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Why Wall Street Matters

Format: Hardcover, 192 pages
Publisher: Random House
On Sale: 02/28/2017
Price: $25.00
ISBN: 978-0-399-59069-6
open close ABOUT THE BOOK
A timely, counterintuitive defense of Wall Street and the big banks as the invisible—albeit flawed—engines that power our ideas, and should be made to work better for all of us

Maybe you think the banks should be broken up and the bankers should be held accountable for the financial crisis in 2008. Maybe you hate the greed of Wall Street but know that it’s important to the proper functioning of the world economy. Maybe you don’t really understand Wall Street, and phrases such as “credit default swap” make your eyes glaze over. Maybe you are utterly confused by the fact that after attacking Wall Street mercilessly during his campaign, Donald Trump has surrounded himself with Wall Street veterans. But if you like your smart phone or your widescreen TV, your car or your morning bacon, your pension or your 401(k), then—whether you know it or not—you are a fan of Wall Street.

William D. Cohan is no knee-jerk advocate for Wall Street and the big banks. He’s one of America’s most respected financial journalists and the progressive bestselling author of House of Cards. He has long been critical of the bad behavior that plagued much of Wall Street in the years leading up to the 2008 financial crisis, and because he spent seventeen years as an investment banker on Wall Street, he is an expert on its inner workings as well.

But in recent years he’s become alarmed by the cheap shots and ceaseless vitriol directed at Wall Street’s bankers, traders, and executives—the people whose job it is to provide capital to those who need it, the grease that keeps our economy humming. In this brisk, no-nonsense narrative, Cohan reminds us of the good these institutions do—and the dire consequences for us all if the essential role they play in making our lives better is carelessly curtailed.

Praise for William D. Cohan

“Cohan writes with an insider’s knowledge of the workings of Wall Street, a reporter’s investigative instincts and a natural storyteller’s narrative command.”—The New York Times

“[Cohan is] one of our most able financial journalists.”—Los Angeles Times

“A former Wall Street man and a talented writer, [Cohan] has the rare gift not only of understanding the fiendishly complicated goings-on, but also of being able to explain them in terms the lay reader can grasp.”The Observer (London)
William D. Cohan is the New York Times bestselling author of The Price of Silence, Money and Power, House of Cards, and The Last Tycoons, which won the 2007 FT/Goldman Sachs Business Book of the Year Award. He is a special correspondent at Vanity Fair and writes a biweekly opinion column in The New York Times. He has also written for the Financial Times, Bloomberg Businessweek, Fortune, The Atlantic, The Nation, and The Washington Post, among other publications. Cohan is a graduate of Duke University, the Columbia University School of Journalism, and the Columbia University Graduate School of Business.
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Chapter 1


The Beginning



he actual Wall Street, in downtown Manhattan, near the island’s southern tip, is just seven--tenths of a mile long and runs from Broadway and Trinity Church to the west and to South Street to the east. It used to be the thoroughfare that connected the East River to the Hudson. (The interstitial role played by Wall Street remains as essential as ever.) Wall Street was named after an actual wall—-composed of twelve--foot--high wooden logs—-that the Dutch inhabitants started building in April 1653, with the help of African slaves, as the northern border of their relatively small enclave. North of the wall was danger and hilly wilderness—-the name Manhattan derives from Mannahatta, the Lenape Indian term for “island of hills.” The Dutch built the wall to protect themselves from the unknown. Indeed, years of fighting between the Dutch and various Native American tribes would be devastating to both sides. The “palisades,” as the Dutch referred to the wall, separated what is today Wall Street from everything else to its north. It was 2,340 feet long, nearly half a mile. But by 1664, the Dutch had run out of gas in New Amsterdam and turned their colony over to the British, who promptly renamed it New York.


In 1685, the British surveyors designed a street to run the length of the wall, from the East River to the Hudson, and by 1699 the British—-now less fearful of the Native Americans than the Dutch had been—-ordered the actual wall removed, leaving only a thoroughfare that stretched from one side of the island to the other, at one of its particularly narrow parts.


The new street—-now known as Wall Street—-became New York’s central artery of commerce. “Few streets in the world are entitled to equal fame,” Frederick Trevor Hill wrote in his 1908 gem, The Story of a Street. “In the annals of American history, it holds a place apart.” Small merchants established themselves along the street to sell their wares, and over time this came to include the sale of stocks and bonds, a form of borrowed money that was still a new concept at the time, of fledgling local companies. Also for sale on Wall Street were slaves. According to the New--York Historical Society, the slave trade in New Amsterdam began in the 1620s—-1626 to be exact, less than two years after the Dutch landed in New Amsterdam—-after a Dutch ship captured a Spanish or Portuguese vessel, with a largely African crew. Often the crews of captured ships were killed, but in this instance the Dutch brought the crew to New Amsterdam, where it was placed in servitude to the Dutch West India Company.


The company’s calculus was a simple and cruel one, alas. It needed laborers to build out the colony of New Amsterdam, to build the fort that is now Battery Park, to build homes, and to build the wall that became Wall Street. But New Amsterdam was not a particularly hospitable place to live, and so attracting Dutch workers to cross the Atlantic was not so easy. The better way, it seemed, to get the labor the Dutch West India Company needed was to enslave it. Charitably, the New--York Historical Society described the Dutch’s enslavement of Africans as New Amsterdam’s first public works department. “They cut the road that became Broadway,” it explained. “They built the wall for which Wall Street is named. Without their work, the colony of New Amsterdam might not have survived.”


Soon enough, individual colonists owned slaves. In fact, according to the historical society, the colony became the largest “slave--holding city” in the northern colonies.


For fifty--one years, between 1711 and 1762, Wall Street housed the colony’s well--established slave market, in a wooden shed, hard on the East River, allowing for immediate trading once boats carrying the people from Africa or the Caribbean tied up at the docks. At any one time, fifty slaves could be found being bought and sold in the structure. The sordid practice was ended in 1762 and the shed eventually torn down, apparently because the structure was blocking views to the river and lowering property values.


Wall Street housed the colony’s more noble aspirations as well. In 1699, stones removed from the footings of the original wall were used for the foundation of what became, a year later, New York’s first City Hall, at 26 Wall Street. Not surprisingly, City Hall, built at a cost of more than £4,000, was at the heart of Wall Street. In it, there was a courtroom, a jury room, the Common Council chamber, a jail, a library—-the first in New York, consisting of 1,642 books that had once been the collection of the Reverend John Millington—-a debtors’ prison, and the offices of the fire department, whose water was supplied from two wells, also dug on Wall Street. Directly across from City Hall, on Broad Street, lay the stockade, meant to be a living, breathing symbol to the colonists of the fate that awaited bad behavior.


In short order, as incredible as this may seem today, Wall Street also became a center of revolutionary fervor. It’s where the copies of John Peter Zenger’s New--York Weekly Journal—-in which Zenger criticized the royal governor—-were burned by the colonial masters and where, on August 4, 1735, inside the City Hall courthouse, Zenger won a resounding legal victory for freedom of the press that has since been dubbed “the dawn of American liberty.” Wall Street was where, in 1765, the so--called Stamp Act Congress convened to vigorously—-and successfully—-oppose the British imposition of a stamp tax on New Yorkers. It was where Paul Revere arrived in May 1774 to announce the first stirrings of the American Revolution.


But in the years after the Revolutionary War, Philadelphia, rather than New York, was the locus of the nation’s financial power. New York was a mess, having suffered mightily during the war itself. It was in Philadelphia, not New York, that Robert Morris, the financier and great friend of George Washington’s, sought to create the first private, commercial bank in the United States, in the vein of those that had been in existence for centuries in Europe. Following a detailed proposal to the Continental Congress for the bank on May 17, 1781, the Congress chartered it nine days later. Within weeks, Morris was sending letters to potential investors, in effect creating the country’s first IPO, or initial public offering, of stock. In a letter on June 11 to the likes of Thomas Jefferson, then governor of Virginia, and John Hancock, then governor of Massachusetts, Morris made his case. He saw it as his duty to create the bank as a way of restoring the financial reputation of the new republic, which had been incurring debts to pay for its revolutionary war but could not afford to repay them. He promised a desirable rate of return on any investment in the stock of the bank. He said investors would feel both pride and patriotism and that the bank would last as long as the United States. (The remnants of Morris’s first bank are now part of Wells Fargo.)


The bank began operating the following January after its successful IPO, and its investors believed the stock would become more valuable over time as the bank did more and more profitable business. Eight years later, in 1790, Philadelphia, by then the most populous and prosperous city in the country, created the nation’s first stock exchange, some two years before New York embarked on its own version. At about the same time, Alexander Hamilton proposed to Congress that a second bank—-the Bank of the United States—-be established in Philadelphia. And in 1791, Hamilton succeeded, also through an IPO, in creating the bank, with the U.S. government buying 20 percent of the bank’s stock using a loan from the bank itself. Soon enough, brokers and merchants along the Eastern Seaboard of the United States were buying and selling the stock of the two Philadelphia banks.


By then, the practice was nearly two centuries old. The first modern IPO occurred in 1604, with the public sale of stock of the Dutch East India Company, to which a monopoly had been given to harvest the riches of the faraway Spice Islands: nutmeg, cloves, cinnamon, pepper, and ginger. No different than we do today, the founders of the company wanted to raise capital from investors to finance its business—-the building and the sending of ships on the long voyage to the other side of the world to obtain the spices it would sell to its customers. The IPO was a watershed moment in the history of capitalism: It proved that capital could be raised from people having nothing to do with the founding or management of a company and that investors would be willing to take what they hoped would be prudent risks in exchange for an expected return. It’s an idea that changed the world and remains as vibrant today as it was more than four hundred years ago. At the same time, the Amsterdam Stock Exchange was created to allow for the trading of the East India Company’s stock. For more than one hundred years, East India’s stock performed well—-at one point in 1720, it was trading for twelve times its IPO price—-until New Year’s Eve 1799, when the company was suddenly dissolved after nearly two hundred years, an important reminder that investing in a company’s equity has always been a risky proposition and that even a corporate lifetime of nearly two centuries is no guarantee of survival.


Despite being trumped by Philadelphia for years as the nation’s financial center, Wall Street was slowly recovering from the Revolutionary War. The first so--called golden age of Wall Street lasted for seven years in the 1780s, during which brief time New York City was the capital of the young republic, the center of its nascent political and financial might. The first Congress of the United States was built and convened on Wall Street. George Washington was inaugurated as the nation’s first president on Wall Street in 1789 and John Adams, its first vice president. During this era, Wall Street was completely rebuilt—-including both the Trinity Church and the First Presbyterian Church—-and many fine homes and taverns lined the road. It attracted the likes of Alexander Hamilton and Aaron Burr, both young attorneys with thriving legal practices. In June 1784, before moving to Philadelphia and starting his second bank, Hamilton created the Bank of New York, with $500,000 in capital. He wrote its constitution and became one of its first directors. Wall Street was also where Hamilton drafted the essays that would form the majority of what became known as the Federalist Papers, the veritable intellectual blueprint of the new nation. It was where President Washington, on September 24, 1789, signed the law creating the Supreme Court of the United States, including the New Yorker John Jay among the first justices. Between 1783 and 1790, Wall Street might as well have been the center of the universe.


That began to change again in January 1790, when Hamilton, the first Treasury secretary, proposed a complex financial plan by which the federal government would absorb the debt of the states—-amounting to roughly $54 million in Hamilton’s accounting, including both foreign and domestic obligations—-that had accumulated during the War of Independence, in part because the Continental Congress had pushed its debts to the states.


Hamilton’s solution, in simple terms, was to have the federal government take over the entirety of the obligations, including both principal and interest, and then to, in effect, tax the states to help to service the new federal debt that would be issued to replace the existing state debt. The plan upset many citizens in the individual states, especially those in places such as Virginia, which had better managed its war debts but would now have to jointly help cover the federal debt. Hamilton also was heavily criticized for paying off the war debt at a hundred cents on the dollar, even though much of it was in the hands of speculators, who had bought the debt at a discount as it became increasingly clear that the new government might not be able to pay it back. Many saw Hamilton’s plan as a way to reward speculators, much like how, 218 years later, many would criticize the federal government’s bailouts of failing Wall Street banks and of AIG, the insurance behemoth.


Indeed the outrage over Hamilton’s proposal was so intense that a compromise had to be fashioned. As the musical Hamilton reminds us, a deal was cut over dinner at the New York City home of Thomas Jefferson, by then secretary of state. “So bitter was the feeling against the Federal plan that Hamilton was forced to offer great concessions to carry his point, and the compromise he negotiated disposed of New York as the permanent national capital,” Frederick Hill wrote. What Jefferson and Hamilton had concocted, in order to win approval for Hamilton’s government bailout of the languishing war debt, was for the capital of the United States to be moved to the banks of the Potomac River. As part of the compromise, for ten years while the new capital was being built, Philadelphia would serve as the nation’s capital. And all because Hamilton believed that the United States would not be able to flourish as a deadbeat nation. He was right.


On July 16, 1790, on Wall Street, President Washington signed the bill into law. He would never return to New York City. In short order, brokers convened in Philadelphia, where the first federal bond—-for $80 million—-was sold to investors in order to refinance the debt from the Revolutionary War. Traders in New York quickly bought, sold, and traded the bonds, marking another important milestone in the history of finance: the opportunity for an investor to sell a security to a broker, or middleman, when he or she needed to or wanted to. The middlemen were willing to take the risk of buying a bond from a seller until a new buyer of it could be found. Of course, they were hoping to do so at a profit—-selling the bond for more than they bought it for—-but that was not, is not, always possible, introducing a new layer of risk into the business of Wall Street.


With its importance in national politics much diminished, Wall Street collectively set about remaking itself into the nation’s center of finance. The United States became one of the few countries in the world to have its seat of political power in a different place from its center of financial power. The city’s first “stock exchange” was opened at 22 Wall Street on March 1, 1792, by a group of “auctioneers” who had been designated by the Treasury to sell the bonds that were issued in order to pay off the young nation’s debt in accordance with Hamilton’s plan. Farther east on Wall Street, at around 70 Wall Street, stood one of the lone trees—-a buttonwood tree, which we now call a sycamore—-that had survived the Revolutionary War intact and thus had metaphorical importance to the young nation. Under that tree, a small group of brokers had already been in the business of buying and selling the new nation’s Treasury debt. They had also been meeting and trading at the Tontine Coffee House, farther east on Wall Street, which was named after a seventeenth--century method of raising capital devised by Lorenzo de Tonti, an Italian, and which was particularly popular in France. The traders were not pleased that the Treasury had appointed the “auctioneers” its exclusive agents.


On May 17, 1792, in an effort to break up the power of the “monopolist” auctioneers farther west on Wall Street, a group of two dozen brokers and merchants entered into what became known as the Buttonwood Agreement, the earliest known written codification of how securities brokers—-people who buy and sell stocks and bonds—-would work together. The twenty--four brokers “do hereby solemnly promise and pledge ourselves to each other, that we will not buy or sell from this day for any person whatsoever, any kind of Public Stock, at a less rate than one quarter percent Commission on the Specie value and that we will give preference to each other in our Negotiations,” according to the agreement. Hamilton’s Bank of New York became the first stock traded on the new exchange. By 1798, it was headquartered at what is now 48 Wall Street. Over time, the brokers succeeded in breaking the cartel of the “monopolists,” and the NYSE became one of the places where stocks and bonds could be bought and sold—-in effect creating a fair market for capital, another hugely important step in the development of the process whereby capital flows from the people who have it and want to invest to the people who need it to start or to grow businesses.