Separating Fools from Their Money

A History of American Financial Scandals

Scott B. MacDonald

• Publisher: Routledge
• Year: 2017
• Print ISBN: 9781138532403
• eBook ISBN: 9781351306782
• Topic: Business
• Subtopic: Business General
• Index: Business

What do Michael Milken and Martha Stewart have in common? What was the most outrageous party thrown by a financial baron of the twentieth century? Which US war hero president became party to, and victim of, an unabashed con man known as the Napoleon of Wall Street?

These questions and more are discussed in Separating Fools from Their Money. The authors trace the history of financial scandals beginning with young republic days through the Enron/WorldCom debacle of modern times. Informative and entertaining, this book reveals human nature in all of its dubious shades of grey. It also exposes themes common to all financial scandals, which remain astonishingly unchanged over time greed, hubris, media connections, self-interested politicians, and booms-gone-bust, to name a few.

This second edition features a new preface and introduction, plus three new chapters, which address the financial panic of 2008, post-panic scandals, and the "princes of Ponzi." This book's accessible writing will interest the casual business reader as well as the seasoned investor.

1

Introduction

What is the chief end of man?—to get rich. In what way?—dishonestly if we can, honestly if we must.

—Mark Twain, 1871

It was January 6, 1872, late on a cold winter day in New York. The man was nervous and irritable. Over lunch at Delmonico’s, a well-known haunt of the wealthy and famous, he had learned that a grand jury had acted to indict him on the charge of blackmail and that a warrant was out for his arrest. High-strung, sensitive to insult, and quick to nurse a grudge, the court decision pushed him over the edge. He was waiting for his nemesis on the first stair landing of the Grand Central Hotel. In his hand was a four-chambered Colt pistol.

Considering his good looks, social standing, and wealth, Edward Stokes, familiarly known as Ned, should have been highly successful. Born in 1841, he came from one of New York’s richest and most distinguished families, managed his own company (the Brooklyn Refinery Company), and married a young and attractive wife, who was well connected in the city’s social hierarchy. Instead, Stokes was a deeply troubled individual, caught between the ups and downs of Wall Street, his compulsion to bet on the horses (usually the wrong ones), and his romantic liaison with the beautiful and calculating Helen Josephine “Josie” Mansfield. Indeed, the combination of these forces had brought him to his current tortured predicament, as he waited in the dim light to strike as an assassin. The strange sequence of events that had brought him to this point began in 1869, when he was introduced to the flamboyant and rotund Jim Fisk, an ebullient Vermonter who had ridden into Wall Street following the end of the American Civil War in 1865 and had become one of the major forces in the volatile and largely unregulated stock market. The meeting between Stokes and Fisk was to be a fateful event for both men. From that day forward, the time left in Fisk’s life was running out. The two men became involved in a number of business deals, and it was through Fisk in November 1869 that Stokes met Josie Mansfield, who was regarded as one of the most attractive women of her day. She had arrived in New York with little to her name, but she had caught Fisk’s eye. She was full-figured and energetic, with big dark eyes and long black hair. Although Fisk was married, his wife Lucy lived in Boston and rarely came to New York. (It was rumored behind closed doors that she was frigid or, more likely, that she preferred women.) The more hot-blooded and ambitious Josie soon became Fisk’s mistress, eventually being put up in a four-story house in New York City, well-equipped with servants and a collection of jewelry and furs. Fisk was smitten.¹

Yet there was trouble brewing between Fisk and his mistress. Fisk was overweight and often preoccupied with his businesses—running the Erie Railroad with partner Jay Gould and presiding over an opera company and a steamship fleet. He was also a colonel of the Ninth Regiment of the New York State Militia. At the same time, Fisk was happy to be seen surrounded by some of the young starlets from his opera company—something that probably did not sit well with Josie.

In contrast to the rotund Vermonter, Stokes was handsome and sophisticated and appeared to have ample leisure time at his disposal (despite running a business and being married with a child). According to a New York Herald reporter in 1871, Stokes was “a gentleman of about twenty eight years of age, of slender but sinewy build, with dark eyes, dark hair and a charming black mustache. He was dressed in the height of fashion and looked to be a man of the world, perfectly self-possessed and well bred and wearing an expression of savior faire which takes well with the female sex.”²

The affair soon became messy and acrimonious. The fact that the Stokes-Mansfield affair occurred in a house that Fisk had bought for his mistress did little to lessen the bitterness of the Wall Street mogul. In 1871, the couple decided to blackmail Fisk. Stokes apparently needed the money to pay off his debts incurred at the racetrack. As for Josie, she was willing to keep Stokes as her lover and have Fisk pay for it.

Although Fisk initially went along, he eventually decided that Stokes would not get the better of him. For all of his jolly exterior, Fisk was highly competitive, and when the occasion demanded, he could be ruthless. First, Fisk involved Stokes in some speculative ventures that lost money. Then, Fisk announced that he was not going to pay any more to Josie. In response, the couple threatened to send Fisk’s love letters to the press. Not to be outdone, Fisk obtained an injunction prohibiting their publication, and Stokes and Mansfield ended up in court, threatened by a charge of blackmail. For her part, Mansfield testified to Fisk’s “oriental tastes and desires,” to give the public something to titter about. Fisk, however, was undeterred as he moved to ruin Stokes’s business, the Brooklyn Refinery Company, threatening the blackmailer with bankruptcy by taking away the cheap rates that his railroad, the Erie, had earlier given to the movement of its products. The train of events was hardly what Stokes had expected. He had picked the wrong man to threaten, and now he was paying the price for his foolishness.

So here Stokes was pacing the stairway landing, waiting for Fisk, who he had learned was coming to the hotel to meet a widow and her family to whom he provided charity. When the time came, Fisk, a large man, made an easy target. Stokes aimed the four-chambered Colt at his nemesis, shouting, “I’ve got you now!” He squeezed the trigger twice, with both bullets ripping into Fisk, one being the mortal wound to the abdomen. The stricken man staggered backward, shouting, “For God’s sake will anybody save me?” Stokes turned and casually walked out of the building.

Fisk lingered painfully, dying the next day; Stokes was soon arrested and went to serve time at Sing Sing Prison. In the end, though, he cheated the hangman and went down in history as the murderer of one of the most colorful characters to have ever walked on Wall Street.

Fisk: The Barnum of Wall Street

Even after his death, Fisk still commands attention. Despite his association with some of Wall Street’s more seedy exploits, Fisk was wellloved by the citizens of Brattleboro, Vermont, where he had spent part of his youth and had become an important philanthropist. Upon his death, the citizens of that southern Vermont town collected money and paid for a monument to Fisk. Located at Brattleboro’s Prospect Cemetery, Jim Fisk’s family plot sits to one side, shaded by a stand of tall leafy trees, but it is the center of attention—just as Fisk was in life.

Sculpted by the same artist who produced the Lincoln Monument at Springfield, Illinois, the Fisk monument too was created to make people remember Jim Fisk’s larger-than-life persona. The monument is a shaft of marble with a portrait medallion of Fisk on its face. At each corner of the large base are four topless young women, each holding a plaque representing Fisk’s main interests—railroads, shipping, the stage, and trade. Sadly, souvenir hunters have taken most of the fingers and toes of the scantily clad women, while time and acid rain have eroded the stone.

Although most Americans have forgotten the colorful Jim Fisk (and even more so his assassin Ned Stokes), Fisk’s monument in a quiet corner of a Vermont cemetery casts a long shadow over US financial history. Fisk, also known as the “Barnum of Wall Street,” was an active participant in the largely unregulated and freewheeling rollercoaster of the US stock market following the American Civil War (1861–1865). His exploits included the rough-and-tumble fight over control of the Erie Railroad and the infamous attempt to corner the US gold market in 1869 that led to Black Friday and a steep economic depression. A celebrity in his own right on Wall Street, he rubbed elbows with the likes of Jay Gould (his erstwhile partner), Daniel Drew, Cornelius Vanderbilt, Boss William Sweeny Tweed, and President Ulysses S. Grant.

A strong extrovert who enjoyed being in the public eye, Fisk was loved by those who benefited from his largesse (like the citizens of Brattleboro) and vilified by those who were on the short end of his financial maneuverings (like the unfortunate Ned Stokes). Although his wheeling and dealing in the stock market and much of his personal life lacked a certain moral compass, he was an essential cog in what made Wall Street work. He was ruthless, aggressive, flamboyant, and keen to exploit the gray areas between what was legal and what was illegal (though he was willing to bribe the right people to make things legal). Although he was not working for the public good, his actions nonetheless helped set in motion forces that would shape Wall Street well into the next centuries. A genuine American success story, he rose up from relatively humble beginnings in Vermont and through hard work, daring, and luck became one of the wealthiest players on Wall Street. The same combination of ruthlessness, ability to exploit the gaps between what was permissible and what was not, and flamboyance has a strong historical echo in the scandals that would follow on Wall Street during the twentieth and twenty-first centuries.

In Fisk we see the forerunner of Michael Milken, Kenneth Lay (and his cohorts at Enron), and other corporate leaders who lived—at least until the party ended—larger than life. At the same time, it is important to note that Wall Street survived Fisk, as it did the others who followed. Indeed, Wall Street was to grow stronger, in part because of these scandals, making it an essential part of the financial system that keeps the global economy in motion. This is the tale of the following pages.

The Kabuki-Like Drama of Scandal

For all its august reputation and stately traditions, the history of American finance constructed around Wall Street resounds with repeated stories of scandals. Despite the shock and indignation, financial scandals have recurred with regularity. A list of colorful characters strides (or skulks) through the pages of this history. Along with these characters come some unforgettable images. Who can forget that aerial photograph of Jeffrey Skilling’s magnificent Florida spread? Or the vodka-spouting statue at Dennis Kozlowski’s birthday bash? Complicated relationships—both professional and personal—abound, from Wall Street’s flashy and brash Fisk, shot by a rival lover for the actress Josie Mansfield in the dim stairwell of the Grand Central Hotel, to Merrill Lynch’s CEO John Thain, who spent $1.2 million for an office renovation in 2008 only months before the ninety-four-year-old brokerage firm announced the billions in losses that pushed it into the arms of Bank of America.

This book traces the history of financial scandals in the United States from the dawn of the republic to modern times, with a focus on three periods—the Gilded Age of the late nineteenth century, the Roaring Twenties, and, of course, the closing years of the twentieth century and the early years of the twety-first century. The implosion of Enron at the close of the century ushered in an intense period of navel-gazing among the habitués of Wall Street—but it is important to understand that financial scandals are a constant factor, rather than an exception, in American history. As New York Times reporter Jack Hitt observed in 2004, “Once the scandal begins, there’s a Kabuki-like quality to the drama. Every person enveloped by the scandal seems to assume an almost ritualized role. In fact, certain characters appear repeatedly: the fallen giant, the whistle-blower, the dogged journalist, the arrogant lieutenants, the little people left twisting in the wind.”³ What was true in 2004 was certainly true in 1792 and during the second half of the nineteenth century.

The economic history of the United States is underwritten by the sometimes volatile mix of industrial and technological advances that paved the way for investment opportunities and financial innovations, which eventually shifted into destabilizing speculative booms. In this sense, there has been a certain Schumpeter-like creative chaos in the American capitalist spirit. While this process has incorporated a series of alarming and intense financial scandals that have left a shadow over

Wall Street, much good has come from it. The spectacular success of the US economy in its first two centuries can be explained only by the important role played by a vibrant and ever-growing capital market. Despite the gamblers, robber barons, and con men, so easily depicted as representing all of Wall Street as a pool of sleaze, US financial markets have provided crucial support for the world’s largest economy. Clearly, Wall Street must have done something right, some of the time. In a sense, Wall Street has gained its legitimacy from delivering the goods in an efficient and innovative fashion.⁴

Consequently, this history is in no way an indictment of the many great and honest people who have populated the pages of American financial history. It is still true that the vast majority of Americans who have amassed fortunes over the past two centuries have done so the old-fashioned way: they earned it. Nonetheless, a small but significant minority have taken great joy in pilfering from Wall Street, eroding public confidence, and gaining political influence. And this has real significance, considering the weight of the stock market on the US economy by the late twentieth century. As veteran market watcher Roger Lowenstein aptly notes, “By the late 1990s, America had become more sensitive to markets, more ruled by markets, than any other country on earth.” This only underscores the importance of understanding the dark side of US financial culture as it evolved through the various stages of the country’s economic history.

The evolution of US financial markets has been a Darwinian process. For all of the sleazier elements and scandals, there has been a very strong tradition of innovation. The potential for great rewards continues to provide a powerful incentive to assume great risks—including a willingness to transgress accepted rules and regulations. Along these lines, important lessons have been learned, new practices have been adopted, and a balance has been struck (at least for a while) between the competing forces of regulation, order, and creative chaos. And in some cases, those vilified as con men and robber barons have eventually emerged as important innovators, individuals who have made a difference in revolutionizing American finance.

What, then, is a scandal? Perhaps it is defined by the eyes of the beholder—I know it when I see it, as the US Supreme Court famously explained with regard to pornography. But most observers could probably agree on a simple definition: a scandal is an act or sequence of events that is publicly perceived as shameful or disgraceful. A financial scandal occurs when financial players—brokers, private investors, banks, partnerships, or companies—become involved in something that is shameful or disgraceful, which entails a breach of the rules and regulations that define what is accepted as proper and ethical behavior by the larger community.

This also implies an erosion of trust in the financial system by a large number of participants. Financial markets work because most participants trust that the system works. Savers would shun banks if they could not trust them; investors would shun the New York Stock Exchange if they lost confidence in its ability to function as a level playing field. Without this confidence, markets, be they financial or otherwise, become dysfunctional.

One of the great strengths of American capitalism is that the system—that broad network of interconnected capital markets, investors, and companies—is widely perceived as fair. But what is “fair” in this context? Does it refer only to an untainted and rule-based system of regulation and justice? Or is it more broadly based, implying that contracts are upheld, big and small investors enjoy equal rules and access to the market, and regulatory authorities function effectively as referees rather than interested participants? The track of American history that follows in these pages reflects the struggle over how fair Wall Street really is: what is myth, and what is reality.

Fundamental Themes

As the following section will reveal, four fundamental threads will weave through every story that this book tells. For all their differences, over a time and space continuum from Orange County, California, in the 1990s to New York City in the 1790s, the extent of the commonalities underlying all of these scandals is truly remarkable. William Duer was the spiritual ancestor of Dennis Kozlowski; Credit Mobilier the forerunner of Drexel. The more things change, the more they stay the same.

1. You Gotta Have Friends

Friends in the right places feature prominently in every unsavory chapter of American financial history. Influence-peddling, government business cronyism, and worse play a central role in every scandal that we examine—not surprising when you consider how much it costs to run for office in the United States, and how much money the great financiers have to throw around. From the 1790s, when William Duer capitalized on his connections to Alexander Hamilton, through the 1990s, when Enron chief Kenneth Lay enlisted President Bill Clinton to help Enron collect past-due accounts in India, politically savvy business honchos have fed from the government trough.

Political support for the corporate heavy hitters runs the gamut from benign neglect to outright corruption. Government regulators generally play an especially interesting role in helping to lay the groundwork for financial scandals. Observers often wonder why scandals occur so regularly in the most transparent, best-regulated markets in the world. Innocent investors are supposed to be protected by a sophisticated net of laws, regulations, and impartial referees who ensure that the system is fair. So why do things go wrong on such a regular basis? Why weren’t widows and orphans protected from the machinations of Jay Gould, Ken Lay, or Bernie Madoff?

The impartial referees are human, of course, and can make mistakes. Many scandals do involve complex, innovative financial transactions that are not easily understood by supervisors or regulators (think derivatives), and wrongdoers can easily exploit this complexity. But more than that, the regulators too often become actual enablers of scandal, with their contribu...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Preface
• 1 Introduction
• 2 Wall Street Loses Its Innocence: William Duer and the Panic of 1792
• 3 The Gilded Age Part I: All That Glitters
• 4 The Gilded Age Part II: Of Presidents and Bankers
• 5 Teapot Dome Erupts
• 6 Empires Undone: Samuel Insull, the Emperor of Utilities
• 7 The Decade of Greed: Michael Milken, Junk Bonds, and Insiders (1980s)
• 8 The Decade of Greed, Continued: Where the Money Is
• 9 The 1990s B.E. (Before Enron): A Few Bad Apples, or Rotten to the Core?
• 10 Enron Etc., Vol. I: Crooks, Liars, and Envelope-Pushers
• 11 Enron Etc., Vol. II: Enablers, Symbols, and Scapegoats
• 12 The Financial Panic of 2008
• 13 Fooled You Again: Scandal in the Post-Panic Years
• 14 The Princes of Ponzi: From Charles Ponzi to Bernie Madoff
• Conclusion
• Selected Bibliography
• Index