EIGHT
THE SPECULATION ECONOMY

While Congress and two presidents were battling over antitrust reform, federal incorporation and railroad regulation, the flood of securities spread out by the merger wave continued to transform the American stock market. As I discussed in Chapter Four, the first phase of the modern market’s development began with the merger wave and then quickly picked up steam. Many small investors could not resist blind speculation in manic markets like the one that swelled during the early spring of 1901. But their investment behavior in general was characterized by relative conservatism, with railroad bonds, a handful of high-grade industrial bonds and sometimes preferred stock serving as the most prominent investments. The socialization of the market was under way, too, as business, political, social and labor leaders encouraged Americans to invest in the new property not only for the sake of their own futures but also for the preservation of American ideals.

As we have seen, stock ownership among ordinary investors had been increasing over the previous decade and with increasing speed. While the years from the turn of the century to the Panic of 1907 marked one stage of growth, driven by the masses of new securities created by the merger wave and its aftermath and taken up by Americans experiencing a new prosperity, the period from the panic to the war formed a second stage. The financial press and retail brokerages were proliferating, industrial stocks became normalized as investment vehicles, and preferred and even common stock no longer frightened the average investor. In fact, some reports characterized the market following the panic as middle-class bargain hunting. Speculation was no longer an evil word; advisors and policymakers only cautioned the public to speculate intelligently rather than gamble. For a still small but growing class of Americans, the stock market had become part of the ordinary course of American life.193

Lawmakers had begun to pay attention to the increasing importance of the market. Portions of the debates over the Hepburn bill and the Mann-Elkins Act explicitly addressed issues of investor protection, while the Hughes Committee and the Hadley Commission studied the effects of speculation on the market and problems of investor protection. With memories of the Panic still strong and the growing number of middle-class investors a perceptible reality, Congress would turn its attention more explicitly to market regulation during the Pujo hearings of 1912. Meanwhile, the market continued to expand and investment styles started to change. Investing for a modest return on safe principal gave way to speculation as preferred stock and then common stock became increasingly attractive to average investors and more widespread across the population. As it did, speculation took on a whole new character. No longer just the manipulations of a handful of professionals nor the blind buying of a frenzied public, speculation had now become simply a matter of buying common stock. The speculation economy was a common stock economy.

THE NEW SPECULATION

The nature of speculation changed during the course of the market’s growth from its first stage during the merger wave to its second stage in the early years of the next decade. The speculation that brought average Americans into the market during that first stage was of a sort familiar to American markets, the kind of gambling that had taken place in bull markets like the one that had collapsed in 1873, ruining the father of American investment banking, Jay Cooke, and plunging the nation into depression. The sudden outpouring of securities during the merger wave at a time of large economic surplus, which allowed ordinary Americans to take their first shot at profiting from developing American industries, created its own bubble and, like all such bubbles, it burst. But unlike the aftermaths of panics like 1873 and 1893, there was no depression this time. The market quickly came roaring back.

Writing in 1965, historian Robert Sobel observed that “never before or since did the turnover rate of listed shares reach the levels of the 1900-1907 period. During four of these years the rate was over 200 per cent,” rising to 319 percent in 1901, the year in which Hill and Harriman rocked the market with their battle for control of the Northern Pacific Railroad. This was speculation of the traditional kind, speculation for profits from increasing stock prices in a market characterized by new conditions like substantial surplus capital, the abundant flow of securities issued by new kinds of corporations and frenzied buying and selling. It rode up and down in several waves and collapsed with the Panic of 1907.¹194

Noyes characterized the early period as the birth of the “New Era.” What made the era new was the attitude of the speculators, an attitude that he wrote was seen again in 1905 and 1908. As Noyes later put it:

In one of its particular phenomena, the public excitement of 1901 foreshadowed 1929 more closely than most people of later date remembered. Probably 1901 was the first speculative episode in American history that based its ideas and conduct on the assumption that Americans were living in a New Era; that old rules and principles of finance were obsolete; that things could safely be done to-day which had been dangerous or impossible in the past.

Noyes was right about the changes in attitude, but there was not all that much new about the speculation he described. It was very much the same kind of speculative mania that Americans had seen in the nineteenth century, though now it had broader public participation. The importance of the new attitude is not found in the behavior of traders during this early period, but rather in the underlying changes in the nature of investing. It is found in the evolution over the long first decade of a new and more permanent concept of speculation.²

Speculation as it developed during the first fourteen years of the twentieth century was conceptually different than before. It was not the speculation of a manic market, although the new kind of speculation certainly did not eradicate the episodic occurrences of manipulated markets or overwrought trading. While these roaring bull markets and market bubbles could be extraordinarily disruptive both to the market and sometimes the larger economy when they collapsed, they have never signified a permanent change in the basic structure of the American economy.

The new kind of speculation that developed during the early part of the century did represent such a permanent change, a change that transformed ordinary Americans, acting as a market, into Veblen’s businessman writ large, into an institution that dominated industry. This new and permanent form of speculation took hold as American investors became comfortable buying common stock—the watered stock of the merger wave issued not on the basis of productive assets or past profits but on the possibility of profits to come at some unspecified point in the future. They demonstrated their willingness to invest on faith, all for a possible share in the wealth that had come to other investors about whom they read in their newspapers and popular magazines. In making this shift, they clearly signaled their increasing comfort with common stock that until that point had been treated not as the stuff of investment but as mere promise.195

These stock buyers were speculators simply because they were willing to buy the future in the hope of higher profits. This new kind of speculation was intrinsic to the investment rather than the behavior of the investor. During the course of the first decade, even as the more traditional kind of speculation led to manic markets from 1899 to 1901 and again from the end of 1903 through 1906, investors began to shift to a more permanent kind of speculation based on the nature of the securities in which they invested. This is the kind of speculation financial writers were describing when they were not referring to the traditional speculative devices of margin buying, short-selling, futures trading and quick turnover during periods of peak market activity. Railroad preferred stock and even high-grade industrial preferred stock became more acceptable as investments. By the beginning of the next decade, average investors started to demonstrate their comfort with common stock as an appropriate investment, too. The characteristics of the different securities had not changed. What had changed was their perceived suitability as repositories for the savings of ordinary people.

The significance of this transformation for business was profound. The securities that had been considered as fitting investments for ordinary Americans were bonds and preferred stock. The principal characteristic of these securities was that they provided a steady promised return. Bonds paid interest at a set rate. Preferred stock, while somewhat more risky because directors had discretion in paying dividends, also promised a fixed return as a percentage of the stock’s par value.

The difference in risk between bonds and preferred stock was more of a difference of degree than of kind. Dividend payment may have been discretionary in law, but directors skipped preferred stock dividends at their peril. Failure to pay dividends on preferred stock was the sign of a failing corporation. It also meant that directors could not pay dividends on the common stock. This was especially important because preferred stock dividends were often cumulative, which meant that all dividend payments skipped on the preferred stock had to be fully paid before directors could pay even a quarterly dividend on the common stock. Moreover, consistently missed dividends affected a corporation’s credit and thus its ability to borrow money either from banks or on the bond market. The critical point is that investors in both kinds of securities expected no greater profits than they had been promised when they bought them, nor were they contractually permitted to demand any more. They also knew that behind their investments stood tangible, productive assets that could be sold or distributed should the company fail.³196

Common stock was different. Few if any salable assets underlay the common. More important, the potential returns from common stock were boundless. The entire residual of the corporation’s profit was theoretically available for dividends on the common stock once the interest and principal on the bonds and the dividends and par value on the preferred had been paid. This made common stock the most risky of investments, but potentially the most profitable as well. It was entitled to whatever the corporation earned. The more money the corporation made, the more money the common shareholders made. While stockholder voting was largely ineffective—either because of the presence of a controlling group or because directors controlled the machinery of voting—dissatisfied shareholders could sell their stock, causing significant drops in prices that could threaten both the managers’ positions and the ability of the corporation to raise capital from other sources. U.S. Steel, among other combinations of the merger wave, suffered both of these consequences during its first few years of existence. Its stock price plummeted, Charles Schwab lost his job to Elbert Gary and the company could not sell its bonds. As common stock with its unlimited profit potential became the dominant form of investment security, the stockholders who owned it and the market in which it traded created profit pressures that were unknown in the days when bonds and preferred stock were the securities issued to the public while controlling interests retained the common stock. As corporations needed to retain cash to grow and dividends became a smaller share of corporate profits, price appreciation followed as a substitute for dividends. And prices could appreciate as quickly as the corporation’s profits grew.⁴

The new speculation put new pressures on business. The nineteenth-century industrialist produced profits to his own satisfaction and at his own pace. But the managers of the giant new combinations had to satisfy the demands of a hungry market increasingly populated by common stockholders who expected their dividends. Veblen’s businessman was the stock market and the dominance of finance over industry had begun to move to a new and more powerful level.

Lawmakers and reformers witnessed these changes. Some, as we have seen in the various legislative debates, worried about the stranglehold finance was coming to have over industry, although most were more limited in their vision. But the growth of the American stock market focused regulatory efforts on controlling speculation. And the speculation they sought to control was of the traditional type: the bear raids, short-selling, highly margined trading and quick turnover that characterized bubbles and panics. Even as they observed Americans adopting common stock as significant portions of their investment portfolios, it was perhaps too early for them to see that it was the stock, not the behavior, that created permanent change. Their efforts were not entirely misdirected because the new order of a common stock market required honesty, transparency and a measure of stability that could only be achieved by controlling abuses, and their labors were vindicated in portions of the Securities Exchange Act of 1934. But the new common stock market demanded more. In order for it to serve the American economy as well as the American investor, it required conditions that would help the new speculators understand the businesses in which they invested and understand the sources, nature and potential limits of the profits available from industry. The New Deal securities acts went some way toward serving these ends at the same time they accepted and legally sanctified the speculation economy that had by then developed.⁵197

THE NEW SPECULATION TAKES ROOT

Speculation as a function of the nature of the investment rather than the behavior of the investor began to develop in a way that forever changed the American stock market by the middle of the first decade. In 1906 The Wall Street Journal, in its regular (and regularly conservative) column Investment and Speculation, marked a significant turn by identifying seven classifications of securities ranging from “investment” to “speculation,” including a class it called “semi-speculative investments.” These semi-speculative investments generally consisted of high-yield bonds and preferred stock that were appropriate purchases for “businessmen” hoping to receive income as well as price appreciation. The article capped a long conservative streak in which the Journal discouraged all but the securities professional from engaging in speculation. It now treated speculation almost as a form of investment.

Cautious advice was still prevalent. John Moody, writing in 1906, claimed that “we may put it down as axiomatic that only those are legitimate investments where the primary motive is the safe securing of one’s principal and the rate of return thereon is looked upon as secondary.” Conservatism still counseled the middle class to invest in the kinds of securities that were traditionally classified as investments. But a speculative wind was blowing and the public smelled money in the air.⁶

Protecting principal remained the dominant theme of investment advisors. But the old speculation of the years following the merger wave continued. The National Banker opined in 1907 that it was not the small investor who was losing money but rather the rich plunger, admittedly because the small investor was “as a class… as careful and cautious and conservative as the man who invests his thousands.” But the small investor proved to be impatient with small returns, although interest rates had risen to 5 or 6 percent by 1907. It was the small investor who appeared to be bargain hunting in the immediate wake of the Panic of 1907. With New York threatening to regulate or prohibit the traditional forms of speculation, professionals told investors that their speculation helped to move market prices in the right direction. The Times predicted that small investors had become so well educated in the ways of the market that they would reap the profits of the next boom, and in fact small investors appeared to be among the profit-takers in the brief market recovery following Taft’s election in November 1908. Even Western farmers were using some of their surplus funds to engage in speculation.⁷198

Alexander Noyes warned investors of the distorting effect that professional speculators’ margin money could have on their own investments. Writing in The Atlantic Monthly, he noted that times of high interest rates combined with rising stock prices signaled a coming drop in the market. High interest rates meant that the borrowing capacity of speculators was strained, and that many soon would have to liquidate their market positions. The result would be a collapse in prices as professionals, scrambling to close out of their margin positions, unloaded their high-priced securities on the unsuspecting investor. Conservative advisors still favored high-grade railroad bonds. If an investor really insisted on a higher rate of return, their advice was at least to be sure of the security of his principal.⁸

The old-style speculative frenzy that lasted from 1905 to 1907 was caused by record wheat, corn and cotton crops and a worldwide increase in the money supply. But the speculation continued despite increasing worldwide demands for money and increasing interest rates. The gold-bound inelastic money supply was strained by funding demands for the Russo-Japanese War, the rapidly increasing cost of living and industrial expansion. European demands for money also increased as traditional speculation infested European stock markets. Bank reserves were dropping and margin loan rates in New York ranged from 25 percent to 125 percent. According to Noyes, the early part of this stock market boom did not involve the small investor but the wealthy, the captains of industry, newly rich from the merger wave and trading heavily on margin. They simply borrowed from Europe when U.S. margin rates became too high. On January 4, 1906, Jacob Schiff predicted a spectacular panic if “currency conditions” did not change materially. Ultimately it appears that the Panic of 1907 was caused in part by America’s demand for more capital than the industrialized world possessed. It was as if the New York markets were trying to corner the world’s cash.⁹199

The Panic of 1907 and its aftermath had an unexpected effect on the investment decisions of average investors. While conservative advice still prevailed, newspapers, magazines and investment advisors encouraged speculative investing. But the speculation they envisioned was of the new type. In the summer of 1909 The Wall Street Journal, comparing American and European investing habits, described the English and the French as looking for safety and the Americans and Germans as looking for large returns and capital appreciation, which could only be realized by investing in common stock. At about the same time, Adolph Lewisohn, who made his fortune in copper at the end of the nineteenth century, wrote in The New York Times that “[i]t is very difficult to draw the line between where investment ceases and speculation commences.” It was a statement that almost nobody would have made just a few years earlier.¹⁰

Even more surprising, The Wall Street Journal both redefined and encouraged speculation by reprinting an article, with evident approval, from the Economist penned by “A Stockbroker.” Speculation, which the author saw as endemic in, and beneficial to, society, “may be defined as the realization of a will to run more or less calculable, and consequently reasonable, risks, which should be rewarded by a special gain.” People of means should speculate because it helped to stimulate new industry. The Journal also remarked upon widespread speculation by Americans of all classes and noted the “growing popularity of substantial stocks and bonds.” In the summer of 1910, as the lifeless market that had begun that year drifted on, the Journal chided Americans for their extravagant spending habits, also characteristic of this period, and encouraged them to invest in American industry to keep it out of foreign hands. Somewhat conservatively, it noted that while stock speculation would not soon return, “there will undoubtedly be a considerable amount of buying of the best dividend paying issues.” Other newspapers continued to warn investors to stay out of common stock unless they had full information about the corporation, which, as we have seen, they were unlikely to have had.¹¹

By 1914, individual investors were well along the way toward shifting their objectives to higher returns rather than safety of principal as they moved from bonds and preferred stock to common stock. Although it remained true until the middle 1920s that small investors buying stock still deeply cared about their dividends, their desire for higher returns—whether through dividends or, increasingly, price appreciation—led them to move from more conservative “investments” to engage in “speculation” in stock. The shift was significant enough to lead Theodore Roosevelt and others to call for action to curb speculation as early as 1908 and the appointment of the Hughes Committee in New York to study the problem that same year. But this early concern with speculation was not so much for the safety and well-being of the investor as it was for the way that old-style stock speculation destabilized banking and the American economy.200

The American economy had fallen into a state of mild depression by the time of Woodrow Wilson’s election. As Noyes put it: “Exploits of Captains of Industry no longer occupied front pages of the newspapers. ‘New Era’ propaganda had entirely disappeared; so had Wall Street’s dream of a New York which was about to become the financial centre of the world; even New York City had found it necessary to place its bonds in Europe.” The stock market reacted in an entirely unexpected way.¹²

THE NEW COMMON STOCKHOLDER

Fundamental economic changes were taking place beneath the decline in irrational exuberance from 1908 to 1914 that not only raised serious concerns about speculation in the market but also, and more important, set the groundwork for the great shift in market structure and investment mentality that flowered after the war.

The market remained flat in 1911 and 1912, producing general economic ennui in 1913. Not even savings banks were buying, perhaps not a surprise after the Panic of 1907, although the Journal encouraged them to invest in the bond market. But there was life in the market again by 1912. Significantly, it appeared that average investors were turning from the dominant railroads to industrials, which until that time had largely been considered too speculative. This shift revealed a greater appetite for risk on the part of the public. Not only were they buying industrials; they were also buying common stock. The American Sugar Refining Company Statement of 1910 noted its total number of shareholders as 19,359, with average holdings of less than fifty shares. Forty-nine percent of shareholders owned ten or fewer shares. Almost 90 percent of U.S. Steel’s common shareholders and 92 percent of its preferred shareholders owned fewer than one hundred shares in 1911, with the overwhelming majority of each class owning fewer than fifty shares. Chauncey Depew, president of the New York Central Railroad, noted his surprise that “people of relatively small means are becoming gradually but surely the majority owners of the stock of the New York Central,” as the average investor increasingly put his money into stock.¹³

The average investor’s turn to common stock was becoming unmistakable. Numbers from the period are not entirely reliable, but the trends are clear. As I noted in Chapter Four, it is likely that the absolute number of new stockholders remained relatively small as a percentage of the population. But the speed with which their participation in the market was increasing, and its direction toward common stock, signaled the growing centrality of the stock market to American business, culture and individual wealth at the same time that it foreshadowed a transformation in the structure and character of American corporate capitalism.¹⁴201

There is at least some reliable and specific data to support this conclusion in finer detail. The National Civic Federation’s Distribution of Ownership in Investments Subcommittee, chaired by economist E.R.A. Seligman, began a study in 1914 to figure out how widely distributed capital ownership had become. The NCF was simultaneously studying the division of American wealth between labor and capital and the degree to which socialism had spread in the United States. Its stock study was prompted by its pronounced fear of creeping socialism. Widespread stock ownership would provide some evidence that the socialist threat was weak.¹⁵

The NCF study used several different databases. The first were publicly available. In February 1914, The Wall Street Joumal had published articles detailing the distribution of stock ownership in a number of railroads and industrial corporations. In contrast to the NCF’s concern with socialism, the Journal’s purpose was to demonstrate to the federal government, during a period of intense legislative activity, that regulation would hurt Americans of modest means rather than plutocrats. The Journal found that seventy-two railroads had 461,445 shareholders. From June 1912 to June 1913, the number had increased by 11 percent even as capitalization had increased by only 2 percent. Average shares per holder decreased from 141 to 133. The Journal sampled a few industrial corporations for which December 1913 data were available and observed the trend continuing. The clear conclusion was that the number of shareholders, and especially the number of small shareholders, was increasing even in a bad market environment. Important, too, the average par value of these individual holdings was approximately $14,000 in 1912 and $13,320 in 1913. While this last number is $273,800 in 2006 dollars, it is important to remember that the market typically imposed heavy discounts on the par values of common stock, so the average market value of these holdings was likely to have been considerably less than the numbers suggest. In any event, these average holdings hardly represent the kind of plutocratic ownership suggested by popular accounts of the market during this era. Regrettably, data is unavailable to derive the distribution of this ownership, but it does seem indisputable that at least the middle-class investor was a dramatically increasing presence in the market. As the Journal put it, the odd-lot investor was the “backbone of the investing world.”¹⁶202

The evidence presented by industrial corporations was even more striking. Three hundred twenty-seven companies had 790,023 shareholders with average holdings of 85 shares at an average par value of $8,500 ($174,722.60 in 2006). There was, as the Journal noted, duplication of shareholders in industrials and in industrials and railroads, but its conclusions were “not materially affected.” Corporate capital ownership was clearly becoming more widespread.¹⁷

In addition to the information published by the Journal, the NCF developed its own database. The subcommittee wrote to more than one hundred corporations requesting stock ownership information. The records of the study in the NCF archives suggest that it was never completed. But the available data is highly suggestive.

Many corporations responded to the survey with more or less detail, which makes it difficult to classify the information, but one can identify three broad categories. Some companies provided very specific information, for varying years, on the distribution of shares (one to five shares, six to ten, etc.), sometimes by type (common and preferred) and sometimes in the aggregate. A larger number simply provided the average number of shares owned by each shareholder. A significant number of companies also provided information on the extent of their shares owned by women and foreigners. In addition to this raw data, there is a compilation in the NCF files of seventy-five of the responding corporations’ average holdings in 1901, 1906 and 1913. Presumably those included were the only corporations in the survey that had remained in continual existence during that period.

Taken together, the information in the NCF archives permits modest but telling claims about the distribution of shareholdings in terms of the size of blocks owned, the growth of small investors and the increasing trend toward speculation by means of common stock ownership. Several respondents themselves expressly noted increases in small shareholdings, greater distribution of their shares, the extent of duplication and the extent of institutional ownership.

The data show a significant spread in share ownership across the population from the turn of the century on, both directly, in holdings of less than one hundred shares, and indirectly in the form of increased stock ownership by insurance companies and savings banks. Large holdings (over one thousand shares) were very small proportions of almost every company’s stockholdings. The compiled data show an increase in the number of shareholders from 140,072 in 1901 to 197,264 in 1906 to 414,945 in 1913, or 41 percent between 1901 and 1906 and 110 percent between 1906 and 1913, with an overall increase of almost 200 percent during the period. Some of the more pronounced leaps included U.S. Steel, whose shareholders increased from 32,000 to 125,000; General Electric, from 2,900 to 10,450; and American Telephone & Telegraph, from 8,143 to 53,737. It is particularly striking to see the extent of growth from 1906 on, both because the period encompassed the highly disruptive Panic of 1907 and its aftermath and because most of the period from 1910 to 1914 was one long flat market underscored by broad economic stagnation.203

The raw data demonstrate the increased popularity of common stock as an investment vehicle, with significant amounts of small holdings as well as increased amounts of outstanding common stock for almost every corporation. Consolidated Gas of Baltimore went from 6.3 million shares of preferred in 1906 to 4.1 million in 1914, a period during which its common shares went from 6.3 million to 11.4 million with only a modest increase in par value. (The company did not provide a breakdown of its capitalization between the common and preferred.) Holding capitalization almost constant, the Chicago & Alton Railroad saw the number of its preferred shareholders rise from 314 in 1906 to 408 in 1914, while the number of common shareholders went from 219 to 671. Companies like Borden’s Condensed Milk, Eastman Kodak, Federal Light & Traction, General Motors, Proctor & Gamble, Seaboard Air Line Railroad and Southern California Edison all had more common than preferred shares and, typically, shareholders. Some companies, like The Texas Company and The Silversmiths Company, had only common stock outstanding. Even in the flat years of 1910 to 1914, common stock was becoming the game.

Interestingly, the data also show the very strong presence of women investors, both in common stocks of speculative companies and as investors more generally. Women’s ownership ranged from 25 percent to over 40 percent in virtually every company reporting such statistics including General Motors, B. F. Goodrich, Borden’s Condensed Milk Co. and National Carbon Company, except in cases like American Locomotive Company, where they owned a majority of the preferred stock, and American Express Company and the Delaware, Lackawanna & Western Coal Co., where they owned an outright majority of all stock. One can tentatively conclude that speculation of the new type had begun to become part of the culture of small investors.¹⁸

As I noted, indirect ownership had increased as well. Fourteen insurance companies identified in the NCF files had 3.5 million life insurance policies in force in 1913, and the NCF noted that 40 million life insurance policies were then effective in the United States. The handful of insurance companies identified in the NCF archives together owned 20 million shares of railroad stock.¹⁹204

Despite largely adverse economic conditions, buying common stock, which had been looked upon only a few years earlier as intrinsically speculative and therefore out-of-bounds for the small investor, became an increasingly normal activity. From 1898 to 1915, the predominance of the “secure” railroad securities traded on the NYSE fell and the number of “speculative” industrials increased from 20 to 173. The language of Wall Street had even developed to include a phrase that marked the transition of a stock from speculative to investment quality; the stock was “‘put on an investment basis.’”

A broader overview of market trends supports the conclusion that average Americans were buying common stock. Capital seeking investment began to grow dramatically in the first decade of the twentieth century, bank assets more than doubled and life insurance assets did even better. As I noted in Chapter Four, the number of individual stockholders increased dramatically. This was the critical transformation for the speculation economy.²⁰

Increased popular press coverage of the market, increased advertising, the rise of retail brokers, the growth of industrials as investment opportunities, the stabilization of the early century combinations by 1914 and the rise of new industries all contributed to bring the individual investor into the market.

Buying stock had never been easier. Investors with little to invest now could have a piece of the action, and new investors entered the market. The rapidly growing practice of selling stocks and bonds on the installment plan provides strong evidence of the small investor’s increasing activity. A typical plan for stock purchases in 1912 would have been for $30 down on stocks priced between $100 and $150 and $5 per month thereafter. (The downpayment was $50 on higher-priced stocks and $20 per hundred in principal on top-grade bonds, with $5 per month thereafter.)

For those who still preferred bonds, corporations began to break the venerable tradition of offering their bonds at $1,000 par value by issuing “Baby Bonds” at $100 par. Investment banking firms like Kidder, Peabody and Lee, Higginson, among others on the retail brokerage side, and Goldman Sachs and Lehman Brothers, underwriting the new light industries, huge retailing houses like Sears Roebuck and consumer products companies like General Cigar, began to bring securities to the masses much in the way the new businesses were bringing their new products to all corners of the country.²¹

Finally, even the law began to encourage small investors to enter the stock market. New York passed the first no-par statute in 1912 in part to help investors understand the difference between nominal and financial value, and other states, beginning in 1916, allowed corporations to set par value as low as they cared to.205

Attitudes toward speculation had changed. The dramatic increase in small holdings of common stock reflected this, as did financial discussion in general. More specifically, almost all of the companies providing detailed information on their capitalizations showed that outstanding common stock exceeded outstanding preferred stock and, while the sample is small, the fact is significant. Little had changed to increase the amount of reliable information available to shareholders, and a flat market and poor economy was hardly like the bubble of the merger wave or the period leading up to 1907, in which speculation increased at least in part as a function of the frenzied environment. It remained for Wilson’s Liberty Bond drives to cement in the public mind the idea that investing in securities was the sort of thing that regular people did, in order to fully transform the character of the stock market into a central part of American culture.

OLD-FASHIONED SPECULATION AND THE SECOND NEW ERA

The establishment of common stock as a legitimate investment vehicle was critically important in determining the course of American corporate capitalism. So was the change in investor expectations, a change that showed itself from time to time throughout the century’s first two decades and reached full flower during the 1920s. That was the shift from investing for income to investing for capital appreciation. The result was a combination of the traditional form of speculation with the new. The increasingly widespread ownership of common stock made speculation in terms of the nature of the security a permanent feature of the American economy. It also amplified the traditional forms of speculation.²²

While preferred and then common stock gradually overtook bonds as popular investment vehicles, effectively obliterating the difference between speculation and investment, most investors during the first two decades did focus their attention on dividends. For the average investor speculation during that period was more a matter of holding stocks, the dividends of which were more uncertain and higher, than profiting from trading. As Benjamin Graham and David Dodd noted in their classic 1934 treatise Security Analysis, before World War I “[i]nvestment in common stock was confined to those [stocks] showing stable dividends and fairly stable earnings; and such issues in turn were expected to maintain a fairly stable market level.”

But things changed fast. “During the postwar period, and particularly during the latter stage of the bull market culminating in 1929, the public acquired a completely different attitude toward the investment merits of common stocks The new theory or principle may be summed up in the sentence: ‘The value of a common stock depends upon what it will earn in the future.’” In this mode, dividend rates and asset values were completely irrelevant. All that mattered was the potential future stock prices, what once had been called the “water.” Meade’s insistence on capitalizing earnings, the promoters’ practice of selling watered common stock, Veblen’s and Commons’s theories of value, all had come to be realized in the new market in a way that would not have been possible had bonds and preferred stock continued to be the individual investor’s way of participating in the market. Water there may have been, but to the new investors it had lost all meaning. The problem of overcapitalization was a thing of the past.²³206

The widespread shift from buying for income to buying for price growth had profound consequences for American corporate capitalism that would not have existed without the trend to common stock. When you bought for income, you had to pay attention to whatever you might learn about the company in which you were investing. You were buying to hold, after all, not to trade. Again in the words of Graham and Dodd:

Another useful approach to the attitude of the prewar common-stock investor is from the standpoint of taking an interest in a private business. The typical common-stock investor was a business man, and it seemed sensible to him to value any corporate enterprise in much the same manner as he would value his own business. This meant that he gave at least as much attention to the asset value behind the shares as he did to their earnings records…. Broadly speaking, the same attitude was formerly taken in an investment purchase of a marketable common stock.

The shift from investment to speculation, from a time when most Americans saw corporate securities as a way to get a steady return while protecting their principal to a time when Americans saw the stock market as a place to trade on the fluctuations of an increasingly volatile market, took place over the second and third decades of the twentieth century. Certainly speculation had been part of American capital and commodities markets for as long as they had existed. But while anybody could speculate in the market and often did, the capital markets were, as we have seen, for most people a place of investment.²⁴

In order for a common stock investor to properly evaluate the wisdom of an investment, he had to understand the business. You might think that a speculator would also have to understand the business to evaluate the potential earnings growth of a corporation. Not so, according to Graham and Dodd. They noted that in earlier speculative times the classic method (still in use) of evaluating future earnings growth was to capitalize earnings. This did not technically require much knowledge of the business, but it did at least force a speculator to look at financial statements. In the postwar period, the speculator did not bother with past earnings—he simply assumed a level of goodwill for Radio Corporation of America or Wright Aeronautical Corporation, or simply watched their price movements.207

Lawrence Chamberlain, general counsel to the Investment Bankers Association and another major financial writer of the period, agreed with Graham and Dodd. He observed the postwar shift from investment to speculation with dismay:

Not only was the utmost possible heresy rampant in our own profession, but this heresy was routing conservative practice in business life with amazing rapidity and on a colossal scale. We were being told in high places and low that long-term investment did not pay, that intelligent speculation was investment, and that Americans lived in a chosen country to which had been vouchsafed a “new era” in which all one had to do was to buy “well-selected” stocks at any time, at any price, and hold with sufficient patience in order to sell for more than one paid and thereby realize on the “investment.”

This was the principal difference between the prewar and postwar stock buyer. The prewar buyer was, for the most part, interested in industry, even if he invested in speculative stocks. He knew the corporation. He paid attention to the business. The postwar buyer did not care about the corporation. He cared about price trends, reputations and rumors. While Noyes described the turn-of-the-century trader as believing in a “New Era,” the postwar market demonstrated the birth of a “Second New Era.”²⁵

Dividend-paying common stock sometimes was considered investment grade despite its capitalization as goodwill (or water) and the absence of corporate financial disclosure. Non-dividend-paying stock—what today is called growth stock—was considered nothing but speculative, and the speculator needed no knowledge of the business in which he was investing. As Chamberlain put it: “If learned financial counsel are right in calling non-dividend paying common stocks investments by virtue of a capital gain that may or does come to them, then the essence of investment is not inherent in income at all.” He was right. It was inherent in the nature of the security. Bonds with secure principal and steady interest were investments; common stock with its potentially unlimited returns was speculative. As the public’s taste for common stock developed, the distinction made earlier in the century between investment and speculation was lost. “Second New Era” investing had profound consequences for the development of American corporate capitalism with its focus on finance.²⁶208

Traditional speculation itself had sometimes come to be treated as acceptable. The Pujo Report, picking up on a distinction made by its predecessor investigatory committees, itself distinguished between “wholesome speculation,” which even its reformist counsel Untermyer admitted was vital to the economy, and “unwholesome speculation.” While noting that speculation was best left to the man who had the appropriate amount of time to spend on it, one popular financial writer opined that speculators did more for society than investors, because they were the people who provided entrepreneurial capital. He believed “that the moral standards of the average speculator before the latter half of the nineteenth century… were below par.” At one point “the Hebrews, the leaders of the world’s business, practically monopolized speculation….” But “with the changing times, speculation has been placed upon a higher moral level than formerly.” Now speculators could be described as “gentlemen.” The market had proven itself to be important, and all but the most radical politicians were concerned that it not be destroyed. Evidence of the adverse effect of antispeculation laws, most prominently those of Germany, cautioned against heavy-handed regulation.²⁷

The market was becoming an important repository of wealth, and common stock a normal part of American life, but this was not the time for radical reform. The year and a half leading up to the European war was a time of industrial depression and a flat stock market. The largest bankruptcy at that point in U.S. history, the collapse of the famous Claflin dry goods empire in June 1914, produced panic in a White House that had come to power on a blended platform of classical conservative and progressive business reform but that had never known economic good times and was beginning to fear the consequences. That would change with a remarkable and, perhaps, improbable reversal of fortune as war broke out in Europe. America’s entry into the war would provide economic rejuvenation and the training ground for massive new numbers of stockholders. When securities regulation finally came into its own, it would embrace the new reality of the speculation economy. But, until then, the shadow of the merger wave continued to loom over legislative efforts.