fed 1 austrian article.pdf

7/29/2019 fed 1 austrian article.pdf

1/18

Articles

T H E S E P A R A T IO N O F C O M M E R C I A LA N D IN V E S T M E N T B A N K IN G :T H E M O R G A N S V S . T H E R O CK EFE LLE RS

A L E X A N D E R T A B A R R O K

T h e B a n k i n g A c t o f 1 9 3 3 , s o m e t im e s r e fe r re d t o a s t h e G l a s s - S t e a g a l l A c t ,s e p a r a te d c o m m e r c i a l a n d i n v e s t m e n t b a n k i n g , i n s t it u t e d F e d e r a l d e p o s i ti n s u r a n c e , p r o h i b i t e d i n t e r e s t p a y m e n t s o n d e m a n d d e p o s i t s , a n d r e o r -g a n i z e d t h e F e d e r al R e s erv e. T h e G l a s s -S t e a g a l l A c t is t y p i c a l l y e x p l a i n e d a s apub l i c - i n t e r es t measu r e des i gned t o r ec t i f y pe r s i s t en t p r ob l ems i n t he bank i ngsyst em, and t o com ba t t he i m m ed i a t e ban k i ng c ris is . I w i l l a rgue , how eve r , t ha ti m p o r t a n t p o r ti o n s o f th e A c t c a n b e b e t te r e x p la i n e d t h r o u g h a p u b l i c - c h o i c eana l ys is t ha t emphas i zes a st rugg le be t we en r iva l e l eme n t s i n the b ank i ng i ndus t r y .

T he f ocus o f t h is d is cuss i on w i l l be on t he sepa r a ti on o f com m er c i a l andi nves t men t b ank i ng and o n o t he r aspec ts o f the G l ass - S teaga l l Ac t , as we l l as Ca r t e rG l ass . 1 Pub l i c - in t e r es t r he t o r i c was used to j us t i f y t he sepa r a t i on o f co m m er c i a l andi nves t men t bank i ng . R ecen t w o r k by W h i t e ( 1986 ) , Bens ton ( 1990 ) , K r oszne r andRa jan ( 1991 ) and o t he r s have shown t ha t t h is r he t o r ic can no t be suppo r t ed i n theo r yo r i n f ac t . Banks t ha t comb i ned depos i t and i nves t men t bank i ng we r e sa f e r t handepo s i t banks w i t ho u t a f fi li a tes , and t hey is sued h i ghe r qu a l i t y secu r it ie s t han d i di n d e p e n d e n t i n v e s t m e n t b a n k s . I a r g u e t h a t t h e s e p a r a t i o n o f c o m m e r c i a l a n di nves t men t bank i ng can be be t t e r unde r s t ood as an a t t emp t by t he Rocke f e l l e rba nk in g g rou p to ra ise the costs o f the i r r iva ls , the H ouse o f M organ . 2 Bo th the Hous eof Morgan and the Rocke fe l le rs , dur ing the 1930s , w ie lded enormous po l i t i ca l andeco no m ic pow er ; so as to be t te r unders tand the Mo rgan and Roc ke fe l le r r i va lry , someback ground is in o rder .

PUBLIC-INTEREST ARG UM ENTSPr oponen t s o f the G l ass- S t eaga ll A c t a r gued t ha t sepa r a t ing com m er c i a l and i nvest -m en t bank i ng w ou l d i ncr ease t he sa fe ty and r educe bank and cu s t ome r con f l ic t s o f

ALEXANDER TABARR OK s associateprofessor of e conom ics at Ba ll State Un iversity. I wish tothank Tyler Cowa n and H ugh H eclo for com ments; and Mu rray N. Rothbard or com ments on anearl ier version of this paper. Any rema ining errors are solely my ow n.

O n depo sit nsurance,see Golem be 1960), Preston I 933 ), and Friedmanand Schwa rtz 1963).2On hetheoryof"raising rivals' costs,"seeSalopand Scheffman I 984 )andW ill iam son (I 96 8).The Qua r ter ly Journa l o f Aust rian Econom ics vol. I , no. I (1998): 1-1 8


2/18

2 THE QUARTERLY OURNAL OF AUSTRIAN ECONOM ICS VO L. 1, NO . 1 (1998)

in terest . Nei ther o f these arguments bares c lose scrut iny here. At the most bas iclevel, i t is c lear tha t m an y secur it ies (s tocks and bonds) are less r isky than are loans.Se cur i ty investmen ts are a lso l iqu id and pu bl ic ly observable. L iq u id i ty le ts banksqu ick ly reba lance the i r por t fo l ios to avo id runs , and pu b l i c ob serva b i l it y improves thee f f ic i ency o f bank m on i t o r i ng by depo s i to r s and bo nd ho l de r s . Even i f a l l secu r it ie swe r e r is k i e r t han a l l l oans , f o r b i dd i ng banks t o i nves t in se cu r it ie s co u l d i nc reaseban k r is k because o f t he b ene f it s o f d i ve r s i f ica t i on ( see M ac ey 1991 ).

T he Sup r eme Cou r t , econom i s t s , h i s t o r i ans , and o t he r s have unc r i t i ca l l y r e -f e r r ed r eade r s t o t he Peco r a - G l ass Subcommi t t ee Hea r i ngs and t o o t he r hea r i ngsf o r ev i denc e t ha t banks w i t h secu r i t y a ff il ia t es c r ea t ed an u nd ue r is k t o depos i t o r s .Bu t i n an exhaus t i ve r ea d i ng o f a l l t he r e l evan t ma t e r i a l , Ben s t on (1990 ) has f oun dno ev i den ce t o suppo r t t h i s conc l us i on . T h e hea r ings a re r ep l e te w i t h unsu ppo r t edasse rt ions and ba l d hypo t heses , bu t no ev i denc e on t he r is k o f un i f i ed b ank i ng waseve r p resen t ed . S i nce t hen , ev i den ce has been f ound w h i c h s t r ong l y i nd i ca t es t ha tsepa r a t ed bank i ng i s r i s k i e r t han un i f i ed bank i ng . Wh i t e ( 1986 ) has exam i ned t hef a i l u r e r a t e i n 1930 - 33 o f na t i ona l banks w i t hou t secu r i t y a f f i l i a t es and na t i ona lbanks w i t h secu r i t y a f f i l i a t es . He f i nds t ha t banks w i t hou t secu r i t y a f f i l i a t es we r efou r times as l i ke ly to fa i l as we re those w i th a f f il ia tes .

An o t h e r a r gum en t aga i ns t un i f i ed bank i ng is t ha t a ban k w i t h secu r i t y a ff il ia t eshas a con f l i c t o f i n t e res t . Sena t o r Bu l k l ey , a s t r ong supp o r t e r o f t he G l ass - S t eaga llAc t , p u t the a r gum en t as f o l l ows :

Ob viously, the ban ker who has nothing to sel l his deposi tors s mu ch be tter qual i f ied toadvise dis interestedly and to regard di ligent ly the safety of deposi tors han the bankerwh o uses he l ist of depos itors n his savingsdepartment o d istr ibute circulars concern-ing the ad vantageof this, that, or the oth er investmen ton w hich the bank s to receive anoriginating profit or an u nde rwrit ing profit or a rading profit.3T h i s a r gum en t m i gh t app l y to a f l y - by - n i gh t ou t f it , bu t once l ong - r un p r o f it s and

r epu t a t i on a r e i nc l uded i n t he ana l ys i s , t he conc l us i on i s r eve r sed . T he mor e aninves tm ent ad v isor has to lose by o f fe r ing bad a dv ice , the less l i ke ly th i s i s to occ ur .Po or inves tm ent a dv ic e o n the par t o f a secur i t ies a f f i l ia te is l i ke ly to lead investo rst o l eave tha t a f f il ia t e and t o w i t hd r aw t he i r funds f r om t he pa r en t bank . Inves to rs ,t he r e f o r e , a re ab l e t o t h r ea ten s t ronge r pun i t i ve ac t i on i f t hey i nves t w i t h a un i f i edbank t ha n i f t hey i nves t w i t h an i nves t men t bank a l one . 4

The co n f l i c t o f i n te rest a rgum ent is a lso con t rad ic ted b y inves to r beha v io r . U n i f i edbanks (banks wi th af f i l ia tes or secur i ty operat ions) were rap id ly increas ing the i r shareo f t he bond is suing mar ke t in the 1920s . In 192 7 , f o r exam p l e , c om m er c i a l banks andthe i r a f f i l i a tes were respons ib le fo r 36 .8 percen t o f a l l i ssues , and in 1930 fo r 61 .2pe rcen t o f a l l issues (Peach 1 941 , p . 110) . I f the co n f l i c t o f i n te res t a rgu m en t w eret rue , one wo u l d exp ec t r a t iona l in ves to rs t o aba ndo n un i f ied banks r a the r t han f l ockt o t hem. M o r e c ons i s t en t w i t h t h is ev i dence is t he f ind i ng o f K r oszne r and R a jan

3Quoted n M acey (1984, p. 15).4Benston (1990 ), Saunders (1985), and Ke lly (198 5) dea l with the con fl ict-of-interest argu-ments n greaterdepth.


3/18

THE SEPARATIONOF COMMER CIALAN D INVESTMENTBANKING 3

(1 9 9 4 ) t h a t u n i f i e d b a n ks i s su e d h i g h e r q u a l i t y se cu r i t i e s (e x pos t ) t h a n d i d i n ve s t -m e n t b a n ks a c t i n g a l o n e , s

T h e p u b l ic - i n te r e s t e x p l a n a t io n is a t w i d e v a r i a n c e w i t h t h e fa cts . T o e x p l a i nt h e G l a ss -S t e a g a l l A c t , t h e re fo re , r e q u i re s e it h e r t h a t C o n g re ss a c t e d i n g re a t e r ro ro r t h a t t h e m o t i va t i o n b e h i n d t h e A c t w a s n o t t h e p u b l i c in t e re s t . 6,7

T H E R OC KE FE LL ER S A N D T H E H O U S E O F M O R G A N 8A s i d e f r o m t h e F e d e r a l g o v e r n m e n t , t h e H o u s e o f M o r g a n a n d t h e R o c k e f e l l e rf a m i l y w e r e t h e la r ge s t a n d m o s t im p o r t a n t e c o n o m i c a n d p o l i t i c a l e n t it ie s i n U . S .h i s to r y . L i ke t h e p re -w a r Ja pa n e se za iba t su , t h e H o u s e o f M o r g a n a n d t h e R o c k e fe l -le rs co n t ro l l e d l a rg e se c ti o n s o f t h e U . S . e co n o m y . In a n a ge o f u n l i m i t e d ca m p a i g nf u n d s , th e se g ro u p s c o u l d a lso e a s i ly m a ke o r b re a k a p o l i t ic i a n ' s ca re e r . In 1 9 3 3 ,t h e P e co ra in ve s t i g a ti o n re ve a l e d th a t J .P . M o rg a n ' s " p re f e r re d l is t ," p e o p l e w h ow e r e g iv e n s to c k a t f a r b e l o w m a r k e t p r ic e s , i n c l u d e d m o r e t h a n o n e e x - p r e s id e n t ,a h o s t o f t re a su ry se c re ta rie s f r o m b o t h p o l i ti ca l p a r t ie s , t h e ch a i rm a n o f th eR e p u b l ic a n N a t i o n a l C o m m i tt e e , th e c h a i r m a n o f t h e D e m o c r a t i c N a t i o n a l C o m -m i t te e , a n d m a n y o t h e r p o l i ti c i a n s a n d m e n o f a ffa ir s (C h e rn o w 1 9 9 0 , p . 3 7 0 ) . F ro mt h e i r b a se i n O h i o , t h e R o cke f e l l e r s a l so d a b b l e d i n p o l i t i c s . M a rk H a n n a , t h el e g e n d a r y R e p u b l ic a n o p e r a t iv e a n d O h i o S e na to r, w a s a s c h o o lm a t e o f J oh n D .Ro cke fe l l e r , as w e l l as a li f e l ong fr ien .d and bus iness a l l y (L und berg 193 7 , p . 58 ) . Itw a s t h r o u g h H a n n a t h a t t h e R o c k e f e ll e rs i n fl u e n c e d t h e M c K i n l e y a d m i n is t ra t io n s .M c K i n l e y ' s e l e c t io n in 1 8 9 6 , fo r e x a m p l e , w a s s u p p o r t e d b y a $ 2 5 0 , 0 0 0 d o n a t i o nf r o m S t a n d a rd O i l , a g i ft w h i c h w a s r e p e a t ed i n th e e l e c t io n o f 1 9 0 0 . H u n d r e d s o ft h o u s a n d s m o r e i n c a m p a i g n f u n d s w e r e o r g a n i z e d t h r o u g h R o c k e f e l l e r ' s o t h e rf i rms and bus iness i n te res t s ( i b i d , pp . 60-61) .

R o cke f e l l e r a l so i n f l u e n ce d p o l i t i c s t h ro u g h N e l so n A l d r i ch . A l d r i ch w a s R h o d eI s la n d ' s S e n a t o r f o r t h i r t y ye ars, d u r i n g w h i c h t i m e h is n e t w o r t h i n c re a se d f r o m$ 5 0 , 0 0 0 t o a t le a s t $ 1 2 m i l l io n (L u n d b e rg 1 9 3 7 , p . 6 1 ).9 A s ch a i rm a n o f th e S e n a tef i n a n c e c o m m i t t e e a n d R e p u b l i c a n w h i p , A l d r i c h c o n t r o l l e d t h e n a t i o n ' s l a r g e s s e .In h is 1905 ser ies in McC l u r e s t it l e d " E n e m i e s o f t h e R e p u b l i c , " L i n co l n S te ffe n s

SBenston (199 0) also finds tha t the evide nce for this assert ion in the doc um entary reco rd iswea k to non-existent. Many of the supposed abuses of the banking industry turn out to be fabrica-t ions or misreading of the actual evidence in the re cord.6Even thoug h the docu me ntary reco rd does not indicate either excessive risk or abuses, t was inthe interestof Pecora and the investigating com m ittee to suggest hat i t did. As a direct re sult of hisinvestigation, and the p ubl ici ty he generated, Pecora beca m e a comm issioner of the ne wly cre-ated Securities and Exchange Com mission. (On the exagge rations of Pecora and others and the irinterests, see C arosso [198 5, 19 73 ] and Karm el [198 0, p. 6 31].) -The me dia uncri t ical ly adoptedPecora's story, and o ve r time it becam e accep ted as fact. Un til B enston (1990 ), ew researchersboth-ered to investigate he a ctual data and testimon y upo n wh ich Pecora's view suppose dly rested. For amo del of this ype of herd beh avior, see Benerjee 1992) and Schaffstein and Stein (1990).71 suspect, m ore precisely, tha t the m ajori ty of Congress sup ported the Glass-Steagall Actbecause of mistaken impressions as to i ts effects, w hile a mino rity supp orted he A ct and g uided i tthrough Congress because of the ir special interests.~'he pol it ical and eco nom ic power o f J.P. Mo rgan and Com pany and the Rockefellers is wel ldocum ented in Che mo w (1990), Kolko (1963), Burch (1980; 1981 ), Lundberg (1937), and C ol lierand Horow i tz (1976).9C oll ier and H orow itz (197 6, p. 93) est ima te Aldrich's fortune at closer to $ 30 m ill ion.


4/18

4 THE QUARTERLY JOURNAL OF AUSTRIAN ECONO MICS VOL . I , NO . I (1998)

cal led Ald r ich the "bos s of the U ni ted States," and D avid Graham Phi ll ips 's seriesin Cosmopol i tan , "The T reason of the S enate," devoted an ent ire chapter to Ald r icht i tled "A ldr ich, the Head of i t A l l . " A ldr ich 's connect ion w i th the Rockefe llers beganf inanc ia l ly and po l i t i ca l ly , bu t became fami l ia l when h is daughter Abby mar r iedJohn D. Rockefel ler, Jr. (Abby's brother Winthrop is also a key player in theseparat ion of commercia l and investment banking; see below). Through Aldr ich,the Rockefe l lers (and other N ew Yo rk bankers) had a profound influence on thecreation of the Federal Reserve. A ldr ich chaired the Na t ional M one tary Com mis-sion of 1910 that produced the "A ldr ich Plan" w hich , wi th s l ight mod i f icat ions dueto Car ter Glass and h is advisor H. Pa rker W i l l is , becam e the foundat ion of theFederal Reserve System (Fr iedm an and Schw artz 196 3, p. 171 ). Little kn ow n at thet ime, Ald r ich 's p lan was hamm ered out by Ald r ich, M organ, Rockefe l ler , and Kuhn,Loeb par tners at a sec ret 1910 meet ing held on Jek yl l Is land , Georgia (Chernow1990, p. 127; Rothbard 1984; Kolko 1963, chap. 8) .

The Rockefe l lers ' weal th and power f lowed from Standard Oi l , but la ter ex-panded into ba nks and other industr ies. The House of Morgan's pow er came notfrom the we alth of J.P. M organ per se, bu t from Mo rgan's strategic posit ion in theU.S. econo m y. A t the turn of the century, A m erican industry underw ent a ser ies ofm ergers and restructurings that reshap ed the econo m y. J.P. M organ and his bankstood at the center of th is grea t cha nge . In 19 01 , Morgan engineered the greatestmerger of a ll t ime , c reating U.S. Steel w i th an in i tia l ca pi ta l izat ion of $1.4 b i l l ion ata t ime wh en GNP w as approx ima te ly $20 b i l l ion . A n equ iva len t merger todayw ou ld be capi ta l ized at around $ 350 b i l l ion . M organ's com missions a lone werewo rth about $15 b i l l ion in 1 99 3 dol lars. M organ's in fluence was fe lt in a l l o f them ajor indus tr ies of the day, especial ly rai lroads, uti li ties, and steel.The 191 2 P ujo hear ings in to the so-cal led "m one y trust" (a code w ord for theMorgan empire), revealed that J.P. Morgan and h is par tners we re pr inc ipal share-holders of doze ns of the largest U.S . corporations and that, in total, they held 7 2directorships in 112 corporations (Chernow 199 0, p. 12 ) . DeLong (1991 ; 19 92, p.1 7) est imates that Morgan-centered groups were in som e w ay connected w i th 40percent of al l the industr ial , f inancial, and commercial capital in the United States.

Twenty-one ye ars la ter , the Pe co ra hea r ings revealed a sim i lar story; M organpartners held 126 directorships in 89 corporations w ith a total of $20 b i l l ion inassets, represent ing approx ima tely on e- th i rd o f GNP (Chernow 1990, p. 366) .Pol i t ica l power f lowed from the House of Morgan's economic power. In 1896,W i l liam Jenn ings Bryan ende d h is speech to the D em ocra t ic conven t ion w i th thefamous oath "you sha ll no t cruc i fy m ankind upon a cross o f go ld . " Bryan was ta lk ingpr im ar i ly about J.P. Morgan wh o, w i th Grover Cleveland, had saved the goldstandard a yea r ear lier. 1 Through out this p er iod, M organ partners and associates wereimportant ad visors and f inancial backe rs to presidents and the po l i t ical el ite. In the

1904 election, for examp le, the Morgan bank gave $150,000 to Theodore Roosevelt'scampa ign fund, in return for wh ich George Perkins, a Morgan par tner , becam e chief

~Bryan's speech s reprinted in Hofstadter and V er Steeg (1969). Chernow (1990 , chap. 5)deals with Morgan's rescueof the g old standard.


5/18

THE SEPARATIONOF COMM ERCIALAN D INVESTMENTBANKING 5

adv i so r to Rooseve lt th ro ugh ou t h i s po l i t ica l ca reer (Ch ern ow 1990 , p . 112). I t wa sP e rk in s w h o p re sse d R o o seve lt t o r u n i n 1 9 1 2 a n d w h o su p p l i e d R o o se ve lt w i t hove r $5 00 ,000 in cam pa ign funds (Ho fs tad te r 1974 , p . 304) . 11

A t t h e 1 9 1 2 D e m o c r a t i c C o n v e n t io n , B r y a n a ga in a t ta c k e d th e H o u s e o f M o r -g a n , t h u n d e r i n g t h a t n o re p re se n t a t ive o f J . P . M o rg a n sh o u l d e ve r r e ce i ve t h eD e m o c ra t i c P a r t y 's P re s id e n t ia l n o m i n a t i o n . In 1 9 2 4 , h o w e ve r , a t t h e h e ig h t o fM o r g a n ' s p o w e r , h e h a d t o a c c e d e to th e n o m i n a t i o n o f J oh n W . D a v is , c h i e f l a w y e ro f th e H o u s e o f M o r g a n .

M o r g a n a n d R o c k e f e ll e r p o w e r d id n o t g o u n o p p o s e d . W i l l i a m J e n n in g s B r ya n ,a s a l r e a d y n o t e d , w a s i m p l a c a b l y o p p o s e d t o t h e M o r g a n s a n d t h e R o c k e f e l l e r s ,a n d , a s S e c r e ta r y o f S ta te u n d e r W o o d r o w W i ls o n , f o u g h t a g a in s t t h e i r c o n t r o l o ft he Federa l Reserve . A l l i ed w i t h h im were p rogress i ve i n te l l ec tua l s l i ke Lou i sBrande is , Fe l i x F rank fu r te r , and L inco ln S te f f ens . B rande i s , i n par t i cu la r , a t t ackedJ .P . M o r g a n a n d C o m p a n y , t h r o u g h o u t h is c a r e e r as a l a w y e r , a d v i s o r t o W i l s o n ,and associa te Jus tice o f t he S uprem e Co ur t . 12 Po l it i c ians l i ke H ue y Long , R obe r tL a F o l l e t t e a n d o t h e rs f o u n d s t ro n g su p p o r t f o r a t t a ck i n g t h e M o rg a n s a n d t h eR o cke f e l le r s a m o n g t h e p u b l ic , w h o f e a re d t h e m o n s t e r tr us ts . P e rh a p s m o re i m p o r -t a n t l y , p o l i t i c i a n s p l a ye d t h e r i va l co a l i t i o n s a g a i n s t o n e a n o t h e r . T h e M o rg a n ssu p p o r t e d a t ta cks o n t h e R o cke f e l le r s , a n d t h e R o cke f e l le r s su p p o r t e d a t t a cks o n t h eM o r g a n s . 13 In d e e d , a c o m b i n a t i o n o f p u b l ic o u t r a g e a n d p o l it ic a l m a n e u v e r i n g b yt h e R o ck f e l le r s w a s re sp o n s ib l e fo r t h e se p a ra t io n o f co m m e rc i a l a n d i n ve s t m e n tb a n k i n g .T h e M o rg a n s a n d t h e R o ck f e ll e rs c l a sh e d o f t e n . T h e ch i e f e co n o m i c r iva l o f t h eH o u s e o f M o r g a n w a s a f o r m i d a b l e c o m b i n a t i o n o f R o c ke fe lle r s ( o il , b a n k i n g ) ,H a r r i m a n s ( ra i lr o a d s ) , a n d b a n ke rs p r i m a r i l y a sso c ia te d w i t h K u h n , L o e b a n dL e h m a n B ro t h e rs2 4 In th e t w e n t i e t h ce n t u ry , Jo h n D . R o cke f e l le r , J r ., W . A ve re l lH a r r i m a n , so n o f E . H . H a r r i m a n , a n d t h e se co n d g e n e ra t i o n o f b a n ke rs a t K u h n ,

11perkins eft the Morg an firm in 1 912.12Chernow (I 990, p. 176 ) cal led B randeis "the m ost cun ning and resourceful foe the Hous eof Mo rgan w ou ld e ver face." D uring the P ujo hearings, Brandeis wrote a series of influent ialarticles for Harper's W eeklyunde r the t it le of "Other People's Mo ney; and H ow the Bankers UseIt." Thes eart ic les were a di rect at tack on J.P. Mo rgan and Com pany and the "m oney t rust. " "OtherPeople's Mone y," was reprinted during the P ecora hearings of 1 933 n book form (Brandeis 1933).13M organ-Rockefel ler rivalry as w ell as the u lt im ate po we r of the Federal gove rnm ent meantthat the M organs and the Rockefellers were by no means always he c ontrol ling pow ers. The factthat mone y f lowe d f rom W al l S treet o W ashington alone canno t tell us in which di rect ion pow erf lowe d. The do minant publ ic-choice theories of regulat ion emphasized he dem and or regulat ionby organized specialinterest groups (Pel tzman 1976 ; Becker 198 5). Pol it ic ians, ho weve r, areactive players n the regulatory and redistribut ive process, and n ot m ere passive sup pliers reac t-ing to pr ivate interest-group deman d. The relat ionship betwee n J.P. Mo rgan and C om panyand Theodore Roosevel t , for example, was at t imes ambivalent and even host i le. I t wasRoosevel t w ho launched the f irst t rust-bust ing at tack on the M organ em pire w i th the N orthernSecuri ties Case of 1902. Payments to Rooseve l t and other pol i tic ians should therefore be seenas part ly a response o threats of regulat ion and con trol. See McC hesney (I 991 ) for a m ode l of thistype of behavior.14Although Morgan and Kuhn, Loeb and somet imes Lehm an Brotherswo uld of ten cooperateon issues, there was alway s an und erly ing econ om ic r ival ry to which was ad ded J.P. Mo rgan'santi-Sem itism. See Ch erno w (I 99 0, p. 9 0 an d passim).


6/18

6 T HE Q UART ERLY JO UR NAL O F AUST RIAN ECO NO MI CS VO L. 1 , NO . 1 (1998)

Loeb, and L ehm an Brothers were th e m ain instigators of the attack on the House o fMorgan , of w hic h the 1933 separation of comm ercial and investment banking w asthe m os t important asp ect of the struggle. The attack was led and organized byW inthrop Aldr ich of Chase Nat ional Bank.

GENESIS OF THE BANKING ACTJohn D. R ockefeller, Sr., had m oved into banking by investing the cash reserves ofStandard O il in the N ationa l C ity Bank. James Stil lman was the president of Na tionalCity, and two of Stil lman 's so ns ma rried daughters of W il l iam Rockefel ler (brotherto Joh n D. Rockefel ler, Sr.), making this a fam ily a l l ianc e (Lundberg 193 7, p. 10).The c ash reserves of Stand ard O i l were so great that this s ingle source madeNational C ity one of the largest banks in N ew York. The R ockefellers, especial lyJohn D. Ro ckefeller, Jr., wa nted to do m inate ban king as the y did o i l , and around1911, Rockefel ler, Sr ., mad e substantial inves tm ents in Equitable Trust. U singEquitable as a base, the R ockefellers rap idly expande d the ir bank holdin gs throu gha series of m ergers (see Johnson 1968, pp. 8 0-1 10 ). By 1920, Equitable, w hic h hadstarted out as a sm all bank, was the eighth largest bank in the co un try, and i tcon t inued to grow through m erger and expansion throu gho ut the 1920s.

In 1929, Winthrop Aldr ich became president of Equi table Trust . WinthropAldr ich was John D. Rockefeller, Jr.'s brother- in- law, and was the son of the famousSenator Nelson A ldrich (a key player in the formation of the F ederal Reserve). s Alawy er by training, he was reluctan t to enter banking, b ut did so at the urging of JohnD. Rockefel ler, Jr., w ho had guided his career from i ts incep tion (see Johnson 1 968,p. 93; and Co l l ier and H oro wi tz 1976, p. 15 9). Un der Aldr ich , E quitable m ergedwith the Morgan-dominated Chase Na t ional Ban k. Chase's di rector was then A lbertH. W iggin. W iggin had bee n a prot~g~ of George F. Baker and H enry P. Davison ofF irst Nat ional B an k, both of whom were prominent wi th in the Morgan group(Johnson 1968, p. 101). Ald rich th en becom e president of the n ew ly formed ChaseBank, and W iggin bec am e chairma n of its Governing Board.

The position of president at Chase was in i t ial ly not a powe rful one. F rom 19 20to 1929, of the f ive men w ho had been president of Chase on ly Wiggin lasted morethan tw o years . The lack of c ont inu i ty meant that power res ted wi th Wiggin.Aldr ich, however, moved q uick ly to establish his ow n p ow er by prom ot ing his ow nmen and cutt ing the number of bank directors. An unpleasant corporate batt leensued in which Aldr ich was opposed by Wiggin, Thomas Lamont, and otherexecutives al l ied wi th the House of M organ. 16 By 1931, Aldr ich held the do m inan tposition, and Wiggin w en t into retireme nt w ith a suspiciously large pension. 17

lSThe Ald rich and Rockefeller fam ilies w ere ve ry close. Two of Rockefeller's sons werenamed Nelson R. and W inthrop , Aldric h fam ily names. Nelson Rockefeller wo rked at Chaseduringthis period (Johnson1968,p. 187).16On Lamont sattempts o b lock A ldrich, see Ferguson 1984, p. 81 ).17Wiggin re tired w ith an astoundingpension of $100,000a year. This became he subject ofembarrassmentduring he Pecorahearingsas neitherWiggin nor Aldrich cou ld adequatelyexplainwhy W iggin's pension was so large. Ald rich and W iggin w ere barely on speaking erms by 1932and, according o Aldrich, the differences between hem were such hat both of them c ou ld not


7/18

THE SEPARATIONOF COMMERC IALAND INVESTMENTBANKING 7

A s R o o s e v e l t t o o k o f f ic e in 1 9 3 3 t h e g re a t d e p re s s io n w a s a t its t r o u g h , 1 5m i ll io n w o r k e r s w e r e u n e m p l o y e d , re a l g ro ss n a t io n a l p r o d u c t h a d fa l le n b y n e a r l y3 0 p e rc e n t s i n c e i t s p e a k i n 1 9 2 9 , a n d g ro s s i n v e s t m e n t w a s v i r t u a l l y n i l (T e m i n1 9 7 6 ) . T h e p u b l i c l o o k e d b a c k a t t h e fi n a n c i a l b o o m o f t h e t w e n t i e s a n d d e e m e dth i s t he o r i g i na l s i n . Bankers and f i nanc ie rs , f ea red and admi red i n t he twen t i es ,w e re f e a re d a n d re v i le d in th e th i r ti e s . P o l i ti c ia n s f u e l e d t h e p u b l ic ' s a n i m o s i t y . Inh is i n a u g u ra t i o n s p e e c h, R o o s e v e l t a t ta c k e d t h e " m o n e y c h a n g e rs " a s " c a l l o u s , "" u n s c ru p u l o u s , " a n d " s e l fi s h , " a t t h e s am e t im e a s h e c a l l e d f o r u n p re c e d e n t e dp o w e r fo r h i m s e l f a n d " a t ra i n e d a n d l o y a l a r m y w i l l i n g t o s a c ri fic e f o r t h e g o o d o fa com m on d i sc ip l i ne . " l a I n Congress , t he Pecora hear ings an d l a te r t he N ye hear ingsf u e le d t h e s a m e f ir e . T h e N y e h e a rin g s o f 1 9 3 6 a c c u se d M o rg a n o f b e i n g a " m e rc h a n to f dea th " respons ib le f o r Am er i ca 's en t ry in to W or ld W ar I, and t he Pecora hear ingsp u rp o r t e d t o s h o w a b a n k i n g h i s t o r y o f " p ro f i t s , g re e d , e x p a n s i o n , p o w e r , a n dd o m i n a t io n . "1 9

W i t h o u t t h e g re a t d e p re s s io n a n d t h e o u t ra g e th a t w a s g e n e ra t e d b y t h e P e c o rah e a rin g s , t h e s e p a ra t io n o f c o m r n e r c i a l a n d i n v e s tm e n t b a n k i n g w o u l d p r o b a b l y n o th a v e o c c u r re d . 2 A s i t w a s , t h e P e c o ra h e a r i n g s re v e a l e d t h a t Ja c k M o rg a n h a d p a i dn o i n c o m e t a x s in c e 1 9 3 0 , a n d t h a t n o n e o f t h e tw e n t y M o r g a n p a r tn e r s h ad p a i di n c o m e t a x in 1 9 3 1 o r 1 9 3 2 ( C h e r n o w 1 9 9 0 , p . 3 66 ) . O t h e r m e m b e r s o f t h e M o r g a ng r o u p , m o s t p a r t i c u la r l y A l b e r t W i g g i n , w e r e a ls o a c c us e d o f i n c o m e t a x e v a sio n .A l t h o u g h a l l o f t h e " e v a s i o n " w a s l e g a l a n d d u e m o s t l y to h u g e s t o c k l o ss e s, t h ep u b l i c w a s i n f u r i a t e d . S e l i g m a n (1 9 8 2 , p . 2 9 ) r e p o r t s t h a t b a n k e rs " b e c a m e t h eo b j e c t o f n e a r - h y s te r ic a l r a g e ." T h e p u b l ic d e m a n d e d t h a t s o m e a c t io n b e t a k e n ,b u t i t w a s le f t t o t h e in s id e rs , l ik e W i n t h ro p A l d r i c h , t o d e t e rm i n e t h e d i r e c t i o n o fc h a n g e .

A l d r i c h a n d th e R o c k e f e l le r b a n k i n g g ro u p w e re i n i t i a l ly i ll s er ve d b y th e P e c o rahear i ngs . Wigg in s t i l l rep resen ted Chase Nat i ona l i n t he m inds o f many , and h i sd i s g ra c e re fl e c te d o n t h e b a n k . T h e o t h e r R o c k e f e l l e r b a n k , N a t io n a l C i ty , w a s a l sobe ing i nves t iga ted , an d its C ha i rma n, Ch ar l es M i t ch e l l , and i ts P res iden t , H ug hB a k e r, w e re f o r c e d t o r es ig n i n la te F e b ru a ry o f 1 9 3 3 . A l d r i c h h a d t o f in d s o m e w a yt o p ro t e c t th e R o c k e f e ll e r b a n k s .

rema in at the ba nk (seeU.S. Congress, Senate 193 4.4018 ). The s olution was e vidently to pay offW ig-gin so he wo uld exit gracefully, W iggin's pension was wha t we toda y would cal l a "golde n parachute"paid to W iggi n so that he wo uld leave Chase rather han continue o f ight he Aldrich-Rockefel ler take-over. O n the inform ation in this note, see Johnson (1968 , pp. 10 7-3 8); my interpretation differs signifi-cant ly from his. On golden parachutes as an incent ive device to lo w er the costs of takeovers, seeKnoeber (1986).18 Roose velt's speec h can be foun d in Peterson (1954 ).19The l ist is from a rhe torical question by S enator Bu lkley: "Did not professional pride be-com e diverted f rom the p ride of safe and honest banking service to that of p rofi ts, greed, expan-sion, pow er, and dom ination?" Quo ted in Benston (I 990 , p. 124).The pu bl ic-choice school of p ol it ical science and econom ics has emphasized the specialinterest nature of mo st regulat ion, but has left unexa m ined the techn iques of pow er which pol i t i-cians use to m obil ize p ol i tical supp ort rom a dif fuse and rat ional ly ignora nt pub l ic. A study of thel ink betwe en hearings and regu lat ion cou ld be very valuable.2See on this point W i ll is and C hapm an (1934, p. 101), Seligman (1982, pp. 2, 29 ), andKennedy (I 973 , p. 212).


8/18

8 THE QUARTERLYJOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

O n M a r c h 7 , N a t i o n a l C i ty B a n k ' s n e w C h a i r m a n J am e s P e r k in a n n o u n c e d t h a tt h e b a n k w o u l d d i v o rc e its s e c u r i t y a f fi li a te . O n M a rc h 8 , A l d r i c h f o l l o w e d P e rk i n 'ss u r pr is e a n n o u n c e m e n t w i t h a s w e e p i n g p l a n f o r b a n k r e f o rm t h a t m a n y in th eb a n k i n g c o m m u n i t y c a l le d a " b e t r a y a l. "21 A l d r i c h d e n o u n c e d t h e c o n n e c t i o n o fi n v e s tm e n t b a n k i n g a n d c o m m e r c i a l b a n k i n g a s " a l m o s t i n e v i ta b l y l e a d in g toa b u s e s . " H e t h re w h i s s u p p o r t b e h i n d t h e G la s s b il l t o s e pa ra te c o m m e rc i a l b a n k sand the i r secur i t y a f f i l i a t es , bu t he a rgued tha t t he b i l l d i d no t go f a r enough . I na d d i t i o n t o t h e c u r re n t p ro v i s i o n s , A l d r i c h a rg u e d t h a t ( 1 ) p r i v a t e b a n k s s h o u l d b ere g u l a t e d a s h e a v i ly a s c o m m e rc i a l b a n k s ; ( 2 ) p r i v a t e b a n k s s h o u l d b e fo r c e d t os e p arate t h e i r c o m m e rc i a l a n d i n v e s t m e n t d i v i s io n s ; a n d (3 ) n o i n t e r l o c k i n g d i r e c -t o ra t e s b e t w e e n a n y t y p e o f b a n k a n d s e c u r it ie s f ir m s h o u l d b e a l l o w e d . 22

T h e p u rp o s e o f A l d r i c h ' s s t ra t e g y is o b v i o u s t o c o n t e m p o ra ry o b se rv e rs . T h eNew York T imes m a d e A l d r ic h ' s a n n o u n c e m e n t f ro n t p ag e n e w s o n M a r c h 9 w i t ht h e h e a d l i n e " A l d r i c h H i t s a t P r i v a t e B a n k e rs i n S w e e p i n g P l a n f o r R e f o rm s . " T h eTimes n o t e d t h a t A l d r i c h , " w h o is a r e p re s e n t a ti v e o f t h e J o hn D . R o c k e f e l le ri n te re s t s ," w a s a t ta c k i n g " s o m e o f W a l l S tree t's m o s t p o w e r f u l f ig u re s a n d t h e i rp a r t i c u l a r i n t e re s t s . " M o re t h a n a n y o n e e l s e , t h e A l d r i c h p ro g ra m " s t r i k e s d i r e c t l ya t t h e p o s it io n o f J .P . M o r g a n a n d C o m p a n y . " " W . W . A l d r ic h , F irs t C h a l le n g e r t oH o u s e o f M o rg a n " w a s a p ro f i l e o f A l d r i c h p u b l is h e d s e ve ra l d a y s l a te r i n t h e W or ldTelegram . 23T h e W al l S t reetJournalwas m o re c i rc u m s p e c t , b u t a ls o a l l u d e d d a rk l yt o a R o c k e f e ll e r c o n s p i r a c y t o v a n q u i s h J .P . M o r g a n a n d C o m p a n y .

M o s t d e v a st at in g t o t h e H o u s e o f M o r g a n w a s A l d r i c h ' s t h ir d p o i n t, t h e b a n o ni n t e r l o c k i n g d i r e c to ra t e s . M o re t h a n a n y o t h e r a s p e c t o f t h e G l a s s -S te a g a l l A c t , i tw a s t h e b a n o n i n t e r l o c k i n g d i r e c t o ra te s t h a t se p a ra te d c o m m e rc i a l f r o m i n v e s t-m e n t b a n k i n g ; o f t h e t w e n t y M o rg a n p a r t n e rs , t e n w e r e d i re c t o r s o f a t le a s t o n ec o m m e r c i a l b a n k (New York T i m e s , M a rc h 9 , 1 9 3 3 ) . M o re o v e r , t h e o f f i c e r s o fM o rg a n -c o n t ro l l e d b a n k s , s u c h as G e o rg e F . B a k e r o f t h e F ir st N a t io n a l B a n k , w e rea lso o ft en d i rec to rs o f o ther banks . The ex ten t o f t he conn ec t i on be tw een banks i n theM o rg a n g ro u p w a s p ro b a b l y b e s t i llu s t ra t e d b y t h e f in d i n g o f th e P e c o ra c o m m i tt e e t h a tJ .P . M orga n a nd Co m pa ny had g i ven " l oa ns" t o s i x ty o ffice rs and d i rec to rs o f o therb a n ks . A s J a c k M o rg a n n o t e d " T h e y a re f ri e n d s o f ou rs , a n d w e k n o w t h a t t h e y a rego od , soun d , s t ra igh t f e l low s . "24

T h e i n t e r lo c k i n g d i re c t o ra t e s o f t h e M o r g a n g r o u p , w h i c h e x t e n d e d t o m a n yc o r p o r a t i o n s a s w e l l a s t o o t h e r b a n k s , m e a n t t h a t M o r g a n c o u l d e c o n o m i z e o nt ransac t ion and i n fo rm at i on cos ts as w e l l as ove rcom e p rob lem s o f adverse se lec tionand mo ra l hazard . Th e Mo rgan ban k wa s no t l a rge , bu t because o f its t ies to co m m erc ia l

21Aldrich's announce men t was widely publ ic ized the fol lowing day, M arc h 9. Surely notcoincidental ly, th is coincided w i th the co nvening o f the new Congress.22See Ald rich's statem ent in the New York Times (Ma rch 9, 1 933 , pp. 1, 2). Aldrich alsowan ted to l imi t the num ber of di rectors a b an k could have (point four in this statement). A newstatute limit ing directors w ou ld sa ve Aldrich the troub le o f an unpleasa nt f ight to term inate orel iminate throu gh attrit ion excess Chase directors; Aldrich's ow n ban k, Chase Na tiona l, was topheavy w i th di rectors because t had grow n through mergers.23New York Wo rld Telegram M arch 13, 193 3), quo ted in Johnson (1968 , p. 152 ).24Quoted n C hernow (1990, p. 364).


9/18

THE SEPARATION OF COM MERC IAL AN D INVESTMENTBANKING 9

b a n k s , J .P . M o r g a n a n d C o m p a n y c o u ld f in a n c e h u g e s e c u r i ty i ss ue s w i t h v e r y l o wreserve requ i rements . I f U.S. Stee l , fo r example , wanted to issue new secur i t ies , theyw o u l d b e b o u g h t b y J .P . M o r g a n a n d C o m p a n y , w h i c h f in a n c e d t h e p u r c h a set h r o u g h a l o a n f r o m a l a r g e - - a n d r e l a t e d - - - c o m m e r c i a l b a n k l i k e F i r s t N a t i o n a l .U .S . S te el w o u l d n o t n e e d t h e e n t i re p r o c e e d s i m m e d i a t e l y a n d w o u l d s i m p l yd e p o s i t t h e f u n d s fr o m M o r g a n i n t o a n o t h e r M o r g a n b a n k , p e r h a p s e v en F i rs tN a t i o n a l . ( A n d w h e n t h e m o n e y w a s s p e n t i t m i g h t g o to a f i rm l ik e G e n e r a l E l e c tr ic ,w h i c h a ls o b an k e d w i t h M o r g a n ) . J.P . M o r g a n a n d C o m p a n y w o u l d t h e n m a r k e t t h es e c u ri ti e s a n d d e p o s i t th e p r o c e e d s . O t h e r i n v e s t m e n t h o u s e s c o u l d n o t f in a n c ela rg e s e c u r i ty i s su e s b e c a u s e t h e y l a c k e d e x t e n s i v e c o n n e c t i o n s w i t h t h e l a r g ec o m m e r c i a l b a n k s w h o a l o n e c o u l d a d v a n c e t h e e n o r m o u s s u m s n e e d e d i n t h ei n t e r m e d i a t e p r o ce s s . If i n f o r m a t i o n w e r e fr ee , a n y in v e s tm e n t b a n k c o u l d b o r r o wm one y on a goo d i ssue . Bu t in a w o r ld o f h igh t ransac t ion cos ts and m ora l haza rd ,i n v e s tm e n t b a n k s w i t h o u t c l o s e ti es t o c o m m e r c i a l b a n k s w e r e c r e d i t r a t io n e d . T h ee ss en ce o f G la s s -S t e a g a ll w a s n o t th e b a n o n d e p o s i t b a n k s i s s u in g s e c u r i t i e s b u t t h eb a n o n i n t e r l o c k i n g d i re c t o ra t e s . A l d r i c h a l o n e p u s h e d t h i s t h r o u g h C o n g r e ss .

T h e s e p a r a ti o n o f c o m m e r c i a l a n d i n v e s t m e n t b a n k i n g w a s c o s t ly to C h a s eN a t i o n a l a n d th e o t h e r R o c k e f e l l e r b a n k s a s w e l l a s t o M o r g a n . I n d e e d , W i g g i n a n dc h a i r m a n o f t h e C h a s e b o a r d , C h a r l e s M c C a i n , h a d b e e n a m o n g t h e m o s t v o c i fe r -o u s c ri t ic s o f s e p a r a t io n . 2s A ld r i c h ' s a c t i o n s , t h e r e f o r e , c a n n o t b e u n d e r s t o o d s im p l ya s a n a t t e m p t t o i n c r e a s e p r o f i ts t h r o u g h g o v e r n m e n t e n t r y r e s t r ic t i o n s . 26 I n s te a d ,A ld r i c h ' s a c t i o n s m u s t b e u n d e r s t o o d a s a n a t t e m p t t o r a i se h is r i v a ls ' c o s t s . T h et h e o r y o f " r a i s i n g - r i v a l s ' c o s t s " s h o w s t h a t i t is p o s s i b l e f o r a f i r m t o i n c r e a s e i tsp ro f i t s by ra is ing indu s t ry cos ts so long as the cos ts to i t s r i va ls inc rea se m ore tha ni t s o w n c o s t s ( a n d d e m a n d i s n o t t o o e l a s t i c ) . C o n s id e r a r e g u la t i o n t h a t r a i s e si n d u s t r y c o s ts b u t , b e c a u s e o f h e t e r o g e n e i t y a m o n g f ir m s , r a is e s t h e c o s t s o f f ir m Bm o r e t h a n t h e c o s ts o f f ir m A . T h e r e a r e t w o e ff ec ts : th e i n d u s t r y a s a w h o l e w i l ls h r i n k w h e n c o s ts a n d p r i c e s r is e, a n d f ir m A w i l l l o s e s o m e p r o p o r t i o n o f t h e s ec u s t om e r s . F i r m A , h o w e v e r , w i l l g a i n so m e o f t h e c u s t o m e r s w h o l ea v e fi rm Bb e c a u s e f i r m A ' s p r i c e s d o n o t r i se as m u c h a s d o t h o s e o f f ir m B . L o o s e l y s p e a k in g ,i f t h e s e c o n d e f f e c t o u t w e ig h s t h e fi rs t , fi r m A c a n b e n e f i t f r o m t h e r e g u la t i o n . 27 A

2SD uring W iggin's testimo ny to the Pecora nvestigation, Aldrich stood close by and repeat-edly indicated that Chasewas no longer fo l lowing the pol ic ies of the Wiggin regime. McC ain, too,was disgraced by Aldrich's renunciation of his policies, and resigne d as chairma n of the board in1934. Aldrich replaced him sh ortly thereafter, thus cem enting the R ockefeller akeover.26Shughart (I 988), Macey (I 984), and Ben ston (I 982) spec ulate hat the Glass-Steagall Ac twas pass ed in order to ben efit comm ercial and/or investm ent banke rs w ith en try restrictions.Although this is a possible mo tive for suppo rting the A ct, n one of these authors demons trate thatthe spe cial interests they discus s had (a nd used) the p olitical pow er necessary o pu sh the actthrough Congress.The m icro-history ap proach of this article is able to pinpoint w hic h g roups hadand used he requisite polit ical pow er.27M ore technically, to increase profits the init iating firm's residual dem and curve m us t r isemo re than its average costs. The size of the residual dem and increasedepen ds upon the increase nrival-f irm costs and the elasticity of total dem and. The m ore inelastic total dem and is the m ore anincrease in rival-firm costs e ads o an increas e n the init iating firm's residual dem and. See Salopand Scheffman (1983). Ra ising the costs of one 's rival can also wor k in a perfectly com petit iveindustry if f irms e arn rents, and c osts hit dispropo rtionately so as to reduce the elasticity o f the


10/18

10 THE QUARTERLYJOURNAL OF AUSTRIAN ECONOM ICS VOU 1, NO . 1 (1998)

c l a s s ic c a se o f t h is t y p e o f b e h a v i o r is a c a p i t a l- i n t e n s i v e f i rm w i t h l a b o r - i n t e n s i v er iv a ls s u p p o r t in g u n i o n i z a t i o n ( W i ll ia m s o n 1 9 6 8 ) .

T h e ra i s in g - r i v a ls ' c o s t t h e o ry fit s t h e e v i d e n c e o f t h e H o u s e o f M o rg a n a n d t h eR o c k e f e l le r b a n k i n g g r o u p . T h e H o u s e o f M o r g a n ' s s t re n g th w a s b u i l t o n i n t e r l o c k -i n g d ir e c to r a te s a n d u n i f ie d b a n k i n g t o a m u c h g r e a te r e x te n t th a n w e r e t h e b a n kso f t h e R o c k e f e l le r g ro u p . C h a s e ' s s e c u r i t y a ff il ia t e w a s n o t m a k i n g m o n e y d u r i n gt h e d e p re s s i o n , a n d i t w a s a b o u t t o b e i n v e s ti g a te d b y t h e P e c o ra c o m m i t te e . T h i se x p l a in s w h y A l d r i c h l o b b i e d f o r t h e s e p a r a ti o n o f c o m m e r c i a l a n d i n v e s tm e n tb a n k i n g , e v e n t h o u g h i t m e a n t th a t C h as e w o u l d b e s p li t a lo n g w i t h J .P . M o r g a n a n dC o m p a n y . T h e R o c k e f e l l e r g ro u p h a d l e s s t o l os e f r o m s e p a ra t io n t h a n d i d t h eM o rg a n s , a n d t h e y h a d m o re t o g a i n f r o m s u p p o r t i n g t h e a d m i n i s t r a t i o n . S i g n i f i -c a n t l y , a f t e r A l d r i c h c a m e o u t f o r s e p a ra t io n , t h e a d m i n i s t r a t i o n ' s i n v e s t ig a t i o n o fC h as e w a s q u i c k l y d r o p p e d .Ca rter Glass, the n om ina l au thor o f the separat ion leg is la t ion, never w an ted toregulate the pr iva te bankers. P r ior to A ldr ich 's lobb y ing , draf ts o f the Glass B i ll spec i fiedon l y t ha t na t i ona l banks w ou ld be separa ted . G lass 's re luc tance t o regu la te t he p r i va tebankers m ay have been i n pa r t because o f con s t i tu t i ona l qua lms , b u t G lass wa s a lsoc l o s e t o t h e H o u s e o f M o rg a n . G l a s s w a s a g o o d f r i e n d o f M o rg a n p a r t n e r R u s s e l lLe f f i ngwe l l . Le f f ingw e l l , on leave f rom M orga n , had been o ne o f G lass's ch ie f ass is tan tsw h e n G la s s w a s S e creta ry o f t h e T re a s u ry u n d e r W i ls o n . L e f fi n g w e l l a n d G la s s b e c a m eq u i t e c lo s e d u r in g th i s t im e , a n d a f t e r L e f f i n g w e l l r e t u rn e d t o M o rg a n t h e y c o m m u -n i ca ted o f t en . Le f f i ngwe l l used h i s con tac t s t o o rgan i ze dona t i ons t o G lass 's po l i t i -c a l c a m p a i g n s , a n d G la s s to o k n o t e o f L e ff in g w e l l' s c o m m e n t s o n b a n k i n g p o l ic y . 2aW h e n R o o s e v e l t a s ke d G la s s t o b e S e c re t a ry o f t h e T re a s u ry , G la s s i n d i c a t e d h ew a n t e d L e f f i n g w e l l a n d a n o t h e r M o rg a n m a n , P a rke r G i l b e r t , a s u n d e r se c re ta rie s .R o o s e v e lt, h o w e v e r , r e fu se d a n y c o n n e c t i o n w i t h t h e H o u s e o f M o r g a n a n d v e t o e dGlass 's cho i ces . Roo seve l t 's ve to was one o f t he reasons G lass u l t ima te l y re jec ted t heT re a su ry p o s i ti o n . 29 W h e n A l d r i c h ' s p ro p o s a l s w e re d ra f t e d i n t o t h e G l a s s -S t e a g a l lB i l l , G l a s s w ro t e t o L e f f i n g w e l l t h a t h e h a d b e e n a g a i n s t t h e p ro v i s i o n a t t a c k i n gM org an bu t t ha t R oosev e l t had f o is ted i t upo n h im . 3

supply curve, thereby increasing p rice and inf ra-marginal rents. Coa te and Klei t (1994) andBou dreau x (199 0) provide useful introduc tions to the raising rivals cost l teratu re as w ell as a c ri-t ique of the idea hat a f i rm can raise its rivals' costs withou t gove rnme nt nvolvem ent.28On the proce eding tw o sentences, see the L eff ingw elI-Glass correspond ence, Box 283 inthe C arter Glass Papers at the Un iversity of Virginia. Leff ingwe ll wro te to Glass at one p oint sayinghe felt their relat ionship was close r to th at of son and father than th at of boss to su bordinate; seeletter to Glass of A pri l 23, 192 9. Leff ingwe ll and Glass disagreed strongly abou t the G lass-Steagallbi ll , and their correspondence became somewh at esty during the 1 932 period. See, o r exam ple,letters of Ap ri l 22, 25, 26, 193 2, and Februa ry 9, 193 2. On Leff ingw ell 's cam paign fund ing, seeGlass's letter of No vem ber 19, 192 9.29SeeBusiness W eek(M arch 15, 1933, pp. 4- 5) and Che rnow (I 990, pp. 355,374-75).3This is reported in C hern ow (I 99 0, p. 37 5), w ho cites a letter from Glass o Leff ingwell . TheLeff ingw ell person al papers are loca ted at Ya le Unive rsity. See also Glass's com me nts in the U.S.Senate (I 934, p. 403 2), where he indicates that he thou ght the prov ision "extrem ely severe" andwe nt along w ith its inclusion only after Aldrich's request and after being pressured by the adm ini-stration (p. 4016 ).Glass's connect ions w i th the H ouse of M organ sho uld not be o ver em phasized. Glass had an


11/18

T H E SEPAR AT ION OF C OM M ER C I AL AN D IN VEST M EN T BAN K I N G 1 1

A l d r i c h f o l l o w e d u p h is s u r p r i se a n n o u n c e m e n t w i t h i n t e n s e l o b b y i n g .T h r o u g h o u t M a r c h h e t ra v e l e d b e t w e e n N e w Y o r k a n d W a s h i n g t o n , D . C . , f re -q u e n t l y m e e t in g w i t h R o o s e v e l t, C a r t e r G l a ss , S e c r e ta r y o f C o m m e r c e D a n i e lR o p e r , a n d o t h e r h ig h o f f ic i a ls in th e R o o s e v e l t a d m i n i s t r a t io n ( J o h n s o n 1 9 6 8 , p .1 5 6 ; F e r g u s on 1 9 8 4 , p . 8 2 ) . 31 S e c r e ta r y o f C o m m e r c e R o p e r w a s p a r t i c u l a r l yh e l p f u l. R o p e r se n t G l a s s a n d t h e b a n k i n g c o m m i t te e a l e tt e r e x p r e s s i n g t h e a d m i n i -s t ra t io n ' s s u p p o r t f o r A l d r i c h ' s p o s i t io n . R o p e r 's i n t e r v e n t io n i n to a n a r e a in w h i c hG l a ss b e l ie v e d h is c o m m i t te e h a d e x c lu s i v e j u r i s d i c t io n a n n o y e d G l a ss , b u t t h ea d m i n is t r a t i o n w a s a b l e t o s ig n a l i ts v i e w s n o n e t h e l e s s . ~ A l d r i c h w a s a l so a i d e d b yC o l o n e l H o u s e , t h e f a m o u s a d v is o r t o W o o d r o w W i ls o n a n d t h e n F r a n k li n D .R o o s e ve l t . H o u s e ' s d a u g h t e r w a s m a r r i e d t o G o r d o n A u c h i n c lo s s , A l d r i c h ' s b e s tf r i e n d a n d a m e m b e r o f t h e C h a s e b o a r d , a n d A l d r i c h u s e d t h is c o n n e c t i o n t o lo b b yH o u s e ( F e r g u s o n 1 9 8 4 , p . 8 2 ) . H o u s e , in t u r n , c o n t a c t e d R o p e r a n d l a t e r R o o s e v e l t,u r g i n g th e m t o m e e t w i t h A l d r i c h . 33 V i n c e n t A s t o r , R o o s e v e l t's c o u s i n a n d g o o d f ri e n d ,w a s a ls o o n th e b o a r d o f C h a s e , a n d h e to o s e r ve d a s a c o n d u i t t o b r i n g t h e t w o g r o u p st o g e t h e r (F e r g u so n 1 9 8 9 , p . 1 5 ; B u r c h 1 9 8 0 , p . 21 ). A l d r i c h ' s l o b b y i n g p a i d o f f w h e nG l a s s - - r e l u c t a n t l y - - a l l o w e d h i m t o d ra f t t h e k e y s e c t io n s o f t h e G l a s s - S te a g a l l A c t t h a ts e p a r a te d c o m m e r c i a l a n d i n v e s tm e n t b a n k i n g . T h e s e s e c t i o n s w e r e s e c t i o n 2 1 , w h i c hf o r b a d e d e p o s i t t a k i n g i n s t i t u t io n s f r o m i s s u in g o r u n d e r w r i t i n g s e c u r i t ie s , a n d s e c -t io n 3 2 , w h i c h f o r b a d e i n t e r l o c k i n g d i re c t o r a te s . 34

i n d e p e n d e n t p o w e r b a se in V i r g i n ia a n d d i d n o t n e e d th e N e w Y o r k b a n ke rs t o a n y g r ea t e x te n t.Mo reover , G lass wa s a devo tee o f the rea l -b il ls do c t r ine , espe c ia l l y as esp ou nde d by h is long - t im ea i d e P r o fe s s o r H . Pa r k e r W i l li s . Ac c o r d i n g t o W i l li s , a l l c o m m e r c i a l b a n k c r e d i t s h o u l d b e b a s e dup on shor t -t e rm se l f - l i qu ida t ing loa ns - -a l l ban k purchases o f secur it ies we re t here fo re suspec t inh is v iew . G lass , t here fo re , had ide o log ica l o r pu b l i c - in te res t reasons to sup po r t t he separa tion o fc o m m e r c i a l a n d in v e s tm e n t b a n k i n g , a l t h o u g h i t s e e m s c l e a r t h a t h e w a s r e lu c t a n t t o a p p l y s e p a -ra t ion t o p r i va te bankers .31Ferguson (1984) i s a c r it i ca l pap er fo r u nders tand ing o f the p o l i t ica l -bu s ines s nexus o f t heN e w D e a l.32SeeGlass 's comm ents in t he U .S. Senate (1934 , p . 4016) .33W r it ing t o Sec re ta ry o f Com m erce Roper , Co lone l House no ted ,W i n t h r o p A l d r i c h . . . g o t i n t o u c h w i t h m e y e s te r d a y t h ro u g h G o r d o n A u c h i n c l o s s . tf oun d A ld r i ch sympathe t ic t o t he las t degree o f wha t the Pres iden t i s t r y ing t o do , a nd I ad-v is e d h i m t o te l l t h e Ba n k i n g C o m m i tt e e t h e w h o l e s t o ry . H e is p r e p a r e d t o d o t h is , a n dh a s g o n e t o th e c o u n t r y t o d a y t o w r i t e h is p r o p o s e d t e s t im o n y i n th e f o r m o f a m e m o r a n -d u m , a c o p y o f w h i c h h e is t o s e n d t o m e t o m o r r o w m o r n in g . H e i n t im a t e d t h a t if t h e rew a s a n y p a r t o f i t t h a t I t h o u g h t s h o u l d b e c h a n g ed h e w o u l d c o n s i d e r d o i n g s o . ( q u o te d inFerguson 1984, p . 83)Ferguson imp l ies A ld r i ch 's con tac t w i t h House he lped to b r ing t he G lass -Steaga l l Ac t t o" f ru i t i on . " Th is mus t be qu a l i f ied . Ho use 's le t te r was wr i t ten in O c tob er o f 1933 , severa l monthsa f te r the G lass -Steaga l l A c t ha d been s igned in to law (June 13 , 1933) . The le t t e r con cern sA ld r i ch 's t es timony in Novem ber o f 1933 , wh ich w as in f avor o f s treng then ing he G lass -Steaga l l Ac t .The re wa s a movem ent to repeal G lass-Steagal l before separat ion w en t in to ef fec t, so in th is sense

Aldr ich 's lobby ing af ter June 13 was in supp or t o f Glass-Steagal l . Fur therm ore, A ldr ich wa s a lso in f lu-en t ia l i n the B ank ing Ac t o f 1 935 , wh ich con t inued the an t i-Morgan e lements o f the Bank ing Ac t o f1933 . House 's e t t e r is h ere fo re an im po r tan t ind ica t ion o f A ld r i ch 's lobb y ing e f fo r ts .Rooseve l t 's le t te r t o H ous e o f De cem ber 20 , 1933 , in Rooseve l t (1947) i ll us tra tes t ha t Ho usec o n ta c te d R o o s e v e lt a n d e n c o u r a g e d h i m t o s e e A l d r i c h .34The fac t t ha t A ld r i ch w ro te t hese sec tions came o u t in A ld r i ch 's t es timony in t he Pecorahear ings in Decem ber o f 1993 (see U .S. Senate , 1934 , p . 4032) .


12/18

12 THE QUARTERLYJOURNAL OF AUSTRIAN ECONO MICS VOU 1, NO. 1 (1998)

A l d r i c h a l so m o v e d t o t u r n th e a t t e n t io n o f t h e P e c o r a i n v e s ti g a ti o n a w a y f r o mC h a s e a n d t o w a r d M o r g a n . T h e New York T imes, f o r e x a m p l e , c o n c l u d e d its M a r c h9 , 1 9 3 3 , a r ti c le o n A l d r i c h ' s r e fo r m p l a n w i t h t h e f o l l o w i n g i n s i g h t i n t o h is m o t i v a -t i o n .

Altho ugh the p lans of the Senate investigating com mittee have not formal ly been dis-closed, it has been reported that the affairs of the C hase National Ban k's security affi l iateand the aff i liates of the other im portant banks were to have been gone into s hortly w ith athoroughnessequal to that displayed in the National City C om pany investigation.Se v e ra l w e e k s l a t e r t h e r e s u lt s o f A l d r i c h ' s m a n e u v e r i n g w e r e e v i d e n t . In a l i v e ly

a r t ic l e t it le d " N e x t , M o r g a n a n d C o m p a n y , " Bus iness W eek n o te d t h at " C o m m e r -c i a l b a n k e r s w i t h i n v e s tm e n t a f fi li a te s g e t a c h a n c e t o b r e a t h e a n d m o p t h e i r b r o w sa s t h e Se n a te ' s s t o c k m a r k e t i n v e s t ig a t o r s t u r n f r o m t h e m t o . . . t h e l o r d l y p r i v a t eb a n k i n g H o u s e o f J .P . M o r g a n a n d C o m p a n y . " F o r t h e i r r e pr ie v e , c o m m e r c i a lb a n k e r s m u s t d o f f t h e i r h a ts t o

W inthro p Wil l iams Aldr ich , head of Rockefel ler 's world- largest Chase Nat ional Bank,w ho is cred ited w i th hav ing maneuvered so cunn ing ly tha t Morgan and Com pany nowoccupy an uncom fortable eminence between him and the government 's guns.3sW . A v e r e l l H a r r i m a n ' s B a n k , B r o w n B r o t h e rs , H a r r i m a n , w a s a ls o n o t a b l y

a b s e n t f r o m Pe c o r a ' s i n v e s t ig a t i o n ( Sc h le s i n g e r 1 9 5 8 , p . 4 4 1 ) . H a r r im a n w a s al o n g - t im e f r i e n d o f F r a n k l in a n d E le a n o r R o o s e v e l t, a n d h e u se d h is c o n n e c t i o n s t ob e c o m e a p o w e r f u l a n d i m p o r t a n t f ig u r e i n t h e R o o s e v e l t a d m i n i s tr a t io n s ( B u r c h1 9 8 9 , p . 5 5 ) . O v e r t h e f o u r a d m i n i s tr a t io n s , h e h e l d a va r i e ty o f d i p l o m a t i c a n da d m i n is t r a ti v e p o st s, i n c l u d i n g c h a i r m a n s h i p o f t h e D e p a r t m e n t o f C o m m e r c e ' sB u s in e s s A d v i s o r y C o u n c i l , a n a d m i n i s tr a t iv e p o s t a t t h e N a t i o n a l R e c o v e r y A d -m in i s t r a t i o n ( fi rs t a t t h e N e w Y o r k D i v i s i o n a n d t h e n n a t i o n a l l y ) , a n d Se c r e t a ry o fC o m m e r c e ( K o u w e n h o v e n 1 9 6 8 , p . 2 0 2 ). 36

T h e B u s in e s s A d v i s o r y C o u n c i l ( B A C ) w a s e s s e n t ia l ly a l o b b y g r o u p f o r b i g - b u s i -n e ss , b u t w a s m a d e m o r e p o w e r f u l b y i ts o f f i c ia l d e s i g n a t i o n a s p a r t o f t h e D e p a r t -m e n t o f C o m m e r c e . T h e B A C w a s e st a b li s h e d i n J u n e o f 1 9 3 3 , p r o b a b l y t o p r o v i d ea f o r u m f o r d i s c u s s io n s b e t w e e n t h e n e w a d m in i s t r a t io n a n d th e n a t io n ' s t o p e c o -no m ic in te res ts (Bu rch 1 980 , p . 18 ). A l th ou gh in i t i a l l y o pen to sma l l bus inesses , andt o b o t h t h e M o r g a n s a n d th e R o c k e fe ll e rs , i t q u i c k l y c a m e t o b e d o m in a t e d b y th e

The re is some confusion ove r exactly w hat Aldrich wrote. In the he arings, Glass m aintainedthat Aldrich wr ote section 32, and Aldrich init ially agreed but suggested hat the final form wassomew hat d i fferent than wh at he wrote or ig inal ly . A few minutes later, however, Aldr ich deniedthat he wrote section 32 but claimed that he had assisted n w rit ing section 21.Section 32 actually contains two clauses, the ban on interlocking directorates and then aweaker vers ion of sect ion 21. I t is the second c lause over w hich Aldr ich and G lass d ispute. Oncethis is understood , the Glass-A ldrich e xchang e make s sense. Aldrich, in m y judgmen t, wrote thefirst clause of se ction 32 as Glass says (recall that the ban w as first propos ed by A ldrich at hisnewspaper conference), but the second unrelated c lause I bel ieve was add ed later (as Aldr ichargues). Glassdoes not dispute that Aldrich aided in the draf~ of section 21.3SBusinessW eek(Ap ril 12, 1933), pp. 12, 14.36Ha rriman 's brother R oland was also an influential supporter of the N ew De al, as we re otherpartners of Brown Brothers, Harr iman, l ike Prescott Bush and Robert Lovell (see Kouw enhoven,1968, p. 203).


13/18

T H E S E P A R A T IO N O F C O M M E R C I A L A N D I N V E ST M E N T B A N K I N G 1 3

Rocke fe lle r g roup . H ar r ima n, w h o w as assoc ia ted w i t h t he Rocke fe lle rs in a nu m be rof bus iness enterpr ises, served f i rs t as the BAC's v ice-chai rman, then as chai rman.A l d r i c h w a s a l s o a m e m b e r o f t h e B A C a n d , a p p ro p r i a t e l y e n o u g h , w a s m a d echa i rman o f t he BAC 's com mi t t ee on bank ing l eg is la tion in N ove m ber o f 1934 (Johnson1968 , p . 198) . O ther p rom inen t members assoc ia ted w i t h t he Rocke fe l l e rs i nc ludedG e ra l d S w o p e , P re s i d e n t o f G e n e ra l E l e c tr ic a n d a d i r e c t o r o f N a t i o n a l C i t y B a n k ,a n d W a l t e r C . T e a g le , p re s i d e n t o f S t a n d a rd O i l , in w h i c h t h e R o c k e f e l le r s s t i llm a in ta ined a la rge s take (Bu tch 1 980 , p . 19 ) .

H a r r im a n ' s b a n k , B r o w n B r o th e r s, H a r r i m a n , w a s c re a t e d in 1 9 3 1 w h e n t h er e c e n t ly f o r m e d H a r r im a n B r o th e r s a n d C o m p a n y m e r g e d w i t h B r o w n B r o th e r s a n dC o m p a n y . B r o w n B r o t h e r s h a d o r i g i n a l l y b e e n i n v o l v e d i n b o t h d e p o s i t b a n k i n ga n d i n v e s t m e n t b a n k i n g , b u t t h e y h a d ta k e n h u g e l o s s e s i n t h e 1 9 2 9 c ra s h a n d ,u n d e r H a r r i m a n ' s g u i d a n c e , t h e y b e g a n t o fo c u s o n c o m m e r c i a l b a n k i n g . B y 1 9 3 3 ,t h e n e w b a n k w a s d o i n g t h e g re a t m a j o r i t y o f i t s b u s i n e s s i n c o m m e rc i a l b a n k i n g .B r o w n B r o th e r s, H a r r i m a n , t h e r e fo r e , w o u l d a ls o g a in f r o m a n a tt a ck o n t h e H o u s eo f M o rg a n . H a r r i m a n ' s in te re s ts w e re a l l ie d w i t h t h o s e o f t h e R o c k e f e l le r s a n d , w i t hH a r r i m a n ' s c l o s e ti e s t o R o o s e ve lt, h e a n d h i s p a r tn e rs w e re c l e a r l y in a n e x c e l l e n tp o s i t io n t o i n f l u e n c e b a n k i n g l e g is l a ti o n . 37

S e c tio n 8 o f t h e B a n k i n g A c t to o k t h e c o n t r o l o f o p e n - m a r k e t o p e r a t io n s a w a yf ro m t h e N e w Y o rk F e d a n d p l a c e d i t w i t h t h e F e d e ra l R e se rv e B o a rd . T h e H o u s e o fM o r g a n h a d d o m i n a t e d F e de ra l R e s erv e p o l i c y t h r o u g h o u t t h e 1 9 2 0 s t h r o u g hB e n j a m i n S tron g , t h e l e g e n d a ry g o v e rn o r o f t h e F e d e ra l R e s e rv e B a n k o f N e wYork . 38 Sec t i on 8 w as the response f rom severa l g roups t ha t had n o t bene f i ted un de rS t rong 's reg ime.

S t ro n g w a s c l o s e l y a s s o cia te d w i t h t h e H o u s e o f M o rg a n t h ro u g h o u t h i s c a re e r.As Chernow (1990 , p . 182) pu t s i t , S t rong "had Morgan wr i t t en a l l over h i s resume. "Th is was l i t e ra l ly t rue . In 19 04 Ha r ry D av i son , l a te r a M org an par tner , h ired S t rong assecre ta ry o f t he Bankers T rust Co m pa ny (succeed ing ano ther Mo rga n par tner , Th om asL a m o n t ) . B a n ke rs T ru s t, w h i c h s t o o d o p p o s i t e J.P . M o rg a n a n d C o m p a n y a t B ro a da n d W a l l S tree t, h a d b e e n c re a t e d b y M o rg a n a s a f u n n e l f o r tr u s t b u s in e s s t h a t th eM o r g a n b a n k c o u l d n o t l e g a l l y h a n d l e . D u r i n g t h e P a n i c o f 1 9 0 7 , S t r o n g b e c a m e

37Harriman was also closely connected wi th the ba nking houses of Kuhn, Loeb and Lehm anBrothers; see Burch (198 0, pp. 21 -24).I t is interest ing to note that when Bro wn Brothers, Ha rriman , was spl i t, i ts investmen t bankersformed a ne w investment bank wi th former bankers of Nat ional Ci ty.3SThe legend of Ben jamin Strong is told by mon etarists and eco nom ists of the Chicagoschool , who claim that had Strong l ived, the Great Depression could have been avoided. I rv ingFisher, w ho originated the Strong egend , stated hat "G ove rnor Strong died in 19 28. I thorou ghlybel ieve that i f he had l ived and his pol ic ies had b een cont inued, w e m ight have had the stockmarket crash in a m i lder form, but af ter the crash there wo uld not ha ve been the g reat ndustr ialdepression." Qu oted in Friedma n and S chwa rtz (1963, p. 413 , see also pp. 411-19) w ho defendthe Strong e gend at length.The essence of the Strong egen d is that Strong used open-m arket operat ions to avert l iquiditycr ises in 1924 and in 1927 and would have do ne so again in 1929-30 . Research by W heelock(1991), W icker (1966), and R othbard (1980, 1 984) show s, how ever, that S trong's open-ma rketoperat ions we re aimed at support ing Bri tain, and not at con trol ling the dom estic econ om y.


14/18

14 THE QUARTERLY OURNALOF AUSTRIANECONOMICS VO L. 1, NO. 1 (1998)one of Mo rgan's trusted ieutenants and his persona l auditor. By 19 14, he was presidentof Banker's Trust, and was in that year asked to be come the Governor of the ne wlycreated N ew Yo rk Federal Reserve Bank.

Strong ini t ia l ly decided to turn do wn the posi tion of Governor; but, over a longweekend in the country, Harry Davison and P au l Warburg convince d him toaccept. Strong was pa rt icularly close to M organ partner Harry Davison. Strong's l ifewas bese t by several tragedies; his first wife com m itted suicide in 1905 , and a dau ghterdied a year later. During this period, he felt unable to look after his remaining threechi ldren properly, and his fr iend, Davison, to ok them into his hom e. 39Strong's close connections to the Ho use of Morgan are not brought forward asevidence tha t Strong was control led by the House of M org an --this w ou ld be a fac i leinterpretation and, given Strong's legendary wi l lpower, an unl ikely one. Strong,

howeve r, cam e from the same m il ieu as the Morgans: he l ived in the sam e neigh-borhoods and joine d the sam e cou ntry c lubs. As we ha ve seen , his career wasguided by M organ partners, and his bes t fr iends were Mo rgan partners. Strong'sbiographer, Lester Chan dler (1958, p. 25), notes: "three men w ho were to ha ve agreat inf luence on his think ing and his future were Henry P. Davison [Harry] ,Thomas W. Lamont, and D wigh t W. M orr ow ." Each of these men wo rked for J. P.Morgan and eventual ly becam e partners of the H ouse of Morgan.The Ho use of Morgan was so l idly international ist, as was B enjamin Strong. TheNe w York branch o f the House of Morgan, J.P. Morgan and Com pany, was matched

by Morgan Grenfel l and Compan y in Lon don , and of Morgan et Com pagnie in Paris.Edw ard Grenfel l ( late r Lo rd St. Just) was senior partner of M organ Grenfel l andCompany, a di rector of the B ank of England, and M organ's main c ontact wi th theBri tish pol i t ical class. A tth e beginning o f W orld W ar I, Davison w en t to B ritain an d,w ith Grenfel l's help, had J.P. Mo rgan and C om pa ny appointed Bri tain's purchasingagent in A merica. 4 France also m ad e Morgan the ir f ina ncie r and purchasing agent.In return for a one percent comm ission (an d the im pl ic i t o ppo rtuni ty to di rectpurchases to M organ f irms l ike U.S. Steel), Mo rgan used their m onopsony po we r tobuy over $3 bi l l ion worth of suppl ies for the Bri t ish alone, about half of Bri tain'stotal purchases.To f inan ce the ir purchases, Bri tain and France needed m assive loans, and, overthe course of the war, Morgan arranged $I .5 bi l l io n in Al l ied credits. To he lp w iththe f inancing of the loan s, Morgan enlisted Strong . Strong, w ho was v i r tual ly incomp lete control of the Fed, ent huge sums to the com mercial banks, created a marketin acceptances o finance trade , and timed gold inflow s and ope n-m arket purchases oease the m oney ma rket as the A l l ied loans were f loated. After the w ar, S trong and theHouse of Morgan wo rked closely to ma intain inte rna tional trade, and in part icular,to bring Bri tain back on to the gold standard. For his pa rt, Stro ng en gag ed inopen-ma rket purchases o kee p U.S. interest rates be low Bri tish rates, so gold w ou ld

39On hesepoints, see he biographyof Strongby Chandler 1958, pp. 20, 31 ,39 , and passim)and Chernow 1990,p. 123, 182).4The theory beh ind his was to make Morgan give monopsony powers so they could keepprices low.


15/18

THE SEPARATIONOF COMMERCIALAND INVESTMENTBANKING 15not f low out o f Bri ta in. Strong also con t inued to keep credi t con di t ions easy in theU nited States so that reconstruction loans for Eu rop e co uld be f loated in the U.S.(e.g., Chand ler 195 8, pp. 271-71 and no te 42). The Ho use of Morgan cooperated bykeeping open a $10 0 m il l ion l ine of cred it to the Bri tish Treasury to defend aga instspeculative attacks.41

Strong's actions aro used the ire o f a t least three grou ps: Ch icago Bankers, Ca lifor-nian A .P . Giannini, and C arter Glass. The isolationist and pro-German mid-We stattacked M orga n's f inancing of Bri tain as warm ongering. In C hicag o, pro-Germandepositors threatened to boycott any ban ks that part icipated in the Bri t ish loans(Chernow 19 90 , p. 20 0). Furthermore, in the late 1920s, Chicago ban ks were heavi lyinvested in s hort-term gove rnm ent secu rities; Strong's ope n-m arket operations to lowerinterest rates, thu s cut directly into th eir earnings (see Epstein and Ferguson 1984, andChan dler 1958, pp. 43 9- 53 , on the ire of the Chicago bankers).42 By 1 928 , C hicagobanks were in open op pos it ion to Strong's con trol, and Chicago pa pers were cal l ingfor Strong's resignation (Tim e, July 30, 1928).

Cal i fornia banker A.P. Gian nini (of Transame rica) also fel t locked ou t of theNew York cl ique. Giannini strongly supported the New Deal banking reforms and,as a result, bec am e the un off icial amb assador of Ca l ifornia big business to W ash-ington. G iann ini was responsible for several sm all clauses of the Glass-Steagal l Act,especial ly section 5114, which required that minori ty stockholders of a nationalbank be given the right to elect representatives to the board in pro port ion to theirstock holdings. G iann ini had rece ntly gained a tenth interest in National C ity Bankbu t was frozen ou t of pow er due, he bel ieved, to Morgan opposit ion. Gia nn ini fel tthat he wo uld be better served by a W ashington -control led Federal Reserve Boardthan by a M org an -con trol led N ew Yo rk Fed and, accordingly, in discussions w ithRooseve lt and the administration, especially M arriner Eccles, he lobb ied for the shiftof po wer to the Board.43

Carter Glass was a lso against Strong's contro l of op en-market operations. Glass,along w i th many othe rs, bel ieved that Strong had too much pow er and that hisexpa nsionist p olicies we re th e cak~se of the stock m arket boom as w ell as theexcessive speculation of the 1920s (see Chan dler 1958, pp. 1 63 -64 , 449 -50 ).Altho ug h he had not always approved of the B oard's actions, he chose the board overthe unregulated con trol of the N ew York Fed (Chandler 1958, p. 449).

W ith the se three force s against them, and w ith the death of the charismaticBenjamin Strong in 1928, the Morgans had l i t t le chance of retaining co ntrol o f theFed; section 8 was the logical result.

41On he events n this paragraph, see Tansill (1938, pp. 32-134,esp. 86-88), Rothbard (1980,1984),Chernow 1990,chap. 10 and pp. 274-77),Anderson 1979,pp. 38, 47),Chandler 1958,chap.6, esp.pp. 117-24,andchap. 8, esp.pp. 316-19),and Wheelock (1992).42Since the Chicago banks were ho lding short-term securities, any cap ital gains on the irport-folio were small and fleeting.43Giannini also benefited rom the extensionof branch banking.


16/18

16 THE QUARTERLYJOURNAL OF AUSTRIAN ECONOMICS VO L. 1, NO . 1 (1998)

C O N C L U S I O NT h e p u b l ic - i n te r e s t a r g u m e n t s f o r t h e s e p a ra t io n o f c o m m e r c i a l a n d i n v e s tm e n tb a n k i n g a re w e a k a n d a p p e a r u n a b l e t o e x p la i n t h e p a ss ag e o f th e B a n k i n g A c t . T h es e p a ra t io n o f c o m m e rc i a l a n d i n v e s t m e n t b a n k i n g is b e t t e r e x p l a i n e d b y p r iv a t e - i n -te rest po l it ics S hu gha r t (1988 ) , M ac ey (198 4) , and Bens ton (19 82) a rgue t ha tp r i va te i n te rest s, l i ke i nves tm ent bankers , ben e f i t ed f rom the B ank ing Ac t , and the ys p e c u l a t e t h a t t h e s e in t e re s t s s u p p o r t e d t h e A c t , b u t t h e y p ro v i d e n o d i r e c t e v i d e n c e .

T h e m i c ro -h i s t o r y a p p ro a c h o f t h is a r t ic l e h a s p i n p o i n t e d t h e s p e c i f ic i n d i v i d u -a l s w h o w e re re s p o n s i b l e f o r t h e G l a s s -S t e a g a l l A c t ' s p ro v i s i o n s s e p a ra t i n g c o m -m e r c i a l a n d i n v e s tm e n t b a n k in g M o r e t h a n a n y o n e e ls e, W i n t h r o p A l d r i c h , r e p re -sen ta t i ve o f t he Ro cke fe l l e r ba nk in g in te rests , wa s respo ns ib le f o r t he separa t ion o fc o m m e r c i a l a n d in v e s t m e n t b a n k i n g . W i t h t h e h e l p o f o t h e r w e l l- c o n n e c t e d a n t i-M o r g a n b a n k e rs li k e W . A v e r e l l H a r r im a n , A l d r i c h d r o v e t h e s e p a r a tio n o f c o m m e r -c i a l a n d i n v e s t m e n t b a n k i n g t h ro u g h C o n g re s s. A l t h o u g h s e p a ra t io n rais e d th e c os tso f b a n k i n g t o t h e R o c k e f e l le r g r o u p , s e p a r a ti on h u r t th e H o u s e o f M o r g a n d i s p r o -p o r t i o n a t e l y a n d g a v e th e R o c k e f e l le r g ro u p a d e c i s i v e a d v a n t a g e in t h e i r b a tt le w i t ht h e M o r g a n s .

REFERENCESAlexand er, J.L. 197 5. "Pro logue to Reform: Ca rter Glass and the O rigins of the F ederal ReserveAc t." Masters Thesis. Univers ity of Virginia.Anderson, B.M. 1979. Econom ics and the Publ ic W el fare. 2nd ed. Indianapolis, Ind .: Liberty Press.Benerjee, A.V . 1992. "A Simple Mod el of Herd B ehavior. " Qua rterly Journal o f Econom ics 107(August): 797 -817 .Becker, G.S. 1985 . "Publ ic Pol icies, Pressure Grou ps, and D ead W eight C osts."Joumal o f Publ icEconomics 28:329-47.Benston, G. J. 1990 . The Separation o f C omm erc ia l and Investment Bank ing. Londo n: Ma cm i llanPress.Boud reaux, D.J. 199 0. "Turn ing Back he Anti-Trust Cloc k." Regulat ion 13, no. 3:45-5 2.Brandeis, L.D . 1933 . Other People's Mo ney. W ashington, D.C .: National H om e Library Foundation.Burch, P.H. 1980. El ites in Am erican His tory . Vo l . 1 . New Y ork: Holmes and Meier.

1981. El ites in Am erica n His tory . Vol . 2. New Y ork: Holmes and Meier.Burns, H.M. 1974. T h e A m e r i c a n B a n k i n g C o m m u n i t y a n d N e w D e a l B a n k i n g R e f o r m s :1933-1935. W estport , Con n. : Green woo d Press.Carosso, V. 19 70 . "Washington and W al l St reet: The N ew De al and Investment Bankers,1933-1940. " Business His tory Review 44 (W inter): 425-45.Chandler, L.V. 1958. Benjam in S trong, Cen tral Banker. W ashington, D .C.: Brookings Inst i tut ion.Che rnow, R. 1990. The House o f Morgan. New York: Simon and Schuster.Coate, M .B. , and A.N. Klei t. 1 994. "Exclusion, Col lusion, or Confusion? The Und erpinnings ofRaising Rivals' Co sts." Research in Law and Economics 16:78-93.Co llier, P., and D. Horow itz. 1 976 . The Rockefel lers. New York: H ol t, Rinehart, and Winston.Delong, J.B. 1991. "Did J.P. Morgan 's Men Add Va lue?" In Inside the Business Enterprise.P. Tem in,ed. Chicago: Un iversity of Ch icago Press. Pp. 205 -36 .. 1 9 9 1 . "W h a t M o rg a n W r o ug h t." W ilson Q uarter ly (Autumn): 17-30.Ferguson, T. 1984 . "Fro m Norm alcy to New Dea l : Industr ial Structure, Party Com pet i tion, andAm erican Pu bl ic P ol icy in the Grea t Dep ression." Internat ional Organizat ion 38, no.

1 :41 -94 .


17/18

THE SEPARATION OF COMMERCIAL AND INVESTMENT BANK ING 17

1989. " Indus t r ia l Co nf l i c t and the Com ing o f the Ne w Dea l . " In The Rise an d Fal l o f theNe w Dea l O rde r , 1939 -1989 . S. Fras erand G . Gerst le , eds. Pr inceton: Pr inceton Un ivers i tyPress. Pp. 3 -32 .

Fr iedman, M., and A.J. Schwartz. 1963. A Monetary H is to ry o f the Un i ted Sta tes , 1867-1960.Princeton: Princeton U niv ers i ty Press.Go ldenw e iser , E .A. 1951. Amer i can Mone ta ry Policy N e w Y o r k: M c G r a w - H i l l.Golembe, C.H. 1969. "The Dep osi t Insurance Legis lat ion of 19 33." Pol i t ica l Science Quarter ly75 , no 2 :181 -200 .Hofstadter, R. 1974. The Am er ican Po l i tica l Tradi t ion. New Yo rk : V in tage Books.Hofstadter, R., and C .L. Ver Steeg, eds. 19 69. Great Issues n Am erican History. Vol . 3 . New York:V in tage Books .James, M ., and B.R. James. 1954. Biography o f a Bank. Ne w Y ork : Harper Bro thersJohnson, A.M . 1968. W inthrop W. A ld r i ch : Lawyer , Banker, D ip lomat . Boston: Harvard Univer-

si ty Press.Karm el, R.S. 1980. "Glass-S teagal l : So me C ri t ica l Reflections." The Banking Law Journal 97, no .9 : 6 3 1 - 4 1 .Kennedy, S.E. 1973. The Banking Cr is is of 1933. Lex ing ton : Un ivers i ty Press o f Kentucky .Knoeber, C. 198 6. " G olde n Parachutes, Shark Repellents, and H ost i le Tende r Offers." Amer i canEconomi c Rev i ew 76, no. 1 :155-67 .Kolko, G. 1963. The Tr iumph of Conservat ism. Chicago: Quadrang le Books .Kou wen hoven , J .A. 1968. Partners in Ban king. New Yo rk : Doub l eday .Kroos, H.E., ed. 19 83. Docu me ntary H is to ry o f Bank ing and C ur rency in the Un i ted Sta tes . N ew

York: Chelsea House Publ ishers.Kroszner, R.S., and R.G . Rajan. 199 4. " Is the Glass-Steag al l Ac t Justif ied?" Amer ican EconomicRev iew 84, no . 4 :810-33 .Lundberg, F. 1937. America 's 60 Fami l ies. New York: Vanguard PressM acey , J.R. 1984. "Specia l In terest Gro up Legis lat ion and the Judic ia l Fun ct ion: The Di lem m a ofGlass-Steagal l ." Emory Law Journa l 3 3 : 1 - 4 0 .Macey, J.R., M .W . M art , a nd S.D. Young. 1991. "T he Glass-Steagall Ac t and the Riskiness ofFinancial Intermediaries." Research n Law an d Economics 14 :19 -30 .McC hesney, F.S. 1991. "Rent E xtract ion and Interest-Group O rga niza t ion in a Coasean M ode l of

Regu la t ion . " Journa l o f Law and Econom i cs 20, no . 1 :73-90 .Mc Lau gh l in , A .C. , and A .B. Har t , eds . 1963. Cyc loped ia o f Am er ican G overnment . Gloucester,

Mass.: P eter Smi th.Peach , W .N. 1941. The Secur ity Aff il ia tes o f Na t ion al Banks. Balt imore : The Johns Hopk ins Un i -vers i ty Press.Pel tzman, S. 1976. "T ow ard a Mo re General The ory of Regulat ion" Journa l o f Law a nd Econom-ics 19, no . 2 :21 1-40 .Perk ins, E.J. 1971. "Th e D ivorce of Comm ercia l and Investment B anking: A H istory." The Bank-

ing Law Journa l 88, no . 6 :483 -528.Peterson, H. ed. 1965. A Treasury of the W or ld 's G reat Speeches. New York : Gro l ie r .Preston, H.H . 1933. "T he Banking Ac t of 19 33." Am er i can Economi c Rev i ew23 , no. 4 : 585 -607 .Rooseve lt , Frank l in D . 1947 -50 . F.D.R.: His Pe rsonal Letters, 1st ed. N ew York: D ue l l , Sloan, and

Pearce.Rothbard , M .N. 1980. "The N ew Dea l and the Mon etary Sys tem." In The Great Depression a ndNe w Dea l Mo ne ta ry Po licy , G. Garret t and M . Rothboard, e ds. San Francisco: Cato Inst i -

tu te. Pp. 79-124.


18/18

18 THE QUARTERLY JOURNAL OF AUSTRIAN ECON OMICS YO U 1 , NO. 1 (1998)

. 1984 . "The Federa l Reserve as a Car te l i za t ion Dev ice : The Ear ly Years 19 13 -19 30 . " I nM on ey in Cr i si s, B.N. Siegel, ed. Cam br idge: Ma ss, Bal l inger . Pp. 89 -1 36 .

Salop, S.C., and D.T. Scheffman. 1983 . "Rais ing Rivals ' Costs." Amer ican Economic Rev iew 73n o . 2 : 2 6 7 - 7 1 .

Schar fs te in , D . , and J.C. Ste in. 1990. "H erd Be hav ior and Inv es tm ent . " Am er ican Econom i c Re -v i ew 8 0 : 4 6 5 - 4 7 9 .Schlesinger, A.M.J. 1958. T he Com i ng o f the Ne w Dea l. Bos ton : Hugh ton M i f f l i n .Sel igman, J. 1981. The Transformat ion of W al l Street. Bos ton : Hough ton M i f f l i n .Shughar t, W.F . 1988 . "A Pub l i c -Cho ice Perspec tive o f the Bank ing A c t o f 1933 . " Ca toJou rna l 7,n o . 3 : 5 9 5 - 6 1 4 .Tans i l l , C .C. 1938. Amer i ca Goes to War . Boston: Li t t le, Brown.Tem in , P . 1976 . D i d M o n e t a r y Forces Cause the Gre at Depression? N e w Y o r k : W . W . N o r t o n.. 1 9 8 9 . Lessons rom the Great Depression. Cam br idge , M ass .: The M IT Press.T imb er lake , R .H . 1989 . "N ew Dea l Mon eta ry Leg isla tion f o r t he W e l fa re o f t he Gove rnm ent . "Cato )ourna l 7, no . 3 :615-19 .U.S. Congress . 1934. Senate Co m m it tee Stock Exchange Prac t ices : Hear ings . Bank ing an d C ur -

r e n c y . 7 3 r d C o n g r e s s - 2 . W a s h i n g t o n , D . C . : U .S . G o v e r n m e n t P r in ti ng O f fi ce .W h e e l o c k , D . C . 1 9 9 1 . The St ra tegy and Cons is tency o f Federa l Reserve Monetary Po l i cy ,1924 -1933 . Cam br idge: Ca m br idg e U n vers i ty Press.. 1 9 9 2 . "M o n e t a r y P o l i c y in t h e G r e a t D e p re s sio n : W h a t t h e F e d D i d a n d W h y . " The Fed-

era l Reserve Bank o f St. Louis R eview 7 4 ( M a r c h / A p r il ): 3 - 2 8 .Whi te , E .N . 1983 . The Regu la t ion and R eform o f the Am er ican Bank ing Sys tem, 19 00-192 9.Pr inceton: Pr inceton Un ivers i ty Press.. 1 9 8 6 . "Be fo re t he G lass-S teaga ll Ac t : An Ana lys is o f t he I nves tment Banking Ac t i v i t ies o fNa t iona l Banks . " Exp lo ra t ions in Economic H is to ry23 :33-55 .Wicker , E. 1966. Federa l Reserve M one tary Po l icy , 1917-19 33. N e w Y o r k : R a nd o m H o u se .W i l l iam so n, O.E. 1968. "W ag e Rates as a Barrier to Ent ry : The Pennington Case. " Qua r te r l y Jour-na l o f Economics 8 2 : 8 5 - 1 1 7 .W i l l is , H .P., and J . M . Chapman. 193 4. The Banking Situation. N e w Y o r k : C o l u m b i a U n i v e r s i t yPress.

fed 1 austrian article.pdf

Documents