The Corporate Giants We Love to Hate Have Shrugged It Off Before

By Charles R. Geisst
Sunday, March 22, 2009

In the 1930s, the term "public enemy" was reserved for gangsters and bootleggers. Today, we have a new breed: the financiers. And no one fits the current definition better than American International Group Inc., better known to us all as AIG.

Insurers aren't supposed to play the villain. They're usually known as conservative, helping businesses and individuals manage risk. Yet it was AIG's risk management that helped create the current crisis, which shows no signs of ending. And last week's revelation that the unit's employees were being paid enormous bonuses was the straw that broke the taxpayers' back.

The public outcry is clear and vocal but it's not exactly new. Americans have gotten righteously indignant at corporate behemoths when they've misbehaved many times before. But then what? Whether or not AIG has to return those bonuses, would you buy a policy from the company? Can these firms rebound from being public enemy No. 1? Usually, the answer is yes.

In the 19th century, the railroads controlled by Commodore Vanderbilt and Jay Gould easily fit the bill as rogue companies. Using them as piggybanks, the owners almost bankrupted them more than once. The men's financial shenanigans became legendary, and investors were so badly hurt that one of the companies actually paid no dividend on its common stock until well into the 20th century. In the 1860s, New York state regulators required the railroads' annual reports to state how many fatal accidents they'd had during the previous year.

Nevertheless, they continued to attract passengers. They had a stranglehold on their businesses and customers had little choice but to continue using them. In fact, that control of the market was part of the problem. When a company's franchise becomes so entrenched, misconduct almost invariably follows. These problems almost always occur during bull markets. When the background turns green, nearly everyone becomes temporarily colorblind.

But, as we're seeing today, green quickly turns to red when markets go sour. Citibank's problems rankled the public and everyone on Wall Street when it became clear that the country's largest bank had dug itself an inescapable hole. The bank that was too big to fail became a ward of the government and had to scale down its activities to survive. But Citi has some experience bouncing back from low public opinion. In the early 1930s, the National City Bank was widely condemned by all, including Franklin D. Roosevelt and Congress, for having helped create the Crash of 1929 and the Depression that followed. Its president was fired and new banking laws were enacted to protect the financial system and the public. But the bank, today Citibank, survived and prospered. Its former president spent the rest of his working days overseeing a well-known brokerage house.

Similarly, the president of the Chase National Bank (today JP Morgan Chase) speculated in his own company's stock in the early 1930s. He actually sold the stock short, later explaining that he was helping stabilize it because the price was too high. These revelations occurred when the unemployment rate was approaching 25 percent and the stock market was in serious trouble. And yet the bank survived to see many more prosperous years. Savers and investors either were uninformed about the problem or were indifferent to it.

Not everyone comes back from the brink. The largest bank failure in the country in the early 1930s was the Bank of United States, located in New York City. It preyed on immigrants and used their savings to speculate in the stock market. Today, we would say that it behaved like a hedge fund, borrowing vast sums to invest in risky assets. After the smoke cleared, the bank was gone. The scandal prompted Congress to create the Federal Deposit Insurance Corp.

Years later, when junk bonds captured public attention in the 1980s, the securities house that created them -- Drexel Burnham Lambert -- was the toast of Wall Street. But the savings and loan crisis of the late 1980s caused a record number of bond defaults, and within two years, regulators shuttered the firm. It survived in a much smaller form with a limited franchise. Its demise was a testament to the hubris of the 1980s bull market.

For companies in these circumstances, it may turn out that any press is good press. The government bailouts of Chrysler and Lockheed more than 20 years ago did not deter customers from using their products. Both rebounded from those problems to survive, although Chrysler's fate is, of course, once again uncertain.

The history of these fiascos suggests that AIG will survive the bad publicity, unless the current populist uproar continues for longer than expected. Of course, it might not be called AIG when the furor subsides. "I think the AIG name is so thoroughly wounded and disgraced that we're probably going to have to change it," AIG chief executive Edward M. Liddy said in congressional testimony last week.

A cynical interpretation of the bonus mess at Merrill Lynch and AIG suggests that both companies already knew the history and precedents of the problem they were creating and proceeded to grant those bonuses anyway. Financial firms actually know more of their industry's history than their actions might suggest. Whether that history will repeat itself is the only remaining question.

Charles R. Geisst is the author of "Wall Street: A History" and the forthcoming "Collateral Damaged: The Marketing of Consumer Debt to America."

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