Do the Ends Justify the Means?

by Inya Ivkovic, MA

When the market collapsed in 1929, Ferdinand Pecora, the then Assistant District Attorney of New York, was given the thankless job of investigating what caused the world to turn topsy-turvy in the years preceding the Great Crash. He spent a year on rather sensationalistic hearings, trying to unearth the roots of Wall Street’s problems so many decades ago.

What he discovered were scandals, in abundance, which led eventually to the creation of the Securities and Exchange Commission (SEC) and the passage of the “Glass-Steagall Act,” which, in effect, split commercial and investment banking and spawned the introduction of the “Securities Act of 1933.” Now, there is talk at the highest of places of invoking something similar: a wide-sweeping congressional inquiry into Wall Street’s newest shenanigans, using Pecora’s investigative model from 1930s. But before both Congress and Wall Street embark on this journey of revelation and self-flagellation, respectively, it might be prudent to actually read some of the things that the Pecora Commission concluded back in 1934.

Apparently, Wall Street hasn’t gotten that much more creative compared to some eight decades ago. Many of the machinations that Pecora had discovered are eerily similar to how the Treasury is trying to unwind and revive the troubled financial industry. An excellent example could be the 1920s scheme called a “pool,” which, back then, was the prime way to engage in price manipulations on the NYSE.


A 1920s pool was an agreement among several parties to trade actively in a single security. As Pecora defined it, the idea was “to raise the price of a security by concerted activity on the part of the pool members and to unload their holdings at a profit upon the public attracted by the activity or by information disseminated about the stock.” In other words, it sounded like a classic “pump and dump” scheme.

Granted, even then, bankers acknowledged that there were “good” pools and “bad” pools, obviously hinting at the best and the worst of intentions of a pool’s participants. The good kinds of pools were intended to stabilize a security’s price, acting almost as self-appointed arbitrageurs; whereas bad pool participants were labeled as nothing more than crooks looking into making a quick buck.

But Pecora wasn’t convinced, not by a long shot. He said that, “In all cases, fictitious activity is intentionally created, and the purchaser is deceived by an appearance of genuine demand for the security. Motive furnishes no justification for the employment of manipulative devices.” In other words, such instruments were not promoters of free markets, but testers of boundaries, looking for vulnerabilities, wondering how far the law would go before breaking.

Fast-forwarding to today, Treasury Secretary Geithner has proposed recently to help the financial industry by taking toxic loans and mortgage-backed securities off the balance sheets of many financial institutions. Under the Treasury’s Public-Private Investment Program, the size of which could easily balloon to $1.0 trillion, the government would act as a side-by-side investor with the private sector: it would bid on those toxic assets and, in effect, act the same way as a 1920s pool, creating a market and a price for something that should have been written off as a loss and/or paid for long time ago. But failure is not the operative word at the moment. Instead, the Treasury plans on driving up the prices and on artificially creating interest in trading in these securities.

As was the case with any 1920s pool, the fundamental flaw of the Treasury’s program is the fact that it promotes purposeful collusion among participants of the program. The government-financed leverage is a huge incentive for the program’s participants to conspire to achieve the best possible prices for them, but at the expense of the taxpayer. Making the matter more dubious is the fact that the Treasury has yet to provide oversight, to untangle all potential instances of conflict of interest, and to formulate proper disclosures for private investors and taxpayers.

At the moment, the Treasury’s biggest argument is that toxic assets are artificially priced at far too low levels to represent any real threat for price pumping. But if this premise proves wrong, the Public-Private Investment Program could end up being nothing more than a government-sponsored, obscured in legalese, and rather elaborate pump and dump scheme, with only one difference from the 1920s grand scheme — this time it won’t be the gullible investors who at least had choice. No, this time it will be taxpayers, who have had neither a choice nor a chance, who will be left to pick up the tab. For some reason, if Pecora could see what has been going on lately, I don’t think he would be impressed.