Jason Dorrier
Into Perspective

The Big Bang

By, 05/28/2010

In 1932, as the ferocious bear market hit bottom, New York Stock Exchange president, Richard Whitney, proclaimed, "The Exchange is a perfect institution." A few years later he was jailed for embezzlement. The twenties and thirties had more than their fair share of financial rascals. But the rules of the road had yet to be codified, and the market was free and wild—a dangerous place for the uninitiated, a lucrative place for the well experienced. The Crash and Depression changed all that, sparking the biggest round of financial regulation the country had ever seen. It was the "big bang" of our tightly ordered financial universe. Subsequent active legislative periods (today's included) pale in comparison. Yet throughout even the New Deal, stocks posted a dramatic bull market run—today is likely to be no different.

The Pecora Committee

After New York Governor Franklin Delano Roosevelt trounced President Herbert Hoover at the polls in 1932,[1] he made it clear his first order of business was Wall Street. But the Senate's stock market investigation (opened earlier in the year) was stagnating—two lead counsels had been fired and a third had resigned. It wasn't until Ferdinand Pecora was appointed lead counsel in January 1933 that the investigation really got wheels. Pecora's dogged, highly publicized, and sometimes bizarre pursuit of Wall Street misdeeds (e.g., JP Morgan, Jr. was infamously pictured with a circus performer on his knee) indelibly tattooed his name on the investigation—soon known simply as the Pecora Committee.[2]

Widespread price manipulation was among the most notorious market practices the Committee explored, though its existence wasn't exactly a secret. Joe Kennedy reputedly urged his friends to "get in before they pass a law against it!" The most prolific market manipulators (including famed and ultimately suicidal Jesse Livermore) assembled pools to inflate the prices of a wide range of stocks, from Studebaker, to Kroger Grocery, to American Tobacco Company. Beyond direct manipulation, operators spread rumors and planted stories in the local press or market newsletters. New York Congressman Fiorello La Guardia (later the mayor of New York) revealed financial PR man, A. Newton Plummer, had paid journalists to plant 20,000 stories in 700 newspapers, including the New York Times and Wall Street Journal.[3]

Though the banking giants of the day—like Charles Mitchell, Albert Wiggin, and JP "Jack" Morgan, Jr.—were called to testify at the Pecora hearings, the "little guys" stole the show. One Edgar Brown testified on the leveraged portfolio of foreign government bonds his broker had sold him: German, Peruvian, Chilean, Hungarian, and Irish—hardly the risk-free investments he'd been led to believe they were. As the Depression forced a wave of sovereign defaults, numerous issues fell flat, taking many an Edgar Brown down with them. As much as stocks' well-known decline hurt, falling bond prices (or outright defaults) were just as painful for small investors who thought bonds were pretty darn safe.[4] In the eyes of lawmakers, bank practices were often at odds with client interests. And though "buyer beware" is a fine notion, the buyer will find it pretty hard to beware without proper disclosure—of which there was precious little back then.

When JP "Jack" Morgan, Jr. took the stand, his presence must have been intimidating—if only a little less so than his famous father. He stood a formidable 6' 2" and had perfected the stern, penetrating Morgan stare. He once said his job was "more fun than being king, pope, or prime minister—for no one can turn me out of it and I don't have to make any compromises with principles." And make no mistake, he was a principled man: "Do your work; be honest; keep your word; help when you can; be fair."[5] But values are a slippery thing, defined by the rules and social norms of the day. Though Morgan saw nothing wrong with the way he did business, his testimony to the Pecora Committee confirmed the Washington stereotype that Wall Street was at times little more than an "old boys club" benefiting the "in" elite. Morgan and others regularly maintained "preferred lists," a common way to swap favors.  Connected individuals were given a pre-market discount on initial public offerings, virtually guaranteeing a risk-free return once the issues went public. Calvin Coolidge, Bernard Baruch, John J. Raskob, even Lucky Lindy were at one time beneficiaries of Morgan's famous "magnanimity." After getting a discount on the initial offering of Morgan's Allegheny Corporation and making a quick profit thereafter, Raskob penned a thank-you note: "I appreciate deeply the courtesies shown me by you and your partners, and sincerely hope the future holds opportunity for me to reciprocate."[6]

A Regulatory Boom

The Pecora Committee uncovered shenanigans aplenty, yet not a single serious charge was levied. The worst allegations? Tax evasion. Surely, Raskob's note alone would have spelled deep legal trouble for him today. But most of these practices were legal in the 1920s. Or if they went against the spirit of the law, gaping loopholes allowed effective legal circumvention. The big stock exchanges were generally left to police themselves—something Roosevelt had no intention of allowing to continue. Before the hearings ended in December, the president began pushing through the most comprehensive set of financial laws yet conceived.

First he signed the Banking Act of 1933, better known as the Glass-Steagall Act (after Senator Carter Glass and Congressman Henry Steagall). Glass-Steagall separated commercial and investment banking until the Gramm-Leach-Bliley Act effectively overturned it in 1999. The Act also created the Federal Deposit Insurance Corporation (FDIC)—perhaps the most effective bit of New Deal regulation. The FDIC would insure bank deposits, imbue public confidence, and prevent bank runs (a key destructive element of the Depression). FDIC insurance took effect January 1, 1934 immediately backing deposits up to $2,500 and doubling that amount in July.[7] Eventually banks were required to pay into a government-custodied insurance fund during the good times thereby insuring deposits in the bad, but in the beginning, the FDIC was funded by $289 million in loans from the US Treasury and Federal Reserve. The FDIC had its skeptics, in the industry and Congress alike, but since implementation it has effectively relegated traditional bank runs to history books.

Enter the Acts

The most ground-shaking regulatory changes were the Securities Act of 1933 and the Securities Act of 1934. These two pieces of legislation founded, by and large, modern securities industry regulation and came to be known simply as "the Acts." The 1933 Act, or the "truth in securities law," aimed to make markets more transparent by registering securities and "obliging underwriters to maintain certain forms and procedures" in offerings literature. Registered securities now had to provide basic information like what kind of security it was, what the company did, and who managed the firm—not to mention, importantly, the provision of timely financial statements. Pretty much all the hallmark pieces of information analyzed and overanalyzed in today's markets. Hard to imagine perhaps, but there really was no such thing as earnings season until after 1933.[8]

The 1934 Act—the "teeth" of the ‘33 Act—was perhaps the most hated and opposed New Deal regulation. The law created the Securities and Exchange Commission (SEC) to administer financial information and stock exchange practices, banning insider trading and other forms of stock price manipulation. Most Wall Streeters may have accepted some new rules were needed and probably inevitable. But they didn't want a cop overseeing it all. Beyond creating the SEC, the ‘34 Act also gave the Fed power to set margin requirements for securities investors in direct response to the wild 1920's call money market, when investors would borrow as much as 90% to fund stock purchases.

In his appointment of first SEC commissioner, FDR went the proverbial fox in the henhouse route: Joe Kennedy. Joe was known more for his hard-drinking and adulterous ways than for being an ethical arbiter of securities laws. The man who once advised getting in on the stock game "before they [passed] a law against it" was now chief enforcer of that very law. In FDR's view, to catch a chicken thief, you need a chicken thief. (Though Kennedy's generous campaign contributions didn't hurt his cause.) FDR felt (and was largely right) that Kennedy would know exactly what to look for in policing securities crimes. Wall Streeters couldn't get much past him—Kennedy knew all the tricks.

An Often Forgotten Bull Market

Through all this monumental change, stocks mostly rose on their way to a broad, even spectacular, 324% recovery between 1932 and 1937.[9] Then, as today, the net effect of positive and negative forces dictated market direction. The lifting of panic and subsequent economic recovery overpowered legislative uncertainty—and the same will likely hold true today. Notably, whereas the intrusion of government in markets was a sea change in the thirties, recent proposals amount to little more than the revision of an already formidable regulatory apparatus. If the market could rise through FDR's first legislative barrage then it's likely to ride out the current regulatory round too. 


[3] Markham Jerry W. A Financial History of the United States: Volume II. Armonk, New York. Pages 143-144.

[4] Geisst, Charles R. Wall Street: A History, From Its Beginnings to the Fall of Enron. Oxford University Press, New York, 2004. Page 213-215.

[5] Fisher, Ken. 100 Minds That Made the Market. Business Classics, Woodside, CA, 1993. Page 91.

[6] Sobel, Robert. The Big Board: A History of the New York Stock Market. The Free Press, New York, 1965. Page 239.

[9] Standard and Poors Index Services, Global Financial Data, Inc., and Thomson Reuters; price level return.


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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