The Ascent of Money_ A Financial History

Chapter 3

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Further, in his own right, Law owned:

the Hotel de Nevers in the rue de Richelieu (now the Bibliotheque Nationale); the Mazarin Palace, where the Company had its offices; more than a third of the buildings at the place Vendome (then place Louis le Grand); more than twelve country estates; several plantations in Louisiana; and 100 million livres of shares in the Mississippi Company.61 Louis XIV of France had said "L"etat, c"est moi": I am the state. John Law could legitimately say "L"economie, c"est moi": I am the economy.

In truth, John Law preferred gambling to praying. In March 1719, for example, he had bet the Duke of Bourbon a thousand new louis d"or that there would be no more ice that winter or spring. (He lost.) On another occasion he wagered 10,000 to 1 that a friend could not throw a designated number with six dice at one throw. (He probably won on that occasion, since the odds against doing so are 66 to 1, or 46,656 to 1.) But his biggest bet was on his own System. Law"s "daily discourse", reported an uneasy British diplomat in August 1719, was that he would "set France higher than ever she was before, and put her in a condition to give the law to all Europe; that he can ruin the trade and credit of England and Holland, whenever he pleases; that he can break our bank, whenever he has a mind; and our East India Company. " to 1, or 46,656 to 1.) But his biggest bet was on his own System. Law"s "daily discourse", reported an uneasy British diplomat in August 1719, was that he would "set France higher than ever she was before, and put her in a condition to give the law to all Europe; that he can ruin the trade and credit of England and Holland, whenever he pleases; that he can break our bank, whenever he has a mind; and our East India Company. "62 Putting his money where his mouth was, Law had made a bet with Thomas Pitt, Earl of Londonderry (and uncle of the Prime Minister William Pitt), that British shares would fall in price in the year ahead. He sold 100,000 of East India stock short for 180,000 (that is at a price of 180 per share, or 80 per cent above face value) for delivery on 25 August 1720. Putting his money where his mouth was, Law had made a bet with Thomas Pitt, Earl of Londonderry (and uncle of the Prime Minister William Pitt), that British shares would fall in price in the year ahead. He sold 100,000 of East India stock short for 180,000 (that is at a price of 180 per share, or 80 per cent above face value) for delivery on 25 August 1720.63 (The price of the shares at the end of August 1719 was 194, indicating Law"s expectation of a 14 price decline.) (The price of the shares at the end of August 1719 was 194, indicating Law"s expectation of a 14 price decline.) Yet the con at the heart of Law"s confidence could not be sustained indefinitely. Even before his appointment as Controller General, the first signs of phase 4 of the five-stage bubble cycle - distress - had begun to manifest themselves. When the Mississippi share price began to decline in December 1719, touching 7,930 livres on 14 December, Law resorted to the first of many artificial expedients to prop it up, opening a bureau at the Banque Royale that guaranteed to buy (and sell) the shares at a floor price of 9,000 livres. As if to simplify matters, on 22 February 1720 it was announced that the Company was taking over the Banque Royale. Law also created options (primes) costing 1,000 livres which ent.i.tled the owner to buy a share for 10,000 livres over the following six months (that is an effective price of 11,000 livres - 900 livres above the actual peak price of 10,100 reached on 8 January). These measures sufficed to keep the share price above 9,000 livres until mid-January (though the effect of the floor price was to render the options worthless; generously Law allowed holders to convert them into shares at the rate of ten primes primes per share). per share).

Inflation, however, was now accelerating alarmingly outside the stock market. At their peak in September 1720, prices in Paris were roughly double what they had been two years before, with most of the increase coming in the previous eleven months. This was a reflection of the extraordinary increase in note circulation Law had caused. In the s.p.a.ce of little more than a year he had more than doubled the volume of paper currency. By May 1720 the total money supply (banknotes and shares held by the public, since the latter could be turned into cash at will) was roughly four times larger in livre terms than the gold and silver coinage France had previously used.64 Not surprisingly, some people began to antic.i.p.ate a depreciation of the banknotes, and began to revert to payment in gold and silver. Ever the absolutist, Law"s initial response was to resort to compulsion. Banknotes were made legal tender. The export of gold and silver was banned as was the production and sale of gold and silver objects. By the Not surprisingly, some people began to antic.i.p.ate a depreciation of the banknotes, and began to revert to payment in gold and silver. Ever the absolutist, Law"s initial response was to resort to compulsion. Banknotes were made legal tender. The export of gold and silver was banned as was the production and sale of gold and silver objects. By the arret arret of 27 February 1720, it became illegal for a private citizen to possess more than 500 livres of metal coin. The authorities were empowered to enforce this measure by searching people"s houses. Voltaire called this "the most unjust edict ever rendered" and "the final limit of a tyrannical absurdity". of 27 February 1720, it became illegal for a private citizen to possess more than 500 livres of metal coin. The authorities were empowered to enforce this measure by searching people"s houses. Voltaire called this "the most unjust edict ever rendered" and "the final limit of a tyrannical absurdity".65 The Mississippi Bubble: Money and share prices (livres)

At the same time, Law obsessively tinkered with the exchange rate of the banknotes in terms of gold and silver, altering the official price of gold twenty-eight times and the price of silver no fewer than thirty-five times between September 1719 and December 1720 - all in an effort to make banknotes more attractive than coins to the public. But the flow of sometimes contradictory regulations served only to bewilder people and to ill.u.s.trate the propensity of an absolutist regime to make up the economic rules to suit itself. "By an all new secret magic," one observer later recalled, "words a.s.sembled and formed Edicts that no one comprehended, and the air was filled with obscure ideas and chimeras."66 One day gold and silver could be freely exported; the next day not. One day notes were being printed as fast as the printing presses could operate; the next Law was aiming to cap the banknote supply at 1.2 million livres. One day there was a floor price of 9,000 livres for Mississippi shares; the next day not. When this floor was removed on 22 February the shares predictably slumped. By the end of the month they were down to 7,825 livres. On 5 March, apparently under pressure from the Regent, Law performed another U-turn, reinst.i.tuting the 9,000 livre floor and reopening the bureau to buy them at this price. But this meant that the lid was once again removed from the money supply - despite the a.s.sertion in the same decree that "the banknote was a money which could not be altered in value", and despite the previous commitment to a 1.2 million livre cap. One day gold and silver could be freely exported; the next day not. One day notes were being printed as fast as the printing presses could operate; the next Law was aiming to cap the banknote supply at 1.2 million livres. One day there was a floor price of 9,000 livres for Mississippi shares; the next day not. When this floor was removed on 22 February the shares predictably slumped. By the end of the month they were down to 7,825 livres. On 5 March, apparently under pressure from the Regent, Law performed another U-turn, reinst.i.tuting the 9,000 livre floor and reopening the bureau to buy them at this price. But this meant that the lid was once again removed from the money supply - despite the a.s.sertion in the same decree that "the banknote was a money which could not be altered in value", and despite the previous commitment to a 1.2 million livre cap.67 By now the smarter investors were more than happy to have 9,000 livres in cash for their each of their shares. Between February and May 1720 there was a 94 per cent increase in the public"s holdings of banknotes. Meanwhile their holdings of shares slumped to less than a third of the total number issued. It seemed inevitable that before long all the shares would be unloaded on the Company, unleashing a further flood of banknotes and a surge in inflation. By now the smarter investors were more than happy to have 9,000 livres in cash for their each of their shares. Between February and May 1720 there was a 94 per cent increase in the public"s holdings of banknotes. Meanwhile their holdings of shares slumped to less than a third of the total number issued. It seemed inevitable that before long all the shares would be unloaded on the Company, unleashing a further flood of banknotes and a surge in inflation.

On 21 May, in a desperate bid to avert meltdown, Law induced the Regent to issue a deflationary decree, reducing the official price of Company shares in monthly steps from 9,000 livres to 5,000 and at the same time halving the number of banknotes in circulation. He also devalued the banknotes, having revoked the previous order guaranteeing that this would not happen. This was when the limits of royal absolutism, the foundation of Law"s System, suddenly became apparent. Violent public outcry forced the government to revoke these measures just six days after their announcement, but the damage to confidence in the System was, by this time, irrevocable. After an initial lull, the share price slid from 9,005 livres (16 May) to 4,200 (31 May). Angry crowds gathered outside the Bank, which had difficulty meeting the demand for notes. Stones were thrown, windows broken. "The heaviest loss", wrote one British observer, "falls on the people of this country and affects all ranks and conditions among them. It is not possible to express how great and general their consternation and despair have appeared to be on this occasion; the Princes of the blood and all the great men exclaim very warmly against it."68 Law was roundly denounced at an extraordinary meeting of the Parlement. The Regent retreated, revoking the 21 May decree. Law offered his resignation, but was dismissed outright on 29 May. He was placed under house arrest; his enemies wanted to see him in the Bastille. For the second time in his life, Law faced jail, conceivably even death. (An investigative commission quickly found evidence that Law"s issues of banknotes had breached the authorized limit, so grounds existed for a prosecution.) The Banque Royale closed its doors. Law was roundly denounced at an extraordinary meeting of the Parlement. The Regent retreated, revoking the 21 May decree. Law offered his resignation, but was dismissed outright on 29 May. He was placed under house arrest; his enemies wanted to see him in the Bastille. For the second time in his life, Law faced jail, conceivably even death. (An investigative commission quickly found evidence that Law"s issues of banknotes had breached the authorized limit, so grounds existed for a prosecution.) The Banque Royale closed its doors.

John Law was an escape artist as well as a con artist. It quickly became apparent that no one but him stood any chance of averting a complete collapse of the financial system - which was, after all, his System. His recall to power (in the less exalted post of Intendant General of Commerce) caused a rally on the stock market, with Mississippi Company shares rising back to 6,350 livres on 6 June. It was, however, only a temporary reprieve. On 10 October the government was forced to reintroduce the use of gold and silver in domestic transactions. The Mississippi share price resumed its downward slide not long after, hitting 2,000 livres in September and 1,000 in December. Full-blown panic could no longer be postponed. It was at this moment that Law, vilified by the people, and lampooned by the press, finally fled the country. He had a "touching farewell" with the Duke of Orleans before he went. "Sire," said Law, "I acknowledge that I have made great mistakes. I made them because I am only human, and all men are liable to err. But I declare that none of these acts proceeded from malice or dishonesty, and that nothing of that character will be discovered in the whole course of my conduct."69 Nevertheless, his wife and daughter were not allowed to leave France so long as he was under investigation. Nevertheless, his wife and daughter were not allowed to leave France so long as he was under investigation.

As if p.r.i.c.ked by a sword, the Mississippi Bubble had now burst, and the noise of escaping air resounded throughout Europe. So incensed was one Dutch investor that he had a series of satirical plates specially commissioned in China. The inscription on one reads: "By G.o.d, all my stock"s worthless!" Another is even more direct: "s.h.i.t shares and wind trade." As far as investors in Amsterdam were concerned, Law"s company had been trading in nothing more substantial than wind - in marked contrast to the Dutch East India Company, which had literally delivered the goods in the form of spices and cloth. As the verses on one satirical Dutch cartoon flysheet put it:

This is the wondrous Mississippi land, Made famous by its share dealings, Which through deceit and devious conduct, Has squandered countless treasures.

However men regard the shares, It is wind and smoke and nothing more.

A series of humorously allegorical engravings were produced and published as The Great Scene of Folly The Great Scene of Folly, which depicted barea.r.s.ed stockbrokers eating coin and excreting Mississippi stock; demented investors running amok in the rue Quincampoix, before being hauled off to the madhouse; and Law himself, blithely pa.s.sing by castles in the air in a carriage pulled by two bedraggled Gallic c.o.c.kerels.70 Law himself did not walk away financially unscathed. He left France with next to nothing, thanks to his bet with Londonderry that English East India stock would fall to 180. By April 1720 the price had risen to 235 and it continued to rise as investors exited the Paris market for what seemed the safer haven of London (then in the grip of its own less spectacular South Sea Bubble). By June the price was at 420, declining only slightly to 345 in August, when Law"s bet fell due. Law"s London banker, George Middleton, was also ruined in his effort to honour his client"s obligation. The losses to France, however, were more than just financial. Law"s bubble and bust fatally set back France"s financial development, putting Frenchmen off paper money and stock markets for generations. The French monarchy"s fiscal crisis went unresolved and for the remainder of the reigns of Louis XV and his successor Louis XVI the crown essentially lived from hand to mouth, lurching from one abortive reform to another until royal bankruptcy finally precipitated revolution. The magnitude of the catastrophe was perhaps best captured by Bernard Picart in his elaborate engraving Monument Consecrated to Posterity Monument Consecrated to Posterity (1721). On the left, penniless Dutch investors troop morosely into the sickhouse, the madhouse and the poorhouse. But the Parisian scene to the right is more apocalyptic. A naked Fortuna rains down Mississippi stock and options on a mob emanating from the rue Quincampoix, while a juggernaut drawn by Indians crushes an accountant under a huge wheel of fortune and two men brawl in the foreground. (1721). On the left, penniless Dutch investors troop morosely into the sickhouse, the madhouse and the poorhouse. But the Parisian scene to the right is more apocalyptic. A naked Fortuna rains down Mississippi stock and options on a mob emanating from the rue Quincampoix, while a juggernaut drawn by Indians crushes an accountant under a huge wheel of fortune and two men brawl in the foreground.71

Brokers turning coin into Mississippi stock and wind: engraving from The Great Scene of Folly The Great Scene of Folly (1720) (1720)

Bernard Picart, Monument Consecrated to Posterity Monument Consecrated to Posterity (1721) (1721) In Britain, by contrast, the contemporaneous South Sea Bubble was significantly smaller and ruined fewer people - not least because the South Sea Company never gained control of the Bank of England the way Law had controlled the Banque Royale. In essence, his English counterpart John Blunt"s South Sea scheme was to convert government debt of various kinds, most of it created to fund the War of the Spanish Succession, into the equity of a company that had been chartered to monopolize trade with the Spanish Empire in South America. Having agreed on conversion prices for the annuities and other debt instruments, the directors of the South Sea Company stood to profit if they could get the existing holders of government annuities to accept South Sea shares at a high market price, since this would leave the directors with surplus shares to sell to the public.72 In this they succeeded, using tricks similar to those employed by Law in Paris. Shares were offered to the public in four tranches, with the price rising from 300 per share in April 1720 to 1,000 in June. Instalment payment was permitted. Loans were offered against shares. Generous dividends were paid. Euphoria duly gave way to mania; as the poet Alexander Pope observed, it was "ignominious (in this Age of Hope and Golden Mountains) not to Venture". In this they succeeded, using tricks similar to those employed by Law in Paris. Shares were offered to the public in four tranches, with the price rising from 300 per share in April 1720 to 1,000 in June. Instalment payment was permitted. Loans were offered against shares. Generous dividends were paid. Euphoria duly gave way to mania; as the poet Alexander Pope observed, it was "ignominious (in this Age of Hope and Golden Mountains) not to Venture".73 Unlike Law, however, Blunt and his a.s.sociates had to contend with compet.i.tion from the Bank of England, which drove up the terms they had to offer the annuitants. Unlike Law, they also had to contend with political opposition in the form of the Whigs in Parliament, which drove up the bribes they had to pay to secure favourable legislation (the Secretary to the Treasury alone made 249,000 from his share options). And, unlike Law, they were unable to establish monopolistic positions on the stock market and the credit market. On the contrary, there was such a rush of new companies - 190 in all - seeking to raise capital in 1720 that the South Sea directors had to get their allies in Parliament to pa.s.s what came to be known as the Bubble Act, designed to restrict new company flotations.x At the same time, when the demand for cash created by the South Sea"s third subscription exceeded the money market"s resources, there was nothing the directors could do to inject additional liquidity; indeed, the South Sea Company"s bank, the Sword Blade Company, ended up failing on 24 September. (Unlike the Bank of England, and unlike the Banque Royale, its notes were not legal tender.) The mania of May and June was followed, after a hiatus of distress in July (when the insiders and foreign speculators took their profits), by panic in August. "Most people thought it wou"d come," lamented the hapless and now poorer Swift, "but no man prepar"d for it; no man consider"d it would come At the same time, when the demand for cash created by the South Sea"s third subscription exceeded the money market"s resources, there was nothing the directors could do to inject additional liquidity; indeed, the South Sea Company"s bank, the Sword Blade Company, ended up failing on 24 September. (Unlike the Bank of England, and unlike the Banque Royale, its notes were not legal tender.) The mania of May and June was followed, after a hiatus of distress in July (when the insiders and foreign speculators took their profits), by panic in August. "Most people thought it wou"d come," lamented the hapless and now poorer Swift, "but no man prepar"d for it; no man consider"d it would come like a Thief in the night like a Thief in the night, exactly as it happens in the case of death."74 Yet the damage caused by the bursting of the bubble was much less fatal than on the other side of the Channel. From par to peak, prices rose by a factor of 9.5 in the case of South Sea stock, compared with 19.6 in the case of Mississippi stock. Other stocks (Bank of England and East India Company) rose by substantially smaller multiples. When stock prices came back down to earth in London, there was no lasting systemic damage to the financial system, aside from the constraint on future joint-stock company formation represented by the Bubble Act. The South Sea Company itself continued to exist; the government debt conversion was not reversed; foreign investors did not turn away from English securities.75 Whereas all France was affected by the inflationary crisis Law had unleashed, provincial England seems to have been little affected by the South Sea crash. Whereas all France was affected by the inflationary crisis Law had unleashed, provincial England seems to have been little affected by the South Sea crash.76 In this tale of two bubbles, it was the French that had the worst of times. In this tale of two bubbles, it was the French that had the worst of times.

Bulls and Bears On 16 October 1929 Yale University economics professor Irving Fisher declared that US stock prices had "reached what looks like a permanently high plateau".77 Eight days later, on "Black Thursday", the Dow Jones Industrial Average declined by 2 per cent. This is when the Wall Street crash is conventionally said to have begun, though in fact the market had been slipping since early September and had already suffered a sharp 6 per cent drop on 23 October. On "Black Monday" (28 October) it plunged by 13 per cent; the next day by a further 12 per cent. In the course of the next three years the US stock market declined a staggering 89 per cent, reaching its nadir in July 1932. The index did not regain its 1929 peak until November 1954. What was worse, this a.s.set price deflation coincided with, if it did not actually cause, the worst depression in all history. In the United States, output collapsed by a third. Unemployment reached a quarter of the civilian labour force, closer to a third if a modern definition is used. It was a global catastrophe that saw prices and output decline in nearly every economy in the world, though only the German slump was as severe as the American. World trade shrank by two thirds as countries sought vainly to hide behind tariff barriers and import quotas. The international financial system fell to pieces in a welter of debt defaults, capital controls and currency depreciations. Only the Soviet Union, with its autarkic, planned economy, was unaffected. Why did it happen? Eight days later, on "Black Thursday", the Dow Jones Industrial Average declined by 2 per cent. This is when the Wall Street crash is conventionally said to have begun, though in fact the market had been slipping since early September and had already suffered a sharp 6 per cent drop on 23 October. On "Black Monday" (28 October) it plunged by 13 per cent; the next day by a further 12 per cent. In the course of the next three years the US stock market declined a staggering 89 per cent, reaching its nadir in July 1932. The index did not regain its 1929 peak until November 1954. What was worse, this a.s.set price deflation coincided with, if it did not actually cause, the worst depression in all history. In the United States, output collapsed by a third. Unemployment reached a quarter of the civilian labour force, closer to a third if a modern definition is used. It was a global catastrophe that saw prices and output decline in nearly every economy in the world, though only the German slump was as severe as the American. World trade shrank by two thirds as countries sought vainly to hide behind tariff barriers and import quotas. The international financial system fell to pieces in a welter of debt defaults, capital controls and currency depreciations. Only the Soviet Union, with its autarkic, planned economy, was unaffected. Why did it happen?

Some financial disasters have obvious causes. Arguably a much worse stock market crash had occurred at the end of July 1914, when the outbreak of the First World War precipitated such a total meltdown that the world"s princ.i.p.al stock markets - including New York"s - simply had to close their doors. And closed they remained from August until the end of 1914.78 But that was the effect of a world war that struck financial markets like a bolt from the blue. But that was the effect of a world war that struck financial markets like a bolt from the blue.79 The crash of October 1929 is much harder to explain. Page 1 of the The crash of October 1929 is much harder to explain. Page 1 of the New York Times New York Times on the day before Black Thursday featured articles about the fall of the French premier Aristide Briand and a vote in the US Senate about duties on imported chemicals. Historians sometimes see the deadlock over Germany"s post-First World War reparations and the increase of American protectionism as triggers of the Depression. But page 1 also features at least four reports on the atrocious gales that had battered the Eastern seaboard the previous day. on the day before Black Thursday featured articles about the fall of the French premier Aristide Briand and a vote in the US Senate about duties on imported chemicals. Historians sometimes see the deadlock over Germany"s post-First World War reparations and the increase of American protectionism as triggers of the Depression. But page 1 also features at least four reports on the atrocious gales that had battered the Eastern seaboard the previous day.80 Maybe historians should blame bad weather for the Wall Street crash. (That might not be such a far-fetched proposition. Many veterans of the City of London still remember that Black Monday - 19 October 1987 - came after the hurricane-force winds that had unexpectedly swept the south-east of England the previous Friday.) Maybe historians should blame bad weather for the Wall Street crash. (That might not be such a far-fetched proposition. Many veterans of the City of London still remember that Black Monday - 19 October 1987 - came after the hurricane-force winds that had unexpectedly swept the south-east of England the previous Friday.) Contemporaries sensed that there was a psychological dimension to the crisis. In his inaugural address, President Franklin Roosevelt argued that all that Americans had to fear was "fear itself". John Maynard Keynes spoke of a "failure in the immaterial devices of the mind". Yet both men also intimated that the crisis was partly due to financial misconduct. Roosevelt took a swipe at "the unscrupulous money changers" of Wall Street; in his General Theory General Theory, Keynes likened the stock market to a casino.

In some measure, it can be argued, the Great Depression had its roots in the global economic dislocations arising from the earlier crisis of 1914. During the First World War, non-European agricultural and industrial production had expanded. When European production came back on stream after the return of peace, there was chronic over-capacity, which had driven down prices of primary products long before 1929. This had made it even harder for countries with large external war debts (including Germany, saddled with reparations) to earn the hard currency they needed to make interest payments to their foreign creditors. The war had also increased the power of organized labour in most combatant countries, making it harder for employers to cut wages in response to price falls. As profit margins were squeezed by rising real wages, firms were forced to lay off workers or risk going bust. Nevertheless, the fact remains that the United States, which was the epicentre of the crisis, was in many respects in fine economic fettle when the Depression struck. There was no shortage of productivity-enhancing technological innovation in the inter-war period by companies like DuPont (nylon), Procter & Gamble (soap powder), Revlon (cosmetics), RCA (radio) and IBM (accounting machines). "A prime reason for expecting future earnings to be greater," argued Yale"s Irving Fisher, "was that we in America were applying science and invention to industry as we had never applied them before."81 Management practices were also being revolutionized by men like Alfred Sloan at General Motors. Management practices were also being revolutionized by men like Alfred Sloan at General Motors.

Yet precisely these strengths may have provided the initial displacement that set in motion a cla.s.sic stock market bubble. To observers like Fisher, it really did seem as if the sky was the limit, as more and more American households aspired to equip themselves with automobiles and consumer durables - products which instalment credit put within their reach. RCA, the tech stock of the 1920s, rose by a dizzying 939 per cent between 1925 and 1929; its price-earnings ratio at the peak of the market was 73.82 Euphoria encouraged a rush of new initial public offerings (IPOs); stock worth $6 billion was issued in 1929, one sixth of it during September. There was a proliferation of new financial inst.i.tutions known as investment trusts, designed to capitalize on the stock market boom. (Goldman Sachs chose 8 August 1929 to announce its own expansion plan, in the form of the Goldman Sachs Trading Corporation; had this not been a free-standing ent.i.ty, its subsequent collapse might well have taken down Goldman Sachs itself.) At the same time, many small investors (like Irving Fisher himself) relied on leverage to increase their stock market exposure, using brokers" loans (which were often supplied by corporations rather than banks) to buy stocks on margin, thus paying only a fraction of the purchase price with their own money. As in 1719, so in 1929, there were unscrupulous insiders, like Charles E. Mitch.e.l.l of National City Bank or William c.r.a.po Durant of GM, and ingenuous outsiders, like Groucho Marx. Euphoria encouraged a rush of new initial public offerings (IPOs); stock worth $6 billion was issued in 1929, one sixth of it during September. There was a proliferation of new financial inst.i.tutions known as investment trusts, designed to capitalize on the stock market boom. (Goldman Sachs chose 8 August 1929 to announce its own expansion plan, in the form of the Goldman Sachs Trading Corporation; had this not been a free-standing ent.i.ty, its subsequent collapse might well have taken down Goldman Sachs itself.) At the same time, many small investors (like Irving Fisher himself) relied on leverage to increase their stock market exposure, using brokers" loans (which were often supplied by corporations rather than banks) to buy stocks on margin, thus paying only a fraction of the purchase price with their own money. As in 1719, so in 1929, there were unscrupulous insiders, like Charles E. Mitch.e.l.l of National City Bank or William c.r.a.po Durant of GM, and ingenuous outsiders, like Groucho Marx.83 As in 1719, flows of hot money between financial markets served to magnify and transmit shocks. And, as in 1719, it was the action of the monetary authorities that determined the magnitude of the bubble and of the consequences when it burst. As in 1719, flows of hot money between financial markets served to magnify and transmit shocks. And, as in 1719, it was the action of the monetary authorities that determined the magnitude of the bubble and of the consequences when it burst.

In perhaps the most important work of American economic history ever published, Milton Friedman and Anna Schwartz argued that it was the Federal Reserve System that bore the primary responsibility for turning the crisis of 1929 into a Great Depression.84 They did not blame the Fed for the bubble itself, arguing that with Benjamin Strong at the Federal Reserve Bank of New York a reasonable balance had been struck between the international obligation of the United States to maintain the restored gold standard and its domestic obligation to maintain price stability. By sterilizing the large gold inflows to the United States (preventing them for generating monetary expansion), the Fed may indeed have prevented the bubble from growing even larger. The New York Fed also responded effectively to the October 1929 panic by conducting large-scale (and unauthorized) open market operations (buying bonds from the financial sector) to inject liquidity into the market. However, after Strong"s death from tuberculosis in October 1928, the Federal Reserve Board in Washington came to dominate monetary policy, with disastrous results. First, too little was done to counteract the credit contraction caused by banking failures. This problem had already surfaced several months before the stock market crash, when commercial banks with deposits of more than $80 million suspended payments. However, it reached critical ma.s.s in November and December 1930, when 608 banks failed, with deposits totalling $550 million, among them the Bank of United States, which accounted for more than a third of the total deposits lost. The failure of merger talks that might have saved the Bank was a critical moment in the history of the Depression. They did not blame the Fed for the bubble itself, arguing that with Benjamin Strong at the Federal Reserve Bank of New York a reasonable balance had been struck between the international obligation of the United States to maintain the restored gold standard and its domestic obligation to maintain price stability. By sterilizing the large gold inflows to the United States (preventing them for generating monetary expansion), the Fed may indeed have prevented the bubble from growing even larger. The New York Fed also responded effectively to the October 1929 panic by conducting large-scale (and unauthorized) open market operations (buying bonds from the financial sector) to inject liquidity into the market. However, after Strong"s death from tuberculosis in October 1928, the Federal Reserve Board in Washington came to dominate monetary policy, with disastrous results. First, too little was done to counteract the credit contraction caused by banking failures. This problem had already surfaced several months before the stock market crash, when commercial banks with deposits of more than $80 million suspended payments. However, it reached critical ma.s.s in November and December 1930, when 608 banks failed, with deposits totalling $550 million, among them the Bank of United States, which accounted for more than a third of the total deposits lost. The failure of merger talks that might have saved the Bank was a critical moment in the history of the Depression.85 Secondly, under the pre-1913 system, before the Fed had been created, a crisis of this sort would have triggered a restriction of convertibility of bank deposits into gold. However, the Fed made matters worse by reducing the amount of credit outstanding (December 1930-April 1931). This forced more and more banks to sell a.s.sets in a frantic dash for liquidity, driving down bond prices and worsening the general position. The next wave of bank failures, between February and August 1931, saw commercial bank deposits fall by $2.7 billion, 9 per cent of the total. Secondly, under the pre-1913 system, before the Fed had been created, a crisis of this sort would have triggered a restriction of convertibility of bank deposits into gold. However, the Fed made matters worse by reducing the amount of credit outstanding (December 1930-April 1931). This forced more and more banks to sell a.s.sets in a frantic dash for liquidity, driving down bond prices and worsening the general position. The next wave of bank failures, between February and August 1931, saw commercial bank deposits fall by $2.7 billion, 9 per cent of the total.86 Thirdly, when Britain abandoned the gold standard in September 1931, precipitating a rush by foreign banks to convert dollar holdings into gold, the Fed raised its discount rate in two steps to 3.5 per cent. This halted the external drain, but drove yet more US banks over the edge: the period August 1931 to January 1932 saw 1,860 banks fail with deposits of $1.45 billion. Thirdly, when Britain abandoned the gold standard in September 1931, precipitating a rush by foreign banks to convert dollar holdings into gold, the Fed raised its discount rate in two steps to 3.5 per cent. This halted the external drain, but drove yet more US banks over the edge: the period August 1931 to January 1932 saw 1,860 banks fail with deposits of $1.45 billion.87 Yet the Fed was in no danger of running out of gold. On the eve of the pound"s departure the US gold stock was at an all-time high of $4.7 billion - 40 per cent of the world"s total. Even at its lowest point that October, the Fed"s gold reserves exceeded its legal requirements for cover by more than $1 billion. Yet the Fed was in no danger of running out of gold. On the eve of the pound"s departure the US gold stock was at an all-time high of $4.7 billion - 40 per cent of the world"s total. Even at its lowest point that October, the Fed"s gold reserves exceeded its legal requirements for cover by more than $1 billion.88 Fourthly, only in April 1932, as a result of ma.s.sive political pressure, did the Fed attempt large-scale open market operations, the first serious step it had taken to counter the liquidity crisis. Even this did not suffice to avert a final wave of bank failures in the last quarter of 1932, which precipitated the first state-wide "bank holidays", temporary closures of all banks. Fourthly, only in April 1932, as a result of ma.s.sive political pressure, did the Fed attempt large-scale open market operations, the first serious step it had taken to counter the liquidity crisis. Even this did not suffice to avert a final wave of bank failures in the last quarter of 1932, which precipitated the first state-wide "bank holidays", temporary closures of all banks.89 Fifthly, when rumours that the new Roosevelt administration would devalue the dollar led to a renewed domestic and foreign flight from dollars into gold, the Fed once again raised the discount rate, setting the scene for the nationwide bank holiday proclaimed by Roosevelt on 6 March 1933, two days after his inauguration - a holiday from which 2,000 banks never returned. Fifthly, when rumours that the new Roosevelt administration would devalue the dollar led to a renewed domestic and foreign flight from dollars into gold, the Fed once again raised the discount rate, setting the scene for the nationwide bank holiday proclaimed by Roosevelt on 6 March 1933, two days after his inauguration - a holiday from which 2,000 banks never returned.90 The Fed"s inability to avert a total of around 10,000 bank failures was crucial not just because of the shock to consumers whose deposits were lost or to shareholders whose equity was lost, but because of the broader effect on the money supply and the volume of credit. Between 1929 and 1933, the public succeeded in increasing its cash holdings by 31 per cent; commercial bank reserves were scarcely altered (indeed, surviving banks built up excess reserves); but commercial bank deposits decreased by 37 per cent and loans by 47 per cent. The absolute numbers reveal the lethal dynamic of the "great contraction". An increase of cash in public hands of $1.2 billion was achieved at the cost of a decline in bank deposits of $15.6 billion and a decline in bank loans of $19.6 billion, equivalent to 19 per cent of 1929 GDP.91 There was a time when academic historians felt squeamish about claiming that lessons could be learned from history. This is a feeling unknown to economists, two generations of whom have struggled to explain the Great Depression precisely in order to avoid its recurrence. Of all the lessons to have emerged from this collective effort, this remains the most important: that inept or inflexible monetary policy in the wake of a sharp decline in a.s.set prices can turn a correction into a recession and a recession into a depression. According to Friedman and Schwartz, the Fed should have aggressively sought to inject liquidity into the banking system from 1929 onwards, using open market operations on a large scale, and expanding rather than contracting lending through the discount window. They also suggest that less attention should have been paid to gold outflows. More recently, it has been argued that the inter-war gold standard itself was the problem, in that it transmitted crises (like the 1931 European bank and currency crises) around the world.92 A second lesson of history would therefore seem to be that the benefits of a stable exchange rate are not so great as to exceed the costs of domestic deflation. Anyone who today doubts that there are lessons to be learned from history needs do no more than compare the academic writings and recent actions of the current chairman of the Federal Reserve System. A second lesson of history would therefore seem to be that the benefits of a stable exchange rate are not so great as to exceed the costs of domestic deflation. Anyone who today doubts that there are lessons to be learned from history needs do no more than compare the academic writings and recent actions of the current chairman of the Federal Reserve System.93 A Tale of Fat Tails Sometimes the most important historical events are the non-events: the things that did not occur. The economist Hyman Minsky put it well when he observed: "The most significant economic event of the era since World War II is something that has not happened: there has not been a deep and long-lasting depression".94 This is indeed surprising, since the world has not been short of "Black Days". This is indeed surprising, since the world has not been short of "Black Days".

If movements in stock market indices were statistically distributed like human heights there would hardly be any such days. Most would be cl.u.s.tered around the average, with only a tiny number of extreme ups or downs. After all, not many of us are below four feet in height or above eight feet. If I drew a histogram of the heights of the male students in my financial history cla.s.s according to their frequency, the result would be a cla.s.sic bell-shaped curve, with nearly everyone cl.u.s.tered within around five inches of the US average of around 5" 10". But in financial markets, it doesn"t look like this. If you plot all the monthly movements of the Dow Jones index on a chart, there is much less cl.u.s.tering around the average, and there are many more big rises and falls out at the extremes, which the statisticians call "fat tails". If stock market movements followed the "normal distribution" or bell curve, like human heights, an annual drop of 10 per cent or more would happen only once every 500 years, whereas on the Dow Jones it has happened about once every five years.95 And stock market plunges of 20 per cent or more would be unheard of - rather like people just a foot tall - whereas in fact there have been nine such crashes in the past century. And stock market plunges of 20 per cent or more would be unheard of - rather like people just a foot tall - whereas in fact there have been nine such crashes in the past century.

On "Black Monday", 19 October 1987, the Dow fell by a terrifying 23 per cent, one of just four days when the index has fallen by more than 10 per cent in a single trading session. The New York Times New York Times"s front page the next morning said it all when it asked "Does 1987 Equal 1929?" From peak to trough, the fall was of nearly one third, a loss in the value of American stocks of close to a trillion dollars. The causes of the crash were much debated at the time. True, the Fed had raised rates the previous month from 5.5 to 6 per cent. But the official task force chaired by Nicholas Brady laid much of the blame for the crash on "mechanical, price-insensitive selling by a [small] number of inst.i.tutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions", as well as "a number of aggressive trading-oriented inst.i.tutions [which tried] to sell in antic.i.p.ation of further market declines". Matters were made worse by a breakdown in the New York Stock Exchange"s automated transaction system, and by the lack of "circuit breakers" which might have interrupted the sell-off on the futures and options markets.96 The remarkable thing, however, was what happened next - or rather, what didn"t happen. There was no Great Depression of the 1990s, despite the forebodings of Lord Rees-Mogg and others. The remarkable thing, however, was what happened next - or rather, what didn"t happen. There was no Great Depression of the 1990s, despite the forebodings of Lord Rees-Mogg and others.97 There wasn"t even a recession in 1988 (only a modest one in 1990-91). Within little more than a year of Black Monday, the Dow was back to where it had been before the crash. For this, some credit must unquestionably be given to the central bankers, and particularly the then novice Federal Reserve Chairman Alan Greenspan, who had taken over from Paul Volcker just two months before. Greenspan"s response to the Black Monday crash was swift and effective. His terse statement on 20 October, affirming the Fed"s "readiness to serve as a source of liquidity to support the economic and financial system", sent a signal to the markets, and particularly the New York banks, that if things got really bad he stood ready to bail them out. There wasn"t even a recession in 1988 (only a modest one in 1990-91). Within little more than a year of Black Monday, the Dow was back to where it had been before the crash. For this, some credit must unquestionably be given to the central bankers, and particularly the then novice Federal Reserve Chairman Alan Greenspan, who had taken over from Paul Volcker just two months before. Greenspan"s response to the Black Monday crash was swift and effective. His terse statement on 20 October, affirming the Fed"s "readiness to serve as a source of liquidity to support the economic and financial system", sent a signal to the markets, and particularly the New York banks, that if things got really bad he stood ready to bail them out.98 Aggressively buying government bonds in the open market, the Fed injected badly needed cash into the system, pushing down the cost of borrowing from the Fed by nearly 2 per cent in the s.p.a.ce of sixteen days. Wall Street breathed again. What Minsky called "It" had not happened. Aggressively buying government bonds in the open market, the Fed injected badly needed cash into the system, pushing down the cost of borrowing from the Fed by nearly 2 per cent in the s.p.a.ce of sixteen days. Wall Street breathed again. What Minsky called "It" had not happened.

Having contained a panic once, the dilemma that lurked in the back of Greenspan"s mind thereafter was whether or not to act pre-emptively the next time - to prevent the panic altogether. This dilemma came to the fore as a cla.s.sic stock market bubble took shape in the mid 1990s. The displacement in this case was the explosion of innovation by the technology and software industry as personal computers met the Internet. But, as in all history"s bubbles, an accommodative monetary policy also played a role. From a peak of 6 per cent in June 1995, the Federal funds target ratey had been reduced to 5.25 per cent (January 1996-February 1997). It had been raised to 5.5 per cent in March 1997, but then cut in steps between September and November 1998 down to 4.75 per cent; and it remained at that level until May 1999, by which time the Dow had pa.s.sed the 10,000 mark. Rates were not raised until June 1999. had been reduced to 5.25 per cent (January 1996-February 1997). It had been raised to 5.5 per cent in March 1997, but then cut in steps between September and November 1998 down to 4.75 per cent; and it remained at that level until May 1999, by which time the Dow had pa.s.sed the 10,000 mark. Rates were not raised until June 1999.

Why did the Fed allow euphoria to run loose in the 1990s? Greenspan himself had felt constrained to warn about "irrational exuberance" on the stock market as early as 5 December 1996, shortly after the Dow had risen above 6,000.z Yet the quarter point rate increase of March 1997 was scarcely sufficient to dispel that exuberance. Partly, Greenspan and his colleagues seem to have underestimated the momentum of the technology bubble. As early as December 1995, with the Dow just past the 5,000 mark, members of the Fed"s Open Market Committee speculated that the market might be approaching its peak. Yet the quarter point rate increase of March 1997 was scarcely sufficient to dispel that exuberance. Partly, Greenspan and his colleagues seem to have underestimated the momentum of the technology bubble. As early as December 1995, with the Dow just past the 5,000 mark, members of the Fed"s Open Market Committee speculated that the market might be approaching its peak.99 Partly, it was because Greenspan felt it was not for the Fed to worry about a.s.set price inflation, only consumer price inflation; and this, he believed, was being reduced by a major improvement in productivity due precisely to the tech boom. Partly, it was because Greenspan felt it was not for the Fed to worry about a.s.set price inflation, only consumer price inflation; and this, he believed, was being reduced by a major improvement in productivity due precisely to the tech boom. 100 100 Partly, as so often happens in stock market bubbles, it was because international pressures - in this case, the crisis precipitated by the Russian debt default of August 1998 - required contrary action. Partly, as so often happens in stock market bubbles, it was because international pressures - in this case, the crisis precipitated by the Russian debt default of August 1998 - required contrary action.101 Partly, it was because Greenspan and his colleagues no longer believed it was the role of the Fed to remove the punchbowl from the party, in the phrase of his precursor but three, William McChesney Martin, Jr. Partly, it was because Greenspan and his colleagues no longer believed it was the role of the Fed to remove the punchbowl from the party, in the phrase of his precursor but three, William McChesney Martin, Jr.102 To give Greenspan his due, his "just-in-time monetary policy" certainly averted a stock market crash. Not only were the 1930s averted; so too was a repeat of the j.a.panese experience, when a conscious effort by the central bank to p.r.i.c.k an a.s.set bubble ended up triggering an 80 per cent stock market sell-off and a decade of economic stagnation. But there was a price to pay for this strategy. Not for the first time in stock market history, an a.s.set-price bubble created the perfect conditions for malfeasance as well as exuberance. To give Greenspan his due, his "just-in-time monetary policy" certainly averted a stock market crash. Not only were the 1930s averted; so too was a repeat of the j.a.panese experience, when a conscious effort by the central bank to p.r.i.c.k an a.s.set bubble ended up triggering an 80 per cent stock market sell-off and a decade of economic stagnation. But there was a price to pay for this strategy. Not for the first time in stock market history, an a.s.set-price bubble created the perfect conditions for malfeasance as well as exuberance.

The nineties seemed to some nervous observers uncannily like a re-run of the Roaring Twenties; and indeed the trajectory of the stock market in the 1990s was almost identical to that of the 1920s. Yet in some ways it was more like a rerun of the 1720s. What John Law"s Mississippi Company had been to the bubble that launched the eighteenth century, so another company would be to the bubble that ended the twentieth. It was a company that promised its investors wealth beyond their wildest imaginings. It was a company that claimed to have reinvented the entire financial system. And it was a company that took full advantage of its impeccable political connections to ride all the way to the top of the bull market. Named by Fortune Fortune magazine as America"s Most Innovative Company for six consecutive years (1996-2001), that company was Enron. magazine as America"s Most Innovative Company for six consecutive years (1996-2001), that company was Enron.

In November 2001, Alan Greenspan received a prestigious award, adding his name to a roll of honour that included Mikhail Gorbachev, Colin Powell and Nelson Mandela. The award was the Enron Prize for Distinguished Public Service. Greenspan had certainly earned his accolade. From February 1995 until June 1999 he had raised US interest rates only once. Traders had begun to speak of the "Greenspan put" because having him at the Fed was like having a "put" option on the stock market (an option but not an obligation to sell stocks at a good price in the future). Since the middle of January 2000, however, the US stock market had been plummeting, belatedly vindicating Greenspan"s earlier warnings about irrational exuberance. There was no one Black Day, as in 1987. Indeed, as the Fed slashed rates, from 6.5 per cent down in steps to 3.5 per cent by August 2001, the economy looked like having a soft landing; at worst a very short recession. And then, quite without warning, a Black Day did dawn in New York - in the form not of a financial crash but of two deliberate plane crashes. Amid talk of war and fears of a 1914-style market shutdown, Greenspan slashed rates again, from 3.5 per cent to 3 per cent and then on down - and down - to an all-time low of 1 per cent in June 2003. More liquidity was pumped out by the Fed after 9/11 than by all the fire engines in Manhattan. But it could not save Enron. On 2 December 2001, just two weeks after Greenspan collected his Enron award, the company filed for bankruptcy.

The resemblances between the careers of John Law, perpetrator of the Mississippi bubble, and Kenneth Lay, chief executive of Enron, are striking, to say the least. John Law"s philosopher"s stone had allowed him "to make gold out of paper". Ken Lay"s equivalent was "to make gold out of gas". Law"s plan had been to revolutionize French government finance. Lay"s was to revolutionize the global energy business. For years the industry had been dominated by huge utility companies that both physically provided the energy - pumped the gas and generated the electricity - and sold it on to consumers. Lay"s big idea, supplied by McKinsey consultant Jeffrey K. Skilling, was to create a kind of Energy Bank, which would act as the intermediary between suppliers and consumers.103 Like Law, Lay, the son of a poor Missouri preacher, had provincial beginnings - as did Enron, originally a small gas company in Omaha, Nebraska. It was Lay who renamed the company Like Law, Lay, the son of a poor Missouri preacher, had provincial beginnings - as did Enron, originally a small gas company in Omaha, Nebraska. It was Lay who renamed the companyaa and relocated its headquarters to Houston, Texas. Like Law, too, Lay had friends in high places. Himself a long-time ally of the Texan energy industry, President George H. W. Bush supported legislation in 1992 that deregulated the industry and removed government price controls. Around three quarters of Enron"s $6.6 million in political contributions went to the Republican Party, including $355,000 from Lay and his wife in the 2000 election. Senator Phil Gramm was Enron"s second-largest recipient of campaign contributions in 1996, and a strong proponent of Californian energy deregulation. and relocated its headquarters to Houston, Texas. Like Law, too, Lay had friends in high places. Himself a long-time ally of the Texan energy industry, President George H. W. Bush supported legislation in 1992 that deregulated the industry and removed government price controls. Around three quarters of Enron"s $6.6 million in political contributions went to the Republican Party, including $355,000 from Lay and his wife in the 2000 election. Senator Phil Gramm was Enron"s second-largest recipient of campaign contributions in 1996, and a strong proponent of Californian energy deregulation.

Alan Greenspan and Kenneth Lay By the end of 2000, Enron was America"s fourth-largest company, employing around 21,000 people. It controlled a quarter of the US natural gas business. Riding a global wave of energy sector privatization, the company snapped up a.s.sets all over the world. In Latin America alone the company had interests in Colombia, Ecuador, Peru and Bolivia, from where Enron laid its pipeline across the continent to Brazil. In Argentina, following the intervention of Lay"s personal friend George W. Bush, Enron bought a controlling stake in the largest natural gas pipeline network in the world. Above all, however, Enron traded, not only in energy but in virtually all the ancient elements of earth, water, fire and air. It even claimed that it could trade in Internet bandwidth. In a scene straight out of The Sting The Sting, bank a.n.a.lysts were escorted through fake trading floors where employees sat in front of computers pretending to do broadband deals. It was the Mississippi Company all over again. And, just as in 1719, the rewards to investors seemed irresistible. In the three years after 1997, Enron"s stock price increased by a factor of nearly five, from less than $20 a share to more than $90. For Enron executives, who were generously "incentivized" with share options, the rewards were greater still. In the final year of its existence Enron paid its top 140 executives an average of $5.3 million each. Luxury car sales went through the roof. So did properties in River Oaks, Houston"s most exclusive neighbourhood. "I"ve thought about this a lot," remarked Skilling, who became Enron chief operating officer in 1997, "and all that matters is money . . . You buy loyalty with money. This touchy-feely stuff isn"t as important as cash. That"s what drives performance."104 "You got multiples of your annual base pay at Enron," Sherron Watkins recalled when I met her outside the now defunct Enron headquarters in Houston. "You were really less thought of if you got a percentage, even if it was 75 per cent of your annual base pay. Oh, you were getting a percentage. You wanted multiples. You wanted two times your annual base pay, three times, four times your annual base pay, as a bonus." "You got multiples of your annual base pay at Enron," Sherron Watkins recalled when I met her outside the now defunct Enron headquarters in Houston. "You were really less thought of if you got a percentage, even if it was 75 per cent of your annual base pay. Oh, you were getting a percentage. You wanted multiples. You wanted two times your annual base pay, three times, four times your annual base pay, as a bonus."105 In the euphoria of April 1999, the Houston Astros even renamed their ballpark Enron Field. In the euphoria of April 1999, the Houston Astros even renamed their ballpark Enron Field.

The only problem was that, like John Law"s System, the Enron "System" was an elaborate fraud, based on market manipulation and cooked books. In tapes that became public in 2004, Enron traders can be heard asking the El Paso Electric Company to shut down production in order to maintain prices. Another exchange concerns "all the money you guys stole from those poor grand-mothers of California". The results of such machinations were not only the higher prices Enron wanted, but also blackouts for consumers. In the s.p.a.ce of just six months after the deregulation law came into effect, California experienced no fewer than thirty-eight rolling blackouts. (In another tape, traders watching television reports of Californian forest fires shout "Burn, baby, burn!" as electricity pylons buckle and fall.) Even with such market-rigging, the company"s stated a.s.sets and profits were vastly inflated, while its debts and losses were concealed in so-called special-purpose ent.i.ties (SPEs) which were not included in the company"s consolidated statements. Each quarter the company"s executives had to use more smoke and more mirrors to make actual losses look like b.u.mper profits. Skilling had risen to the top by exploiting new financial techniques like mark-to-market accounting and debt securitization. But not even chief finance officer Andrew Fastow could ma.s.sage losses into profits indefinitely, especially as he was now using SPEs like the aptly named Chewco Investments to line his and other executives" pockets. Enron"s international business, in particular, was haemorrhaging money by the mid 1990s, most spectacularly after the cancellation of a major power generation project in the Indian state of Maharashtra. EnronOnline, the first web-based commodity-trading system, had a high turnover; but did it make any money? In Houston, the euphoria was fading; the insiders were feeling the first symptoms of distress. Fastow"s SPEs were being given increasingly ominous names: Raptor I, Talon. He and others surrept.i.tiously unloaded $924 million of Enron shares while the going was good.

Investors had been a.s.sured that Enron"s stock price would soon hit $100. When (for "personal reasons") Skilling unexpectedly announced his resignation on 14 August 2001, however, the price tumbled to below $40. That same month, Sherron Watkins wrote to Lay to express her fear that Enron would "implode in a wave of accounting scandals". This was precisely what happened. On 16 October Enron reported a $618 million third-quarter loss and a $1.2 billion reduction in shareholder equity. Eight days later, with a Securities and Exchange Commission inquiry pending, Fastow stepped down as CFO. On 8 November the company was obliged to revise its profits for the preceding five years; the overstatement was revealed to be $567 million. When Enron filed for bankruptcy on 2 December, it was revealed that the audited balance sheet had understated the company"s long-term debt by $25 billion: it was in fact not $13 billion but $38 billion. By now, distress had turned to revulsion; and panic was hard on its heels. By the end of 2001 Enron shares were worth just 30 cents.

In May 2006 Lay was found guilty of all ten of the charges against him, including conspiracy, false statements, securities fraud and bank fraud. Skilling was found guilty on 18 out of 27 counts. Lay died before sentencing while on holiday in Aspen, Colorado. Skilling was sentenced to 24 years and 4 months in prison and ordered to repay $26 million to the Enron pension fund; an appeal is pending. All told, sixteen people pled guilty to Enron-related charges and five others (so far) have been found guilty at trial. The firm"s auditors, Arthur Andersen, were destroyed by the scandal. The princ.i.p.al losers, however, were the ordinary employees and small shareholders whose savings went up in smoke, turned into mere "wind", just like the millions of livres lost in the Mississippi crash.

Invented almost exactly four hundred years ago, the joint-stock, limited-liability company is indeed a miraculous inst.i.tution, as is the stock market where its ownership can be bought and sold. And yet throughout financial history there have been crooked companies, just as there have been irrational markets. Indeed the two go hand in hand - for it is when the bulls are stampeding most enthusiastically that people are most likely to get taken for the proverbial ride. A crucial role, however, is nearly always played by central bankers, who are supposed to be the cowboys in control of the herd. Clearly, without his Banque Royale, Law could never have achieved what he did. Equally clearly, without the loose money policy of the Federal Reserve in the 1990s, Ken Lay and Jeff Skilling would have struggled to crank up the price of Enron stock to $90. By contrast, the Great Depression offers a searing lesson in the dangers of excessively restrictive monetary policy during a stock market crash. Avoiding a repeat of the Great Depression is sometimes seen as an end that justifies any means. Yet the history of the Dutch East India Company, the original joint-stock company, shows that, with sound money of the sort provided by the Amsterdam Exchange Bank, stock market bubbles and busts can be avoided.

In the end, the path of financial markets can never be as smooth as we might like. So long as human expectations of the future veer from the over-optimistic

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