In Goldman, Sachs We Trust
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That's a line - a chapter title actually - from Galbraith's classic The Great Crash 1929. In Goldman, Sachs We Trust. The idea of a trust was that a bunch of investors would pool their cash by buying stock in an investment company (Galbraith, 47). Not a bad idea on the surface. The investment company's management was supposed to be better at picking stocks than the average investor because, supposedly, they had better information. The trusts were initially big in England and Scotland (Galbraith, 48). Through the early twenties, there were very few trusts in the United States. That was to change, however.
The first trusts in America had rules. They'd tell you what stock they were going to purchase, place them in a real trust, and tell you what rules they were going to follow in managing the assets of the trust Galbraith, 48). You could trust them. Sounds pretty good, doesn't it? The rules didn't last.
Ultimately, the management of a trust sold you some sort of stock or bond representing ownership of a trust. You didn't know what they held. You just trusted management. There were "secrecy" reasons why they wouldn't tell you what they held - just like the South Sea Bubble stock funds, in fact (Galbraith, 49). Pretty interesting parallel if you think about it.
Then things got really interesting. You could now, for instance, buy five hundred dollars of stocks in a trust for two hundred dollars. You owed the owners of the trust three hundred dollars that you paid off over time (Galbraith, 53). This was genius. In a rising market, your money rose even faster. Markets always went up, didn't they? Well, for a time in the twenties, they sure did. People made a lot of money.
Then, things got even better. Trusts started new trusts. They didn't buy stocks in corporations. No, they bought stocks in other trusts. When you did that, you essentially leveraged your investment more. Now, when stocks went up, so did you trust holdings. But, and this is really neat, they went up even more than before. This was really neat.
It was all predicated on a rising market. When everything was going up, everyone made out. When things were going down, however, they really went down. That's what happened, essentially, in the fall of 1929. Things went really down - fast. A lot of people got hurt.
That's what unregulated leverage does. That's what it did in 1929. Why did I mention Goldman, Sachs in the title? While they entered the trust game late, they started one of these trust pyramids that lost a whole lot of people a whole lot of money. It took them more than thirty years to regain what had been a fine reputation.
Galbraith's summary lays out a lot of the problems and points to solutions (Galbraith, 177):
- Incomes weren't equitably distributed. Some five per cent of the population received some thirty per cent of all the incomes. They had to spend it, first on consumerism, and then, on investments.
- Businesses weren't run properly. They hosted "an exceptional number of promoters, grafters, swindlers, impostors, and frauds (Galbraith, 178)."
- The banking structure was bad (Galbraith, 179). There were too many banking units. When one failed, runs began on others. Things dominoed. Not good.
- Foreign nations owed a lot of money to the United States. Banks loaned a lot of money to them. There was graft. There were defaults (Galbraith, 182). Not good for U. S. banks.
- Economic intelligence was flawed (Galbraith, 182) or non-existent. No one knew what companies or trusts were really doing. There was too much "trust". Bad idea.
The thing about this that bothers me, and ought to bother you, is this has continued to happen. Maybe it is not shocking so much as inevitable. There are answers. Unfortunately, we are having to live through a very similar marketplace and discover the answers all over again. Amazing.
Galbraith, John Kenneth. The Great Crash. 1929. A Mariner Book. Houghton Mifflin Company. 1954.