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Financial Reform: Lessons from 1929


As a congressional inquiry into the crisis begins, history shows the perils of dawdling

The Financial Crisis Inquiry Commission, set up by Congress to tell us who killed the banks and what to do about it, has just held its first meeting. Established by law in May, the 10-member panel gathered on Sept. 17 to appoint its executive director: Thomas Greene, a longtime California prosecutor. In the interim, the major banks, reincarnated by government bailouts, have sprinted ahead with near-record profits and new financial products.

Will the commission catch up in this tortoise-and-hare race and propose solutions before another crisis hits? As usual, history is our best guide.

When Congress appropriated $8 million to examine the causes of the recent crisis, it had in mind the example of Ferdinand Pecora, the flamboyant hero of a similar inquiry in the 1930s. Pecora, a young New York prosecutor, became the star of hearings run by the Senate Banking & Currency Committee—in part by grilling bankers about their excesses. His efforts helped build the foundation for the securities laws that govern today's markets.

But few remember how long the panel stumbled about before that. Pecora wasn't the group's first leader; he was the fifth. And the panel didn't finish its work until four years after the 1929 crash, when the country was mired in the Great Depression.

Nor did it get a swift start. After Black Monday and Tuesday in October 1929, several senators called for new laws to prevent another crisis. But over the next six months, stocks recovered 90% of their losses from the Crash. (President Herbert Hoover called it "the little bull market.") Appetite for reform waned, and bankers assured Congress that heavy-handed regulation was unnecessary—even counterproductive. They would reform themselves. Sound familiar?

When Hoover and the Republican Congress finally approved an investigation of Wall Street, Peter Norbeck, a senior member of the Senate Banking & Currency Committee, took the reins. Senator Norbeck, a former oil man from South Dakota, wrote that he was fortunate "the stuff goes over my head. I do not understand it all. If I did, maybe I wouldn't sleep."

The first hearings, in 1932, were sluggish, as Joel Seligman explains in The Transformation of Wall Street. The commission's first counsel, Rhode Island lawyer Claude Branch, was overwhelmed by his lead-off witness, New York Stock Exchange President Richard Whitney. The smooth-talking Whitney dazzled reporters and onlookers as he denied that any short-selling schemes had occurred on his watch. Branch was gone a few days later. His replacement, Republican trial lawyer William Gray, didn't last much longer. The Democrats accused him of political favoritism, ousting him after he accused their party's national chairman of manipulating the price of General Motors stock. On to the third counsel: A friend of Norbeck from South Dakota agreed to fill in until the Presidential election, which Hoover lost to Franklin Roosevelt.

With Roosevelt in power, reformers hoped for a strong replacement, perhaps Chicago activist Harold Ickes or New York superlawyer Samuel Untermyer. Both declined, citing the uncertain extent of the panel's authority. The job went to New York attorney Irving Ben Cooper, 30, a junior corruption investigator. When Cooper requested 500 subpoenas, the Senate balked. He quit, complaining that Washington just wanted someone to "sit on the lid."

Pecora arrived in February 1933 and blew off the lid. After Norbeck gave him "all the authority necessary," he hauled in dozens of financiers for public floggings, earning the moniker "hellhound of Wall Street" and guiding the panel toward its recommendations.

There are reasons to be skeptical of the new commission, just as there was to doubt the chances of reform one year after the 1929 crash. Then, as now, the panel was outmatched by Wall Street. Then, as now, it was slow to start, faced serious political obstacles, and had limited subpoena power. There were years of economic stagnation (and new scandals) before Congress passed reforms aimed at protecting investors from crisis. Early prospects were dim. They brightened only when Pecora dashed ahead. The current commission's final report is due Dec. 15, 2010. The race is on.

Frank Partnoy, the George E. Barrett Professor of Law Finance at the University of San Diego law school, is author of The Match King: Ivar Kreuger, the Financial Genius Behind a Century of Wall Street Scandals.

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