In the first hour that morning Pecora’s deliberate pace, Mitchell’s vague grasp of details, his constant hushed conferences with his lawyers, and the missing documents all slowed the hearing to a crawl. A journalist who sat through the hearings described “the monotonous flow of questions and answers” during these slack interludes as “like the mumbling of bees pecking at the flowers in a summer garden on a sultry afternoon.” The reporters were bored and the senators were getting antsy; they wanted drama and, so far, they weren’t getting any. Of course, Pecora had a purpose—before he got too confrontational with Mitchell he wanted to lay a foundation for questions he would ask later on in the hearings. It was what a careful lawyer did. The senators, on the other hand, wanted to cut to the chase, and so Senator James Couzens, the white-haired and jowly Michigan progressive, decided to jump in.16
In some ways, there was no one in the room more qualified than Couzens to question Mitchell. Many politicians are business neophytes, but not James Couzens. He was one of Henry Ford’s original partners and the former general manager of Ford Motor Company. He had helped build the company from the ground up, and there were more than a few knowledgeable observers who gave Couzens as much credit as Henry Ford for the company’s success. Like Mitchell, Couzens had even built up a nationwide network of salesmen, although they sold Model Ts instead of stocks and bonds. After a decade of building Ford into one of the largest corporations in the country, however, Couzens had grown restless. “There comes a time,” he told an interviewer, “when the fun of making money is all gone. . . . The battle is won; the goal is achieved; it is time for something else.” It was a sentiment that Mitchell never came close to uttering. Ford and Couzens had famously split a few years later, with Ford buying out Couzens’s stake. That made Couzens a multimillionaire, by far the richest man in the Senate when he arrived there in 1922.17
In his public life, Couzens espoused a simple philosophy, one that seemed diametrically opposed to Mitchell’s. “I want,” Couzens explained, “to do what I can to see that life is not made a burden for the many and a holiday for the few. I want to do that which will contribute the greatest good to the greatest number.” That statement was more than just empty political rhetoric. Couzens’s most famous act at Ford was his crusade for a more equitable sharing of profits between the shareholders and employees. He instituted a plan that reduced the hours of Ford employees while at the same time raising the company’s minimum wage to the then unheard-of amount of five dollars a day.
Couzens was well aware of how bad things were in the country. As a result of his great wealth and prominent position, he was inundated with letters from people asking for small gifts, most of which contained harrowing stories of distress. Each received a courteous and sympathetic reply explaining that the senator confined his giving to charitable organizations, and he was as good as his word. He gave away nearly $30 million of his own fortune to provide indigent children with health care. Accounting for inflation, Couzens’s philanthropy put him on a level of generosity equal to the gifts of Bill Gates and Warren Buffett.18
In the Senate, Couzens quickly became a thorn in the side of the rich and powerful. He famously battled Andrew Mellon in the mid-1920s over the Treasury secretary’s plan to reduce income taxes on the wealthiest Americans, an early iteration of “trickle-down” economics. Couzens actually thought the government should raise their taxes, and his opposition to Mellon’s proposal led him to investigate the Internal Revenue Bureau, an inquiry that publicized a host of tax loopholes. Couzens’s high-profile investigation of a Treasury Department bureau incensed Mellon. In retaliation, he authorized a tax suit against Couzens, claiming the senator had underpaid his taxes when he sold his Ford stock. Much to Mellon’s chagrin, the suit showed that Couzens had actually overpaid. There was a hint of the lingering animosity over that episode in the hearing room that morning. Garrard Winston previously worked at Treasury for Mellon. In the Washington-Wall Street revolving door at the time, Winston was named a director of the affiliate the day after he left Treasury, in 1927. While still in government, Winston had publicly defended the retaliatory tax suit against Couzens. At one point in the hearings that morning, Winston was giving so much assistance to Mitchell that Couzens asked if he was a City Bank employee, and proposed that the committee could make everybody’s life easier if they just put Winston directly on the stand. The Shearman partner simply winked at Couzens and went back to advising Mitchell.19
Like other midwestern progressives, Couzens had long been a critic of Wall Street. As early as 1928, Couzens warned President Coolidge that Wall Street was headed for disaster. Couzens possessed a rigid moral code and firmly believed in conservative commercial banking. Banks, he thought, took in deposits and made short-term loans. They shouldn’t be stock and bond promoters. Couzens couldn’t help but believe that had business leaders acted less recklessly and more ethically, the crash might have been avoided. Because of these and other progressive views, Couzens was accused of being a radical. Some called him a “scab millionaire” and, like Roosevelt, a traitor to his class. His response was straightforward: “Yes, I’m radical as hell when I see an evil that ought to be ended.”
As he sat in Room 301 that morning, Couzens was exhausted. He was in the thick of the frantic efforts to prop up the collapsed banks in his home state. Indeed, it was Couzens’s rivalry with Ford that helped spark the Michigan bank closure in the first place. Couzens, who had been investigating improper RFC bank loans, insisted that Ford subordinate his substantial deposits in a Michigan banking group as a condition for the RFC loan that would have kept the banking group open. Ford refused and threatened to withdraw all his money from Detroit banks, a move that would have precipitated a full-blown panic. It was then that Michigan’s governor stepped in and declared a holiday. The senator was under most circumstances belligerent, blunt spoken, and downright crotchety. “I’ve never known a man,” one contemporary remarked, “whom you could count on to be unpleasant to the extent that you could him.” Couzens relished a good fight, and now, a week after his confrontation with his former business partner, the already caustic business critic seemed even more ornery. With the banks back home shuttered—in his opinion because of the dishonesty and greed of the men who ran them—and with Couzens already getting heat in the press for the role he played in the Michigan crisis, the senator appeared to be in no mood for coddling bankers, especially prominent ones from New York.20
While Couzens undoubtedly had the business stature to challenge Mitchell, he was not a lawyer, and his initial attempt to quiz the Wall Street banker was inept. Couzens wanted to talk about how the affiliate made all its money. When a corporation sells securities to the public, in most cases it doesn’t do so directly. The corporation retains an investment bank and sells the securities to it. The investment bank is essentially a wholesaler; it turns around and sells those securities to investors at a somewhat higher price, profiting on the markup. Peering at the banker seated across the table from him through his large round glasses, Senator Couzens asked how City Bank went about determining the difference between those two prices, known as the “spread.”
Mitchell responded vaguely: “The necessities of a situation, of course, were constantly under discussion in each particular issue. The officer in charge of the negotiations was the man who ultimately negotiated the spread.”
Couzens pressed on: “And, then, I suppose, you had different acquisitions of securities, where the spread was small in one case, and larger in another case, and intermediate in another case?”
“Oh, quite so,” Mitchell readily agreed.
That was when Couzens tried to go in for the kill. The spread depended “upon the gullibility of the public, or the ease with which the sale of securities might be made, or the soundness of the securities, I suppose?”
Most likely Couzens just wanted to make Mitchell squirm, but Mitchell was not a man who squirmed easily. If, instead, it was an attempt to get an admission out of Mitchell,
it was a terribly clumsy one. Whatever else Mitchell might have been he was far from dumb. One of his associates wrote that when he met with Mitchell, what struck him most was that his “remarkable mind functioned as a huge machine. I could almost see it spinning as a great wheel in a Power House.” Senator Couzens’s question didn’t trip up the banker for even a moment: “I would not grant your expression, gullibility of the public.” Mitchell then carefully and patiently explained the many factors that went into determining a spread: “I think you will grant very readily, Senator Couzens, that there is a great deal of difference between selling, for instance, a bond of the State of New York and selling a bond of the primest [sic] of our railroads. Sales requirements, methods of distribution, are very different, and different in their cost, and that is all represented in the spread.”21
If Pecora was chafing at the senators’ amateurishness, he didn’t show it. He stuck with his plan. A good showman knows that you have to leave the audience wanting more. And, as the lunch break approached, Pecora appeared to want to leave the assembled reporters with something juicy to write about. It was time to establish Mitchell’s motive for pushing the affiliate to churn out $20 billion in securities in the ten years before the crash (nearly $3 trillion in today’s dollars).22
Pecora asked Mitchell about the management fund—the bonus pool at the bank—and what it was designed to do. Mitchell was more than happy to explain; indeed, he seemed eager to demonstrate how clever he had been to devise it. The securities affiliate wasn’t really a commercial bank, he informed Pecora, it was an investment bank and it “selected as its executives men who would normally be of the type to hold partnerships in private banking and investment companies.” Those private partnerships were “extremely lucrative,” and for City Bank to compete with them it had to offer the executives of its affiliate “some share in the profits that they should make.”
Mitchell’s explanation was more than just incomplete; it simply didn’t make sense. The management fund, as Pecora quickly showed, applied not just to the employees at the affiliate, but also to the commercial banking executives. That, and the generalities of Mitchell’s answer, raised a host of questions. What incentives did the management fund create for those executives and were those incentives the right ones for a bank that was a “quasi-public” institution? If City Bank was attracting executives who would normally “hold partnerships in private banking and investment companies,” how would their different investment approaches and greater appetites for risk change the bank? What did the shareholders know about the operation of this bonus pool? How big was “some share” of the profits?
From his investigation, Pecora had a pretty good idea what the answers to those questions were. Now, he continued to grill Mitchell on the details of how the bonus pool operated. What was immediately apparent as Mitchell spoke was that his conceptions about appropriate compensation were radically different from those of the average American. He explained that to properly incentivize his men their salaries “were held at what was regarded as a low figure,” just $25,000. That low figure was more than twice what Pecora made in his best year and thirty-three times the average annual income in 1929.
The primary compensation for Mitchell and the other officers was the management fund. After deducting an initial 8 percent return for the shareholders, the officers collectively shared 20 percent of all the remaining profits. In broad strokes, City Bank’s management fund looked similar to compensation in hedge funds today, and for Pecora, it provided the same incentive for excessive risk taking. In fact, it might have created even greater incentives for risk. A hedge fund typically collects 20 percent of all profits, but the executives at City Bank had “nothing to gain and everything to lose, individually, by a conservative policy” because their profit sharing did not kick in until the bank had crossed that initial 8 percent threshold.
There was another factor, as well, that pushed the executives to ever riskier securities offerings. Every year it took more and more sales to get the management fund into the black. Mitchell was continuously expanding his far-flung securities-selling network. By 1929 it had offices across the country linked by the latest information technology of the day. The overhead on the system was enormous, and City Bank had to sell larger and larger amounts of securities just to break even. “I say without fear of contradiction,” the former City Bank salesman Julian Sherrod wrote, “that hundreds of millions of dollars have been lost through investments that were originated primarily to pay operating expenses of a large, expensive and unnecessary system of distribution.”23
Payments out of the management fund were made twice a year, so the executives eligible to participate in it had incentives to focus on short-term profits, not long-term performance. As Pecora had Mitchell spin out the details, Senator Couzens was nonplussed and jumped back into the questioning, this time much more effectively. Couzens had authorized his fair share of bonuses back at Ford. Bonuses in and of themselves didn’t bother him. What bothered him, especially given his deeply ingrained suspicion of financiers, were the incentives these particular bonuses created. “And, as you look at it in retrospect,” the senator asked Mitchell, “do you think that was a good system to set up for a financial institution?”
Mitchell adamantly believed that it was; it created, he thought, a wonderful “esprit de corps” among the bank’s officers.
Couzens was not convinced, and he offered his own perceptions about the incentives he thought those bonuses created: “Does it not also inspire a lack of care in the handling and sale of securities to the public, because each individual officer has a split?”
Mitchell said he understood why Couzens might take that view, and he conceded “that it must have some influence, Senator Couzens. At the same time, I do not recall seeing it operate in that way.”
“You would not see it,” Couzens replied. “Only the customers would see it after they had gotten the securities.”
That scornful gibe worked, because it made a simple and powerful point about Mitchell’s testimony. Mitchell had originally pitched his bonus plan as a way to “concentrate the attention of the officers upon service to the institution.” Later, his justifications for the bonus system spoke volumes about his own personal motivations. “Unless the man of energy and perhaps ability,” he said, “can see within the organization for which he is working a point that he can possibly reach that has great material benefit attached to it, I say unless he can see that his work is going to be somewhat . . . dulled.”
Couzens and Pecora saw it very differently. The officers at City Bank were paid potentially enormous amounts, but only if they were able to sell vast amounts of securities. And, since they did not bear the cost of securities that went down in value, they had incentives to sell as many securities as possible, even if they were of dubious quality. The affiliate, Pecora wrote, was “a gigantic, foolproof device for gambling freely with the stockholders’ money, taking huge profits when the gambles won, and risking not a penny of their own money if they lost.”24
To be sure, the institution as a whole might be concerned about preserving the reputation that it was trying so hard to sell to investors. After all, every failed deal that City Bank pawned off on its customers tarnished that reputation a little bit more, presumably making it that much harder to make the next sale. But with bonus checks calculated every six months and the market booming, such long-term considerations were probably only distant, fleeting thoughts to the average City Bank executive, if they occurred at all.
All of these disclosures were clearly rubbing Couzens the wrong way, so the truculent senator pushed his point even further. “I understand,” he said, “you have quite a national reputation as a salesman and a financier, both. . . . Which are you, a better salesman or a better financier?” It was classic Couzens, confrontational and in-your-face. Mitchell tried to shake it off. He smiled and asked whether Couzens thought that was a fair question. Couzens, never one to back down, said he thought it was and that he w
ould be willing to answer it himself.
Mitchell responded diplomatically: “I have rarely seen an executive who had to do with the public and the management of a great corporation who was not inherently, by personality or otherwise, in the class that might be called a good salesman.”
“I should judge you to be,” Couzens responded, “a better salesman than a financier—and that is no disparagement on your financial ability at all.”
“I thank you for the compliment,” Mitchell muttered gamely.25
Now it was Pecora’s turn to jump back into the questioning. He cleverly played off Mitchell’s reluctance to describe himself as a salesman to lay a trap for the banker. Mr. Mitchell, he asked innocently, since the affiliate was primarily in the business of selling securities, didn’t he earn his salary more as a salesman than as a financier? Mitchell, as expected, again denied he was just a salesman. In his “loftiest moral tone” Mitchell explained to Pecora that City Bank did not just sell securities, it “manufactured” them.
Couzens, the former auto executive, didn’t think much of that analogy; manufacturing, he said, was an “unfortunate” word for a securities business.
But Mitchell stuck with it; he had been describing City Bank’s business in these terms for years, a fact that Pecora surely knew as he questioned the banker that morning. “It may be in your mind Senator Couzens,” Mitchell reiterated. “At the same time, that has an analogy that I do not consider amiss. A large part of the business of the National City Co., and a large part of the executive brains, is devoted to the development of long-term credits suitable for public investment.”26
According to Mitchell, City Bank’s job was no different than Ford’s. It didn’t manufacture cars; it manufactured another kind of consumer product—investment securities. And not just any securities; City Bank “manufactured” securities that were “safe and proper” for investors. It was the same rhetoric City Bank used in its sales training classes and in its advertisements. Trainers told the new recruits that the company had its own “yardstick” by which it measured the quality of its offerings. That yardstick, the trainer assured his class, “would never be shortened.” The company’s advertisements touted its “sound securities,” which were offered to the public only after they had been thoroughly investigated by its expert staff. It was a claim that Pecora intended to test over the course of the hearings, and Mitchell’s boasts about creating only securities that were “suitable” for its customers gave Pecora a great launching point for that inquiry. Indeed, this little bit of testimony would come back to haunt Mitchell and the other City Bank executives in week two of the hearings as Pecora marched them through the long list of securities that City Bank thought fit that criterion.27
The Hellhound of Wall Street Page 17