The Banality of Madoff

Bernie Madoff in October 7, 1999, photographed by Jonathan Saunders.

Bernie Madoff's 150 year prison sentence, pronounced on June 29, 2009, is considered largely symbolic. Now in his mid-70s, suffering from kidney cancer and heart disease, the maximum term is more than necessary to ensure that this "psychopath" and "monster" never experiences freedom again.

While Madoff's crime of defrauding millions in the largest Ponzi scheme in history has been described as "extraordinary evil," the case also reminds me of the "banality of evil."

In the years since his one-way trip to Butner Federal Correctional Complex (25 miles northwest of Raleigh, NC), it has been difficult for prosecutors to convict co-conspirators. In many cases, the bankers and regulators who made his scheme possible — with their arcane credit-default swaps, lax regulatory enforcement, and badly managed financial firms— can claim that they were simply doing their job.

Nonetheless, a lawsuit brought by investors in July 2013 sought to redeem $60 million in investor funds lost to Madoff by showing that their custodial bank— Westport National — failed at its job. Vowing to vigorously defend itself, bank lawyers argued if the US government couldn't figure out the scheme, how could a poor little ol' community bank in Connecticut possibly do it?

They had a hard enough time figuring out what was in the vault! When president Richard T. Cummings, Jr., a 36-year veteran of banking with a finance degree from Georgetown, was asked how the bank maintained accurate records, he replied "I can't answer that question."

What due diligence did the bank do to ensure that customers’ assets existed, and were safe? “I don’t know.”

And anyway, lawyers argued, the bank's ability to safeguard funds was limited to “ministerial” duties. Like those administered by Dennis Clark, the bank’s former vice president and manager of custody services.

Testifying by video deposition (he died in 2012), Mr. Clark said that he sometimes reviewed Madoff's trade confirmations out of “curiosity,” but then simply filed them away. He did not verify prices for derivative securities because he did not understand how puts and calls were priced.

Mr. Clark did, however, make an effort to look up stock prices listed on Madoff's monthly statements. (Fees for the bank were based on assets under management — real or imagined, the New York Times reported.)

Many of the disputed custody accounts at Westport National were referrals from Robert L. Silverman, a professional actuary who ran a consulting firm about half a mile from the bank.

More than a dozen Westport customers told their lawyers that Mr. Silverman recommended the arrangement. Mr. Silverman’s business, PSCC Services, got about four-fifths of the fees the bank collected from Madoff accounts, according to the New York Times.

"These investors were betrayed twice," Connecticut Attorney General Richard Blumenthal said in 2010. "First by Madoff and then by their advisers."

“I live in a tormented state now, knowing of all the pain and suffering that I have created," Madoff said at his sentencing in 2009. "I am sorry,” adding abruptly, “I know that doesn’t help you.”

Train Wrecks and Clown Bankers

Jubilant board members of PNC Bank after receiving TARP funds.

On June 22, 1918, while performers slept, the engineer of a empty equipment train going fifty miles per hour was himself taking a snooze when he rammed his iron horse into the circus train idling on the tracks.

Constructed mostly of wood, the circus' forty sleeper cars were lit by kerosene lamps. Upon impact, almost all cars were derailed and eventually caught fire. Many bodies were charred beyond recognition, but the New York Times was able to list a few of the ninety-six dead--in some cases entire families.

Rooney Family - bareback riders
Donovan Family - elephant trainers
Robert Elis and wife - aerialists
Mark Adams - clown

While there were no animals injured in the wreck, the Hagenbeck-Wallace circus was famous for its animal acts, led by trainer Carl Hagenbeck. A pioneer of rewards-based training, Hagenbeck "was convinced that far more could be achieved by gentleness and sympathy than was ever accomplished by tyrannical cruelty," he wrote in his autobiography.

When the circus wasn't managing animals and clowns, it was managing bankers. In March 1904, after Peru National Bank refused to process the show's barrels of nickels labelled "nails," Ben Wallace opened his own bank, the Wabash Valley Bank and Trust. For eighty years, Wabash Valley operated on the corner of Main and Broadway in Peru, Indiana, with the third floor used as a workshop for making circus costumes.

After the train tragedy, Wallace and Hagenbeck sold the circus to Jeremiah Mugivan and Bert Bowers who renamed it the American Circus Company, and a year later, the American Circus Corporation. In 1929, John Ringling--a former clown--bought five circus groups including the American Circus Corp to create the largest circus in the world at the time, the Ringling Brothers Barnum & Bailey.

So, too, the Wabash Valley Bank and Trust eventually became the First of America Bank, then the National City Bank. In 2008, in a spate of bank mergers after a financial train wreck, it was purchased by PNC Bank.

The National City/PNC deal was quite controversial at the time. PNC essentially used TARP funds to finance the merger, just weeks after National City was denied those funds. Describing how the $700 billion bailout was distributed to the banks, former director of the Office of Thrift Supervision Tim Ryan said it was “a four-ring circus.”

The Sinking of the Germania Bank

Illustration is from Puck, a magazine founded by German immigrants, and shows an old, haggard "Justice" sitting in a chair on a rock in the East River, cobwebs have grown over her sword, scales, and an "Indictment"; in the background, the steamship General Slocum is engulfed in flames (it burned on June 15th 1904 with a loss of over 1,000 lives). From LOC.gov

On a sunny, June 15th Wednesday in 1904, a steamboat called the General Slocum carrying parishioners from St. Marks German Lutheran Church to its annual picnic erupted into flames and sank in the East River. Almost all of the 1,021 killed were women and their children.

The Pastor, who survived, described the scene. "Women were shrieking and clasping their children in their arms. Some mothers had as many as three or four with them. Death by fire was to be escaped only by death by water."

Passengers who chose water were horrified to realize that the boat's "life preservers" (which hadn't been replaced since 1895) were filled with ground cork instead of solid. Since most Americans could not swim at the time, many, including the Pastor's wife and daughter, drowned. In the preceding trials, the captain and crew escaped punishment for their part in the greatest loss of life in New York's history (until 9/11/2001).

In the days that followed, the avenues and byways of Little Germany that had for generations been famous for outdoor gaiety were silent. Mourning crepe hung on every door. The windows wept.

"We all knew each other and now--all dead," a grief-stricken resident told the New York Times.

Many attributed the Slocum tragedy to the eventual death of Little Germany itself. But the transition from Kleindeutschland to what we now know as the East Village was certainly hastened by a wave of anti-German sentiment. German bier gartens were the bete noir of the Prohibition Movement, and the onset of World War I brought hatred of Germans to a frothy peak.

The New York Times ran letters defending German-Americans. "Of all the peoples of nations that have come to our shores there are none who have made better or more patriotic citizens," John Crimmins wrote in 1914. "Steady, industrious, sober, [German immigrants] have given to the United States great merchants, manufacturers, and bankers."

Including the bankers of Little Germany's own Germania Bank. Successful since its founding in1869, it drowned in 1918 under the weight of anti-German feeling. When it was apparent that there was no place in America for a bank with German in its name, the well-capitalized and deposit-rich concern changed it.

On April 15th a small corner of the New York Times made the announcement: "Beginning today the Germania Bank will be known as the Commonwealth Bank."

Post Script: The Germania Bank Building, however, survives to this day. Described by New York Magazine as a "72-room Bohemian dream house," the former home of Little Germany's local bank is now the home of Jay Maisel. The photographer bought the six-story, 35,000-square-foot single family residence in 1966 for $102,000. He still lives there with his wife and daughter, but perhaps it's a little too much for them. From the outside it looks vacant. The artists have done wonders with the interior, though. Check it out here.

On the Death of John Pierpont Morgan

John Pierpont Morgan and Uncle Sam rowing a boat, circa 1911. From LOC.gov.

You might think I was April Foolin' if I said that there was a time when the death of a banker caused national mourning. But such was the case on April 1, 1913 when papers reported on the death of John Pierpont Morgan.

"World Mourns Loss of Great Financier," the New York Sun headline ran. Flags flew at half-mast. For the first time in its history, the New York Stock Exchange suspended operations to commemorate the life of the great banker.

Mr. Morgan was 76 when he died. Papers attributed his demise, however, not to age but rather to "emotions caused by the investigation carried out by the Pujo committee." Formed in May 1912 by Arsène Pujo of Louisiana, the congressional subcommittee's underlying purpose was to show that the "panic of 1907 was a manufactured panic which would have been impossible had it not been for the concentration of money and its control in a group of Wall St. financiers," reported the San Francisco Call in December 1912.

Newspaper reports from the investigation that the House of Morgan controlled $25 billion, a large sum even by today's standards, startled everyday Americans whose average salary at the time was $800 per year.

The revelations of the extent of the nation's wealth disparity gave Congress the public support it needed to pass legislation that redistributed that wealth, namely the power to levy income tax (16th Amendment, Feb 1913), government-sponsored centralized banking (Federal Reserve Act, Dec 1913), and tougher rules around monopolies (Clayton Antitrust Act, Oct 1914).

(And you thought Dodd-Frank was bad!)

For their part, Congressmen disputed claims that their investigation caused Morgan's death. "The insinuation that the committee's courteous examination of Mr. Morgan contributed in any manner whatever to his demise appears to be a studied attempt make capital (hah!) of his death, and to arouse sympathy for a system that in many respects is at a decided variance with the interests of our people," Congressmen Neely of Kansas said in the Washington Times.

While the cause of his death was disputed, his impact, at least according to the many condolences reprinted in the New York Tribune, was not. One such tribute by banker Joseph Harriman predicted Mr Morgan's enduring legacy.

"It is hard to give an estimate of the loss which the entire country has suffered through Mr. Morgan's death. He was a great organizer and developer and the monuments that he reared will live for all time. Not the least great and lasting work to his credit is the wonderfully equipped banking firm he has left behind him, which will perpetuate his name for many years to come."

Indeed, 101 years later,  JP Morgan Chase is the largest bank in the United States.

Asheville's Depression Debt Redemption

Asheville's historic Legal Building

On March 24, 1663, King Charles II granted a land charter for the Province of Carolina (named after his father, Charles I, Carolus being the Latin version of 'Charles') to eight Lords Proprietors, a form of repayment for their help in restoring him to the throne.

On another March 24, Samuel Ashe, the ninth governor of North Carolina, was born in 1725. Ashe is the namesake for many parts of the state, including Asheville.

The Miami Beach of the Mountains, Asheville is "the happiest city in America" according to Self Magazine. But it wasn't always so, at least for bankers.

On November 20, 1930, eight North Carolina banks failed, including Asheville's largest Central Bank and Trust. Thousands lost their life savings, including the city itself. With $8 million gone in a single day, projects halted, employees lost salaries, the budget was cut in half.

An independent audit of the city's finances found that officials used public funds to try to save the bank. Their efforts were not appreciated. "Even if the city's commissioners pursued the course they thought best," the New York Times reported, "as public officials they have destroyed themselves plunged the city headlong into debt, betrayed their trust and forfeited the right to their possessions."

The bankers took it hard. On February 17, 1931, the vice president of Central, Arthur R. Rankin, shot himself to death. Later that week, a bank cashier cut his throat but survived. On February 23, four days after bank and public officials were indicted for fraud and conspiracy, Asheville mayor Galatin Roberts went to the fourth floor bathroom of the Legal Building and shot himself in the temple. He left a note.

"My soul is sensitive and I am wounded unto death. God knows I did no wrong during my term in office. My hands are clean and my conscience is clear."

With the largest municipal debt per capita of any American city ever, Asheville experienced four decades of economic stagnation and population decline. Bankruptcy might have been easier, but the community refused. "We owe this money and we ought to pay it," Asheville city employee Weldon Weir explained. Each year as bonds were retired, the Asheville Citizen ran a headline "Bonds Cremated." The last payment was made in 1976.

Though it wasn't easy, the experience is treated as a blessing.  In the go-go 1960s when other cities were destroying buildings to "modernize" (e.g, New York's Pennsylvania Station), depression-era debt payments forced Asheville's skyline to stay beautifully stuck in Art Deco-y 1930, "and is why our historic fabric was not bulldozed," writes Ashevillenow.com.

Today, with debts repaid and conscience cleared, Governor Ashe's namesake town is a downright happy place to be.

Mississippi's Mixed-up 13th Amendment

Portraits of Blanche Kelso Bruce, Frederick Douglass, and Hiram Rhoades Revels surrounded by scenes of African American life and portraits of Jno. R. Lynch, Abraham Lincoln, James A. Garfield, Ulysses S. Grant, Joseph H. Rainey, Charles E. Nash, John Brown, and Robert Smalls. Crica 1883, from LOC.gov

March 16 marks the anniversary of Mississippi's ratification of the 13th Amendment, the one that proclaims "Neither slavery nor involuntary servitude shall exist within the United States." March 16, 1995, that is.

The 13th Amendment became part of the Constitution in 1865, after three-fourths of the states adopted it, but four took their sweet time: Texas ratified in 1870, Delaware 1901, Kentucky 1976, and Mississippi 1995.

To make matters more delayed, it wasn't until last year that the ratification was official, since the Mississippi legislature forgot (?) to let the US archivist know. After being inspired by the movie "Lincoln," Dr. Ranjan Batra, a professor of Neurobiology at the University of Mississippi, worked with the state archives to fix the clerical oversight, ABCnews reported in February 2013.

Back in 1865, Mississippi's Memphis Daily clarified that their opposition to the amendment was not to the first section outlawing slavery "as the slave states themselves have in convention solemnly decreed emancipation," the newspaper wrote in November. Rather it was the second section that was "amenable to grave objection to every man who is sensible of the high duty of preserving the state sovereignty feature of a mixed government."

The second section states that "Congress shall have power to enforce this article by appropriate legislation."

This encroachment on states rights, the editors declared ironically enough, made its citizens less free. They likened its passage to Napoleon III's 1851 "bloodless coup d'etat that passed France from a Republic to an Empire. The nation went to bed in a polity of freedom and woke up to find masters." (I guess no one likes to be a slave.)

While Mississippi was advocating for laws that disenfranchised its majority black population (just 45% of Mississippians were white at the time), they were also electing 226 black Mississippians to public office, compared to only 46 blacks in Arkansas and 20 in Tennessee, according to the Mississippi Historical Society.

Mississippi also sent the nation's first and second African-Americans to the US Congress, Hiram R. Revels who served an incomplete term 1870-1871, and Blanche Kelso Bruce who served a full term 1874-1881.

Political progress was not enough for the prejudice seared into hearts and minds, concluded Colonel Samuel Thomas, the assistant commissioner of the Freedman's Bureau.  Though white Mississippians “admit that the individual relations of masters and slaves have been destroyed by the war and the President's emancipation proclamation, they still have an ingrained feeling that the blacks at large belong to the whites at large,” Colonel Thomas told lawmakers in 1865.

Between 1881 and 1898, however, America's currency at large belonged to Mississippi Senator and former-slave Blanche K. Bruce. Senator Bruce was appointed by President Garfield to be the Register of the Treasury, making him the first African-American whose signature was represented on U.S. paper currency.

When he was re-appointed by President William McKinley in 1897, editors at the Washington Bee were unequivocal.

"Newspapers of all shades of politics agree that in the appointment of exSenator Bruce to the Register of the Treasury, President McKinley has made an admirable selection."  Editors from the Herald in Rochester, NY concluded, "Blanche K. Bruce, the new Register of the Treasury, is of African decent, but the name on a greenback is not to be sneezed at."

Senator Bruce died one year later, on March 17, 1898.

In Fed We Trust: Bank Panics, Broken Promises

President Herbert Hoover escorting Franklin Delano Roosevelt from the White House to the Capitol to take the oath of office as President, March 4, 1933. From LOC.gov

Trust is a funny thing. It can build empires and be broken by a promise. It is gained slowly but lost quickly. While not essential for life, we can't live without it. And in March 1933 it was in short supply.

The root of the bank crisis that led to the Great Depression can be traced to a promise broken by the Federal Reserve, so argued Milton Friedman and Anna Schwartz in their seminal book "Monetary History of the United States."

Established in 1913, in the wake of the 1907 panic, the Federal Reserve was designed to prevent major bank failures by acting as the lender of last resort. Prior to the Fed's creation, as Ben Bernanke explained in a 2002 speech, bank panics were typically handled by banks or bankers themselves. Large, solvent banks had an incentive to act because they knew that an unchecked panic would ultimately threaten their own finances.

But there was always a fear that "men may not be found in an emergency with the patriotism, courage and capacity" necessary to prevent a catastrophe. This was one of the arguments for central banking put forth by Senator Nelson Aldrich in the wake of 1907 crisis.

That isn't to say that Americans feared bank failures. In fact, many believed that by weeding out "weak" banks, failure was a harsh but necessary component of a healthy banking system. Between 1921-1929, an average of 600 banks failed every year, according to FDIC data. Liquidationist and Treasury Secretary Andrew Mellon advised President Hoover that it was not the Fed's job to rescue poorly managed, failing institutions.

So they didn't. In December 1930 (a year after the market crash) the Fed refused to bailout New York's Bank of the United States.* But it was not managerial weakness, per se, that caused the BUS to fail. In November, the announcement that merger negotiations between the BUS and three other banks broke down "aroused distrust in the general public," according to the New York Times. In December, a false rumor that a shareholder had not been paid for his shares sparked a run that eventually forced the bank into a liquidity crises.

When the Fed refused to insure the bank's liabilities, Americans--bankers and consumers alike--felt duped. Unlike the small, state bank failures that occurred during the 1920s, the BUS was a member of the Federal Reserve System. It was also the largest ever to suspend payments, "possibly the largest in the world to close its doors." Letting it fail caused thousands to lose their life savings, and severely diminished America's faith in the Fed's ability to prevent major bank failures (understandably so).

Since the Fed was designed to serve as lender of last resort, the previous infrastructure that allowed others to step up was gone. In October 1931--after a run on banks sparked by Great Britain's abandonment of the gold standard--a consortium of private bankers attempted to fill the gap by organizing the National Credit Corporation. That organization failed within weeks.

Business leaders then appealed to the federal government. In January 1932, the Hoover Administration responded by creating the Reconstruction Finance Corporation (RFC) whose primary function was to make advances to banks. By the end of 1932, the RFC had assisted over 4,000 banks, authorized almost $900 million in loans, and bank failures subsided. But appearance of a bank's name on the RFC list was interpreted as a sign of weakness, discouraging banks from borrowing. Had Congress not publicly disclosed the names of borrowers, the RFC may have been able to assist more banks.

In the winter of 1933, with no reliable lender of last resort, faith in the nation's banking system froze. The fear contagion started on Valentine's Day in Michigan. Trying to prevent the failure of Detroit's large banks, Michigan Governor William A. Comstock declared a statewide banking holiday. This succeeded in preventing bank failures, but the bank closures confirmed the public’s worst fears—that the banks needed to be closed.

As depositors in every state lined up outside bank branches, failure became a self-fulfilling prophecy. On March 5 (barely a day in office), FDR shut down all of the nation's banks, proclaiming what is known today as the Bank Holiday (a misnomer if ever there was one).

On March 9, he signed the Emergency Bank Act, declaring a sort of Martial Law on the nation's economy. The Act gave the President control of the entire banking system, and nearly unlimited resources to resolve its problems. This hasty legislation--only one copy was made and Congressmen cast their vote after having it read to them aloud--was the first bold move the President made to restore confidence.

The second occurred on Sunday March 12 with the first-ever "fire side chat." At 10 PM, radios nation-wide broadcast his avuncular assurances. With a simple, explanatory speech about the state of America's banks, confusion and fear abated. When they reopened on March 13, depositors stood in line to re-deposit their cash.

In 2008, by fully exercising the Federal Reserve's lender of last resort powers, Ben Bernanke and others made sure not to repeat the mistakes of the past. Many agree their bold and decisive actions prevented another Great Depression, though those actions were deeply unpopular, especially the requirement that healthy banks take TARP funds. (But wasn't this just an attempt to avoid the RFC's mistake of advertising weak banks?)

There's no denying that by shifting the responsibility of providing liquidity in financial crises from the banks (who for the most part created the problems) to the people via government guarantees, the existence of the Fed creates a moral hazard. This is an unsavory reality. What central bankers learned from 1933, however, is that as long as the Fed exists it must keep its promises or the system will be destroyed by them.

In November 2002, at Milton Friedman's 90th birthday, Ben Bernanke thanked the Nobel-prize winning economist for his invaluable work, including his insights into the causes of the Great Depression and the 1933 crisis. Referring to his role as a central banker, Bernanke concluded "Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." He kept his promise.

Watch Milton Friedman discuss the failure of the Bank of the United States and the anatomy of bank runs on YouTube.

*Things might have been less severe if the Bank of the United States had a different name. "Though an ordinary commercial bank," Friedman wrote, "its name had led many at home and abroad to regard it as somehow the official bank."

America the Binary? Chang and Eng and the Election of 1824

"Siamese Twins," Brothers Chang and Eng Bunker, a symbol of America?

At protests, we often hear the phrase "the people united will never be defeated." But in America, we are wise to remember another phrase: "never say never."

Take the election of 1824. While first thought to unify the country, America's brief experiment with a one party system (1818-1824) led to a un-popular conclusion in 1824. With all four candidates representing the same party, the Democratic-Republicans, none received a majority of the electoral votes, and the US House of Representatives was left to decide.

Despite receiving a plurality of both the popular (43%) and electoral votes (99), General Andrew Jackson was defeated by his runner up, John Quincy Adams. Under what Jackson supporters later dubbed the "corrupt bargain," Congress elected Adams to be the sixth President of the United States on February 9, 1824.

Jacksonians were furious, and within months had nominated him to be the1828 presidential candidate (Hilary, what's the hold-up?).

During JQA's one-term Presidency--which was mostly marred with malevolence--the Chang and Eng Bunker Brothers, "Siamese Twins" born in Taiwan, first came to the United States in 1827. These conjoined twins would later reside in Mt. Airy, North Carolina, own slaves, and father 11 and 12 children respectively (with two different wives). In many ways, they were also a sign of the times, of America's unfolding, interdependent duality.

The controversial 1824 election paved the way for our two party system, with the Jacksonian faction becoming the modern Democratic Party, and the Adams faction absorbed by the National Republicans (aka Whig Party).

Culturally, the Adams/Jackson rematch in 1828 was a battle between America's emerging extremes. Adams hailed from the North (Massachusetts) Jackson from the South (Tennessee). Adams was from a long line of aristocrats, Jackson was born in poverty.

Jackson was charismatic, Adams dull. The son of the second President, John Adams' detractors called him "a chip off the old iceberg."

Adams was academic, Jackson a man of action. “J. Q. Adams can write” one slogan read, “Andy Jackson can fight”.

Adams was stately, Jackson characterized as a brute. Henry Clay once quipped "killing 2500 (?!) Englishman at the Battle of New Orleans" did not qualify Jackson for "the various difficult and complicated duties of the chief magistrate."

Adams was a deeply religious man, Jackson prone to vice. During the 1828 election, Adams supporters discredited Jackson for living with his wife before she was legally divorced from her first husband.

And where Adams favored a National Bank, Jackson pushed for independent state banks. Jackson won the election of 1828 by a landslide, and the dream of national banking was buried until the Republican, President Abraham Lincoln, signed the National Bank Act in 1863. (Today America is the only major economy that has a dual banking system, one that charters both state and national banks.)

Many of the Jackson and Adams' battles are echoed in today's cultural conversations. But today we have a new way to describe our binary nature: Red vs Blue.

Listen to a campaign song, "Hunters of Kentucky, or Half Horse and Half Alligator (another beautiful binary!)," sung by Jackson supporters in the 1824 election. It glorifies Andrew Jackson at the Battle of New Orleans.

Good Intentions, Bad Results: Lessons from the Panic of 1826

They say the road to hell is paved with good intentions. In 1825, to deal with the "Indian Problem," the US Congress formed a region known as "Indian Country," lands West of the Mississippi (today Oklahoma). Their intentions were good.

"The removal of the tribes from the territory which they now inhabit would not only shield them from impending ruin, but promote their welfare and happiness," President James Monroe told Congress on January 27. He went so far as to say that without a defined Indian country "their degradation and extermination will be inevitable."

It's heartening to know that at least some of the President's contemporaries could see through his good intentions. New York County District Attorney Hugh Maxwell and twelve other prominent New Yorkers wrote in a pamphlet published in1825 that "the American Indians, now living upon lands derived from their ancestors and never alienated or surrendered, have a perfect right to the continued and undisturbed possession of these lands," and the "removal of any nation of Indians from their country by force would be an instance of gross and cruel oppression."

History was not on Mr. Maxwell's side, nor with his attempts to reform the financial industry a few years later. His prosecution of the Life & Fire Insurance Company, whose owners Jacob Barker, et al perpetuated a fraud that led to the Panic of 1826, resulted in a hung jury. (Eventually, Mr. Maxwell's efforts did lead to comprehensive reform, including: financial reporting requirements, accounting standards, and defined roles & responsibilities for directors, according to Professor Eric Hilt in a paper about the Panic of 1826.)

Mr. Maxwell's rationality was no match for his era's good intentions. For what lead Life & Fire's directors to commit fraud in the first place was in part driven by a desire (so they claimed) to extend credit to high-risk borrowers being ignored by traditional banks. When those borrowers started to default en masse, fraud appeared to be the only way to repay their investors, but unfortunately, even that didn't work.

Why was an insurance company doing a bank's work? In the 19th century, banking was the most profitably industry in America, and incumbent banks fought hard to protect their profits. To open a new one involved special-act charters and bitter legislative battles. Would-be owners required both political and financial capital, which few had in equal measure.

Enterprising merchants like Mr. Barker started circumventing these laws by forming insurance companies whose charter empowered them to lend their capital. In so doing, they created a new financial product called a post note. A typical post note transaction went as follows: a borrower approached an insurance company and requested a six-month IOU of $1000, minus a discount of say 3%. The borrower would then sell the discounted $970 post note on the money market, also paying a discount to the post note purchaser of say $30, receiving $940 in cash.

After six months, the borrower would repay the insurance company's IOU of $1000. The insurance company would repay the money market investor's post note of $970, yielding a $30 profit for both the insurance company and the investor.

While rates and terms varied, it was not unusual for post notes to trade at yields of 2 percent per month or more, compared to banks that were lending at yields of five percent per year, Professor Hilt's research found. Needless to say, these products were very profitable as long as default rates were low.

But higher yield meant higher risk, since borrowers who sought out post notes did so because they did not qualify for the less expensive credit from traditional banks. Despite their dubious quality, the corporate guaranty by the insurance company created a sense that the investments were safe. This combination of high yield and seemingly low risk sparked a credit boom.

"The judge the lawyer the doctor the clergy the widow the trustee of orphans all fell into the common vortex of investing in these bonds," Life and Fire Insurance Company director Jacob Barker wrote in a letter in 1827.

Like post notes, what made sub-prime mortgage-backed securities (MBS) so attractive to investors during the boom years was their high yield and perceived low risk. Unlike 1826, where the secondary market was created by the private sector, our government in many ways created the secondary market that gave sub-prime loans both the cash and perceived safety they needed to expand.

This was all done with good intentions. Looking to increase the homeownership rate and "foster affordable housing," the Housing and Urban Development (HUD) department issued regulations that required 55% of all government sponsored entities (GSEs) to purchase "affordable" loans from banks, either directly or through packaged MBS.

Most of these "affordable" loans were in fact sub-prime, "for persons with blemished or limited credit histories," and "carry a higher rate of interest than prime loans to compensate for increased credit risk," according to HUD.gov. In 2009, forty percent of mortgages were sub-prime according to Forbes.com.

By WTBrooks via Wikimedia Commons

By 2007, Fannie Mae and Freddie Max held $227 billion (one in six loans) in nonprime (aka subprime) pools, and approximately $1.6 trillion in low-quality loans altogether, according to Forbes.com and the Congressional Budget Office (CBO).

Value of mortgage-backed security issuances in $USD trillions, 1990-2009.
source: Congressional Budget Office (CBO)

"That was a huge, huge mistake," said Patricia McCoy, who teaches securities law at the University of Connecticut. "That just pumped more capital into a very unregulated market that has turned out to be a disaster."

Nonetheless, when the crisis hit in the Fall 2008, the financial world seemed to be blind-sided. "It's a new financial world on the verge of a complete reorganization," said Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey.

But was it a new financial world? In many ways, looking back to the Panic of 1826, we see ourselves looking back at us. Both were defined by financial innovations that seemed to defy the natural law of risk and reward, by promising a high yield and low risk. Both crises fooled investors into believing that transferring risk is the same thing as removing it. Both crises were made worse by the good intention that lending money to people who can't pay it back is good for society. Both crises proved it's not.

In our time, the implosion of the subprime lending market "has left a scar on the finances of black Americans," the Washington Post reported in 2012, "that not only wiped out a generation of economic progress but could leave them at a financial disadvantage for decades." (HUD.gov studies reveal that African-Americans are one-and-a-half times more likely to have a subprime loan than persons in white neighborhoods.)

Like the comprehensive financial reforms made after the 1826 panic, we can be reasonably sure that the numerous reforms issued after our own will fail to avert another crisis. This is because financial regulation cannot address the cause of financial crises that lives in our mirror. As long as there are borrowers who can't see through good intentions, and take on more debt then they can repay, there will be financial crises.

Real financial reform means living within our means, and abiding by the natural law of risk and reward. With the rising default rate on student loans, the increasing popularity of sub-prime auto loans, I fear that we have not yet learned our lesson. I'm confident we will eventually, but like our predecessors, it may have to be the hard way.

*

"Daddy Warbucks," the Treaty of Versailles and Forming the Federal Reserve

PAUL M. WARBURG at the 1ST PAN AMERICAN FINANCIAL CONFERENCE, WASHINGTON, D.C., MAY 1915. 

On January 19, 1920, newspapers around the country were chronicling the US Senate's debate--for the second time--on whether to officially end war with Germany, ratify the Treaty of Versailles and join the League of Nations. In favor of ratification was a German emigre-turned-American-banker, Paul M. Warburg.

Echoing some of today's debates on Iraq, Warburg argued that by playing a part in the war, we had a moral responsibility in ensuring the peace. "There are many who, disgusted and disheartened, believe that we should wash our hands of Europe, and leave her to iron out her own affairs. It is too late for that. Europe relies on us," wrote Warburg in 1919.

And we relied on Europe, at least when it came to designing our modern banking system. Before advocating for world peace, Mr. Warburg was an advocate for centralized banking in the US. A descendant of a prominent German banking family, Mr. Warburg moved across the pond in 1895 after marrying into a prominent American banking family. Having an intimate view into both systems, he found the US uncharacteristically behind the times.

In a 1907 article printed in the New York Times, Warburg wrote that the American system was "in fact at about the same point that had been reached by Europe at the time of the Medicis, and by Asia, in all likelihood, at the time of Hammurabi." (Ouch!)

The European and Asian systems facilitated an elastic currency, Warburg said, "that follows the requirements of commerce." The United States' decentralized system, on the other hand, maintained an inelastic currency based on 6500 banks. "Under present conditions, instead of sending an army we send a soldier in to fight alone."

In passing the Federal Reserve Act of 1913, we heeded Warburg's advice and joined the league of centralized banking.  When it came to joining the League of Nations, however, we ignored the ex-German and soldiered it alone.

The purported inspiration for the "Daddy Warbucks" character in the Little Orphan Annie story, one could say Mr. Warburg was the father of our modern banking system. And in the hard-knocked world of finance, Warburg taught us that we shouldn't have to reinvent the wheel.

"I think that we are greatly mistaken if we believe that our country is so entirely different from all others that we should continue to do the opposite of what is done by them, while the system of all other important nations has proved to be excellent, and ours has proved to be defective."

I wonder what Mr. Warburg would think of today's healthcare system...

Banker's Notes cannot resist the convergence of banking and music, so let's enjoy Hard Knocked Life from the 1982 movie Annie, shall we?  At YouTube here >> http://youtu.be/-0bOH8ABpco



PS: In refusing to join the League of Nations, Senate Republicans used for the first time the "cloture," a procedural tool originally advocated by President Woodrow Wilson that allows Senators to place a time limit on the debate of a bill. Senate Republicans used the cloture against President Wilson to end debate on the Treaty, which eventually lead to its first rejection, on November 19, 1919.

In today's bipartisan bitterness, the cloture is still a favorite tool used by Republicans. Rachel Maddow found that the113th Congress is on track to be the most "do nothing" Congress in history in part because of Republican's frequent deployment of the tool. Of 2013's 64 roll call votes, the cloture was invoked more than the combined total of 1917 to 1978.

Banker's Notes 2013: Top 10 Best, Worst and Lessons Learned

In its inaugural year, Banker's Notes experienced the bliss of briefly going viral as well as the bust of boring posts. Below is the Banker's Notes Top 10 Best, Worst and Lesson Learned from 2013.

1) Most Insightful Commentary: Thank you +David Rider! 

BNer David Rider blessed Banker's Notes this year by not only reading the posts, but thoughtfully commenting, as in this one after the Panic of 1907 article:

2) Most Fun Email Received in Response to a Post: +Julie Kinloch and JP Morgan Jr Fights for his Life with the Help of His Powerful Wife, posted Sep 8

This post, detailing the failed assassination attempt on banker JP Morgan Jr, inspired the most interesting emails, such as this one from Julie Kinloch: "that one was fuckin fabulous and i love how he was wielding a pistol and a PhD from Cornell."


3) Most Supportive Parents: +Bill and Julie Wick

I want to give a shout out to my parents who not only signed up to receive (and consistently read!) Banker's Notes, but also recruited several of you to join as well. Thank you Mom and Dad!

4) Oldest Friend Reconnection: +Christine Cadrecha

Through Banker's Notes, I was able to reconnect with perhaps my oldest friend in the world, my one-time neighbor Christine Cadrecha. When we lived down the street from each other in Burlington, Vermont, we used to play pool in her basement and then swim in the pool in her backyard. Now we wade in the pool of the healthcare debate, thanks to the Banker's Notes post about the birthday of economist Kenneth Arrow, who said "There's really no logical relation whatever between employment and health care..."

5) Most Corrected Post: Federal Credit Union Act is Passed, posted Jun 25

In this post, I think I let my personal feeling that credit unions should be taxed just like banks cloud my reporting. Thankfully, I received this corrective comment from a careful reader who randomly found Banker's Notes. Our exchange is below:

6) Most Google+ Recommendations: Panic of 1907 vs. Crisis of 2008, posted Nov 18

This essay was inspired by a speech by +Ben Bernanke, and it not only received the most recommendations, it was also re-posted on the website StrategyDriven.com. One of the longer BN posts, it showed me that telling how we got to where we are, even on the dry topic of central banking, can be interesting and not just to me!

This post also benefited from a retweet from New Jersey banker +Jeff Marsico.

7) Most Community Building: Wilmington Coup D'Etat, posted Nov 10

While this post did not receive many pageviews, it demonstrated the power of the internet to build community. Through it, I was introduced to Wilmington filmmaker Chris Everett who is creating a documentary on the Wilmington Coup D'Etat. You can learn more about his film "Wilmington on Fire" and his kickstarter campaign here.

8) The Best: The Alaska Appropriations Affair, posted Oct 20

This story about the House of Representatives' refusal in the 1860s to pay Russia for our purchase of Alaska (even after we celebrated its inclusion as a US territory) received the most pageviews.

I think what made this post the most popular was the strong link between historical and current events. When it posted, our government had just shutdown because Congress had similarly refused to pay for ObamaCare even after the law's blessing by the Supreme Court.

This post also benefited from a retweet from +Alex Tabarrok, an economics professor at George Mason University and founder of the blog Marginal Revolution.

9) The Worst: Ad Man Bell Bernach: "The truth isn't the truth until people believe you", posted Aug 17

With three piddly pageviews (most likely all from me!), this story commemorating the birth of the inventor of the "Mikey" Life Cereal commercials was the least popular post. From this experience, I came to appreciate the wisdom of the ancient adage "embedded video does not an interesting post make." There are no shortcuts in blogging!

10) My Favorite Banker's Notes Post of 2013: Ship of Gold, posted Aug 24

I think my most favorite post of 2013 was the "Ship of Gold." This story delighted because when it came to a choice between life and money, survivors of this sinking ship chose life.

Did you have a favorite post this year?

If you have any thoughts on Banker's Notes--what worked well and especially what could work better in 2014--I hope that you will comment on this post, or email me!  Cara@bankersnotes.com

As always thanks for reading!

Banker's Notes will be back Sunday Jan 12 (I'm on a 10-day meditation retreat Dec 27-Jan 7). Until then, Happy New Year to you!

Love,
Cara

'Tis the Season for Opinons: Jefferson's Embargo Act of 1807

President Jefferson addressing a group of disgruntled men, as he defends the policy of his Embargo which, combined with the Non-Intercourse Act, was intended to bring about a suspension of foreign commerce. Circa 1808, from LOC.gov

In a December 20 op-ed posted on Forbes.com, commentators Mieke Eoyang and Gabriel Horwitz proclaimed our founding fathers would be "horrified" by the NSA's collection efforts. Specifically, that our third President would be "dismayed" that our government "was doing things that could hurt our competitiveness and our ability to set the terms of global trade."

Perhaps in hindsight, yes. But with the Embargo Act, signed into law on December 22, 1807, Thomas Jefferson did his part to both expand government and limit our global competitiveness.

A ban on trade between the United Kingdom and France was intended as a diplomatic response to these militarily-superior nation's flagrant refusal to honor US neutrality during the Napoleonic Wars. Instead of economic harm to our enemies, however, the policy inflicted a devastating burden on the U.S. economy, while managing only to postpone the war until 1812.

According to historian Leonard Levy, Jefferson's doctrinaire approach to enforcing the embargo violated his own commitment to limited government. It also had the pernicious effect of undermining American citizens' faith that their government could execute its own laws fairly, and strengthened the conviction among America's dissenters that her republican form of government was inept and ineffectual.

After just 15 months, the embargo was revoked on March 1, 1809, in the last days of Jefferson's presidency.

An opinion piece from the time, taken from the Library of Congress, reveals that expanded government--even when enacted by a cherished founding father!--is an idea whose unpopularity stands the test of time. Below one citizen expressed his frustration in an aa bb rhyming pattern. (Oh that all op-eds could be written in verse.)

A Poem about General Washington with Some Remarks on Jeffersonian Policy
Reprinted by Nathaniel Coverly, Boston 1807

But we must all forbear to sigh
Since WASHINGTON was born to die,
He ever was his country's friend
But Washington must have an end
And must it be since he is dead,
That all our happiness is fled;
Behold the dismal change of late,
See JEFFERSON in chair of state.

He took to presidential chair,
And then soon after we did hear,
Of his great doings, and his fame
He sent to France and fetch'd Tom Paine,
To give him counsel and advice
To buy Louisiana with great price,
For want of money sold our ships
I'm sure we all know how he nips

Gunboats--he then went and built
To save men's blood from being spilt
Poor things indeed we all do know,
That ne'er defend us from the foe,
He then exerted all his wits
And laid an embargo on our ships,
And for fear that we should trade
'Gainst Canada embargoes laid.

Great Washington our friend is dead
And Jefferson reigns in his stead,
Much reason then to mourn and sigh,
But Jefferson must die
A man he is a frail one too
At sad experience now doth shew
Then will forsake out present head
And chase a better in his stead.

Banker's Notes would like to wish all of you a very Happy Holidays, and say a big THANK YOU for blessing me by joining the Banker's Notes family this year.

With gratitude,
Cara

John Lennon Shot Outside The Dakota: Howard Cosell Reminds us "Football is just a game"

The Dakota, circa 1890

In the music world, December 8, 1980 is a truly infamous day. Beatles founder and writer of "Imagine," John Lennon was fatally shot by Mark David Chapman in front of Lennon's New York City apartment complex known as the The Dakota.

A born-again Christian, and former Beatles devotee,  Chapman came to view Lennon as a "phony" for imagining a world without possessions, but still having them. "There he was with millions of dollars and yachts and farms and country estates, [who] laughed at people like me who had believed the lies and bought the records and built a big part of their lives around his music," Chapman told his biographer Jack Jones.

Most people who live in the Dakota, however, have possessions. Completed in 1884, the Dakota was the first high-end apartment complex in the city. Its name was derived from its location, at the time a rural north west corner of Manhattan, "bound on the north and south by humble cottagers," considered as remote as the Dakota territory.

In the second half of the twentieth century, it was a haven for famous artists. Lately, though, they've let in a banker or two like Morgan Stanley CFO Ruth Porat.

Earlier this year, President Barack Obama considered nominating Porat as the next Deputy Secretary of the Treasury. It could be said that her possessions killed her nomination.

In March, the New York Times reported that Porat withdrew because she did not want to face questions about her finances, and suffer the kind of acrimonious confirmation process inflicted upon then Treasury Secretary-nominee Jack Lew. (Lew was scrutinized for receiving a bonus from Citigroup at the time the bank was receiving government bailout funds, according to Bloomberg news).

In July, Obama nominated Federal Reserve Board Governor Sarah Bloom Raskin to the deputy post.

Back on December 8, 1980, in breaking the Lennon news, Monday Night Football announcers Howard Cosell and Frank Gifford reminded us things are just things, football just a game.

Gifford: (whistle blows) John Smith is on the line. And I don't care what's on the line, Howard, you have got to say what we know in the booth.

Cosell: Yes, we have to say it. Football is just a game, no matter who wins or loses. An unspeakable tragedy confirmed to us by ABC News in New York City: John Lennon, outside of his apartment building on the West Side of New York City, the most famous perhaps, of all of The Beatles, shot twice in the back, rushed to Roosevelt Hospital, dead on arrival. Hard to go back to the game after that news flash, which, in duty bound, we have to take. Frank?

Gifford: (after a pause) Indeed, it is.

Kennedy and Lincoln, Oswald and Booth

Washington, D.C., May 1865. Spectators at side of the Capitol, which is hung with mourning crepe and has flag at half-mast.
From LOC.gov

In commemoration of the Kennedy assassination, the New York Times put together a wonderful interactive spread of their coverage following the events of November 22, 1963. It included remembrances of past assassinations (four total) including another time a slain President was replaced by a Johnson, on April 15, 1865.

The first President assassinated in office, Lincoln's murder was part of a conspiracy to depose all the leaders of the US government. There were six conspirators, but only two fulfilled their duties, and only two were killed as a result: Lincoln and Frederick William Seward, the son of the Secretary of State.

The country was devastated by the news. Headlines ran "The Great Calamity!" The New York Tribune reported, "every city was draped in mourning, every hotel and almost every house displaying crepe from the doors and windows."

While Lincoln was killed in a theater, Kennedy's assassin, Lee Harvey Oswald, was captured in one just hours after the act. It took eleven days, however, to capture Lincoln's assassin, John Wilkes Booth, who escaped on horseback.

Relying on word of mouth sitings, primarily from disbanded rebels, Booth was eventually tracked down on April 26, 1865 in Bowling Green, VA.

As the New York Daily Tribune reported, Booth was with his accomplice David C. Herold when they were surrounded in a barn.  Ordered to surrender, Booth declared that we would not be taken alive. So, the police decided to burn down the barn.

Once the first match was lit, Herold came out hands raised (he would later be hung for his crimes). Booth remained in the barn "for some time" but when he finally did exit, he was shot in the neck by a police sergeant.

According to the Tribune's recounting, Booth stayed alive for a couple of hours "whispering blasphemies about the government and messages to his mother desiring her to be informed that he died for his country."

Oswald appears to have been similarly motivated. Studying Marxist economic theories, "I could see the impoverishment of the masses in my own mother,"  Oswald told a United Press International correspondent in an interview. His fervor for Marxist ideology was so strong that he attempted to exchange his US citizenship for a Soviet one, spending two years in Russia, and marrying a Russian woman (the USSR denied his citizenship request).

But if Oswald's actions were designed to help his mother, his plan backfired. Upon learning that her son assassinated Kennedy, she told the Star-Telegram that his defection to the Soviet Union made her life lonely, "and now they will turn their backs on me again."

Only Booth admitted to his crime. After firing the fatal shoot he leaped onto the stage and declared with a dramatic flair "sic semper tyrannis" ("thus, always, to tyrants"). On the afternoon of November 22, despite vast evidence to the contrary, Oswald told reporters "I haven't shot anybody."

Fifty years after Lincoln's death, on April 15, 1915, President Wilson declared a national holiday (the Federal Reserve Bank, however, remained open). To honor the Great Emancipator, flags across the country and the world flew at half-mast. The New York Tribune reprinted a poem written for Lincoln by Vermonter and federal judge Wendell Phillips Stafford. Excerpted below.

Look back upon thy people now! 
Behold the world thy hands have wrought--
The conquest of thy bleeding brow, 
The harvest of thy sleepless thought

From sea to sea from palm to pine
The day of lord and slave is done.
The wind will float no flag but thine
The long divided house is one.