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The Making of a Stock Market Society


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The Speculation Economy

How Finance Triumphed

Over Industry

By Lawrence E. Mitchell

Berrett-Koehler; 395 pp; $35

Back in the bad old days, the books of U.S. corporations were frequently cooked, management routinely ignored the rights of ordinary shareholders, and financial transparency was almost nonexistent. No, I'm not talking about the 1990s-era abuses that led to today's Sarbanes-Oxley reforms. A century earlier, many of the same financial shenanigans ushered in a similarly transformative wave of legislation that led to many of the investor protections we now take for granted.

That metamorphosis is the subject of Lawrence Mitchell's fascinating, if unevenly written, The Speculation Economy: How Finance Triumphed Over Industry. The author, a law professor at George Washington University, details America's early struggles over regulation of nascent financial markets. Although the effort initially focused on limiting the monopoly power of the fast-growing railroads and other trusts, it eventually led to disclosure rules that became the hallmark of U.S. capital markets. While half of Mitchell's volume tracks that regulatory evolution, the book is at its best describing the societal changes that made all that oversight necessary.

Before the last decades of the 19th century, American commerce was characterized by tens of thousands of individual plants and merchants, each usually doing business in a limited geographic region and often controlled by family owner/operators. But, as Mitchell painstakingly shows, between 1890 and 1910, savvy promoters such as J.P. Morgan, John Gates, and sugar king Henry Havemeyer used borrowed money or thinly capitalized stock to merge thousands of plants into newfangled conglomerations called corporations. The financiers' heavy use of public offerings of stock to cash out of these roll-ups resulted in ownership—if not control—being passed on to America's new investing class.

This vast transfer of ownership coincided with what the author argues was a seismic change in the way average Americans viewed the risk of buying stocks. Previously, a small number of equity investors had treated stocks much like bonds, preferring those with hard assets backing each share and an uninterrupted dividend stream. But a torrent of stock market success stories in the media changed that, and thus was born the culture of speculation noted in the book's title.

This new form of speculation was based on a growing willingness to own stock "issued not on the basis of productive assets or past profits but on the possibility of profits to come at some unspecified point in the future." In less than a generation, stocks morphed from being casino chips for the rich into respectable investments for the middle class.

While stock promoters were eager to grab the cash of these new small investors, they often exhibited a callous disregard for their ownership rights, as Mitchell nicely details. For example, George Westinghouse blithely explained in a 1901 letter to Westinghouse Electric shareholders that the directors and largest shareholders had decided not to disclose financial reports for the previous four years, because they felt it would not be in "the interests of all." Westinghouse didn't distribute another annual report until 1906.

But over time, the expectations of the investor class brought a radical switch in how managers of public corporations operated. No longer could they solely focus on maximizing plant efficiency or besting competitors. Instead, investors' lust for ever-higher share prices meant the stock market ceased being a mere financing vehicle and became an institution "whose insatiable desire for profit demanded satisfaction from even the most powerful corporations." By spawning this culture of "short-termism," finance had trumped industry, and U.S. business would never be the same.

Despite such insight, Mitchell's volume is not without disappointments. The author has a maddening penchant for repetition. And he often provides so much detail about specific pieces of legislation that some readers may lose track of the broader story. That would be a shame, since Mitchell's saga of an earlier America's uneven attempts to curtail market excesses without stifling capitalism's animal spirits has so much relevance for our own age.


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