Credit Shenanigans
SEGAL, HARVEY H.
Credit Shenanigans Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken By James Grant. Farrar Straus Giroux. 513 pp. $27.50. Reviewed by Harvey H....
...He was convicted, among other felonies, of selling $200 million of highly risky junk bonds, issued by his real estate company, the American Continental Corporation, to thousands of the S&L's elderly depositors...
...Depositors eventually recouped 83.5 cents on the dollar...
...So long as the army of commissioned salesman could peddle new issues, the company could make good on the obligation to support its bond prices...
...Simon W. Straus, known as the "Prince of Thrift," was another precursor of the credit high jinks in the 1980s...
...When we try to beat inflation with borrowed money, " he explained, "we just make the problem worse...
...Prices of real estate and other tangible assets fall, and the burden of accumulated debt becomes heavier as belt-tightening by businesses and consumers retards the growth of national income...
...During the investigation, the paper became the accredited vent for stories leaked to coerce witnesses into corroborating Ivan Boesky's accusations...
...As he ably demonstrates, it is hazardous to dwell exclusively on the quantity of credit while ignoring its quality—and far more is at stake than the health of banks and other lenders...
...Money of the Mind is essential reading for those who would boldly answer No...
...first mortgages gave way to second ones...
...After unsuccessful attempts to rescue the bank through reorganization or a merger with Manufacturers Trust, and after runs on several of its branches, it was closed by the state authorities...
...Following a withering assault by special prosecutor Max Steu-er, one of the great trial lawyers of his day, they were convicted and sent up-river to Sing Sing...
...What's truly scandalous about the S&L losses is not that speculators and larcenists abused deposit insurance...
...Are we forever condemned, as George Santayana warned, to repeat the errors of history...
...Briefly, the theory holds that businesses and households throw caution to the winds when employment is full and prices are rising...
...Grant, though, is highly principled...
...In a clear case of conflicting interests, some 24 per cent of the bank's capital and reserves was tied up in loans to its own real estate subsidiaries, which were also financed by selling stock to depositors...
...The great strengths of this elegant, eccentric and occasionally wronghead-ed history are its wholesale embrace of the proposition that "in financial markets almost nothing is unprecedented," and its preoccupation with credit...
...That predisposition could prove fatal in another writer...
...Operating out of extravagantly appointed Manhattan headquarters (the metal railings and grilles of its 1924 neo-Renaissance palazzo were embellished with gold), the firm did a thriving business selling bonds that were exclusively secured, customers were assured, by first mortgages on fully rented commercial properties...
...Inflation, which had begun to ebb in 1979, was not greatly affected...
...it is the government's subsequent refusal to reform the system...
...For instance, Charles H. Keating Jr., once head of the notorious Lincoln Savings & Loan Association, is now in prison...
...A recently leaked examiners' report from the Office of the Comptroller of the Currency points up serious problems with Citicorp's huge mortgage portfolio that were uncovered when batches of these loans were sold to Fannie Mae and similar specialized financial intermediaries...
...But the episode was still significant, James Grant maintains, since "the President, in one televised stroke, was able to reduce that part of the 'money supply' that is lodged in the minds of credit-using individuals...
...Straus and Company was the Tiffany of mortgage-bond houses in the '20s, the very best of a bad lot...
...Mortgage loans were made on partially rented, second-tier properties in overbuilt markets...
...But he also carries some heavy ideological baggage...
...Because of the drastic cutback in personal spending, the GNP shrank at an annu-al rate of 9 per cent for the three months ending with June...
...It thus contributed significantly to the severity of the Depression...
...He was a singularly graceful writer at Barron's, and afterward the editor of the highly-respected Grant's Interest Rate Observer, where he predicted the collapse of the '80s boom and the onset of stagnation...
...Some two years later the man who succeeded him as company president was charged with grand larceny...
...That failure, at the time the largest on record, froze $220 million of deposits belonging to 440,000 people...
...Infact, only a desire to ensure passage of the Banking Act of 1933 led President Franklin D. Roosevelt, who in 1927 chaired an investigation of the mortgage-bond business, to drop his strong opposition to the idea...
...Despite his relentless criticism of junk bonds, he dubs the Wall Street Journal the Justice Department's "useful idiot" in its case against Michael Milken...
...Public disclosure is ineffective—buyers of Keating's worthless bonds, unlike Marcus' victims, were duly warned of the great risk in prospectuses that went unread or unheeded—but by contrast, the Federal guarantee of bank deposits is positively pernicious...
...If you believe a reprise of the Straus and other mortgage-bond fiascoes is precluded by the vigilance of the Securities and Exchange Commission, think again...
...To bolster the confidence of small investors, Straus even obligated itself to buy back its unexpired bonds at 99 cents on the dollar...
...Yet no one was any the wiser, for Straus completely controlled the market for its bonds and was not required to make public disclosures of its financial health...
...Grant is at his impressive best when demonstrating that long before World War I opponents of deposit insurance, both Democrats and Republicans, were warning that it would lead to reckless banking practices...
...All that remains of the Bank of United States now are fading memories and two striking residential landmarks: the San Re-mo Towers and the Beresford, at 74th and 81st streets respectively, on New York's Central Park West...
...To substantiate his claim that little happens in financial markets wholly without precedent, Grant parallels recent events and illuminating, long-forgotten dramas from the 1930s...
...With a keen sense of timing, Simon Straus died, still full of honor, in 1930...
...But Keating was more than matched by Bernard K. Marcus, Roy M. Cohn's uncle, who presided over the 1930 collapse of the Bank of United States...
...Indeed, after decades of numbing commentary on the arcane mechanics of the money supply, Grant's return to credit basics is welcome for reasons at once obvious and important...
...Marcus and his deputy, Saul Singer, were tried for violations of New York banking laws...
...The unique insight Grant brings to his task results from his wide experience...
...He greatly admires Jacques Rueff, Charles de Gaulle's palace goldbug, and he pejoratively characterizes U.S...
...Large debts at ever higher interest rates are incurred to finance highly speculative ventures...
...In April, outstanding consumer credit fell by nearly $2 billion, then the largest monthly decline on record, only to be topped by a $3.4 billion plunge in May...
...A deterioration in the state of credit and a rash of defaults of the sort that began in the late 1980s can depress the entire economy, first by making lenders wary, next by discouraging borrowers...
...In the present period of anxiety about our banks and the relative strengths of world currencies, James Grant's brilliant illustration of the fearsome continuity between the financial follies of the past and present raises hard questions about the future...
...Reviewed by Harvey H. Segal Author, "Corporate Makeover" In March 1980, when inflation and interest rates were running at alarming double-digit levels, an exasperated Jimmy Carter took to the airwaves and urged consumers to make fewer credit-card purchases...
...In the lax 1980s, big banks pumped tens of billions into mortgages without securing adequate information about the creditworthiness of borrowers or the condition of the properties...
...As the animal spirits of speculation overcame reason in the late 1920s, however, the quality of Straus' underlying portfolio steadily declined...
...The yardstick he uses to judge monetary systems is a naively roseate view of the pre-1914 "pure" gold standard...
...financial developments since 1860 as a drift toward the "democratization of credit and the socialization of risk...
...Formulated in the 1930s, after the great Yale economist came a cropper in the collapse of the bull market, it remains an incisive analysis of the dynamics of financially sophisticated capitalism...
...The ensuing stagnation persists until levels of debt, fixed-asset prices and incomes are painfully realigned—a correction that, depending on the severity of the initial distortion, might require years...
...When expectations of hefty returns are dashed, a deflationary reaction follows...
...A bond trader who quickly dismissed the President's exercise in moral suasion as "toothless" was soon proved wrong...
...Although Grant's picaresque approach precludes an articulated view of how seriously bad credit practices destabilize economies, clearly implicit in what he writes is Irving Fisher's debt-deflation model...
...When the inflow of dollars trickled off, the game was up...
Vol. 75 • September 1992 • No. 12
