange County bankruptcy] filing made the rating agencies look like
fools, " Partnoy writes. "Just a few months before [the bankruptcy], in August
1994, Moody’s Investor Service had given Orange County a rating of Aa1, the
highest rating of any California county. A cover memo to the rating letter
stated, ‘Well done, Orange County.’ Now, on Dec. 7, an embarrassed Moody’s
declared Orange County’s bonds to be ‘junk’ – and Moody’s was regarded as the
most sophisticated ratings agency."
Partnoy accuses Morgan Stanley of using derivatives to collude with Japanese
companies to, in effect, doctor their books and hide their loses. In light of
what has been happening to business in the Far East these last months, this is
not a private act of betrayal affecting a few greedy businessmen. The possible
ramifications of these transactions can be almost global. (Imagine, if the
businessmen have managed to create securities that conceal financial
irregularities and crimes, what the politicians/legislators are doing with the
trillions they have collected over the years from American taxpayers, using
similar devices to conceal their embezzlement! WFI Editor)
He writes that Morgan Stanley was meticulous in staying within what it construed
to be the letter of the law; "nevertheless, these deals involved plain deceit by
the Japanese investors, and if Morgan Stanley ever ends up in court on these
deals, disclaimer letters notwithstanding, it may find its ass badly exposed."
Partnoy refers here to gigantic deals – in one of which Morgan Stanley pocketed
$74.6 million for what he takes to be about two weeks’ work by a handful of
people. Taken together, the major points in this book are grounds for some
sleepless nights. If Partnoy is correct, some Americans and American firms are
partially responsible for that lack of transparency in Japanese and other
financial markets, which American officials are saying played a large role in
the mess over there. (Although Partnoy was middling high up at the bank, the
names of Morgan Stanley’s Japanese customers were not revealed to him). He lays
out a picture of a multitrillion-dollar industry, touching on the fate and
future of all of us, that is shot full of chicane, deception, and fraud.
To cap it off, he tells us that this daily dishonesty is being perpetrated not
by flitting fly-by-night, marginal bucket shop operators but by the creme de la
creme of Wall Street – Morgan Stanley, Merrill Lynch and the rest of the
platinum names we have been taught to honor. Because Partnoy writes with
authority and lucidity and because of the gravity of what he’s saying, a reader
wishes his book were more detailed. Moreover, his conclusion is disappointingly
meager: "What lessons did I draw from my experience selling derivatives? I
believe derivatives are the most recent example of a basic theme in the history
of finance: Wall Street bilks Main Street."
SOURCE: Reprinted from the Los Angeles Book Review, from the 8 February, 1998,
issue of the Los Angeles Times, Orange County Edition. Reprinted in the public
service of the national interest of the American people.
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