Have You Cashed Out Today?

“The Great Crash, 1929,” by John Kenneth Galbraith, with 1988 forward, 1954 – 1988.

This classic, recently cited by Rolling Stone’s Matt Tiabbi in his roaring Goldman Sachs take-down, should be read by everyone interested in the present market meltdown. In elegant, humorous, evenly-paced prose, Galbraith elucidates the story of the 1929 crash month by month, week by week, nailing every pompous fool, while staying remarkably even-handed. He follows it up with a short section relating the crash to the Great Depression. Galbraith is best known as a Keynesian, which in this day and age signifies a veritable revolutionary. However, Galbraith insists that ‘robbery’ is an individual failing, not a failing of any one class. He is, after all, a defender of a humanized capitalism.

In Galbraith’s 1988 forward (written right after the 1987 crash) he insists that market bubbles are based on 3 things: “a vested interest in euphoria;’ the ‘speculative instinct’ and tax reductions that benefit the wealthy. Contrary to the trickle-down, supply- side theory that says when rich people get money, they buy plant and equipment, and put people to work (such generous wonders!) – Galbraith points out that they actually put their money into speculation and luxury goods. I.E. tax cuts for the rich are very good for yacht builders and hedge funds, not capital improvement.

During 1929 there was no FDIC; no insider-trading rules, no government regulation of the NYSE, no wall between banks and capital markets; no rules on margin; no rules on leverage or assets on hand; no rules on price manipulation; no rules on public disclosures, no rules barring insider trading, and a confirmed overall policy of no government intervention. Imaginative financial products were encouraged. Inflation was feared; deficits were hated and a balanced budget was the goal of all good Republicans and Democrats. It is for you to decide how much this looks like today’s picture.

Investment trusts were one of the new financial inventions, buying stock in many other companies, including other investment trusts. At their height, they controlled $3B in assets. Goldman Sachs Trading Corporation was one of the largest and most prominent investment trusts, cited by Taibbi when he pointed out Goldman’s continuing role in ‘bringing down the house.’ These trusts were similar to the present mutual fund. However, they were so highly leveraged that only tiny real assets controlled massive amounts of what later became illusory capital. One investment trust, highly secretive, successfully solicited funds ‘for an Undertaking which shall in due time be revealed.’ And no one laughed.

Prior to the meltdown in October and November 1929, the market had an incredible run-up. People felt that it would never end, and that they all deserved to make ridiculous amounts of money for essentially doing nothing. Harvard and Yale professors, captains of industry, the press (with the notable exception of the New York Times and Standard & Poor’s) and government politicians like Hoover all joined in the chorus. But as Galbraith points out, every run-up has the seeds of its own destruction within it. Most players, of course, think they can get out in time. What made 1929 unique was that it teased the speculators and ‘investors’ into believing they could turn the market around – with positive thoughts, with ‘organized intervention’ (the banks agreeing to support the market by buying stock…which happened several times) and, even, companies buying their OWN stock to prop up the price. In effect, as Galbraith says, ‘swindling themselves,’ as the stock was then nearly worthless.

One myth Galbraith punctures is that ‘everyone’ was in the market in 1929. He points out that the market dominated the culture, and made brokers and corporate insiders into cocktail-party heroes. As he slyly puts it, “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.” And “it is far, far better to be wrong in a respectable way than to be right for the wrong reasons.” By his calculation, out of a population of 120 million, 1.5 million owned stock, and of those, 600,000 were speculators on margin. This, really, is a small proportion of the whole population.

Tuesday, October 29, 1929 was probably the most devastating day on any market in history – 33,000,000 shares would have traded all day if the volume had kept up with what happened in the first ½ hour. As Galbraith says, the first week was the slaughter of the market innocents, but “during the second week there is some evidence that it was the well-to-do and the wealthy who were being subjected to a leveling process comparable in magnitude and suddenness to that presided over a decade before by Lenin.” The ‘Crash,’ or should we say ‘Slide,’ lead to a continual decline in stock prices for 3 years, until 1932.

Another myth he takes a shot at is that a good number of speculators and bankers later committed suicide. While we might find this myth oddly comforting, unfortunately the rates for New York City rose only after time, and he attributes this to the Depression itself. It was the poor hurling themselves off bridges, not the rich. What he found more interesting – and what we are finding anew – is that embezzlement, fraud and financial weakness were suddenly revealed on a massive scale. 1929 revealed crooks like Chase Bank’s Albert Wiggins, National City Bank’s Charles Mitchell and even the head of the New York Stock Exchange itself, Richard Whitney. The latter’s indictment was the day the business class surrendered to Roosevelt. In today's Great Recession, Bernie Madoff has become the largest swindler in world history – stealing billions. Here in Minneapolis we have several large Ponzi thieves of our very own - Tom Petters and Denny Hecker to name two. The whole nation is now dotted with indicted schemers and embezzlers who presided over failed hedge funds and businesses that were highly leveraged on the basis of … lies. Seeing what was behind these illusory fortunes is the inevitable aftermath of a broken bubble.

Galbraith talks of tax cuts as a Keynesian response to a financial crisis. It is, indeed, the only action Hoover took, and Galbraith applauds it. Hoover’s mistake was to announce the crisis over, and over, and over again. And he paid with his job.

Galbraith thinks the Crash is related to the Great Depression in 5 ways. Conventional wisdom has it that cheap money (the Federal Reserve lowered rates in mid-1929) caused the speculation. He asserts there are times when money is cheap and yet speculation does NOT occur because the pre-requisite ‘euphoria’ is not present. (Note to the Austrian monetarist followers of Ron Paul.)

Galbraith’s 5 reasons:

1. Bad Distribution of Income. 5% of the population has 1/3rd of the income. The collapse in buying power of the rich affected production more that it might now – they were vital to consumerism and to savings and investment.
2. Bad Corporate Structure. Instead of being prudent, American business was full of ‘grafters, promoters, swindlers, imposters and frauds.’ Investment trusts and holding companies were inherently unstable, as they had little real assets. I.E. too much leverage.
3. Bad Banking Structure. A domino effect of one failing bank lead to it knocking down the next one, and so on. 346 banks failed in the first 6 months of 1929, for instance.
4. The high balance of payments account with the rest of the world. The U.S. was a ‘creditor’ nation. Dangerous loans made around the world could not be paid back. In addition, the tariff was increased, which damaged farm and industrial exports.
5. Poor state of economic intelligence. No matter the economic situation, the parties supported an increase in taxes or reduction in spending, to balance the budget and to stop inflation. As Galbraith puts it, “The simple precepts of a simple world did not hold amid the growing complexities of the early thirties.”

Galbraith ends the book with a excessively sanguine conclusion, as he points out in 1988 that the laws passed in the 30s mitigate some of these 5 problems. However, in 1988 when he wrote the last intro, the Commodity Futures Modernization Act had not been passed, and Glass-Steagal had not been repealed. Nor had requirements for bank assets been lowered farther - something the SEC allowed to happen in 2004. For instance, some present banks like Ing have 42 to 1 ratios of debt to assets. In addition, the distribution of income has gotten increasingly worse since 1988. And of key interest - government regulators do not actually have to USE the laws they have. The slavishness of the government to Wall Street reached a nadir under Clinton and Bush - also after 1988.

The U.S. is now a debtor nation, which has allowed us – so far – to blackmail holders of dollars and Treasuries into continued support. And the FDIC has prevented – so far – a run on the banks, because of the experience with the Depression. However, the FDIC will need to be re-funded very soon. The ruling class HAS learned that passivity is not its own reward – which accounts for the massive bi-partisan action to save some brokerage firms and banks by Bush and now Obama - an action which to this point has succeeded for the big banks.

And I bought it at May Day books used-book section –
Red Frog, 9/1/2009