The Hellhound of Wall Street: How Ferdinand Pecora’s Investigation of the Great Crash Forever Changed American Finance

James Grant’s October 2010 review of Michael Perino’s book The Hellhound of Wall Street is titled “Out for Blood: A Portrait of the prosecutor charged with investigating the 1929 crash.” Trying to distinguish between size of shock and ability to withstand a shock of a given size, James Grant contrasts the stability of banks back then compared to banks now:

For 10 days in March 1933, Pecora’s investigatory target was Charles E. Mitchell, chief executive of National City Bank, later to become Citigroup. “Sunshine Charley,” as Mitchell was mockingly known after his fall from grace, came pre-convicted, but his bank was a pillar of strength. Today, in the wake of the serial bailouts of 2008-09, Mitchell’s managerial achievement seems almost mythical. From the 1929 peak to the 1933 depths, nominal GDP fell by 45.6%—the American economy was virtually sawed in half. By contrast, during our late, Great Recession, nominal GDP dropped by only 3.1%. Yet this comparatively minor perturbation sent Citigroup into the arms of the federal government to the tune of $45 billion in TARP funds and wholesale FDIC guarantees of the bank’s tattered mortgage portfolio.

National City did accept a $50 million federal investment in 1934, after Mitchell resigned. However—and herein lies the difference—the bank’s solvency didn’t hinge on that cash infusion. Many banks did fail in the Depression, of course. But from today’s perspective the wonder is that so many didn’t.

There is a moral to this story. We have better monetary policy now than at the beginning of the Great Depression. And we know enough to know that to save the economy we need to bail banks out, if they would otherwise drag the economy with them. But what we have not yet learned is that to keep banks from needing to be bailed out, the key is to have much higher equity requirements than those contemplated today, even under the heading of financial reform.

Here is how I frame the issue in my column “How to Avoid Another Nasdaq Meltdown: Slow It Down (to Only 20 Times Per Second)”:

In academic finance, concerns about high-frequency trading go under the heading of “market microstructure” issues. There are other bigger problems in finance at the macroeconomic level that I have talked about morethanonce [3 different links]. The best reason to fix unfairness—or even perceived unfairness—in market microstructure is so people aren’t distracted from noticing how those in the financial industry use low levels of equity financing (often misleadingly called capital) to shift risks onto the backs of taxpayers and rewards into their own pockets. In quantum mechanics, electrons can “tunnel” from one side of a barrier to another. Using massive borrowing to ensure later government bailouts, the financial industry has perfected an even more amazing form of tunneling: the art of tunneling money from the government so that the profits appear on their balance sheets and in their pockets long before the money disappears from the US Treasury in bailouts. By comparison with this financial quantum tunneling of money from the US taxpayer that has been a mainstay of the financial industry, high-frequency trading profits of a few billion dollars a year are small change.

And here is the question I posed in my column “Three Big Questions for Larry Summers, Janet Yellen, or Anyone Else Who Wants to Head the Fed”:

What do you think of what Anat Admati and Martin Hellwig have to say about financial regulation in their book The Bankers’ New Clothes: What’s Wrong with Banking and What to Do About It? Their argument comes down to this: despite all of the efforts of bankers and the rest of the financial industry to obscure the issues, it all comes down to making sure banks are taking risks with their own money—that is, funds provided by stockholders—rather than with taxpayers’ or depositors’ money. For that purpose, there is no good substitute to requiring that a large share of the funds banks and other financial firms work with come from stockholders. (For follow-up questions on financial regulation, Admati and Hellwig have an invaluable cheatsheet.)

That is a question I now pose to all of you. I give my answer here and here.