The distinction of being the first bank in American history to fail goes to Farmers Exchange Bank of Glocester, Rhode Island, which departed this world in the spring of 1809. The Farmers Exchange went down because it issued bank notes which it promised to redeem in gold it did not have.
Incidents like this prompted President John Adams to cry out that “Banks have done more injury to the religion, morality, tranquillity, prosperity, and even the wealth of the nation than they can have done or ever will do good.” The fact that George Washington owned stock in the Bank of England seems not to have impressed Adams, or Missouri’s Senator Thomas Hart Benton, who asked, “Are men with pens sticking behind their ears to be allowed to put an end to this republic?”
To ensure that such a disaster would not befall us the states of Texas, Arkansas, Oregon, and Iowa prohibited the banking trade while Andrew Jackson did much the same thing for the federal system by destroying the Bank of the United States. Most of this admirable, if misdirected, anger took hold of men because they did not understand what banks do. Try as they did, even such dissimilar advocates of banking as Alexander Hamilton and Tom Paine had little success in persuading people to accept this sinister activity. The suspicion and ignorance of banks hang on, although with the publication of Martin Mayer’s The Bankers we can hope that some part of them may be dispelled.
In a field where bankers and economists work at expressing themselves in language of impenetrable viscosity, Mayer has written a book that we can understand. We had best do it too, because no society, capitalist or socialist, can function without a banking system, whether it is called that or not. It is the only means we have of collecting the unused wealth generated in one place and apportioning it some-place else so that resources are put to work where we think we most need them. The problem with banks, as Mayer tells us, is not that they exist but how to make them do what we want.
“Franchised fast-food establishments sprang up around the country like dragons’ teeth in large part because the First National Bank of Chicago was willing to supply the money,” writes Mayer, who quotes a bank executive saying, “We are the leading bankers for Kentucky Fried Chicken and McDonald’s; we got out of Minnie Pearl before it collapsed.” At the same time as First National was financing the research and development of the Big Mac—two beef patties on a sesame seed bun—the city in which the bank was located was falling down on its ears in part because the lending institutions had refused to allow the black and white working-class population to participate in the mortgage markets.
For sixty years some of the braver members of Congress have been trying with indifferent success to get banks to put money where the needs seem greatest. Where the needs are greatest the potential profit is often smallest, so the banks have been intractable in their refusal to make less than the maximum possible buck. But they will take horrendous risks to gain an extra-super profit.
Manhattan Island gives testimony that, far from being the cautious people they’re alleged to be, bankers will gamble immense amounts of money on socially wasteful propositions that no prudent businessman would touch. After the banks and insurance companies pumped something like $5 billion into office building construction during the last four or five years they find that vacancy rates are up to 1939 levels. With one square mile of unrentable space, some of the biggest names in the industry are taking a bath of impressive proportions. Morgan Guaranty, Irving Trust, and Chemical Bank have had to foreclose on a $62 million loan at 1633 Broadway. Chase Manhattan is losing a bundle on One New York Plaza, while it is estimated that First National City, Bankers Trust, and a clutch of other big ones are “exposed,” as they say in the trade, to losses that could reach up into the hundreds of millions.
Doubtless some of this loss is due to the recession, but much of it is due to indefensible loan policies. For a long time banks wouldn’t finance this kind of construction unless the developer could produce signed leases from first-class, triple-A credit risk tenants. In the last few years, though, greed got hold of those staid chaps in the pinstripes, and they began making loans on the construction of buildings for which there were no visible tenants.
“Historically—and we live today in a repetition of this history—banks have gotten into trouble by forgetting that real estate loans are neither so safe nor so liquid as other loans, and that the values pledged to their repayment can plunge drastically and overnight, so that the loans publicly proclaimed as ‘well secured’ are really expressions of faith rather than items of business,” writes Mayer. Another reason the banks have gotten into trouble is that they joined the rest of the business world in trying to push up the value of their stock to enable them to play the acquisition game.
Banks invariably bring difficulties down on themselves and everybody else when they expand out of the banking business into other lines of work. To do what he ought to be doing properly, a banker should have a detached eye with which to examine loan applications. That’s difficult enough when he confines his activities to banking, but when he gets into other businesses he begins to think like a borrower.
The importance of separating functions is not easily learned. In the eighteenth and nineteenth centuries banks were frequently set up to finance railroads, canals, and factories. Aaron Burr’s Bank of the Manhattan Company was chartered by the legislature primarily because it was supposed to build and operate New York City’s waterworks. After any number of mis-adventures, including bank activity in the stock market of the 1920s, it became apparent that a banker who lends to himself can’t do his job well.
One of a banker’s main jobs is to see that the wealth of a society isn’t squandered on junk. In a free market system “squandering” usually has to be defined as investing money in profitless enterprises, and, while that definition doesn’t assure us the money will get where most of us might think it ought to go, it ought to protect us against some of the worst forms of waste.
It hasn’t, however. As much as Congress and the regulatory agencies have tried to keep the bankers in banking and out of everything else, the same bankers, who can be invincibly obtuse about some things, have been clever enough to get their snouts in all sorts of places they don’t belong. The principal device they’ve used is the bank holding-company law. Since the banks are forbidden to own other businesses, what they’ve done is to sell themselves to their own holding companies, which can buy and operate other businesses.
Manufacturers Hanover lost $30 billion in the course of lending that sum to the now failed Franklin National Bank so that Franklin could buy a factoring company, i.e., a company that purchases and collects accounts receivable. Never mind the messes banks have gotten themselves into when they’ve entered the factoring business in the past; the regulations still permit their holding companies to enter that and a number of other businesses which are defined as “bank related,” and that is what Franklin National did.
“Through the holding companies,” says Tom Clausen, president of the Bank of America, the nation’s largest, “we are coming closer and closer to having commercial banking activities in the broadest sense in all states. We are not there yet, but through finance companies, new banks in several states—we are ourselves in Florida, Texas, Illinois, and New York—mortgage banking operations, computer leasing and other leasing operations, we are having a broader array of financial services outside our own home-base state of California.”
So while the laws seem to prohibit it, the major banks are achieving a de facto form of national and even international branch banking. Manufacturers Hanover, for instance, is part owner of the Anglo-Romanian Bank. This is nicely explained by Mayer in his description of the growth of “term loans,” that is, unsecured loans, which require no collateral, that are made to businesses and are to be paid back, not out of profits, but out of cash flow. This practice pushes the banks very close to being operating partners.
These loans do not, however, even begin to encompass the degree and nature of the entwining of banking with nonbanking industries. In addition to term loans, the banks also assume a quasi-management role through the leasing business. Thanks to certain provisions in the tax law it is very profitable for the banks to buy everything from jet airplanes and freight cars to drill presses, and rent them to companies who can’t get their hands on the money to buy the equipment they need. At the expiration of the lease the bank not only has its rentals but can then turn around and sell or re-rent the equipment.
Term loans and leases are the most expensive ways for a company to get capital. For many, however, they’re the only ways. The cheapest way, of course, is to sell stock, since investment capital obtained in that fashion requires no interest payments; but as the stock market has become more and more of an eccentric crap shoot, it has become increasingly difficult for a company to float an issue. Offering bonds, which used to be another good way of raising money, has become prohibitively expensive. Until we return to the days when people will buy a high-grade bond that pays 3 percent a year, many companies have no choice but to go to the banks or to go out of business.
Of course the steep prices the banks charge must be passed on to their customers by companies who borrow from them. Some would argue as well that the banks are gaining too much control of the economy as they supply more and more capital for investment. But a more immediate danger of this trend is that they will become the captives of their borrowers. If you lend a man $100,000 that he can’t repay, you don’t foreclose on him, you lend him more money in hopes that the second loan will help him generate the income necessary to pay off the first one. Billions upon billions of dollars can thus be misallocated into inefficient or corrupt or superfluous enterprises. A banker’s job is to facilitate the necessary, sound, and reasonable activities of a society by making well-secured, safe loans. It is not to be a high-risk conduit of waste.
In this the banks aren’t solely to blame. The government, through the instrument of the Federal Reserve Board, has been nudging the banks into making loans to large corporations which might otherwise fail. In the last year it has been rumored, but never confirmed, that such has been the case with Pan Am, W. T. Grant, Chrysler, and Westinghouse. This kind of back-door, junk socialism isn’t practiced so much for the benefit of the bond holders and other creditors of these companies as it is to save jobs. Mayer doesn’t go into this aspect of things as extensively as a reader might like. Nevertheless he does discuss how the banks made money available to assemble some of the huge and badly administered conglomerates which are now sinking.
The problem in writing a book like The Bankers is that you’re addressing yourself to one of the central mechanisms of our society. The leads, connections, and implications trail off in every direction and you can’t follow them all up. Mayer has chosen to let some of the bigger questions he might have pursued dangle in favor of a more anecdotal and personalized portrait of banking than seems required for a serious book. Do we want to know that “Josef Kramer, a compact, strikingly handsome man who heads the Bank of America operation in Zurich, was born in a country town near Basel”? Does it aid our understanding to be told that “Walter Wriston of First National City has demonstrated that a man who radiates nervous energy can flash to the top in American banking”?
The book is well supplied with descriptions of nervous energy radiators, perhaps because Mayer thinks these qualifiers will draw us into what might otherwise be a dull subject, or, possibly, because Mayer has come to admire the bankers he met while doing his researching. His respect, sometimes even awe, in his account of them may disguise and dilute his more general conclusions, which aren’t nearly so friendly.
Mayer tells his readers the truth about banking. He knows the truth too, because, in addition to interviewing a huge number of people in and about the industry, he has based his work on a formidable acquaintance with the best literature available in the field. Book of the Month Club selection notwithstanding, this is no schlock job.
Indeed, Mayer may know too much about banking. The detailed adventures of a check from the moment of its writing, through counting rooms, electronic sorters, clearing houses, messengers, key-punch operators, and computers may be more fatiguing than enlightening. But if you have the patience to learn that it is Mrs. Carol Salisbury and Mrs. Libby Ott who do the “proving” at the East Hampton branch of the Valley Bank of Long Island, you will get a picture of the banking industry which undermines the impression of proficiency we laymen have of it. The banking industry is dangerously innovative where tradition might serve as a better guide, and traditional where innovation is needed. It is crippling itself in its efforts to deal with 27 billion checks a year because it can’t organize itself to switch over to an electronic, checkless banking system. Indeed, as Martin Mayer explains, bankers have only the most imprecise idea of what their costs of doing business are.
A walk around New York or Los Angeles with a critical eye will bear that out. Both places have more banks than they have grocery stores. These ubiquitous branches, with their gift toasters and hot trays, are layered with people walking around with no discernible responsibilities. They and their offices’ presence are symbolic of a rapacious desperation to snag every loose, uncommitted dollar, D-Mark, yen, and centavo in the world. The best and most important parts of Mayer’s book describe the thousand and one ways in which modern banking is finding money that doesn’t exist and then lending it.
While most of us still think of banks as lending the money their depositors leave with them, Mayer tells us that banks have come to be money brokers who borrow funds at a lower interest rate which they then turn around and lend at a higher one. One of the things that brought Franklin National down was its proclivity for reversing this process by borrowing high and lending low. Often highly volatile money is moving at weird velocities. With billions of dollars shifted around in gigantic overnight loans to make the books come out even in the morning, international finance has erected a structure of miraculous fragility.
The nature of these billions is one of complex insubstantiality. One of the triumphs of Mayer’s book is the clarity with which he tells us how one real dollar is converted into multiples of itself through chains of credit that are created by the banks and that extend across the nation, overseas, and back again, until no one is able to say what if anything these catenations of notes, acceptances, deposits, credits, and loans may be worth. It is a fact that nobody knows how many of those famous Eurodollars—credits expressed in dollars owned by non-American nationals—there are. All that can be said for certain is that many foreigners hold title to somewhere between $50 and $250 billion worth of paper obligations which somebody some day may have to start making good on. In which case a lot of students of this rat race predict that the banks will go down in rows before the central banks of the world can save them.
Nobody knows if they will. And one of the reasons nobody knows is that just at this time when we need the best and quickest data about money and banking we’re finding out that many of the statistical studies we’ve relied on are unreliable. The Federal Reserve Board has a committee of heavy domed professors working on the matter, but as of now such elementary numbers as the size of the current money supply cannot be ascertained with accuracy. Nor can the various purposes for which loans are made. This is what happens when, as Mayer says, the power to create money is allowed to slip out of the government’s regulatory hands. The first requirement for sensible control of banking is the accurate information no one now has, including the banks.
Inflationary as cooking up dubious assets and then using them as the basis for making loans may be, it would be less dangerous if the banks hadn’t made many loans. Unfortunately, they’ve made far too many, as this quote from Mayer shows:
“When I came here,” says Willard Butcher of Chase, “they told me we were thirty percent loaned.” (That is, the total loan portfolio was 30 percent of the total deposits on the books.) “Now they tell me we’re sixty percent loaned. Hell, we’re really four hundred percent loaned!” [Italics are Mayer’s.]
To get away with that and avoid bankruptcy everybody has to keep his money in the bank and all loans must be paid off, but now it appears that people aren’t keeping their money in the bank. The latest figures show the largest conversions of deposits to currency since the Depression.
Moreover many modern loans never get paid off. They’re not meant to. When they come due they are “rolled over,” that is, renewed, for some corporations are now operating like the government with a permanent debt structure that is too large to liquidate. In and of itself that’s not fatal unless the debtor company is like Pan Am, which is estimated to be in hock for close to $2 billion. Not long ago it had to borrow money to pay for operating costs, i.e., the interest on what it owes; that is the path to oblivion for borrower and lender alike.
This doesn’t concern a banking system that doesn’t care to be a balance wheel for the orderly development of the economy. As Mayer writes: “It does not matter much to the banking system whether the money that it circulates from its windows [is used for] nourishing the construction of a power plant, the purchase of a television set, or a speculation in silver fortunes…. It is all terribly risky…. There are billions of dollars of potential loan losses in the system, and the clock ticks toward the moment of their detonation. The banking structure that is now building can collapse; the larger the regulatory apparatus permits it to grow, the more catastrophic the collapse will be.”
The preponderance of expert opinion is that the structure won’t collapse because the government won’t let it. In that sense, as Mayer observes, Washington must support this over-ballooned tangle. If worst comes to worst, the Federal Reserve Board can send convoys of trucks through the night to make sure the devalued green bucks are on hand when the banks open in the morning. The costs will be paid in high prices and unemployment although the banks and their largest debtors will be saved.
Mayer argues that what’s needed is timely and effective bank regulation. The banks have been able to circum-navigate most of the New Deal legislation that was enacted after the last time they went berserk. The fact that they could get around so many laws and regulatory agencies is a tribute to the ingenuity the pursuit of pelf inspires. It also tells us how hard these institutions are to regulate. Money has a way of its own. Neither wage nor price control has proven as difficult to carry out as money control.
Congressman Reuss, the new chairman of the House Banking Committee, wants to force banks to allocate credit where it is most needed in the economy. That proposal will be fiercely resisted; and the redistribution of credit that would result as politicians and bureaucrats and big executives struggle over which “priorities” are to be favored is hardly a reassuring prospect, especially in view of past failures to channel credit and our current ignorance of how the economy really works. We may be forced to accept the extreme libertarian-free-market view that banking in which more dollars are lent than are deposited is theft, and outlaw it. Be that as it may, Mayer is incontestably right when he says we’re running out of time to make changes.
Changes would have been made long since if people had understood banking and what the bankers have been up to. Without that knowledge there can be no political sentiment for change until the disaster hits, which is why we should thank Martin Mayer for writing this book and giving us this chance to be forearmed.
March 6, 1975