J. Rufus Wallingford, a financial speculator in a 1911 novel by George Randolph Chester, of whom it was said “he toils not, neither does he spin,” is an exemplar who, in every generation, has followers in real life. Bernard Baruch, no mean speculator himself (a biography of him is entitled The Speculator), was one of the few of the breed to anticipate the Great Depression. His favorite book was Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (1841), discussing various financial panics beginning with the Dutch tulip craze.
There have been cycles in American history; the Panic of 1907 was followed by a clean-up operation by private bankers assembled in the Morgan Library and ultimately by the Pujo investigation and the creation of the Federal Reserve Board. The 1929 crash gave rise to the Pecora investigation, which had bipartisan support, and ultimately to the Securities Acts of 1933 and 1934, the Public Utility Holding Company Act, and the Glass–Steagall Act, which divorced commercial banking from investment banking.
These New Deal reforms were followed by a 50-year period in which there were no significant American banking failures; banking became a dull occupation inhabited by boring upper-middle-class men with green eyeshades and repetitive functions, watched over by bank examiners.
The separation of banks, investment banks, savings and loan institutions, and credit unions was deplored by the Hunt Commission in the Nixon administration, and a process of deregulation began.
In Great Britain, this process was accelerated by Margaret Thatcher, a reincarnated Manchester liberal, whose “big bang” of deregulation in 1986 was highly profitable for British bankers, who were much envied in the United States. Restrictions on permissible investments by savings and loan associations were removed as a result of local pressures on a Democratic Congress, leading to state-level savings and loan crises in Ohio and Maryland in 1984 and a federal crisis three years later.
The cure for these came from massive government bailouts and the consolidation of small institutions into a relative handful of large banks. These, in turn, were deregulated by the ‘neo-liberal’ Clinton administration, which repealed the Glass–Steagall Act and plunged commercial banks into the sub-prime mortgage business, further corrupted by the Community Investment Act, giving the naive buyers of inner-city properties, many of them Black, the priceless gift of negative equity.
Unlike earlier crises, the perpetrators of this one, involving the wholesale use of dubious appraisals, went scot free, and the five largest banks were propped up by being allowed to borrow at bargain rates from the Federal Reserve, to the detriment of their community bank competitors.
Investment banking likewise became much more exciting. State laws restricting permissible investments by pension funds were relaxed, as were state restrictions on compensation of fund managers. In Maryland, a previous statutory limit of 1.2 percent of funds managed was repealed at the behest of the Martin O’Malley Democratic administration; compensation for managers of alternative investments such as hedge funds and natural resources, and real estate is now customarily 2 percent of assets plus 20 percent of annual gains.
In Maryland, fund managers received compensation of $222.6 million in calendar 2023. The state’s pension fund, once invested in highly liquid publicly traded stocks and bonds, in 2024, was invested 21 percent in private equity, 9.3 percent in real estate, and 5.1 percent in natural resources. The net yield on private equity was 5.2 percent of investments, on real estate 7.7 percent, and on “boring” public equity 17.9 percent.
Worse still, investors in private equity, i.e., large or controlling positions in corporations, have found that it is not easily liquidated. Yale University, a pioneer in this area, has recently incurred significant losses in attempting to return its endowment to more conventional investments. The values ascribed to private equity in annual statements are not based on public markets but on private appraisals, the overwhelming majority of which are commissioned by the private entity itself.
Private equity has two other detriments. It not infrequently involves the purchase of corporate control, in which the high interest rates incurred by the private equity purchaser are sought to be offset by asset-stripping of the acquired corporation and short-term sweating of workers. Private equity firms currently own companies employing 8 percent of the labor force, to whom they owe no continuing responsibility beyond the next sale. It also involves huge commissions, the 20 percent contingent portions of which are deemed “carried equity” and are taxed as capital gains, not ordinary income.
Whereas in an earlier time the income and wealth of financiers like J.P. Morgan were dwarfed by the wealth of industrialists like Rockefeller and Carnegie, this, thanks in part to tax benefits, is no longer the case. Fund managers like BlackRock and Carlyle generate billionaires. (RELATED: BlackRock and American Airlines: Is Larry Fink the New Sam Bankman-Fried?)
The nation’s public and large private pension funds have by now been tapped out by the promoters of alternative investments. The worldwide commissions of “alternative investment” firms increased from $41 billion in 2013 to $252 billion in 2023. They are now looking for greener pastures in the form of smaller, private, individually-controlled retirement funds with assets totalling $12 trillion.
At present, only “accredited investors” with financial sophistication and assets in the millions are permitted by the Securities and Exchange Commission to invest in private equity and its analogues; the industry is clamoring for relaxation of this rule. A toxic combination of inadequate appraisals, illiquidity, growing disparities in income and personal wealth, and growing instability in corporate ownership is certain to result.
Forty years ago, the author of this article earned a certain notoriety by accurately predicting the Maryland savings and loan crisis and its consequences for the public fisc. At that time, those ignoring cautionary words had the excuse that there had not been a financial crisis for 50 years. No such excuse exists now. The proposals to expand “alternative investing” are not merely an accident; they are purposeful, and their almost certain result is an irresponsible plutocracy, financial crises, and the political consequences that are sure to follow in their wake.
This may recall Pope Pius XI’s epitaph on the Depression, in his encyclical Quadrigesimo Anno of 1931:
Economic dictatorship has supplanted the free market; unbridled ambition for power has likewise succeeded greed for gain; all economic life has become hard, inexorable, and cruel. To these are to be added the grave evils that have resulted from an intermingling and shameful confusion of the functions and duties of public authority with those of the economic sphere — such as, one of the worst, the virtual degradation of the majesty of the State, which although it ought to sit on high like a queen and supreme arbitress, free from all partiality and intent upon the one common good and justice, is become a slave, surrendered and delivered to the passions and greed of men.
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The writer, who expresses his own views, is president of the Library Company of the Baltimore Bar and the author of various works on law and history, including The Fall of The House of Speyer (Bloomsbury).