Nerves were raw in> the aftermath of a devastating financial crisis. Leading figures from major Wall Street institutions were on hand in Washington to testify. In tense sessions, CEOs discussed manipulative practices that allowed banks to make huge profits at the expense of ordinary Americans.
The setting? No, not this morning s grilling of bank CEOs about the origins of the recent economic meltdown. It is instead a description eerily familiar -- of a 1933 Senate investigation into the causes of the 1929 stock market crash.
Those hearings, of course, led to the creation of the Securities Exchange Act and the Securities and Exchange Commission. Today, as the bipartisan Financial Crisis Inquiry Commission gets underway, the question is: Are equally revolutionary reforms in store? At least some historians think so. If history repeats itself, this new commission will make the public much more aware of some of the shady practices that were going on, and I see that as making it easier to pass the reform legislation despite the tremendous opposition of the banks, says Richard Sylla, a professor of the history of financial institutions at New York University s Stern School of Business.
The current commission, chaired by former California state treasurer Phil Angelides, was created by the Fraud Enforcement and Recovery Act signed into law last May. Commission members were appointed by congressional leaders and are tasked with investigating the practices that led to the recent financial crisis.
The 1930s committee, in comparison, had begun under Herbert Hoover, but didn t uncover much of note at first. That changed once Ferdinand Pecora was brought on board as general counsel. A former New York City assistant district attorney, Pecora questioned bankers extensively about their personal finances as well as their trading practices. He decided that he would simply shame and embarrass the witnesses in any way that he could come up with, says Paul Mahoney, the dean of the University of Virginia Law School. The proceedings grew colorful enough that representatives of Ringling Brothers brought in a midget to jump on J.P. Morgan s lap, creating a photo op to underscore the theme that the investigation had become a circus, Mahoney says.
Pecora revealed, for example, that J.P. Morgan himself hadn t paid any personal income tax in 1931 or 1932, Mahoney says. Some of the concerns were very similar to concerns today that the bankers were fat cats, that they had made out like bandits, that they were paying bonuses when people were hungry, says Hillary Sale, a professor of law and business at Washington University in St. Louis.
More concrete issues Pecora took up also still resonate with modern market observers. National City Bank was found to have sold Latin American securities that it knew were doomed to fail, misrepresenting them as sound investments -- not unlike the way modern investment banks shorted their own risky mortgage-backed securities.
Some questions asked by members of Congress during the proceedings did demonstrate a lack of understanding of how the stock market worked. For example, witnesses were asked why a stock s price went up if a company hadn t increased its dividend or developed new manufacturing capabilities missing the role of expectations in setting stock prices.
Pecora s populist approach got results, however. Congressional leaders faced a lot of pressure from the financial industry not to make any major changes, but the hearings generated popular anger that helped create the political will to enact reforms like the Securities Exchange Act that created the Securities and Exchange Commission.
Pecora s focus on conflicts of interest on the part of commercial banks that sold securities to ordinary investors likely provided some basis for the part of the Glass-Steagall Act that divided investment banking from commercial banking, says Randall Kroszner, a professor of economics at the University of Chicago s Booth School of Business. However, statistical analysis of securities underwritten by commercial and investment banks shows no difference in the performance of securities underwritten with this apparent conflict of interest, Kroszner says. That kind of sophisticated data analysis wasn t available to Pecora.
The question for observers is how much today s commission will follow in Pecora s footsteps, in rallying popular anger or in paving the way for reform. It depends on whether the leaders of it have the kind of gumption that Pecora did, says Sylla.