A little while ago, I was watching White House spokesman Ari Fleischer get grilled concerning the decision by the Justice Department to launch a criminal investigation into the Enron disaster. Well, it just so happens I stumbled on a story or two from the 1920s with some similarities. This first one concerns the Van Sweringen brothers.

Boy, these guys were weird. Born outside Wooster, Ohio, Oris Paxton and Mantis James Van Sweringen (who we will call the Vans from here on, as they were known in their day) were two years apart in age, but in everything else were like twins. Short in stature, quiet and modest, neither went beyond the 8th grade. In later life, one was never seen without the other, as they lived in a sprawling Cleveland mansion, employed no servants, lived in only a few rooms, even slept in twin beds. Well, I guess that's all we really need, or want, to know about their personal situation.

Anyway, Oris and Mantis (they themselves never knew the origin of their unusual names) started off as office boys before getting into real estate. It was soon apparent they had quite a knack in this realm, and they took advantage of opportunities presented to them at the end of Cleveland's great boom in the early 1900s.

First, they developed Cleveland Heights, before acquiring an adjacent 1,366-acre farm, which they then turned into Shaker Heights, one of the nation's wealthiest communities.

By the end of World War I the Vans had a well-deserved reputation in their field, plus they had amassed loads of Wall Street connections and about $500,000 in cash. At this time they decided it was time to take an interest in railroads.

Their new venture started when they realized it made sense to connect Shaker Heights to downtown Cleveland by rail. At the time there was an ancient streetcar line, so they decided to build a high-speed train. But the New York, Chicago & St. Louis railroad also wanted the location that the Vans had chosen for a new terminal.

Well, it just so happens that the owner of the New York, Chicago was one Al Smith*. He had had prior dealings with the Vans (they purchased a farm he owned for the development of Shaker Heights) and he convinced bankers that the Vans were good for the $8.5 million price for his railroad that he chose to accept, even though the brothers had but $500,000 in cash.

Actually, they had their own $500,000 plus $500,000 from friends, so they needed $7.5 million to complete the deal. Smith told J.P. Morgan and Company, "I have had many experiences with these two boys. They are very capable...I want you to cooperate with them in any way you legitimately can." [Geisst]

Now what the Vans did to complete the transaction was form something new for that day, a holding company, called "Nickel Plate Securities Co.," which then sold stock and raised more than the needed $7.5 million.

The holding company was a hallmark of the 1920s and the bull market. Some have called the era a period of consolidation rather than innovation in the markets, and market historian Charles Geisst cites John Kenneth Galbraith, who pointed out that "through all the consolidation there was a shortage of stock which helped push up share prices." [Geisst's quote]

Of course it was another financial invention of the time, the "investment trust," the first mutual funds, which used pools of money to buy up shares in holding companies, or other institutions.

For their part, the Vans turned the railroad into a profitable business and liked the industry so much they sold off their real estate holdings and went full bore into buying up railroad properties; including the giant Chesapeake & Ohio, the Erie, and the Missouri Pacific. And how did they do it? By floating bonds and selling stock, of course. What they really did was create a giant pyramid scheme, one with massive paper wealth through the holding company, the vehicle which was used to manipulate earnings since no one understood all the leverage that was being employed in the different subsidiaries. [Kind of like Enron and its partnerships, eh?]

Historian Robert Sobel writes that at cocktail parties, investment bankers would try to explain how Nickel Plate Securities Co. worked, but "usually with little success." Though the facts seemed to be public, so
it HAD to be explainable.

Well, here's a description, as told by Sobel.

"By the end of the decade (the 20s) the flotations, amalgamations, and manipulations had resulted in a chaotic jumble of companies which, taken together, made the brothers one of the most important forces in transportation. [Ed. By one estimation they had an empire of $2 billion at their peak.] At the top of the Van Sweringen pyramid were the General Securities Corporation and the Vaness Co. The brothers owned 40 percent of G.S.C. and 80 percent of Vaness. Since Vaness owned an additional 50 percent of General Securities, control of both was assured.

"General Securities controlled Alleghany Corporation, which controlled Chesapeake Corporation, which controlled the Chesapeake & Ohio Railroad. The C. & O. in turn held stock in other lines, together with Vaness, General Securities, Alleghany, and the Chesapeake Corporation. The Wheeling & Lake Erie, the Kansas City Southern, the Chicago & Eastern Illinois, the Missouri Pacific, and the Denver & Rio Grande were also in the Van Sweringen web. So complex was the pyramid that the brothers' equity in the small Hocking Valley was only .25 percent, but they controlled it nonetheless. Much of this was beyond Oris' and Mantis' comprehension; their lawyers and accountants took care of such details."

And we have this example of just the Alleghany spoke of the Vans' holdings.

"On January 29 the Van Sweringens sold to (J.P.) Morgan $35 million in 5 percent bonds for $32.75 million, $25 million in preferred stock, and 1.25 million of the 3.5 million common shares for $20 a share, or $25 million. In addition, Morgan paid $375,000 to obtain warrants for another 375,000 shares of common at $30 per share. The Vans also took warrants for 375,000 shares at the same price and bought 2.25 million shares of common at $20 a share. For this stock they paid not cash but 100,000 shares of Nickel Plate common and 440,286 shares of Chesapeake Corporation common. Then they sold to their own General Securities Corporation the 2.25 million shares of Alleghany and 1.725 million option warrants at $1 per warrant. Since all the directors of Alleghany were Van Sweringen associates, the deal amounted to trading with themselves." Or, as an official said at the time, "The control of the parent's directors over the subsidiaries' machinery is absolute; even the information disclosed may be so blind as to be unintelligible."
[Maury Klein, "Rainbow's End."]

Of course it all came crashing down, or I wouldn't be telling this story now, would I? Shares in Alleghany Corp., which became the main trading vehicle for the Vans' holdings, hit $57 before tumbling to below $5 in July 1932 when the overall market bottomed, and they never recovered. Then Senator Harry Truman complained that the Van Sweringen's were like the railway bandits of the 19th century, but that they were worse than Jesse James.

Charles Geisst, in a discussion of this era, makes an interesting comment that is just as applicable to today. "Get-rich-quick notions had seduced the average investor, but the fall of these highly leveraged
industrial empires caused a serious deterioration in national savings."

Next week...Samuel Insull, power broker.

Sources:

"The Great Bull Market," Robert Sobel
"Rainbow's End: The Crash of 1929," Maury Klein
"Monopolies in America," Charles R. Geisst
"Wall Street: A History," Charles R. Geisst
"Devil Take the Hindmost," Edward Chancellor

*I need to explain the reference to Al Smith. From the above noted sources, it is not clear if the Al Smith of New York gubernatorial fame and the Ohio Al Smith are the same. While I'm assuming they aren't, some of the sourced authors do not make this clear (actually, it is quite confusing). The Geisst quote would have me believe we are dealing with two different Smith's.

Brian Trumbore

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