Sunday, 25 January 2009

Contrary En-djinns of war

Most of us can trace our existence back through time.

We may even come to know the strange vicissitudes, narrow escapes or long wanderings of our fore-fathers. If we are lucky they may relate something of their adventures to us.

That is, if they have not fallen in the former holocausts of war or suffered some tragic or premature fate. When that happens we have not just lost some enlightenment, we have lost our past.

Letting slip the dogs of war invites all sorts of consequences.

War is a particularly cruel sieve that scatters or sorts the genes from which we may derive.

My father was a pilot and intelligence officer in WW2 for 454 squadron and would not have been my father if he had not sidestepped an unfortunate fuel starvation fault in the Baltimore bomber. This was no random shrapnel event (one that he also survived) but a design fault that was only exposed in the necessary extreme manoevers of war. See: History.htm

So for me war, the architecture of war, the design of the engines of destruction, was personal before I became or could become a sentient being. It was going on when I was innocent. It goes on today…and for my name if not in my name.

What then of a design fault that condemned others to an early sudden death if they were brave, or left the survivors facing the charge of lack of moral fibre for excusing themselves from the fray when they knew the odds were so bad it was best to run and fight another day. This is not a cynicism about wartime exploits or a judgement on cowardice in the face of the enemy, but a warning against any overconfidence by the architects of war.

Now, I know the best equipped troops can come a cropper. I know that the new President’s new limousine, as fully armoured as it is, is vulnerable to a simple disc of copper in an improvised explosive.

Google: …concave copper armour pierce Obama….

No one is safe from ‘the dog-whip’s reach’ now. And we all have microwave ovens which can easily be modified to take out our neighbour’s if we have that intent.

But I also know that we (and the children we might have had) can be wiped from the ledgers of life by the stroke of a designers pen, with a complete absence of intent on their part. More so in the scrabble of total war when an unfortunate design oversight can be made unnecessary by a simple improvement in technology by the enemy.

All the more reason for intelligent design, anticipating your enemy, or outwitting him, rather than a negative cynicism.
Even Diogenes carried a big stick for when argument or example failed. But neither might have been enough if his enemies were more determined than him.

Then anything, any means, becomes a device, a design, a construction erected in our name. Otherwise there might be no one to erect anything in our memory.

I have just been reading the papers of a recently deceased uncle, an ex-Halton boy who joined the RAF in the days of string-bag aircraft and worked as an engineer on radial engines, then the Vulcan bomber and the Concorde, seeing the best of design and at least hearing about some of the worst designs that cost many lives.

Also he was stationed with some of our then 40 national nuclear strike Vulcan aircraft, assisting the crews who were in their cockpits at one point (on October the 27th, 1962). They were on 15 minute standby for a whole weekend waiting to see if they were required to unleash nuclear bombs at the heart of the Soviet Union. This has only recently become public knowledge.

That would have cost many lives more than the assassination of a President or the engineering faults of a few aircraft.

He was a patriot who nevertheless passed another story down to me, about the WW2 “Brewster Buffalo” aircraft.

Here are a few excerpts from a book he mentioned:

A Captain Phillip R White said in the book ” that any commander who orders pilots out for combat in a Brewster should consider the pilot as lost before leaving the ground”….

…it seems the Americans had made the awful mistake of believing their own PR…. Aided no doubt by early models, one ton lighter having some success with the Finnish Air Force against enemy biplanes.

In comparing the ‘Brewster Buffalo’ to its then Japanese opponent, the Mitsubishi Zero, ….the Brewster was a big barge, full of armour plate but with rotten little guns; while the Zero was extremely light, with fantastic range, and two big cannons firing explosive shells. A Zero could out turn a Brewster without even trying….

As if that wasn’t enough, there were reports of sabotage in the American factory…drilling holes in a life saving arrester hook to weaken it. One flight of three buffaloes intercepted some bombers only to find that out of their combined total of twelve guns only one was working. In three months 154 Buffaloes were destroyed by Japanese enemy action, one entire squadron was wiped out to a man. Only one Buffalo survived the fall of Singapore.

The above was published in a book “ the World’s Worst Aircraft” found in Nelson Public Library, New Zealand, but my late uncle appended this note which as far as I know has never been published about a Far East incident regarding the 27th Squadron.

…”21 Squadron RAAF were with them and were supposed to be an escort for 27 on the way out to their target and to rendevous half way on 27’s return from their mission. On the last 27 mission there was no escort awaiting them at the halfway mark and when they got back to Sungi Patani airfield they found the base deserted with Buffaloes all over the place and fuel tankers belching out fuel unattended, the stores ransacked and all the Aussies vanished off the base.
The only ‘erks’ or ground staff were 27’s and they were stationed on the opposite side of the airfield to 21 Squadron. Apparently there was a fifth column report that the ‘Japs’ were five miles away in the rubber advancing and the Aussies just up and skidaddled leaving 27 to cope with the situation. …but there is no doubt that they had to fly with an aircraft which they knew was useless against the ‘Japs’ who bombed Singapore from 27,000 feet and the Buffaloes could only reach 17,000 feet . Not that they could have done much good against the Zero escorts”.

From the book again, “one pilot , ‘Pappy’ Boyington, speaking from a mess bar that was understandably riddled with machine gun bullet holes, was told as a newcomer that “Long before the RAF gets around to announcing an alert, you will see two Brewster Buffaloes take off in a Westerly direction regardless of the wind sock. That’s the signal”, he was told, The Japanese were flying in from the East.”

So much for distant events.

Also passed down to me, this time, from my Grandfather, I have a rare Tissot gold hunter stopwatch that he had been given to him by a wartime ‘test’ pilot, Walter Handley.

They flew together as civilians before the war. Walter was a famous TT rider, motor-car racer and a test pilot. Once in practice he found himself going in the wrong direction but often won races and once managed to set the fastest lap record.

He broke every bone in his body apparently and was helped by my Grandfather from time to time according to family testimony. He would have been an unfortunate choice of pilot if the aircraft he flew failed on him, being a celebrity much admired by his peers. This is exactly what happened

He died flying an RAF Bell P-39 Airacobra in Scotland in 1941. Whilst later models had some success, apparently RAF fighter pilots soon dismissed the heavy fighter as a “widowmaker” and simply refused to fly it. Internet forums have noticed USAF pilots in the Pacific joking saying “they would have preferred to fly trucks, as they had “better speed and a higher service ceiling”.

It was mid-engined and with a propshaft leading forward to the propeller, accidents were best avoided. I am a veteran of a propshaft failing beneath my feet and the complex mathematics of physical force usually prevails over the supposed easy arithmetic of flight.

But for me, the architecture of war, even the failure or near failure of the design of the engines of war has touched my life in benevolent ways. But not for the millions who have died. Some unnecessarily.

And we are right to be cynical if it will save lives.

It is all about the survival of the fittest normally. Normally those with the most flexibility are those who will prevail.
But that flexibility must also allow for cynicism, dissent, and insisting on safety. It is not all about Heros and Zeros.

I am grateful that my father survived the design flaw of the Baltimore. Because he survived and reported the fuel starvation in a particular manoever, others lives were probably saved. Walter Handley’s sacrifice early on probably saved many more lives. But war insists on sacrifice, and
The organisation of war does not allow for pilots to refuse to fly, for a squadron to run away or to fly in the opposite direction when ordered to engage an enemy. Yet it happens.

Much truth is lost in war, morale has to be kept up, Defeatism has to be kept in check. I hope this account some 60 years after events, offers some hope that lives will today not be wasted at either end of the barrel of a gun, and that other methods are employed so that some good might prevail. We should learn from history that the only ‘sin’ is unnecessary cruelty. Lest We Forget.

Otherwise we might all become cynics. And then we could not prevail. We might as well hole up in a barrel complaining about people stealing our light.

And the inspiration for this piece:

Books, like men, have their fates. Some meet solitary and tragic ends, some fall in holocausts; and some, after strange vicissitudes, narrow escapes, and long wandering, find peaceful asylums where, nursing their scars and mellowed by experience, they will relate something of their adventures to the curious.

James Westfall Thompson,
The Medieval Library.

Monday, 19 January 2009

A History Lesson - Part 2 - The Crash

More extracts from Professor Galbraith's classic work: The Great Crash 1929. A more accessible and witty summary of what happened in that year I have yet to read.

I hope the ghost of the Professor will forgive me for inserting the occasional Diogenerian comment here and there, especially as we currently seem to be living through a similar period in our history.

Most of these extracts come from the chapters in his book that are entitled: 'The Twilight of Illusion' and 'The Crash'. I would urge anyone who is interested in such things, and who wishes to understand more of what is going on today, to invest in this modest volume.

Without doubt, the most striking feature of the financial era which ended in the autumn of 1929 was the desire of people to buy securities and the effect of this on values. But the increase in the number of securities to buy was hardly less striking. And the ingenuity and zeal with which companies were devised in which securities might be sold was as remarkable as anything.

The most notable piece of speculative architecture of the late twenties, and the one by which, more than any other device, the public demand for common stocks was satisfied, was the investment trust or company. The investment trust did not promote new enterprises or enlarge old ones. It merely arranged that people could own stock in old companies through the medium of new ones. Even in the United States, in the twenties, there were limits to the amount of real capital which existing enterprises could use or new ones could be created to employ. The virtue of the investment trust was that it brought about an almost complete divorce of the volume of corporate securities outstanding from the volume of corporate assets in existence. The former could be twice, thrice, or any multiple of the latter. The volume of underwriting business and of securities available for trading on the exchanges all expanded accordingly. So did the securities to own, for the investment trusts sold more securities than they bought. The difference went into the call market, real estate, or the pockets of the promoters. It is hard to imagine an invention better suited to the time or one better designed to eliminate the anxiety about the possible shortage of common stocks.

Things like investment trusts are the holy grail to the financial markets. They don't want to be held back by trivial things like 'How much is the company worth?' or 'How many things have we got to sell to people?'. They want to be able to generate huge profits, out of all proportion to their own size. Imagine if a bank could only lend out the equivalent of how much gold it had in it's vaults? How is it meant to grow into a world beating company that can afford to pay it's executives huge bonuses?

The trouble with selling real things is that once you have sold them all, you have to spend money making or buying more of them. You are limited by your assets - what you have in stock. You are never going to get rich that way.

If you want to get rich, it is vital that you come up with some way - be it investment trusts, consolidated debt obligations, securities or derivatives - that enables you to separate your ability to generate money, from any aspect of reality. Reality is far too limiting. You are interested in unlimited growth. Things in the real world don't grow without limit.

The idea of the investment trust is an old one, although, oddly enough, it came late to the United States. Since the eighties in England and Scotland, investors, mostly smaller ones, had pooled their resources by buying stock in an investment company. The latter, in turn, invested the funds so secured. A typical trust held securities in from five hundred to a thousand operating companies. As a result, the man with a few pounds, or even a few hundred, was able to spread his risk far more widely than were he himself to invest. And the management of the trusts could be expected to have a far better knowledge of companies and prospects in Singapore, Madras, Capetown, and the Argentine, places to which British funds regularly found their way, than the widow in Bristol or the doctor in Glasgow. The smaller risk and better information well justified the modest compensation of those who managed the enterprise. Despite some early misadventures, the investment trusts soon became an established part of the British scene.

The managers of the British trusts normally enjoy the greatest of discretion in investing the funds placed at their disposal. At first the American promoters were wary of asking for such a vote of confidence. Many of the early trusts were [literally] trusts - the investor bought an interest in a specified assortment of securities which were then deposited with a trust company. At the least the promoters committed themselves to a rigorous set of rules on the kinds of securities to be purchased and the way they were to be held and managed. But as the twenties wore along, such niceties disappeared. The investment trust became, in fact, an investment corporation. It sold its securities to the public - sometimes just common stock, more often common and preferred stock, debenture and mortgage bonds - and the proceeds were then invested as the management saw fit. Any possible tendency of the common stockholder to interfere with the management was prevented by selling him non-voting stock or having him assign his voting rights to a management-controlled voting trust.

Brilliant! Use their money, but don't allow them to have any say over how it is used. Which is fine as long as the interest keeps rolling in, of course - no one cares too much. It's when it stops and people realise that their money isn't actually their money any more, that things get interesting.

Historians have told with wonder of one of the promotions at the time of the South Sea Bubble. It was 'For an Undertaking which shall in due time be revealed'. The stock is said to have sold exceedingly well. As promotions the investment trusts were, on the record, more wonderful. They were undertakings the nature of which was never to be revealed, and their stock also sold exceedingly well.

I'm sure that no one would be this stupid today! Fancy buying something without knowing or understanding what it was.

During 1928 an estimated 186 investment trusts were organized; by the early months of 1929 they were being promoted at the rate of approximately one each business day, and a total of 265 made their appearance during the course of the year. In 1927 the trusts sold to the public about $400,000,000 worth of securities; in 1929 they marketed an estimated three billions worth. This was at least a third of all the new capital issues in that year; by the autumn of 1929 the total assets of the investment trusts were estimated to exceed eight billions of dollars. They had increased approximately elevenfold since the beginning of I927.

The parthenogenesis of an investment trust differed from that of an ordinary corporation. In nearly all cases it was sponsored by another company, and by 1929 a surprising number of different kinds of concerns were bringing the trusts into being. Investment banking houses, commercial banks, brokerage firms, securities dealers, and, most important, other investment trusts were busy giving birth to other trusts.

So a company that has no assets is able to borrow enough money to create other companies, none of which have any assets, and they in turn can borrow money to set up yet more companies, none of which have any assets, and so on, and on.

Yet, had these securities all been sold on the market, the proceeds would invariably have been less, and often much less, than the current value of the outstanding securities of the investment company. The latter, obviously, had some claim to value which went well beyond the assets behind them.

That premium was, in effect, the value an admiring community placed on professional financial knowledge, skill, and manipulative ability. To value a portfolio of stocks 'at the market' was to regard it only as inert property. But as the property of an investment trust it was much more, for the portfolio was then combined with the precious ingredient of financial genius. Such special ability could invoke a whole strategy for increasing the value of securities.

Consider by way of illustration, the case of an investment trust organised in 1920 with a capital of $150 million - a plausible size by then. Let it be assumed, further, that a third of the capital was realised from the sale of bonds, a third from preferred stock , and the rest from the sale of common stock. If this $150 million were invested, and if the securities so purchased showed a normal appreciation, the portfolio value would have increased by midsummer by about fifty percent. The assets would be worth $225 million. The bonds and preferred stock would still be worth only $100 million; their earnings would not have increased, and they could claim no greater share of the assets in the hypothetical event of a liquidation of the company. The remaining $125 million, therefore, would underlie the value of the common stock of the trust. The latter, in other words, would have increased in asset value from $50 million to $125 million, or by a hundred and fifty per cent, and as the result of an increase of only fifty per cent in the value of the assets of the trust as a whole.

This was the magic of leverage, but this was not all of it. Were the common stock of the trust, which had so miraculously increased in value, held by still another trust with similar leverage, the common stock of that trust would get an increase of between seven hundred and eight hundred per cent from the original fifty per cent advance. And so forth.

In 1929 the discovery of the wonders of the geometric series struck Wall Street with a force comparable to the invention of the wheel.

There was a rush to sponsor investment trusts which would sponsor investment trusts, which would, in turn, sponsor investment trusts. The miracle of leverage, moreover, made this a relatively costless operation to the ultimate man behind all of the trusts. Having launched one trust and retained a share of the common stock, the capital gains from leverage made it relatively easy to swing a second and larger one which enhanced the gains and made possible a third and still bigger trust.

Ah, leverage. I learned about this magic when I first read Galbraith's book. It seems to be inherent in the way that all financial markets work, at least nowadays. It is what caused the problems then, and it is what has caused many of the problems now. All the laws and regulations that were put in place after 1929, to stop it happening again, have been slowly removed and repealed.

The thing that immediately occurred to me, the first time I read Galbraith's book, was: 'Well that's ok when things are going well, but what happens when things are not going well?'

Galbraith addresses this very point later on in the chapter.

Leverage, it was later to develop, works both ways. Not all of the securities held by the Founders were of a kind calculated to rise indefinitely, much less to resist depression. Some years later the portfolio was found to have contained 5,000 shares of Kreuger and Toll, 20,000 shares of Kolo Products Corporation, an adventuresome new company which was to make soap out of banana oil, and $295,000 in the bonds of the Kingdom of Yugoslavia. As Kreuger and Toll moved down to its ultimate value of nothing, leverage was also at work - geometric series are equally dramatic in reverse. But this aspect of the mathematics of leverage was still unrevealed in early 1929, and notice must first be taken of the most dramatic of all the investment company promotions of that remarkable year, those of Goldman, Sachs.

That's the trouble with financial genius - good on calculating consolidated debt obligations, bad at remembering their school maths lessons.

In the two months after its formation, the new company sold some more stock to the public, and on 21 February it merged with another investment trust, the Financial and Industrial Securities Corporation. The assets of the resulting company were valued at $235 million, reflecting a gain of well over a hundred per cent in under three months. By 2 February, roughly three weeks before the merger, the stock for which the original investors had paid $104 was selling for $136.50. Five days later, on 7 February, it reached $222.50. At this latter figure it had a value approximately twice that of the current total worth of the securities, cash, and other assets owned by the Trading Corporation.

This remarkable premium was not the undiluted result of public enthusiasm for the financial genius of Goldman, Sachs. Goldman, Sachs had considerable enthusiasm for itself, and the Trading Corporation was buying heavily of its own securities. By 14 March it had bought 560,724 shares of its own stock for a total outlay of $57,021,936. This, in turn, had boomed their value. However, perhaps foreseeing the exiguous character of an investment company which had its investments all in its own common stock, the Trading Corporation stopped buying itself in March. Then it resold part of the stock to William Crapo Durant, who re-resold it to the public as opportunity allowed.

That's clever. I don't know if it's legal, but it's very clever.

The spring and early summer were relatively quiet for Goldman, Sachs, but it was a period of preparation. By 26 July it was ready. On that date the Trading Corporation, jointly with Harrison Williams, launched the Shenandoah Corporation, the first of two remarkable trusts. The initial securities issue by Shenandoah was $102,500,000 (there was an additional issue a couple of months later) and it was reported to have been oversubscribed some sevenfold. There were both preferred and common stock, for by now Goldman, Sachs knew the advantages of leverage. Of the five million shares of common stock in the initial offering, two million were taken by the Trading Corporation, and two million by Central States Electric Corporation on behalf of the co-sponsor, Harrison Williams. Williams was a member of the small board along with partners in Goldman, Sachs. Another board member was a prominent New York attorney whose lack of discrimination in this instance may perhaps be attributed to youthful optimism. It was Mr John Foster Dulles. The stock of Shenandoah was issued at $17.50. There was brisk trading on a 'when issued' basis. It opened at 30, reached a high of 36 and closed at 36, or 18.5 above the issue price.

Meanwhile Goldman, Sachs was already preparing its second tribute to the countryside of Thomas Jefferson, the prophet of small and simple enterprises. This was the even mightier Blue Ridge Corporation, which made its appearance on 20 August. Blue Ridge had a capital of $142,000,000, and nothing about it was more remarkable than the fact that it was sponsored by Shenandoah, its precursor by precisely twenty-five days. Blue Ridge had the same board of directors as Shenandoah, including the still optimistic Mr Dulles, and of its 7,250,000 shares of common stock (there was also a substantial issue of preferred) Shenandoah subscribed a total of 6,250,000. Goldman, Sachs by now was applying leverage with a vengeance.

This is all starting to sound a bit incestuous. I don't usually subscribe to the idea of a small clique of rich, powerful people running things behind the scenes, but I am starting to wonder - although this happened in 1929 - I'm sure it's different now.
Having issued more than a quarter of a billion dollars' worth of securities in less than a month - an operation that would not then have been unimpressive for the United States Treasury -activity at Goldman, Sachs subsided somewhat.

Thus, on 1 August the papers announced the formation of Anglo-American Shares, Inc., a company which, with a soigné touch not often seen in a Delaware corporation, had among its directors the Marquess of Carisbrooke, G.C.B., G.C.V.O., and Colonel the Master of Sempill, A.F.C., otherwise identified as the President of the Royal Aeronautical Society, London.

American Insuranstocks Corporation was launched the same day, though boasting no more glamorous a director than William Gibbs McAdoo. On succeeding days came Gude Winmill Trading Corporation, National Republic Investment Trust, Insull Utility Investments, Inc., International Carriers, Ltd, Tri-Continental Allied Corporation, and Solvay American Investment Corporation.

On 13 August the papers also announced that an Assistant U.S. Attorney had visited the offices of the Cosmopolitan Fiscal Corporation and also an investment service called the Financial Counsellor. In both cases the principals were absent. The offices of the Financial Counsellor were equipped with a peephole like a speakeasy.

Do you know, I'm starting to wonder if these were real companies. I think they were just making them up as they went along.

More investment trust securities were offered in September of 1929 even than in August - the total was above $600 million. However, the nearly simultaneous promotion of Shenandoah and Blue Ridge was to stand as the pinnacle of new era finance. It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity. If there must be madness something may be said for having it on a heroic scale.

I'm shocked that a respected economist like Professor Galbraith should describe this behaviour as gargantuan insanity. Clearly he does not understand the complexities of the financial markets, and how they can provide continuous growth and ever-increasing wealth. Forever.

More than the prices of common stocks were rising. So, at an appalling rate, was the volume of speculation.

Brokers' loans during the summer increased at a rate of about $400,000,000 a month. By the end of the summer, the total exceeded seven billions. Of that more than half was being supplied by corporations and individuals, at home and abroad, who were taking advantage of the excellent rate of return which New York was providing on money. Only rarely did the rate on call loans during that summer get as low as six per cent. The normal range was seven to twelve. On one ocasion the rate touched fifteen. Since, as earlier observed, these loans provided all but total safety, liquidity, and ease of administration, the interest would not have seemed unattractive to a usurious moneylender in Bombay. To a few alarmed observers it seemed as though Wall Street were by way of devouring all the money of the entire world. However, in accordance with the cultural practice, as the summer passed, the sound and responsible spokesmen decried not the increase in brokers' loans, but those who insisted on attaching significance to this trend. There was a sharp criticism of the prophets of doom.

There were two sources of intelligence on brokers' loans. One was the monthly tabulation of the New York Stock Exchange, which in general is used here. The other was the slightly less complete return of the Federal Reserve System which was published weekly. Each Friday this report showed a large increase in loans; each Friday it was firmly stated that it didn't mean a thing, and anyone who suggested otherwise was administered a stern rebuke. It seems probable that only a minority of the people in the market related the volume of the brokers' loans to the volume of purchases on margin and thence to the amount of speculation. Accordingly, an expression of concern over these loans was easily attacked as a gratuitous effort to undermine confidence. Thus, in Barren's on 8 July, Sheldon Sinclair Wells explained that those who worried about brokers' loans, and about the influx of funds from corporations, simply did not know what was going on. The call market had become a great new investment outlet for corporate reserves, he argued. The critics did not appreciate this change.

The bankers were also a source of encouragement to those who wished to believe in the permanence of the boom. A great many of them abandoned their historic role as the guardians of the nation's fiscal pessimism and enjoyed a brief respite of optimism. They had reasons for doing so. In the years preceding, a considerable number of the commercial banks, including the largest of the New York houses, had organized securities affiliates. These affiliates sold stocks and bonds to the public, and this business had become important. It was a business that compelled a rosy view of the future. In addition, individual bankers, perhaps taking a cue from the heads of the National City and Chase in New York, were speculating vigorously on their own behalf. They were unlikely to say, much less advocate, anything that would jar the market..

However, there were exceptions. One was Paul M. Warburg of the International Acceptance Bank, whose predictions must be accorded the same prominence as the forecasts of Irving Fisher. They were remarkably prescient. In March 1929, he called for a stronger Federal Reserve policy and argued that if the present orgy of 'unrestrained speculation' were not brought promptly to a halt there would ultimately be a disastrous collapse. This, he suggested, would be unfortunate not alone for the speculators. It would 'bring about a general depression involving the entire country'.

He was clearly a troublemaker - best to ignore him.

Only Wall Street spokesmen who took the most charitable view of Warburg contented themselves with describing him as obsolete. One said he was 'sandbagging American prosperity'. Others hinted that he had a motive - presumably a short position. As the market went up and up, his warnings were recalled only with contempt.

The most notable sceptics were provided by the press. They were a great minority to be sure. Most magazines and most newspapers in 1929 reported the upward sweep of the market with admiration and awe and without alarm. They viewed both the present and the future with exuberance. Moreover, by 1929 numerous journalists were sternly resisting the more subtle blandishments and flattery to which they have been thought susceptible.

Thank goodness - at least they could rely on the gentlemen of the press for fair and objective reporting.

Instead they were demanding cold cash for news favourable to the market. A financial columnist of the Daily News, who signed himself 'The Trader', received some $19,000 in 1929 and early 1930 from a free-lance operator named John J. Levenson. 'The Trader' repeatedly spoke well of stocks in which Mr Levenson was interested. Mr Levenson later insisted, howeyer, that this was a coincidence and the payment reflected his more or less habitual generosity.

Main Street had always had one citizen who could speak knowingly about buying or selling stocks. Now he became an oracle. In New York, on the edge of any gathering of significantly interesting people there had long been a literate broker or investment counsellor who was abreast of current plans for pools, syndicates, and mergers, and was aware of attractive possibilities. He helpfully advised his friends on investments, and pressed, he would always tell what he knew of the market and much that he didn't. Now these men, even in the company of artists, playwrights, poets, and beautiful concubines, suddenly shone forth. Their words, more or less literally, became golden. Their audience listened not with the casual heed of people who are collecting quotable epigrams, but with the truly rapt attention of those who expect to make money by what they hear.

That much of what was repeated about the market - then as now - bore no relation to reality is important, but not remarkable. Between human beings there is a type of intercourse which proceeds not from knowledge, or even from lack of knowledge, but from failure to know what isn't known. This was true of much of the discourse on the market. At luncheon in downtown Scranton, the knowledgeable physician spoke of the impending split-up in the stock of Western Utility Investors and the effect on prices. Neither the doctor nor his listeners knew why there should be a split-up, why it should increase values, or even why Western Utility Investors should have any value. But neither the doctor nor his audience knew that he did not know. Wisdom, itself, is often an abstraction associated not with fact or reality but with the man who asserts it and the manner of its assertion.

In later years, a Senate committee investigating the securities markets undertook to ascertain the number of people who were involved in securities speculation in 1929. The member firms of twenty-nine exchanges in that year reported themselves as having accounts with a total of 1,548,707 customers. (Of these, 1,371,920 were customers of member firms of the New York Stock Exchange.) Thus only one and a half million people, out of a population of approximately 120 million and of between 29 and 30 million families, had an active association of any sort with the stock market. And not all of these were speculators. Brokerage firms estimated for the Senate committee that only about 600,000 of the accounts just mentioned were for margin trading, as compared with roughly 950,000 in which trading was for cash.

The striking thing about the stock market speculation of 1929 was not the massiveness of the participation. Rather it was the way it became central to the culture.

By the end of the summer of 1929, brokers' bulletins and letters no longer contented themselves with saying what stocks would rise that day and by how much. They went on to say that at 2 p.m. Radio or General Motors would be 'taken in hand'. The conviction that the market had become the personal instrument of mysterious but omnipotent men was never stronger. And, indeed, this was a period of exceedingly active pool and syndicate operations - in short, of manipulation.

During 1929 more than a hundred issues on the New York Stock Exchange were subject to manipulative operations, in which members of the Exchange or their partners had participated. The nature of these operations varied somewhat but, in a typical operation, a number of traders pooled their resources to boom a particular stock. They appointed a pool manager, promised not to double-cross each other by private operations, and the pool manager then took a position in the stock which might also include shares contributed by the participants. This buying would increase prices and attract the interest of people watching the tape across the country. The interest of the latter would then be further stimulated by active selling and buying, all of which gave the impression that something big was afloat. Tipsheets and market commentators would tell of exciting developments in the offing. If all went well, the public would come in to buy, and prices would rise on their own. The pool manager would then sell out, pay himself a percentage of the profits, and divide the rest with his investors.

While it lasted, there was never a more agreeable way of making money.

Of course, no party can go on forever. In the end, you always have to pay the piper.

On 3 September, by common consent, the great bull market of the nineteen-twenties came to an end. Economics, as always, vouchsafes us few dramatic turning points. Its events are invariably fuzzy or even indeterminate. On some days that followed - a few only - some averages were actually higher. However, never again did the market manifest its old confidence. The later peaks were not peaks but brief interruptions of a downward trend.

There were some who said, cause and effect run from the economy to the stock market, never the reverse. In 1929 the economy was headed for trouble. Eventually, that trouble was reflected in Wall Street.

In 1929 there were good, or at least strategic, reasons for this view, and it is easy to understand why it has become high doctrine. In Wall Street, as elsewhere in 1929, few people wanted a bad depression. In Wall Street, as elsewhere, there is deep faith in the power of incantation. When the market fell many Wall Street citizens immediately sensed the real danger, which was that income and employment - prosperity in general - would be adversely affected. This had to be prevented.

Preventive incantation required that as many important people as possible repeat as firmly as they could that it wouldn't happen. This they did. They explained how the stock market was merely the froth and that the real substance of economic life rested in production, employment, and spending, all of which would remain unaffected. No one knew for sure that this was so. As an instrument of economic policy, incantation does not permit of minor doubts or scruples.

No one seemed to want to admit that the tail had started to wag the dog. That far from the stock market being the speculative froth on top of the solid, sound and, above all, real economy, the sheer amount of speculation was instead capable of overturning and possibly sinking the real economy. A bit like someone in a tree sawing off the very branch they are sitting on.

I'm not sure how that affects us now, here in dear old Blighty, because for many years we haven't really had much production, so most of our wealth seems to be of the more 'frothy' kind anyway.

In the later years of depression it was important to continue emphasizing the unimportance of the stock market. The depression was an exceptionally disagreeable experience. Wall Street has not always been a cherished symbol in our national life. In some of the devout regions of the nation, those who speculate in stocks - the even more opprobrious term gamblers is used - are not counted the greatest moral adornments of our society. Any explanation of the depression which attributed importance to the market collapse would accordingly have been taken very seriously, and it would have meant serious trouble for Wall Street.

Wall Street, no doubt, would have survived, but there would have been scars. We should be clear that no deliberate conspiracy existed to minimize the consequences of the Wall Street crash for the economy. Rather, it merely appeared to everyone with an instinct for conservative survival that Wall Street had better be kept out of it. It was vulnerable.

Professor Galbraith shows himself to have a truely Diogenerian turn of phrase.

It is in the nature of a speculative boom that almost anything can collapse it. Any serious shock to confidence can cause sales by those speculators who have always hoped to get out before the final collapse, but after all possible gains from rising prices have been reaped. Their pessimism will infect those simpler souls who had thought the market might go up forever but who will now change their minds and sell. Soon there will be margin calls, and still others will be forced to sell. So the bubble breaks.

Along with the downturn of the indexes Wall Street has always attributed importance to two other events in the pricking of the bubble. In England on 20 September 1929 the enterprises of Clarence Hatry suddenly collapsed. Hatry was one of those curiously un-English figures with whom the English periodically find themselves unable to cope. Although his earlier financial history had been anything but reassuring, Hatry in the twenties had built up an industrial and financial empire of truly impressive proportions. The nucleus, all the more remarkably, was a line of coin-in-the-slot vending and automatic photograph machines. From these unprepossessing enterprises he had marched on into investment trusts and high finance. His expansion owed much to the issuance of unauthorized stock, the increase of assets by the forging of stock certificates, and other equally informal financing. In the lore of 1929, the unmasking of Hatry in London is supposed to have struck a sharp blow to confidence in New York.

A bit like Northern Rock asking for help from the Bank of England.

Ranking with Hatry in this lore was the refusal on 11 October of the Massachusetts Department of Public Utilities to allow Boston Edison to split its stocks four to one. As the company argued, such split-ups were much in fashion. To avoid going along was to risk being considered back in the corporate gaslight era. The refusal was unprecedented. Moreover, the Department added insult to injury by announcing an investigation of the company's rates and by suggesting that the present value of the stock, 'due to the action of speculators', had reached a level where 'no one, in our judgement ... on the basis of its earnings, would find it to his advantage to buy it'.

Confidence did not disintegrate at once. As noted, through September and into October, although the trend of the market was generally down, good days came with the bad. Volume was high. On the New York Stock Exchange sales were nearly always above four million, and frequently above five. In September new issues appeared in even greater volume than in August, and they regularly commanded a premium over the offering price. On 20 September the Times noted that the stock of the recently launched Lehman Corporation which had been offered at $104 had sold the day before at $136. (In the case of this well-managed investment trust the public enthusiasm was not entirely misguided.) During September brokers' loans increased by nearly $670 million, by far the largest increase of any month to date. This showed that speculative zeal had not diminished.

Ah, Lehmans - whatever happened to them?

Other signs indicated that the gods of the New Era were still in their temples. In its 12 October issue, The Saturday Evening Post had a lead story by Isaac F. Marcosson on Ivar Kreuger. This was a scoop, for Kreuger had previously been inaccessible to journalists. 'Kreuger,' Marcosson observed, 'like Hoover, is an engineer. He has consistently applied engineer precision to the welding of his far-flung industry.' And this was not the only resemblance. 'Like Hoover,' the author added, 'Kreuger rules through pure reason.'

In the interview Kreuger was remarkably candid on one point. He told Mr Marcosson: 'Whatever success I have had may perhaps be attributable to three things: one is silence, the second is more silence, while the third is still more silence.' This was so. Two and a half years later Kreuger committed suicide in his Paris apartment, and shortly thereafter it was discovered that his aversion to divulging information, especially if accurate, had kept even his most intimate acquaintances in ignorance of the greatest fraud in history. His American underwriters, the eminently respectable firm of Lee, Higginson and Company of Boston, had heard nothing and knew nothing. One of the members of the firm, Donald Durant, was a member of the board of directors of the Kreuger enterprises. He had never attended a directors' meeting, and it is certain that he would have been no wiser had he done so.

Well, the greatest fraud in history until Bernard Madoff hit the headlines.

On Sunday the market was front-page news - the Times headline read, 'Stocks driven down as wave of selling engulfs the market', and the financial editor next day reported for perhaps the tenth time that the end had come. (He had learned, however, to hedge. 'For the time at any rate', he said, 'Wall Street seemed to see the reality of things.') No immediate explanation of the break was forthcoming. The Federal Reserve had long been quiet. Babson had said nothing new. Hatry and the Massachusetts Department of Public Utilities were from a week to a month in the past. They became explanations only later.

The papers that Sunday carried three comments which were to become familiar in the days that followed. After Saturday's trading, it was noted, quite a few margin calls went out. This meant that the value of stock which the recipients held on margin had declined to the point where it was no longer sufficient collateral for the loan that had paid for it. The speculator was being asked for more cash.

The other two observations were more reassuring. The papers agreed, and this was also the informed view on Wall Street, that the worst was over. And it was predicted that on the following day the market would begin to receive organized support. Weakness, should it appear, would be tolerated no longer.

Never was there a phrase with more magic than 'organized support'. Almost immediately it was on every tongue and in every news story about the market. Organized support meant that powerful people would organize to keep prices of stocks at a reasonable level. Opinions differed as to who would organize this support. Some had in mind the big operators like Cutten, Durant, and Raskob. They, of all people, couldn't afford a collapse. Some thought of the bankers - Charles Mitchell had acted once before, and certainly if things got bad he would act again. Some had in mind the investment trusts. They held huge portfolios of common stocks, and obviously they could not afford to have them become cheap. Also, they had cash. So if stocks did become cheap the investment trusts would be in the market picking up bargains. This would mean that the bargains wouldn't last. With so many people wanting to avoid a further fall, a further fall would clearly be avoided.

In the ensuing weeks the Sabbath pause had a marked tendency to breed uneasiness and doubts and pessimism and a decision to get out on Monday. This, it seems certain, was what happened on Sunday, 20 October.

Monday, 21 October, was a very poor day. Sales totalled 6,091,870, the third greatest volume in history, and some tens of thousands who were watching the market throughout the country made a disturbing discovery. There was no way of telling what was happening.

Previously on big days of the bull market the ticker had often fallen behind, and one didn't discover until well after the market closed how much richer he had become. But the experience with a falling market had been much more limited. Not since March had the ticker fallen seriously behind on declining values. Many now learned for the first time that they could be ruined, totally and forever, and not even know it. And if they were not ruined there was a strong tendency to imagine it. From the opening on the 21st the ticker lagged, and by noon it was an hour late. Not till an hour and forty minutes after the close of the market did it record the last transaction. Every ten minutes prices of selected bonds were printed on the bond ticker, but the wide divergence between these and the prices on the tape only added to the uneasiness - and to the growing conviction that it might be best to sell.

Of course that could never happen today, with modern technology. Provided that the computer's don't crash. Or a particularly virulent computer virus infests the computer networks used by the financial centres. Or a ship's anchor slices through an undersea cable. Or the country becomes the victim of a cyberattack from a hostile nation.

On Tuesday, Charles M. Mitchell dropped anchor in New York with the observation that 'the decline had gone too far'. (Time and sundry congressional and court proceedings were to show that Mr Mitchell had strong personal reasons for feeling that way.) He added that conditions were 'fundamentally sound', said again that too much attention had been paid to the large volume of brokers' loans, and concluded that the situation was one which would correct itself if left alone.

However, another jarring suggestion came from Babson. He recommended selling stocks and buying gold.

That afternoon and evening thousands of speculators decided to get out while - as they mistakenly supposed - the getting was good. Other thousands were told they had no choice but to get out unless they posted more collateral, for as the day's business came to an end an unprecedented volume of margin calls went out.

Thursday, 24 October, is the first of the days which history - such as it is on the subject - identifies with the panic of 1929. Measured by disorder, fright, and confusion, it deserves to be so regarded. That day 12,894,650 shares changed hands, many of them at prices which shattered the dreams and the hopes of those who had owned them. Of all the mysteries of the Stock Exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. 24 October 1929, showed that what is mysterious is not inevitable. Often there were no buyers, and only after wide vertical declines could anyone be induced to bid.

The panic did not last all day. It was a phenomenon of the morning hours. The market opening itself was unspectacular, and for a while prices were firm. Volume, however, was very large, and soon prices began to sag. Once again the ticker dropped behind. Prices fell further and faster, and the ticker lagged more and more. By eleven o'clock the market had degenerated into a wild, mad scramble to sell. In the crowded boardrooms across the country the ticker told of a frightful collapse. But the selected quotations coming in over the bond ticker also showed that current values were far below the ancient history of the tape. The uncertainty led more and more people to try to sell. Others, no longer able to respond to margin calls, were sold out.

By eleven-thirty the market had surrendered to blind, relentless fear. This, indeed, was panic.

Outside the Exchange in Broad Street a weird roar could be heard. A crowd gathered. Police Commissioner Grover Whalen became aware that something was happening and dispatched a special police detail to Wall Street to ensure the peace. More people came and waited, though apparently no one knew for what. A workman appeared atop one of the high buildings to accomplish some repairs, and the multitude assumed he was a would-be suicide and waited impatiently for him to jump.

In New York at least the panic was over by noon. At noon the organised support appeared.

A bit like our Government pumping £37 billion into our banking system. They are about to do it again, presumably because it worked so well the first time. Get banks lending. Get people spending. Get back to normal.

Or maybe we are starting to get a glimpse of just how little real money we have really got, and see just how successful - or unsuccessful - some companies, including banks, really are. That is, when you take away the make-believe money that the financial markets seem to work with.

At twelve o'clock reporters learned that a meeting [of the chief executives of the major banks] was convened at 23 Wall Street at the offices of JP Morgan and Company. A decision was quickly reached to pool resources to support the market. Prices firmed at once and started to rise.

Then at one thirty Richard Whitney appeared on the trading floor and went to the post where steel was traded. [...] He bid 205 for 10,000 shares. This was the price of the last sale, and the current bids were several points lower.

This was it. The bankers, obviously, had moved in. The effect was electric. Fear vanished and gave way to concern lest the new advance be missed. Prices boomed upwards.

On Friday and Saturday trading continued heavy - just under six million on Friday and over two million at the short session on Saturday. Prices, on the whole, were steady - the averages were a trifle up on Friday but slid off on Saturday. It was thought that the bankers were able to dispose of most of the securities they had acquired while shoring up the market on Thursday. Not only were things better, but everyone was clear as to who had made them so. The bankers had shown both their courage and their power, and the people applauded warmly and generously. The financial community, the Times said, now felt 'secure in the knowledge that the most powerful banks in the country stood ready to prevent a recurrence [of panic]'. As a result it had 'relaxed its anxiety'.

Almost everyone believed that the heavenly knuckle-rapping was over and that speculation could be now resumed in earnest. The papers were full of the prospects for next week's market.

Stocks, it was agreed, were again cheap and accordingly there would be a heavy rush to buy. Numerous stories from the brokerage houses, some of them possibly inspired, told of a fabulous volume of buying orders which was piling up in anticipation of the opening of the market. In a concerted advertising campaign in Monday's papers, stock market firms urged the wisdom of picking up these bargains promptly. 'We believe', said one house, 'that the investor who purchases securities at this time with the discrimination that is always a condition of prudent investing, may do so with utmost confidence.

On Monday the real disaster began.

Coming soon: Things become more serious - The Aftermath

Friday, 9 January 2009

So It Was, So Shall It Ever Be

I've just come across this article from the Telegraph:

Definitive proof that the Bank of England saw the financial crisis coming

All the warning signs were there but nobody did anything....

Do you know, that reminds me of something that I have recently read in a book .... now what was it called again.....

Thursday, 8 January 2009

A History Lesson - Part 1

The Great Crash 1929
John Kenneth Galbraith


This is a book that made a profound impact on me when I read it as a student, more than two decades ago. I wanted to understand the world of stocks and shares, and in order to understand a system, I have always found that one learns more by studying it when it is at its most atypical.

If, to be considered a Diogenerian, one must view the world with, what some might call, a cynical gaze, then this book is, in no small way, responsible for my being able to be so considered.

If you wish to understand something of the current economic crisis, I can think of no guide who is more clear, more witty and more readable than Professor Galbraith. It is with this in mind that I humbly present these extracts from his classic study.

Galbraith starts off by explaining why he spent the Summer of 1954 writing his book.
A good knowledge of what happened in 1929 remains our best safeguard against the recurrence of the more unhappy events of those days. Since 1929 we have enacted numerous laws designed to make securities speculation more honest and, it is hoped, more readily restrained. None of these is a perfect safeguard. The signal feature of the mass escape from reality that occurred in 1929 and before - and which has characterized every previous speculative outburst from the South Sea Bubble to the Florida land boom - was that it carried Authority with it. Governments were either bemused as were the speculators or they deemed it unwise to be sane at a time when sanity exposed one to ridicule, condemnation for spoiling the game, or the threat of severe political retribution.

Until the beginning of 1928, even a man of conservative mind could believe that the prices of common stock were catching up with the increase in corporation earnings, [...] and the certainty that the Administration, then firmly in power in Washington, would take no more than necessary of any earnings in taxes.

Early in 1928, [however,] the nature of the boom changed. The mass escape into make-believe, so much a part of the true speculative orgy, started in earnest. It was still necessary to reassure those who required some tie, however tenuous, to reality. And, as will be seen presently, this process of reassurance ... eventually achieved the status of a profession. However, the time had come, as in all periods of speculation, when men sought not to be persuaded of the reality of things but to find excuses for escaping into the new world of fantasy.

During the same month reassurance came from still higher authority. Andrew W. Mellon [the Secretary to the Treasury] said, 'There is no cause for worry. The high tide of prosperity will continue.'

Mr Mellon did not know. Neither did any of the other public figures who then, as since, made similar statements. These are not forecasts; it is not to be supposed that the men who make them are privileged to look further into the future than the rest. Mr Mellon was participating in a ritual which, in our society, is thought to be of great value for influencing the course of the business cycle. By affirming solemnly that prosperity will continue, it is believed, one can help insure that prosperity will in fact continue. Especially among businessmen the faith in the efficiency of such incantation is very great.
You see, being a cynic, I've always been bothered by this notion that house prices always go up. People would keep telling me that, even after I pointed out to them that I could remember two occasions in my lifetime (not counting the present one) when they had gone down, quite dramatically. Of course, what I didn't understand, until I read Galbraith, was that, for these clever people in the money markets of the world, the last thing that they want to do is actually own something.

As noted, at some point in the growth of a boom all aspects of property ownership become irrelevant except the prospect for an early rise in price.

It follows that the only reward to ownership in which the boomtime owner has an interest is the increase in values. Could the right to the increased value be somehow divorced from the other and now unimportant fruits of possession and also from as many as possible of the burdens of ownership, this would be much welcomed by the speculator. Such an arrangement would enable him to concentrate on speculation which, after all, is the business of a speculator.

Such is the genius of capitalism that where a real demand exists it does not go long unfilled. In all great speculative orgies devices have appeared to enable the speculator so to concentrate on his business. In the Florida boom the trading was in 'binders'. Not the land itself but the right to buy the land at a stated price was traded. This right to buy - which was obtained by a down payment of ten per cent of the purchase price - could be sold. It thus conferred on the speculators the full benefit of the increase in values. After the value of the lot had risen he could resell the binder for what he had paid plus the full amount of the increase in price.

The worst of the burdens of ownership, whether of land or any other asset, is the need to put up the cash represented by the purchase price. The use of the binder cut this burden by ninety per cent - or it multiplied tenfold the amount of acreage from which the speculator could harvest an increase in value. The buyer happily gave up the other advantages of ownership. These included the current income of which, invariably, there was none and the prospect of permanent use in which he had not the slightest interest.

The machinery by which Wall Street separates the opportunity to speculate from the unwanted returns and burdens of ownership is ingenious, precise, and almost beautiful. Banks supply funds to brokers, brokers to customers, and the collateral goes back to banks in a smooth and all but automatic flow.

It's marvellous, isn't it. And such is the genius of the markets that it is only a small step to apply this idea - separation of the opportunity to speculate, from the unwanted burdens of ownership - not only to physical assets such as land or buildings, but to the stocks and shares themselves!

People were swarming to buy stocks on margin - in other words, to have the increase in price without the cost of ownership.

One of the paradoxes of speculation in securities is that the loans that underwrite it are among the safest of all investments. They are protected by stocks which under all ordinary circumstances are instantly saleable, and by a cash margin as well. The money ... can be retrieved on demand. At the beginning of 1928 this admirably liquid and exceptionally secure outlet for non-risk capital was paying around five percent. The rate rose steadily through 1928, and during the last week of the year it reached twelve per cent. This was still with complete safety.

In Montreal, London, Shanghai, and Hong Kong there was talk of these rates. A great river of gold began to converge on Wall Street.

Corporations also found these rates attractive. At twelve per cent Wall Street might even provide a more profitable use for the working capital of a company than additional production. A few firms made this decision: instead of trying to produce goods with its manifold headaches and inconveniences, they confined themselves to financing speculation. Many more companies started lending their surplus funds on Wall Street.

Thank heavens for the regulators, who stop abuses of the system. Otherwise you might get someone setting up a hedge fund which turns out to be no more than a glorified pyramid scheme, which eventually collapses leaving debts of 50 billion.

All this being so, the position of the people who had at least nominal responsibility for what was going on was a complex one. One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom.

Some of those in positions of authority wanted the boom to continue. They were making money out of it, and they may have had an intimation of the personal disaster which awaited them when the boom came to an end. But there were also some who saw, however dimly, that a wild speculation was in progress and that something should be done. For these people, however, every proposal to act raised the same intractable problem. The consequences of successful action seemed almost as terrible as the consequences of inaction, and they could be more horrible for those who took the action.

A bubble can be easily punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy. The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Someone would certainly be blamed for the ultimate collapse when it came. There was no question whatever as to who would be blamed should the boom be deliberately deflated. The Federal Reserve Authorities. One may doubt if at any time in early 1929 the problem was ever framed in terms of quite such stark alternatives. But however disguised or evaded, these were the choices which haunted every serious conference on what to do about the market.

The men who had responsibility for these ineluctable choices were the President of the United States, the Secretary of the Treasury, the Federal Reserve Board in Washington, and the Governor of the Federal Reserve Bank of New York.

President Coolidge neither knew nor cared what was going on. A few days before leaving office in 1929, he cheerily observed that things were 'absolutely sound' and that stocks were 'cheap at current prices'.

So unlike our own Tony Blair, or even George W Bush.

These men do not issue orders; at most they suggest. Chiefly they move interest rates, buy or sell securities and, in doing so, nudge the economy here and restrain it there. Because the meanings of their actions are not understood by the great majority of the people, they can reasonably be assumed to have superior wisdom. Their actions will on occasion be criticized. More often they will be scrutinized for hidden meanings.

Such is the mystique of central banking. Such was the awe-inspiring role in 1929 of the Federal Reserve Board in Washington, the policy-making body which guided and directed the twelve Federal Reserve Banks. However, there was a jarring difficulty. The Federal Reserve Board in those times was a body of startling incompetence.

The New York Federal Reserve Bank, under Governor Strong's leadership, may not have been sufficiently perturbed by the speculation. Nor was it after Governor Strong died in October 1928 and was replaced by George L. Harrison. A reason, no doubt, was the reassurance provided by people in high places who were themselves speculating heavily. One such was Charles E. Mitchell, the Chairman of the Board of the National City Bank, who on 1 January 1929 became a class A director of the Federal Reserve Bank of New York. The end of the boom would mean the end of Mitchell. He was not a man to expedite his own demise.

Actually, not even new legislation, or the threat of it, was needed. In 1929, a robust denunciation of speculators and speculation by someone in high authority and a warning that the market was too high would almost certainly have broken the spell. It would have brought some people back from the world of make-believe. Those who were planning to stay in the market as long as possible but still get out (or go short) in time would have got out or gone short. Their occupational nervousness could readily have been translated into an acute desire to sell. Once the selling started, some more vigorously voiced pessimism could easily have kept it going.

The very effectiveness of such a measure was the problem. Of all the weapons in the Federal Reserve arsenal, words were the most unpredictable in their consequences. Their effect might be sudden and terrible. Moreover, these consequences could be attributed with the greatest of precision to the person or persons who uttered the words. Retribution would follow. To the more cautious of the Federal Reserve officials in the early part of 1929 silence seemed literally golden.

Then toward the end of the month disquieting news reached Wall Street. The Federal Reserve Board was meeting daily in Washington. It issued no statements. Newspapermen pressed the members after the sessions and were met with what then, as now, was known as tight-lipped silence. There was not a hint as to what the meetings were about, although everyone knew they concerned the market. The meetings continued day after day, and there was also an unprecedented Saturday session.

Soon it was too much. On Monday, 25 March, the first market day following the unseemly Saturday meeting, the tension became unbearable. Although, or rather because, Washington was still silent, people began to sell. Speculative favourites - Commercial Solvents, Wright Aero, American Railway Express - dropped 10 or 12 points or more; the Times industrial average was off 9.5 points for the day. More important, some banks decided that, in the event of a Federal Reserve crackdown, virtue might have a reward above revenue. They began curtailing their loans in the call market, and the rate on brokers' loans went to fourteen per cent.

On the next day, Tuesday, 26 March, everything was much worse. The Federal Reserve Board was still maintaining its by now demoralizing silence. A wave of fear swept the market. More people decided to sell, and they sold in astonishing volume. An amazing 8,246,740 shares changed hands on the New York Stock Exchange, far above every previous record. Prices seemed to drop vertically.

To avoid confusion, I should say at this point that this was not, in fact, the Great Crash. This was simply a minor dip in the apparently ever-rising tide of prosperity. What was soon to come would make this look like the calm before the storm.

26 March 1929 could have been the end. Money could have remained tight. The authorities might have remained firm in their intention to keep it so. The panic might have continued. Each fall in prices would have forced a new echelon of speculators to sell, and so forced prices down still more. It did not happen, and if any man can be credited with this, the credit belongs to Charles E. Mitchell. The Federal Reserve authorities were ambivalent, but Mitchell was not. He was for the boom. Moreover, his prestige as head of one of the two largest and most influential commercial banks, his reputation as an aggressive and highly successful investment banker, and his position as a director of the New York Federal Reserve Bank meant that he spoke with at least as much authority as anyone in Washington. During the day, as money tightened, rates rose, and the market fell, Mitchell decided to take a hand. He told the press, 'We feel that we have an obligation which is paramount to any Federal Reserve warning, or anything else, to avert any dangerous crisis in the money market.' The National City, he said, would loan money as necessary to prevent liquidation. It would also (and did) borrow money from the New York Federal Reserve Bank to do what the Federal Reserve Bank had warned against doing. Disguised only slightly by the prose form of finance, Mitchell issued the Wall Street counterpart of Mayor Hague's famous manifesto, *I am the law in Jersey City.*

I'm sure that no on in a position of power would behave in this way today! Pumping huge sums of borrowed money into the system to prevent collapse. How silly can you get!

Mitchell's words were like magic. By the end of trading on the 26th money rates had eased, and the market had rallied. The Federal Reserve remained silent, but now its silence was reassuring. It meant that it conceded Mitchell's mastery. The next day the National City regularized its commitment to the boom: it announced that it would insure reasonable interest rates by putting $25 million into the call market - $5 million when the rate was sixteen per cent, and $5 million additional for each percentage point.

Of course, Wall Street doesn't like regulators interfering with it's running, even if it is to their benefit. To try and illustrate this, let's say, hypothetically, that our banks have been forced to accept a bailout package from the Government because they are in danger of going bankrupt. It couldn't possibly happen, of course, but I am speaking hypothetically. Would they be grateful? Or would they complain that the Government wanted too much control over the way that they are run? Would they still refuse to lend money, displaying what some might call a lack of gratitude? Surely only the most cynical would wonder if all of the taxpayer's money that had been pumped into the banks had actually been wasted? Perhaps the only lesson that we can draw is that, seemingly, men who are used to power don't like being told what to do - even if they are being told to get into a lifeboat.

The Federal Reserve was criticized [for interfering in the running of the markets] even more than Mitchell - even though it could hardly have done less than it did. Arthur Brisbane said judiciously: 'If buying and selling stocks is wrong the government should close the Stock Exchange. If not, the Federal Reserve should mind its own business.' In a leading article in Barron's, a Mr Seth Axley was less even-handed:' For the Federal Reserve Board to deny investors the means of recognizing economies which are now proved, skill which is now learned, and inventions which are almost unbelievable seems to justify doubt whether it is adequately interpreting the times.' Since the principal action which the Federal Reserve had taken against investors had been to hold meetings and maintain silence, this was doubtless a trifle harsh.

After the defeat by Mitchell in March, the Federal Reserve retired from the field. There continued to be some slight anxiety [from Wall Street that they might still try to regulate the market]. In April, William Crapo Durant is supposed to have paid a secret night visit to the White House to warn President Hoover that if the Board were not called off it would precipate a terrible crash. The President was noncommittal, and Durant is said to have reduced his holdings before leaving on a trip to Europe. In June from Princeton Mr Lawrence said that the Board was still 'doing its utmost to cast the proverbial monkey wrench into the machinery of prosperity'. He warned the Board that it had 'aroused the enmity of an honest, intelligent, and public-spirited community'. (Some hardened Wall Streeters may have been surprised when they realized that this meant them.) But the Board, in fact, had decided to leave that honest, intelligent, and public-spirited community strictly to its own devices.

If there is one thing that Wall Street demands from it's regulators, it is that they should not try to regulate - only appear to do so. After all, what's a 50 billion hedge fund between friends?

Governor Young said subsequently, that 'while the hysteria might be somewhat restrained', it would have to run its course, and the Reserve Banks could only brace themselves for the 'inevitable collapse'. More accurately, the Federal Reserve authorities had decided not to be responsible for the collapse.

In August the Board finally agreed to an increase in the rediscount rate to six per cent. The market weakened only for a day. Any conceivable consequence of the action was nullified by a simultaneous easing of the buying rate on acceptances.

In fact, from the end of March on, the market had nothing further to fear from authority. President Hoover did ask Henry M. Robinson, a Los Angeles banker, to proceed as his emissary to New York and talk to the bankers there about the boom. According to Mr Hoover, Robinson was assured that things were sound. Richard Whitney, the Vice-President of the Exchange, was also summoned to the White House and told that something should be done about speculation. Nothing was done, and Mr Hoover was able to find some solace in the thought that primary responsibility for regulating the Stock Exchange rested with the Governor of New York, Franklin D. Roosevelt.

Roosevelt, too, was following a laissez-faire policy, at least on the matter of the stock market.

For now, free at last from all threat of government reaction or retribution, the market sailed off into the wild blue yonder. Especially after 1 June all hesitation disappeared. Never before or since have so many become so wondrously, so effortlessly, and so quickly rich. Perhaps Messrs Hoover and Mellon and the Federal Reserve were right in keeping their hands off. Perhaps it was worth being poor for a long time to be so rich for just a little while.

Coming soon: The Twilight of Illusion - The Crash.

Followed by: Things Become More Serious - The Aftermath

Get the Abbey Habit

It's a relief to know that most reputable Building Societies are protecting their director's salaries ... er .. I mean, shareholder's interests ... by ensuring that their flexible mortgage products aren't quite as flexible as they seemed to be.

If you own such a mortgage, I would strongly suggest that you do not watch this video, as it will lead to a lack of confidence, and possibly panic, which, I am sure you will agree, we all wish to avoid in these uncertain times.

I'm sure you won't let me down.

Tuesday, 6 January 2009


It was Manton who out of boredom first asked our faithful retainer Sibbes to go down into the club archives and fetch up something interesting. Sibbes returned presently pulling a large tin box behind him. This he placed in the middle of the floor. “This was the best I could find sir.”

“What is in it?”

“I have no idea sir”

Squatting down upon a stool in front of it, Manton looked it over. The box was dusty and rusted in parts and was marked with the initials MH. He unfastened the leather strapping and threw back the lid. I could see that it was a third full with bundles of paper tied up with red tape into separate packages.

He lifted bundle after bundle glancing at the handwritten wording on each. One said “The Tarleton Murders” and other “The Case of Vamberry”, “The Adventure of the Old Russian Woman”, “The Singular Affair of the Aluminium Crutch”, “Ricoletti”.

“What on earth’s this little lot do you think?”

“I’m sure I couldn’t say, Sir,” said Sibbes.

“Where did you get it from?”

"When I was cleaning out the basement some months ago, after we had that leaking pipe you remember, sir?"

“Yes I recall.”

“...Well I saw the box then and thought it very curious. And when you asked me to bring you something interesting I recalled it to mind.”

"Very good. Well leave it here for now and I will have a look through it more carefully.”

After Sibbes left, I picked out a bundle at random and relaxed back into an armchair with a glass of The Macallan for company and began to read.


I had called upon my friend Mr Sherlock Holmes early in January in order to wish him the compliments of the new year. He was sitting upright at his desk, dressed in an old dun-coloured dressing-gown, a glowing meerschaum pipe in one hand and a lens in the other. A silver pair of spectacles lay in front of him and was the evident study that took up his full attention.

"You are busy," said I; "I shall call another time."

"Not at all, Watson. Come in, come in. I should be glad of your company and in any case you might be able to shed some light on this little problem here. The matter is of course quite trivial, but there are one or two points of interest. What do you make of these?” He held out the spectacles then tossed them to me.

I seated myself in front of his fire. The flames danced and gave out a welcomed glow. "Are you working on some case?" I asked, "and are these the clue to some clever crime?”

"No, nothing so ordinary," said Sherlock Holmes, smiling. "What you hold in your hand is the memento of a ghostly visitation upon one of our local shopkeepers Watson. It is said that there are more things in heaven and earth than are dreamt of – well here is the evidence of it in your own hand.” He sat back in his own chair and smiled at the puzzled look upon my face. “You know Jennings, the constable who walks our particular patch of Baker Street?"


"He dropped those by for me yesterday."

"And why did he do that?"

"He found them and thought they might interest me. But let me tell you the story. Jennings, who as you know is a most diligent law officer, was making his way down the Edgware Road two nights ago on his usual beat. As was his practice Jennings spent some time looking into premises and trying the door handles. But one door he looked into gave him a start. As he tried the handle, it flew open and out shot a man screaming as he went. He pushed passed Jennings and ran out into the street yelling “Lord God Save me! Don’t let it get me.”

“Jennings was in two minds, whether to follow after the man or enter the building to see what caused the fellow to take to his heels in such terror. As the man was halfway up the street by this time, he decided to enter the building which was Mr Comfrey’s patent shoe shop. Making his way through the shop found nothing out of the usual and decided to ascend the stairs to the upper floors. Halfway up, in front of him he saw, in the dim gaslight, a luminous shape, gliding across the landing.”

“A luminous shape?”

“That is how he describes it. But that is not all. Jennings says that the glowing spectre glided right past him and then headed straight though the wall. Jennings made a thorough search of the upper floor but could find nothing.”

"But surely you don’t accept that?"

“If it were anyone other than Jennings I would certainly have my doubts, but you know him as well as I do and he does not strike me as one who would easily be deceived. He is certainly one of the best of our flat-footed friends. No, my dear fellow, I think we have to take the evidence as it presents itself. However, the one thing that Jennings did find was those spectacles you are holding. They were on the floor by the wall at the very place the spectre vanished.

"I presume they belong to the owner of the shop”

"Ah well there lies the problem. He has not been seen these last two days and cannot be traced. Jennings believes that the man who passed him was already wearing glasses which suggests that these belong to another, does it not? Either way they are the only tangible evidence that Jennings was able to recover that might shed any light on the disappearance of the shoe seller.”

"What, then, did Jennings do?"

"He brought the spectacles round to me, knowing how interested I am in such puzzles.

“And what can you gather from these?"

"Only as much as we can deduce."

"Huh! What can you gather from these old things?"

"Here is my lens. You know my methods. What can you gather?”

I turned the spectacles over in my hands rather indifferently. They were handsomely constructed, gold-rimmed spectacles of the sort that were much in fashion a few years ago. They had clearly become worn through constant use. One of the arms had lost its returning spring and one of the lenses was a good deal scratched. The nose pads were also missing and some attempt had been made to replace them rather crudely with cork. For the rest it there was very little remarkable about them. "Beyond the obvious fact that the owner is long-sighted, I can see nothing," said I, handing them back to my friend.

"My dear Watson, you see everything, but discover nothing.”

“Then, pray tell me, what significance do you see in them?"

He picked them up and held them languidly in that peculiar fashion of his that told me his mind was alive with activity. "It is perhaps less suggestive than it might have been," he remarked, "but there are some clear and certain inferences which can be made and one or two guesses which must hold at least a strong balance of probability. That the man has a thin narrow face with an unusually broad nose is of course obvious. He is, as you pointed out, long-sighted with slight astigmatism in his right eye though his left eye has deteriorated to the state where he can see almost nothing out of it. He is around 50 years of age and he has been well off financially until quite recently when he has lost all his money – perhaps through gambling or some other hardship.”

"I don’t see how you see all that in these spectacles.”

“Furthermore, he has a poor memory to the point of being habitually forgetful,” he continued ignoring my interruption, “and since he has no other pair of spectacles than these, their loss will no doubt be much missed. He is a solitary man without wife or friends and spends much of his time alone. He also suffers from low morale.”


“Also, by-the-way, it is extremely likely that he has recently redecorated his house and painted his woodwork white within the last month."

“You are certainly joking."

“Not at all." Sherlock Homes sat back and smiled. "I am surprised that after all these years of following my methods you are still unable to see how they are attained?"

"No doubt you think me very simple, but I confess I am still unable to follow you.”

“Well, the shape of his head is plain is it not? The width of these frames is quite narrow, yet the nose rests are unusually broad, thus we have a narrow faced man with a broad nose.”

“Well that is clear enough. What about his age?”

Any optician will tell you that presbyopia is the most common cause of long-sightedness and is the natural result of aging. The ability to focus on near objects declines throughout life and follows a set pattern. The strength of these lenses indicates an age around 50 years when he bought them. The astigmatism is clear from the cylindrical lenses which are evident when you rotate them.

“And his left eye?”

There are deep scratches on the left lens, which you have yourself noted. But they are so deep as to obscure the vision almost totally. I doubt if anyone with half reasonable eyesight could bear to have it obscured to this degree. It is my guess that it has deteriorated to the point where he can see nothing from it.

“Well that is plain enough. And the loss of his fortune?"

"If this man could afford to buy so expensive a pair of glasses three years ago, yet cannot afford to have them repaired now he has surely had a change in fortune. These spectacles are gold rimmed and would have cost a tidy sum.”

“You said they were his only spectacles. How do you know he doesn’t have another pair?”

“My dear Watson, when you see nose pads which have been cut out from cork so roughly as this, it suggests that the man who cut them could not see clearly what he was doing which means that he had no spare pair of glasses to use. For the same reason it is unlikely that he had any friend or close relative who he could have called upon to help him. No, we have here a solitary man who is friendless."

"Well, that is clear enough, certainly. But how about the habitual forgetfulness?"

“The ends of the spectacle arms show small marks that indicate they have been attached to a neck strap. When a man is reduced to wearing his glasses around his neck then one can conclude that he not only misplaces his glasses but does so habitually. And since the neck strap is missing and he has not troubled to replace it, it is also obvious that he has become more careless and indifferent to loss, which is distinct evidence of a lowering of morale, probably linked to his financial losses.”

"You have an answer to everything. And how do you deduce that he has recently been painting his woodwork?”

Sherlock Holmes laughed. "Observe closely how the left lens has some very fine spots of paint which are clearly clean and fresh. You may have seen them through the lens. They are flecks of a glossy white paint, the sort which is used on woodwork and the angle of the droplets indicates that he was painting above head height; hence decorating must come to mind. Satisfied?"

"Well, it is quite obvious now that you explain it.”

Sherlock Holmes had opened his mouth to reply, when there was a sharp rap on the door. It then flew open and Jennings the constable, rushed into the apartment.

"Mr. Holmes! Please come at once, sir!" he gasped. be continued.

Saturday, 3 January 2009

The Non-Transitive Voting Paradox

It was around this time of the year that we used to hold the elections for the club president. There are many who scoff at the need for such things and it is true that today most members prefer a much more egalitarian approach to membership and would shy away from any suggestion of a club hierarchy. But it was not always so. There have been 29 successive presidents of the Diogenes Club as indicated on the plaque on the library wall. But that all came to an end the year the elections took a strange turn.

Three people stood for president that year, Anstruther, Baldwin and Caldwell. A poll showed that there was almost equal support for each of the three candidates. One third of the members rated the candidates in order of preference A, B then C. Another third of the members rated the candidates in order of preference B, C then A. The last third of the members rated the candidates in order of preference C, A then B.

1/3 A, B, C
1/3 B, C, A
1/3 C, A, B

As a consequence Anstruthers quite rightly claimed that 2/3 of members preferred him to Baldwin. Baldwin claimed that 2/3 of members preferred him to Caldwell. And Caldwell claimed that 2/3 of members preferred him to Anstruthers. And the truth is they were all absolutely correct.

And there in a nutshell was the problem. The more deep thinking amongst us then realised that a clever committee could decide who would get the post by simply deciding the order of the voting. If they decided to vote first between A and B, then A would win, and the final run off vote between A and C would mean that C would win overall. But if we started off with a first vote between B and C, then B would win and the final runoff vote with A would see A winning. It didn't depend on the members wishes but on who was put forward first.

Well, when the members realised this, then they understood that it meant that the whole democratic voting system was faulty. It was not a problem with the three candidates, but a problem with the system itself. How often has a candidate come in first with less than half of the vote, which meant that more people didn't want him than did.

Every voting system was faulty and the members decided to have nothing more to do with it. So we did what any logical club would do. We did away with voting and with presidents altogether. And much better we have all been for it.

2.7182... and the meaning of e

The year 2009 promises to be a very interesting one as far as banks and credit are concerned. The banks have been bailed out by government but they have not been so keen to pass on their good fortune to other less powerful industries. On Monday of this coming week the last Woolies shop will close its doors and others such as Adams have gone into receivership. How many more before the end of the this year?... well only time will tell.

Entwhistle, or "The Prof" as one of our more distinguished club members is known, was muttering about 'exponential increases' and other mathematical terms that had some members hot under the collar. "what is all this exponential stuff about?" asked Carruthers blithely.

The Prof looked at him as though he were addressing an ignorant student. "There are two mysterious numbers. One is pi and the other is e. Pi = 3.14159... and e = 2.7182... Most people know about the first but have not heard much about the second.

"Look has this got anything to do with banking?" asked Carruthers.

"Oh quite a bit," said the Prof, "if you will just give me a moment of your time.

"Is it going to affect my savings?" interjected Manton.

"Well if will affect how you understand them. For instance suppose you borrow £1 and suppose the interest rate is 100% per annum."

"Bit steep isn't it?"

"You wait until next year!" shouted someone from the back. "It won't be far off that!"

"Anyway," said the Prof, ignoring the interruptions. "After one year you owe £1 borrowed plus £1 interest making £2 in all."

"That clear enough," said Carruthers.

"Yes but the bank wants to get more than that. And it can do it by not putting up the interest rate."

"How can it do that?"

"Simply by spreading the interest out over a number of payments and making it compound." People looked perplexed so he continued. "Look, if they split the interest to two payments of 50% every six months what would you pay then?"

"The same."

"No. You would owe £1 borrowed plus £0.50 first interest plus £0.75 second interest equals £2.25 total. Which is the same as (1+1/2)2 It compounds because you owe £1.50 after the first six months and so interest is more. Not a bad way to earn even more."

"The banks know all the tricks," said someone.

"And if you make the interest monthly, then that becomes (1+1/12)12 = 2.6130 which you end up owing."

"It gets more every time."

"Exactly. and if they could make it daily interest you would be paying (1+1/365)365 = 2.71457. Of course if you paid interest at smaller and smaller intervals you would pay more, but there is a limit and that limit is 2.7182 which is exponential number that is given the symbol e. If you take 1000 intervals you get 2.7169, and if you take an infinte number you end up with e. Strange isn't it? It is one of those special beautiful numbers that are always turning up in mathematics. It can't be expressed as an exact fraction, just like pi, but it is important never the less."

"Is it going to help us with the credit crunch Prof?"

"I doubt it very much. But it will help you with your calculus problems." The Prof looked very pleased with himself. But no one else did. He always did go off on a tangent.

"Happy new year, Prof!"