Stock Plot: Corporate Scandals Reprise Wall Street Themes of Passion, Broken Hearts

23 July 2003

Today's corporate scandals are a repeat of a cycle of infatuation and betrayal recurring throughout Wall Street's history. Wall Street would not be Wall Street without its episodic display of high-fliers who descend as fallen financial angels.

The drama goes back to The Street's origins in l792 as a financial center and follows a rather predictable script. As always, the three symbolic streets of America play their parts. During the euphoric phase of this repetitive cycle, there are the Wall Street schemers and speculators with privileged information, the Main Street small investors who are seduced into the setup, and a compliant, cheer-leading Pennsylvania Avenue representing the policy-regulatory monitors.

Recently, the first large investigatory undertaking after the puncture of the bubble produced the "Global Settlement", dealing with the inconsistency between what investment bankers told themselves and their retail clients about technology IPOs, or Initial Public Offerings.

But Wall Street has been through all this before. Its origins in the l792 Buttonwood Agreement among 24 elite brokers followed on a plan of the first treasury secretary, Alexander Hamilton, for dissolving Revolutionary War debt. Financial scandal ensued. As that cycle of euphoria turned to despair, the leader of the speculation, William Duer, suffered a fate described thus by a New York contemporary: "There is scarcely anything but Noise and Racket last night, and the night before we had a mob raised, and nothing would satisfy them but [to get at] the father of Speculation, the great William Duer, who is confined in gaol at present ... Lately the mob has endeavored to get him out of gaol, but the Mayor and city officers have prevented them as yet". Today's version, of course, is the "Perp Walk", when we see fallen financial giants handcuffed and led before the media.

After that aspect of the cycle came government attempts-some successful, some not-to prevent future scandals. The 1792 Buttonwood signatories tried to fend off intrusive regulation as the New York state legislature was considering a law banning all brokering in financial paper. To accomplish this, they established the first important legal principle governing Wall Street, that of an exclusive self-regulated private organization which would organize sales and purchases of financial paper under rules it would formulate itself.

There was no need for government regulation, they argued, because any individual could enter this market and invest his money at his own risk under the rules of this club. This notion of a private self-regulated institution is the core legal foundation behind Wall Street, and prevailed until l934 when the Securities and Exchange Commission was created during another cycle of boom and bust. (In some corners that notion still obtains today, as in the current debate over the accounting industry, which also asserts its claims as a private self-regulated club with rules and standards of its own making.)

Investment banking, the target of the recent global settlement, first made its mark on Wall Street during and after the War of 1812 when its leader, Nathaniel Prime, inspired the great canal-building era in America, which included the monumental Erie Canal (1835). Prime became the first president of the New York Stock and Exchange Board (1817) from which today's NYSE takes its lineage.

Prime, who sought to establish a bond of trust between his firm and his clients, would no doubt be appalled at the behavior of his counterparts today. Like many who would follow him, however, Prime lived out his later years as a rich man with a troubled spirit. One contemporary account of him stated that, "A strange fancy seized upon his mind, that he was becoming poor, [and] that his destiny was to die in an almshouse. Under this singular monomania, and hallucianation of mind, he cut his throat with a razor, and died on the instant".

The phrase "Dictum meum pactum", (my word is my bond), embraces the idea of fidelity between investment banker and client. It reached its pinnacle in the late 19th century era of J.P. Morgan with the creation of the trust certificate, attributed to a Wall Street lawyer, Samuel C.T. Dodd. Morgan issued trust securities and exchanged them for individually-held company shares. He acquired voting securities, and those who sold them to him received from him income-producing trust securities while giving up voting rights.

Morgan concentrated enormous economic and industrial power in his bank. He made himself the trustee not only of other people's money, but also asserted trusteeship over the nation's industrial wealth, and claimed stewardship over the value of the nation's money. He even exceeded today's standards; he and his partners held 72 directorships in 112 corporations, and underwrote some $2 billion in equities in the first decade of the 20th century. Some 78 companies had direct banking relations with the Morgan bank.

Populists of the late 19th century challenged the assertion of Morgan as warden over the nation's wealth. Like others today, they claimed that two sets of banking practices were used in the United States: one for the wealthy and the banks of Wall Street, where character and connections were the basis for credit, and another for the Main Street banks where the transparent balance sheet was the basis for credit.

After Morgan's remarkable feat of single-handedly bailing out and stabilizing the dollar in world markets (1907), Congressional hearings were convened to look into what was called "The Money Trusts". The comittee counsel, Saumel Untermyer, underscored the existence of dual banking systems in a colloquy with Morgan, asking: "Is not commercial credit based primarily upon money or property?" "No sir", Morgan answered. "The first thing is character".

Morgan died in l913, and a year later a new voice emerged, that of Louis D. Brandeis, the future Supreme Court Justice known as "the people's lawyer". He framed the issue in terms of "Other People's Money", the title of his 1914 book. In it, he discussed how money's concentration was usurped by a "financial oligarchy" that was "dangerous...when combined in the same person".

The recent global settlement is about all of these questions raised by previous scandals and financial imbrogilios. It is, first, about the self-regulating private character of Wall Street that shields residual activity not proscribed by statute. It is still unclear whether any laws were violated by research departments of investment banking firms knowingly passing on false information about securities they underwrote in IPOs. Second, keeping two sets of books harkens back to the dualism previously faced by Wall Street insiders and Main Street outsiders. Although unethical, this practice appears to be within existing law.

Like William Duer in the nation's first financial scandal in 1792, today's has many surrogates for a Wall Street in which some feast at the high table, while others feed off leftover scraps. Also today, as throughout Wall Street's history, when infatuation turns to betrayal after a bubble's burst, there is talk of the end of Wall Street. But nothing can replace it in the monopoly over the American imagination, the country's infatuation with money as idol and the quixotic attachment to the one place that embodies the gambler's illusions that are scattered about the many Main Streets of America.

Wall Street continues to be in the business not only of marketing securities, but of manufacturing dreams.

Copyright 2003 Los Angeles Daily Journal