December 16, 2007
Gregory Mark on Lawrence Mitchell, The Speculation Economy: How Finance Triumphed Over Industry
Posted by Gordon Smith

Gregory Mark of Rutgers School of Law has been kind enough to contribute another review of Larry Mitchell's book, The Speculation Economy: How Finance Triumphed Over Industry:

It is a pleasure to see a fine mind at work.  Larry Mitchell, long known as something of an iconoclast among scholars of corporate law, has in recent years turned towards the history of corporate law.  This book represents what I, at least, hope is but the first of his book-length efforts in history, for it demonstrates the explanatory power of a deft mind with a talent for prose.  The book should also serve to remind the legal academy of one of its grandest traditions (and its attendant cautions), the law professor as autodidact.

Mitchell’s thesis, that finance has subsumed industry and that it is possible to identify a moment - really a moment crossing several years - when the conquest of commerce by finance took place, is one about which I have more than a little reservation.  But his identification of the thirty year period from 1890 to 1920 as somehow transformative is certainly correct, though not unique to him.  Mitchell’s contribution, and it is a major one, is to combine the business history of that period with the legal history of the period and to demonstrate that the two were intimately connected.  As with any fine work of history, however, even if the thesis is contestable, it provides an invaluable set of insights and explanations.  I wish to single out but one explanation and one insight built on a metaphor to demonstrate the virtues of the book, before delving into my quibble with the thesis.

Watered stock.  To a modern law student, a modern lawyer, or a modern person of business, that concept is utterly foreign.  When an occasional reference to watered stock appears in a casebook or history, by definition universally pejoratively, I would guess that most people read right over it, happy to know that it was bad but unconcerned about why that might be, or even what it is.  Yet, until roughly World War II, it was a concept that excited the imagination of financial manipulator and reformer alike.  Mitchell provides the definition, “stock [issued] at a par value higher than a corporation’s tangible economic value.  The difference was called ‘water.’” (59) The evil is seems clear.  The seller somehow cons the buyer into paying more than the stock is worth.  Of course, much depends on the concepts of “par value” and “tangible,” but the nature of the scam is clear.  Mitchell’s elaboration on the anxieties provoked by watered stock is nothing short of brilliant, the more so since he understands that modern finance simply scratches its head at such a notion.  To the modern market, assuming a reasonable flow of truthful information, the selling price is the price is the price, and a company is worth not its tangible assets, but the value of its projected income streams compared to other available investments, each valued the same way.  But, in eras when truthful flows of information were themselves rare, and legal protections relatively costly, reliance on “par” and “tangible” had meaning they lack today.  And, of course, the triumph of finance, Mitchell argues, is premised in part in a change in attitude, from regarding a company as a collection of assets to a mechanism for the production of income.  His explanation of watered stick is thus the best I have ever read, both for its clarity and for its significance historically.

Mitchell’s virtues as an author, however, are not limited to clarity of exposition.  He can turn a metaphor with the best of them.  What better metaphor than modern financial instruments as somehow agricultural to make the new understandable to citizens in a society in flux?  Watered stock is, after all, itself a metaphor for the dark side of the transformation.  The agricultural metaphor’s positive force, or at least its legitimating force is one that, to my knowledge at least, is best developed by Mitchell’s work.   And, he knows it.  With a becoming modesty he notes that, as a new form of property, the stock market could fill the evaporating role of the land ... in classical American life and thought. ...  I exaggerate only a little to say that this idea of corporate securities as the new family farm helped to legitimate the stock market as an American institution[.]” (4)  As an author he knows that the metaphor works its spell not just on the subjects about whom he writes, but on the reader as well, making smoothly understandable the jarring transitions of the era.

Alas, however much I admire the work, I simply cannot bring myself to subscribe to its ultimate thesis, that somewhere between 1890 and 1930 finance came to dominate industry.  I am perfectly prepared to believe, and do believe, that Mitchell demonstrates that this era represents such a shift, but that it represents the shift is something else again.  The capacity of finance to dominate industry has been a perpetual fear that has reared its head episodically throughout the history of the republic.  The fear of foreign financiers dominated much of the early nineteenth century.  The first national bank’s charter was allowed to lapse because of such fears.  The prevalence of those fears was not without cause.  The industry of America was commercial agriculture in that era, and the indebted farmer’s perpetual plight is a standard trope of the period’s politics and literature.  The farmers whose land was seized in foreclosure, and then sold off by financiers at their profit, was but a precursor to the railroad and industrial reorganizations in Mitchell’s decades.  And in the decades after Mitchell’s era corporate managers fought, and largely succeeded, in keeping finance at bay, financing growth through retained earnings and dipping into capital markets as lightly as possible.  Managers, always accused after Berle and Means of not wanting to answer to shareholders, shared a palpable aversion to answering to financiers also.  If one is to believe the work of people like Ron Chernow, for example, investment banks moved from financing and reorganizing industries to countries at the end of Mitchell’s period.  For a variety of reasons, some legal, some macroeconomic, and some political, financial institutions played second fiddle to the companies for which they raised money for some time after the Second World War.  While anecdote is of limited evidentiary value in contending with a thesis as sweeping as Mitchell’s, allow me to proffer two: IBM and Barbarians at The Gate.  IBM, an industrial icon, borrowed no money on the bond markets in its computer manufacturing days until the last few years of the twentieth century.  The story of Ross Johnson’s corporate folly is the story of a man who invited the financial community in because he succumbed to the siren song of the buyout, not because he was not having fun and living well running the company (shareholder welfare to one side).  All this is to suggest not that Mitchell is wrong in the story he tells, but rather in the significance he attributes to it.  American business history is, it seems to me, better described the story of a tension between financial and commercial/industrial entities.  In some periods, for some reasons, finance dominates.  In other periods, it does not - it is sleepy.  In some years Harvard Business School graduates flock to industry.  In some years they do not.  Mitchell tells the story of an era better than any I know, combining technical legal expertise with a nuanced understanding of finance, commerce, and industry developed from prodigious research and the realism of someone who sends lawyers from law school into the trenches.  The transformation he interprets is vital, but hardly final.  In history, as in ideas, there are no final victories.

Thus, my final comment, not really on the book but on the project.  The legal academy is undergoing a profound change, in which the profession is being sliced up into turfs dominated by individuals with additional professional training, be it economics, history, philosophy, medicine, what have you.  An unfortunate by-product of this otherwise salutary intellectual development, is a kind of balkanization of the collective endeavor and a concomitant tendency to devalue the work of those without the formal training.  Mitchell reminds us that important contributions can come from those who master material, whether they burnish their resume with academic epaulettes or not.

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