Wall Streeters, by Edward Morris (preface)

rs o t p u r r nd Co a s r o at nce a n i The Cre F n America of

is r r o m e d wa r d

preface

America has a love-hate relationship with Wall Street. We all know that “the Street” plays a vital role in the economy; it channels capital to promote new industries and create more jobs. Yet it also seems to be the headquarters for greed, inequity, and a host of other social ills. Indeed, the money changers can behave very badly in their temples.

If you don’t spend your days in those temples, it can be maddeningly difficult to make sense of what goes on inside them. But it wasn’t always that way. Wall Street was once a fairly straightforward place where stocks, bonds, and mutual funds were originated and sold. Now joining those plain vanilla investments are a bewildering variety of derivatives, asset-backed bonds, junk bonds, index funds, and exchange-traded funds. And while the institutions that line Wall Street were once mainly commercial banks or investment firms, trillions of dollars now flow from giant hedge funds, private equity funds, venture capital funds, and “securitizers”—based both on the Street and off.

The aim of Wall Streeters is to make sense of the world of high finance by telling the stories of those who shaped it—and tracing, through their biographies, the development of financial innovations, the growth of financial markets, and the causes of financial crises. As the book’s subtitle suggests, the men profiled embody both the good and the bad of Wall Street,

xii

preface

but the dichotomy is rarely all that clear. “Bad” on Wall Street is often just “good” taken to a ruinous extreme.

I’ve always found mini-biographies to be a great way to develop interest and learning. I remember a high school biology teacher who encouraged our class to read The Microbe Hunters by Paul de Kruif. That book, originally published in 1926 and still in print today, is a lively compilation of the life stories of Louis Pasteur, Robert Koch, Walter Reed, and nine other trailblazing scientists. I don’t know a lot about bacteriology or immunology—but much of what I do know came from that book.

A few years later I enrolled in Economics 101 and had a similar experience. Along with a dry textbook full of charts and theory, the professor assigned Robert Heilbroner’s The Worldly Philosophers, an account of the lives and contributions of history’s great economists, from Adam Smith to John Maynard Keynes to Joseph Schumpeter. The book gave me an enduring appreciation of the dismal science of economics and the thinkers who changed the world through their ideas.

It’s no great mystery why those two books made such a lasting impression. Human beings are wired to learn through stories, which is why the most effective teachers have an instinct and talent for storytelling. So shortly after I took up my second career as a professor of finance—the first career being an investment banker—I taught a short-form course that surveyed the history of modern Wall Street through brief biographies of some of its influential individuals over the last century.

Almost as enjoyable as teaching the course was the Solomon-like determination of who was in and who was out when it came to “influential.”

(On the first day of class I explained to my students that being influential was different from being famous. The world’s best-known value investor is Warren Buffett. But Benjamin Graham, the man who literally wrote the book on value investing and who was Buffett’s teacher in college, is far less famous.) The biography format worked beyond my expectations, and by the end of the course I decided to turn my lecture notes into a book.

Each of the fourteen men I selected gets a separate chapter, and their stories are told in more or less chronological order, with J. Pierpont Morgan, the dominant financier at the turn of the twentieth century, serving as the starting point and the subject of the first chapter. The remaining thirteen chapters are further divided into five parts—Reformers, Democratizers, Academics, Financial Engineers, and Empire Builders—each categorizing a different aspect of the development of Wall Street between Morgan’s time and our own.

preface xiii

Reforms. A successful financial system requires confidence in the integrity of its markets and the staying power of its institutions—and at the beginning of the twentieth century that confidence was in short supply. Without a central bank, financial panics plagued the economy with awful regularity until a financial panic in 1907 finally spurred the formation of the Federal Reserve System. It took the combined work of an odd couple to make that happen: a cerebral, German-born investment banker and a scrappy Virginia congressman. And it took the 1929 stock market crash to finally move the U.S. Congress to enact effective financial regulation and create the Securities and Exchange Commission as part of Franklin Delano Roosevelt’s New Deal legislation in the 1930s.

It’s unlikely that legislation would have passed absent the sensational and highly publicized congressional hearings into Wall Street practices led by a tenacious former New York prosecutor. The newly formed Federal Reserve and SEC became the two vital regulatory institutions necessary to build public confidence and promote the growth of the nation’s financial institutions and markets.

Democratization. One of the important drivers of Wall Street’s growth was the expansion of the securities markets to individual investors. That’s in part due to the protections afforded by the SEC, but it’s also due to the work of “Good Time Charlie,” a colorful entrepreneur who built the world’s most successful retail investment firm. Another individual—“Saint Jack”— deserves equal billing for turning the United States into “shareholder nation” through the popularization of index mutual funds and the creation of a shareholder-friendly mutual fund organization that today, with around $3 trillion under management for investors, is the world’s largest.

Risk embracement. No one has tested and expanded more on the relationship between financial risk and financial return than professors in the business schools. Part III profiles three of them who, keeping one foot in academia and the other in the business world, made major differences in the practice of finance with their approaches to risk taking. The man who quantified risk and developed the field of securities analysis, for instance, ran the Graham-Newman money management firm by day and lectured in the evening at Columbia University. Around the same time, one of the legendary professors at the Harvard Business School created and managed a new and vital kind of financial intermediary called a venture capital firm.

The third professor profiled is a Nobel laureate recognized for his work in creating the analytical model that spurred the derivatives market. He balanced teaching at Stanford with managing a hedge fund and demonstrated

xiv

preface

how derivatives and financial arbitrage can work to reduce investment risk—or, as in the case of his own hedge fund, grossly inflate it.

Financial engineering. Product expansion also explains much of Wall Street’s recent growth. In 1949, a social activist and writer conceived of a private fund that would simultaneously invest in risky “long” and “short” positions so as to reduce risk; such funds became known as hedge funds.

Twenty years later, a twenty-three-year-old Wharton graduate began taking low-rated corporate bonds under his wing and later was the major force behind their use in a wave of leveraged buyouts and corporate restructuring in the 1980s. One of his contemporaries, working at the mortgage desk at Salomon Brothers, resurrected another out-of-favor bond—one that was mortgage backed. He succeeded in devising new ways to package— “securitize”—home mortgages to make them attractive investments for institutional investors.

Deregulation. Through most of the twentieth century, U.S. commercial banks and investment banks were held in close check by their regulators— and they were not allowed to operate in each other’s arena. But beginning in the 1970s, both commercial banking and investment banking were suddenly transformed and their businesses greatly enlarged by two monumental deregulatory actions—both of which were essentially forced on the authorities. In 1970, the three young principals of an upstart investment banking firm challenged the New York Stock Exchange’s ban on outside ownership by making a wide distribution of shares of their common stock through an initial public offering. Over the following years, all the major investment firms went public and grew improbably large—often dangerously so—by tapping into new sources of external capital. The second challenge occurred thirty years later when a hard-charging banker forced the repeal of the Glass-Steagall Act that had prohibited the operation of commercial banking and investment banking under the same roof.

Several of the readers of the early drafts of Wall Streeters offered good arguments for adding individuals to the lineup or subbing out one for another. In order to keep the profiles to a manageable number, however, I stuck with the men I chose originally and, in the main, I still think I have it right. Others questioned why all of the profiles are of men, and the short answer to that question is that the world of finance in the twentieth century was almost exclusively male. When Muriel Siebert became a member of the New York Stock Exchange in 1967, the makeup of exchange members changed from 1,366 men—to 1,365 men and one woman. At that time the Exchange Luncheon Club didn’t even have a ladies’ room. When she rang

preface xv

the opening bell at the NYSE on December 28, 2007, in commemoration of the fortieth year of her membership, women were still a minority on Wall Street, yet one that was growing in number and influence. Sheila Bair, Brooksley Born, and Elizabeth Warren, for instance, had become important figures in financial regulation—though their prescient warnings did not gain enough traction to forestall the 2008 crisis. And of course Janet Yellen, the first female chair of the Federal Reserve, is likely to become a historical figure.

Another observation from early readers was that twenty or so pages per chapter are not enough to give depth to either the individual profiled or to the area of finance he influenced. That’s certainly true, and I encourage readers who want more depth on the individuals profiled to consult the full-length biographies and memoirs included in the Suggestions for Further Reading section of this book. My hope is simply that Wall Streeters will leave you with a better understanding of the American system of finance—how it evolved and how it works today.

morris

PRAISE FOR

— George

H. Wa l k er III , former chairman, Stifel, Nicolaus, & Co., and former United States ambassador to Hungary

ed morris

“Enjoyable to read, easy to understand, Wall Streeters is a compendium of the last 150 years of ups and downs in American finance. Ed Morris uses the informative lens of biography to bring this history alive, and they are all here, from the saints to the sinners. Along the way readers will learn the problems of finance and Wall Street and their value to our nation.”

— David

Cowen , president, Museum of American Finance

“Wall Streeters is a wonderful narrative review and an interesting read. This book will be very significant for students, academics, and investment professionals if they want to understand and learn from the mistakes of the past.”

— Victor

Riccia rdi , Goucher College

Jacket design: Noah Arlow

$29.95

Jacket photos: Getty Images

columbia university press

/ new

cup.columbia.edu

york

ISBN: 978-0-231-17054-3

52995

9 780231 170543

the creators and corruptors of american finance

“Wall Streeters is a long-overdue book by a highly respected student of American finance. Readers of this book will develop a fuller understanding of how and why Wall Street has become what it is today.”

is a professor of finance and former dean of the business school at Lindenwood University. Before beginning his teaching career, he was an investment banker and served as executive vice president of Stifel, Nicolaus, & Co. He has served on the boards of companies listed on the New York Stock Exchange, the American Stock Exchange, and NASDAQ.

$29.95

the 2008 financial collapse, the expansion of corporate and private wealth, the influence of money in politics—many of Wall Street’s contemporary trends can be traced back to the work of fourteen critical figures who wrote, and occasionally broke, the rules of American finance.

s r o t p u r or C d n a s tor a e r C nce a e n i Th F n ica r e m A f o

s i r r o m d r a w ed

Edward Morris plots in absorbing detail Wall Street’s transformation from a clubby enclave of financiers to a symbol of vast economic power. His book begins with J. Pierpont Morgan, who ruled the American banking system at the turn of the twentieth century, and ends with Sandy Weill, whose collapsing Citigroup required the largest taxpayer bailout in history. In between, Wall Streeters relates the triumphs and missteps of twelve other financial visionaries. From Charles Merrill, who founded Merrill Lynch and introduced the small investor to the American stock market, to Michael Milken, the so-called junk bond king, to Jack Bogle, whose index funds redefined the mutual fund business, to Myron Scholes, who laid the groundwork for derivative securities, and to Benjamin Graham, who cowrote the book on securities analysis. Anyone interested in the modern institution of American finance will devour this history of some of its most important players.