I met Chris while I was a broker. As everyone knows, brokers are salesmen who happen to deal in the stock market. It is better to know nothing about the stock market and be a good salesperson than to have twenty years’ experience in the stock market and have no sales experience. The first thing the brokerage firm tells you when you are hired is to call up all your friends and get them to invest with you. Once you have gone through your list of friends, then you call your friends’ friends, and then you call the friends of your friends’ friends. When you run out of leads, start cold calling. Chris was actually the friend of a friend. Chris loved the stock market, followed it every day, and knew the ups and downs of individual stocks—the perfect candidate. My friend arranged for us to get together so we could see if I could interest him in allowing me to manager part of his portfolio. The meeting was planned at a restaurant in two weeks. Knowing Chris was a mover and a shaker, I decided to suggest some tech stocks to him, something that could move fast, make him some money, and get him to come back for more. This was back in the early 1990s when tech stocks were just beginning to hit their stride before the internet bubble blew apart all concepts of a fair return. I did my research and found three stocks I thought were going to do well over the next few years: Microsoft, Cisco Systems, and Intel. All were ones with high growth potential and all would do well as the use of personal computers grew. You never know how a potential client is going to take your recommendations. They might reject a proposal because a stock was too risky, or reject the same stock because it was too safe. I remember I had pitched Cisco to a client, described how it had risen in price for several years, how its earnings were consistently growing, how their product was the backbone of the internet and how the company would grow as the internet expanded. In other words, the stock couldn’t lose, which turned out to be true. The customer was really excited about it and was ready to invest. She asked me how much it was and when I told her it was currently trading at $75, she asked me, “Don’t you have anything cheaper?” I tried to explain to her that the price didn’t matter. It was better to buy 10 shares of a stock that was going up than a 100 shares of a stock that was going down, even if the stock had a higher price, but to no avail. I had a similar problem with Chris. A couple weeks after meeting him, my friend called me back and let me know that Chris wasn’t interested in investing with me. Were my recommendations too risky? I asked. No, it wasn’t that, he replied. If anything, my recommendations were too conservative. The main issue was that my firm charged commissions that were more than he was willing to pay. I could have suggested the perfect stock to him and because of my commissions, he wouldn’t have invested with me. Now he tells me, I thought. This was the early 1990s when investing without a broker was just starting to catch on. The stock market hadn’t reached the point where people could trade on line yet; that was still a few years away, but it was close. Even brokers couldn’t trade on line yet. We still had a vacuum tube system in the office. We filled out an order to buy or sell stocks, stuck the order in a cylindrical tube (similar to the ones you put money in at the drive-through at the bank — as if any of you remember that), sent it to the operations manager who would type in the order and send it to New York. We were amazed when we got the response back through the vacuum tube system only a few minutes later. Not only was there no on-line trading, but CNBC had yet to create a near-monopoly on stock market coverage. There was no CNBC, but there was a local channel in Los Angeles that provided financial news during the morning. The channel paid for itself not only by selling commercial time, but by allowing different stock promoters to have fifteen minute programs on while the market was open and after the market had closed. Since we were in California, the market closed at 1pm, and the hour after the market close was the prime time for stock promoters. It was two hours of pump and dump before the channel turned to Spanish-language programming for the rest of the day. Most of the programs were 15 minutes long, which was about all the promoters could afford, but the one right after the close, Profits through Penny Stocks, was a 30-minute pump-and-dump show par excellence. Penny stocks appeal to gamblers, to the people who think they can outwit the market, but inevitably get outwitted themselves. A penny stock is any stock that trades for under one dollar. The stock usually has hundreds of millions of shares outstanding, but the company is worth less than a lemonade stand. Penny stocks appeal to gamblers for two reasons. First, the stocks are cheap so anyone can afford them. No one is going to ask if you have something cheaper. Since the stocks trade for ten cents or five cents, the buyer reasons, if only the stock goes up five or ten cents, I will double my money. The punters are willing to believe this because the stock used to be at five cents only a few months before, and now it is at twenty-five cents. Since the stock has already moved up five-fold, there is no reason it couldn’t move up to one dollar, or more. By following the recommendations on TV, the investor could easily make thousands of dollars, but rarely did. Second, the investor could own a lot of shares. This reinforces the illusion that the investor can make a lot of money. While it takes thousands of dollars to own just one share of Berkshire Hathaway stock, with a penny stock, the investor could buy 100,000 shares of a stock trading at five cents for only $5,000. Never mind that there are probably a hundred million shares outstanding, and the company can always issue more shares, and probably will. The whole process is psychological and has very little to do with reality. Unfortunately for the investor, the stock rarely goes up in price, it usually goes down as the promoter unloads his shares on the adoring public. When the stock price hits $0.001 or less, the company does a 1000 to one reverse split and 100,000 shares become 100 shares which trade at the price the shares originally sold for the year before. These companies don’t create value, they destroy value. Another trick of the trade is to issue warrants. A warrant allows you to buy shares at a certain price when the regular stock goes up in price. The advantage is that if the common stock goes up five-fold, the warrants can go up fifty-fold. They rarely do, but it is a good pipe dream. In 1992, Profits Through Pennies was promoting a stock called Spectrum Information Technologies which was developing a “secret” technology that would allow users to fax wirelessly, rather than being tied down to a phone line. Chris had no concept of diversification. His idea was, if the stock is going to work, then why not put everything you have into it? Why leave your money in some loser stocks when you can put all your money into one winner? The answer is that the one stock you put your money into is rarely the winner, and you risk losing everything as a result. This fact of life didn’t discourage Chris, nor did the fact that none of his previous sure things had worked out either. All Chris needed was to hit the jackpot once, and all his problems would be solved, or so he thought. Spectrum had lain dormant for several months, gradually moving up a little at a time. Chris had put his entire portfolio into Spectrum. He took what was left from his previous investments that had gone awry and put them all into Spectrum. He owned the common stock, he owned both the warrants, he owned the units. Then, by some miracle, rumors started to spread that the new technology might actually work. The stock started to go up. Chris was actually making a profit. Profits Through Pennies, which was probably more amazed than Chris at the unexpected activity in Spectrum, assured its viewers that this was the big one. Viewers needed to call up their brokerage firm and put even more money into the stock. Because Chris had lost a good portion of his initial investment in several other stocks, he had to raise capital to double up on his profits. In this, Chris left no stone unturned. He realized he could borrow cash against his credit card, and he did. He realized he could get additional credit cards to borrow against, and he did. He realized he could take out a second mortgage on his house, and he did. He wasn’t able to sell his mother into the white slave trade, but he did borrow money from her. And, of course, he bragged about his profits to his friends and got as many of them as possible to invest with him. As Spectrum started to rise in price, others began to notice. Not only did the stock start to move up rapidly, but it also fluctuated dramatically. One day it would be up twenty percent, the next day down fifteen percent. It would move up for four days, then fall for three. For the average investor, this is the worst type of stock to be in. You know it is moving on pure speculation. You know it could double or triple in price from here, or today could be the day it starts moving down for good. As a friend of mine put it, “you worry when it goes up and you worry when it goes down.” A stock like this would turn a heavy sleeper into an insomniac. Then the stock started to go nuts. The stock had been at 25 cents when I first spoke to Chris. Now it was at $1, then it moved up to $2 in one day. The warrants had gone from 5 cents to $1 and were soon in the money. The stock started trading wildly, swinging up and down on a daily basis. Then the most incredible thing happened. In one wild day in which 75 million shares traded, a record on Nasdaq, Spectrum hit $10. My friend was now a millionaire. His investment had paid off.   As luck would have it, the day I spoke to Chris was the day the stock hit its peak. In two days it lost half of its value, and in a week it was back down to $2. In one week, he had made and lost over $1 million. At that point, you know the stock isn’t going to go back to its high, but you know at some point it will get a dead-cat bounce. The problem is everyone else knows this, and everyone is waiting to sell their stock to a sucker who thinks the stock will go higher than they will. The technical term for this is the “greater fool theory.” You may have been a fool to buy the stock at $2, but you hope you can find an even greater fool who will buy the stock at $3. The problem is, sometimes you’re the greater fool. The other problem with owning a large block of shares is that you have to get rid of them. It may be easy to accumulate hundreds of thousands of shares over time, but selling hundreds of thousands of shares, all at once, will only depress the price. A few weeks later new rumors started to spread that the ex-CEO of a rival technology firm was going to be hired to bring the technology into fruition. Activity picked up in the stock again, the stock rose in price, and Chris sold into the rally. Despite having lost a million dollars in paper profits, he ended up making $100,000 on his rollercoaster ride.  

But that isn’t why we called him Crazy Chris.

Like any addiction, it is the thrill that keeps the person in the game. It simply isn’t possible to make a large profit and walk away forever. Making a large profit only whets the appetite for more, and now that Chris had restored his capital base through profiting on Spectrum, which a few years later went bankrupt, after a month’s vacation, he was ready for some more action. The next penny stock to be promoted on Profits through Pennies couldn’t have been more different. Yes, it was a technology stock, but it wasn’t an internet company, but one that had new railroad technology. This company was about to revolutionize an industry in a way that hadn’t occurred in over a century, Profits through Pennies promised. In fact, this stock was such a secret, its story hadn’t even reached the United States yet. The stock traded on the Vancouver Stock Exchange. Now, the fact that the stock traded on the Vancouver stock Exchange would be enough to worry me. Any respectable Canadian stock traded on the Toronto Stock Exchange. Oil and mining stocks that couldn’t qualify for the Toronto Stock Exchange because they had no history or prospect of profits listed on the Vancouver Stock Exchange. Now that technology stocks were taking the place of oil and mining stocks, Vancouver offered them an opportunity they couldn’t get anywhere else. Vancouver made Las Vegas look safe and conservative. The fact that Kelly Technologies (Keltech as they referred to it) actually traded on the Vancouver Stock Exchange was promoted as one of its selling points. Profits through Pennies promised that once people in the US discovered the stock, it would go nuts! The stock had hit twenty several years ago, but now was under $1. So why couldn’t it go up to $20 once again and surpass that? They always can return to their old highs, but they rarely do. Chris was sold on this chance of a lifetime, and he started to pour his money into Keltech. Not only did Chris take all his money from Spectrum and put it into Keltech, but he borrowed against what little equity was left in his house. Now you have to understand that since Chris owned over 100,000 shares in the company and consequently was a substantial shareholder, he felt he had the right to get information directly from the company’s president. Keltech only had a hundred or so people working for the company, and only one person in shareholder relations, so she got to know Chris pretty well. When a report was due on the new technology, Chris called her up to see how the tests had gone. A couple times, he even got to speak to the President of the company, and once he had done this, he expected to be able to talk to the President whenever he called up. Unfortunately, the tests did not go as planned and the stock started to sink in price. The stock was headed for twenty cents, not twenty dollars. As with Spectrum, Chris had researched the technology and knew all the competitors and as much information about the technology as he could understand. At first, Chris called up once a week, then as the tests failed to produce the promised results, he began to call up several times a week, pestering the shareholder representative to let him talk to the President. After all, Chris owned several hundred thousand shares, and by his reckoning, he was one of the larger shareholders in the company. During each conversation, Chris would make suggestions on how to improve the technology, how to conduct the tests, how to make “his” company more profitable. The President soon became fed up with the constant haranguing, and one day, out of exasperation, he told Chris, “Well, if you know how to do things so well, why don’t you come up here to Canada and show us how to run things?”, thinking this would put Chris in his place. Unfortunately, it did the opposite. “You probably do need my help,” Chris replied. “That isn’t a bad idea.” The President of the company was even more flabbergasted when the next month, Chris called up and gave him his travel itinerary and told him he had rented an apartment only one mile from the company’s headquarters. What the President of the company didn’t know was that Chris had sacrificed everything in his life to become rich off of this one stock. Chris had borrowed tens of thousands through his credit cards, for which he barely met the minimum payment. His house had been foreclosed upon because he had failed to make timely payments on the house’s three mortgages. His job performance was poor because he spent more time thinking about Keltech than the company he worked for, and he had lost his job. His girlfriend had left him, and now he was practically broke. Chris had lost everything except the shares he owned in Keltech. At first Chris worked for free, inspecting the technology, making suggestions, and helping where he could. To the President’s surprise, Chris actually had some good ideas, and after two weeks, the President of the company decided to hire Chris. Nevertheless, the stock continued to sink, falling not only to twenty cents, but down to ten cents. At the end of the year, the President of the company left and Chris became the new CEO of Keltech. In a little over a year, Chris had gone from not knowing about Keltech, to investing his life savings in the company, to losing everything he had, to moving to Canada, and eventually becoming President of the company in which he had unwittingly sunk his life savings. That is why we called him Crazy Chris. Chris stuck with the company for another year, but eventually left the company because the technology tests always showed new problems, and the solution always seemed one more test away. By the time he left Keltech, not only had Chris lost interest in the company, but what was even more amazing, he had lost interest in the stock market. Chris moved back to California, and got a job with a manufacturing firm. Although this was when the internet bubble was going full speed, Chris didn’t invest in anything. It was torture avoiding investing as the NASDAQ moved up to 5000, but when it crashed from there, he felt relieved. Crazy Chris wasn’t crazy anymore.

There were only four stock market corners in the United States in the twentieth century: Northern Pacific in 1901, Stutz Motor Co. in 1920, Piggly Wiggly in 1923 and RCA in 1928. Although the Northern Pacific short was settled amicably because the short squeeze was a by-product of the attempt to take over Northern Pacific, the Stutz corner turned into a war between the shorts and Allan A. Ryan, who owned Stutz Motor Co. and who cornered the shorts. Unfortunately, as detailed in John Brooks’ article in The New Yorker, “A Corner in Stutz,” the corner ended in a disaster for both sides. In today’s electronic stock market, the battle between bulls and bears is usually impersonal, one computer algorithm trading against another computer algorithm, but in 1920, it was man vs. man, bull vs. bear, and as in the Stutz corner, the conflict got personal. The New York Stock Exchange was still overseen primarily by “old school” financiers who ran the NYSE more as their personal fief than as a corporation that served its customers.  

Ryan Races to Produce Roadsters

Thomas Fortune Ryan, Allan A. Ryan’s father, helped his son to get his start on Wall Street. Thomas Ryan opened a brokerage firm in 1873 and bought a seat on the NYSE in 1874. Ryan made his fortune by consolidating public transportation in New York City, amassing personal wealth estimated at $50 million in the process. Ryan built the Metropolitan Traction Company out of street railroads that ran through New York City. Ryan also formed the Union Tobacco Co. in 1898 which consolidated with James Duke to form the American Tobacco Co. Together, Ryan and Duke developed the British-American Tobacco Co. to protect their American tobacco interests. Ryan also owned Royal Typewriter and backed the maker of the Thompson submachine gun. At the time of his death in 1928, Ryan’s fortune was estimated at over $150 million, making him the tenth wealthiest man in the United States. Thomas Ryan tutored his son, Allan Aloysious in the intricacies of finance and in 1905, when he was 25, he turned over his seat on the NYSE to his son. Three years later, Charles M. Schwab, first chairman of U.S. Steel, befriended Allan Ryan after Ryan’s father introduced him to Schwab. His son formed a brokerage firm, Allan A. Ryan & Co. The stock market boomed after America’s entry into World War I in 1917, with the DJIA almost doubling in price by October 1919. Ryan was one of the primary bulls on the exchange and enjoyed profiting from squeezing the shorts. Ryan also invested in the Stutz Motor Car Co. of America, Inc. which he gained a controlling interest in and became president of in 1916. The company was incorporated in New York and took control of the Stutz Motor Car Co. of Indiana. Stutz Motor Car Co. was most famous for making the Bearcat at its factory in Indianapolis, an expensive and high-performing roadster which became synonymous with the roaring twenties. While a Model T cost $500 in the 1920s, a Stutz Bearcat cost $2000. Stutz stock participated in the bull market rally, moving up from 40 at the end of 1918 to 144.875 in October 1919. The DJIA peaked at 118.63 on November 1, 1919, as inflation cut into post-war demand, but Stutz stock remained strong in the face of the post-war bear market. On February 28, 1919, the DJIA hit 91.31, a 23% decline from the top and by definition, a bear market. Nevertheless, the bear market still had strength left in it.   Other Stutz shareholders took their profits, but Ryan continued to buy Stutz stock while the shorts, even more certain that the price of the stock would ultimately collapse, shorted even more shares. Ryan borrowed millions of dollars to support the price of his stock, and by the end of the month, Ryan was almost the sole owner of shares in the Stutz Motor Co. Confident that he could break the back of the bear raid, and owning virtually all the outstanding stock, Ryan continued to loan shares to the shorts so he could squeeze them until they faced either financial ruin, or if they were unable to buy the shares back, potentially face prison for breach of contract. As Daniel Drew said during Jay Gould’s attempt to corner gold in 1869: “He who sells what isn’t his’n, must buy it back or go to prison.”  

The Shorts Are Cornered

Since Ryan was the sole lender, he knew who the borrowers were, and he knew they were primarily fellow members of the NYSE, including members of the Exchange’s Board of Governors. The men he worked with on the floor on a daily basis were shorting his company’s stock, trying to ruin him financially. During the week ending March 27, Stutz stock moved up from 220 to 318 on 73,900 shares. Stutz stock closed at 329 on March 29, at 370 on March 30 and at 391 on March 31 when only 930 shares were traded because no stock was available. The shorts had clearly underestimated Ryan’s resolve. Ryan was called before the Exchange’s Business Conduct Committee on March 31 to explain the wild gyrations in Stutz stock. As The New York Times put it, It was clear enough before noon that offerings of the stock had practically disappeared and the Governors acted through a moratorium to protect those speculators who had worked themselves into this untenable position. A single group was found to own more stock and contracts for delivery of stock than the full outstanding Stutz shares. The ruling prevents Stock Exchange members from participating in further dealings in Stutz stock until the ban is lifted. Ryan told the Committee that he would settle with the shorts, some of whom were on the Committee he faced, and allow the shorts to fulfill their contracts at $750 a share. The offer probably made the shorts sick to their stomachs. Ryan knew there were more shares short than there were shares outstanding, and that he owned all the outstanding shares. Ryan could have asked $1000 or $5000 per share. The shorts had put themselves in this position, and they had only themselves to blame. Ryan had cornered Stutz stock, and he wanted the shorts to pay for their bear raid. The shorts in the Northern Pacific corner had paid the price that Harriman had set, so why shouldn’t Ryan set the price for Stutz stock and force the shorts to pay up?  

The NYSE Tips the Scales

Ryan may have cornered the stock, but the shorts were determined to use their power in the NYSE to destroy Ryan and save their skin. The Committee threatened to strike Stutz from the stock exchange list, and Ryan responded by threatening to demand $1000 a share. Nevertheless, the NYSE decided to suspend all trading in Stutz stock. When a reporter said there was no precedent or rule for the suspension of trading in shares, a NYSE spokesman replied, “The Exchange can do anything.” On April 5 came the most amazing announcement of all when the Law Committee of the NYSE announced, “The Exchange will not treat failure to deliver Stutz Motor stock, due to inability of the contracting party to obtain same, as a failure to comply with his contract.” Essentially, the NYSE sanctioned breach of contract by the shorts, putting them under no legal obligation to cover their shorts. The NYSE told Ryan he was free to challenge their ruling in court. In response, Ryan demanded that the NYSE obtain a settlement price for all the shorts to avoid the trouble of Ryan having to negotiate with each of the shorts. When nations don’t agree, they go to war; when companies don’t agree, they call in the lawyers and go to court. The shorts hired the Dos Passos Brothers, who were the leading experts on stock exchange law. John Randolph Dos Passos had written the standard work on stock exchange law, Treatise on the Law of Stock Brokers and Stock Exchanges in 1882, and had rigorously opposed the Sherman Anti-Trust Act in his book, Commercial Trust, written in 1901. His son, John Roderigo Dos Passos, later wrote his socialist trilogy, U.S.A. in rebellion against his father’s defense of capitalism. Interestingly enough, by the 1950s, Dos Passos had changed his political views dramatically and campaigned for both Barry Goldwater and Richard Nixon. Ryan hired the firm of Stanchfield & Levy, the lesser firm in this David vs. Goliath battle. Realizing it was Ryan vs. the NYSE, Ryan resigned his seat in the NYSE because he felt the Exchange was changing the rules to benefit the shorts. Ryan’s resignation freed him to act independently. He was no longer bound by the NYSE’s restriction on members selling shares since he was no longer a member of the Exchange. Ryan gave a reporter of the New York World the names of the NYSE governors, some of whom were on the committees that had sat in judgment on Ryan, whom he said were caught short in Stutz stock. The obvious conflict of interest led some to demand that the NYSE come under state or federal regulation, something members of the NYSE definitely wanted to avoid. The NYSE backed down from their position that shorts could violate their contracts and left the resolution of the issue up to Ryan and the shorts. On April 20, the protective committee capitulated and said they were ready to accept impartial mediation on a negotiated settlement price between Ryan and the shorts. There were 56 firms that held shares short in Stutz involving 5500 shares. On the other hand, the banks that had loaned Ryan millions to defend Stutz stock also became involved to insure there were sufficient funds for Ryan to repay his loans. Negotiations dragged on for several days and with no resolution, Ryan indicated that he planned to buy in all the stock on April 24, a Saturday, on the Curb Stock Exchange which operated literally on the curb of the New York Stock Exchange on Broad Street. Traders on the Curb didn’t move into their own building until 1921 when the New York Curb Exchange Building was built on Greenwich Street. Brokers made trades on the street in the open air, then signaled to the clerks in the office windows above to carry out their trades. This was where the High Noon shoot-out between Ryan and the shorts was to take place.  

High Noon on the Curb

Hundreds showed up that Saturday morning just for the spectacle of seeing Ryan place his order to close out his position on the shorts. Colonel John W. Prentiss, who had become the principal spokesman for the shorts, said they should come to terms with Ryan before the Curb opened for its half-day of operations that Saturday. The shorts agreed to act in unison, and slips of paper were passed around where the shorts could write down what they thought would be an appropriate settlement figure. Prentiss then took the average of the numbers that had been written down. A delegation went to the office of Allan A. Ryan & Co. at 111 Broadway, arriving at nine-forty A.M. The delegation offered Ryan $550 per share, which Ryan unhesitatingly accepted, and at two minutes before ten, Colonel Prentiss announced to reporters that the Stutz matter had been settled at $550 per share. Everyone was happy except the spectators on Broad Street who were deprived of viewing the showdown. This appeared to be a great victory for Ryan since he had made almost $1.5 million in the transactions and remained the sole owner of Stutz Motor Co., and was worth, on paper, over $100 million. Unfortunately, for Ryan, this was a Pyrrhic victory. Ryan still owed millions to the banks, and the only way he could raise the money to cover his debts was by selling shares in Stutz Motor Co. With trading in Stutz stock still suspended on the NYSE, Ryan lacked a liquid market to sell large blocks of shares to the public. Unless he could raise sufficient funds to cover his loans, Ryan could become bankrupt.  

Ryan’s Victory Ends in Bankruptcy

Though defeated, the shorts were still determined to have their pound of flesh. The NYSE refused to accept Ryan’s resignation from the Exchange, and the Board of Governors adopted a resolution saying Ryan’s conduct had been “inconsistent with just and equitable principles of trade;” because he had created “an arbitrary and fictitious price” for Stutz stock. Ryan was called to appear at a closed hearing at the NYSE to defend his actions. Ryan refused to appear before the “star chamber” and he was tried in abstentia. Ryan was found guilty as charged and was voted unanimously to be expulsed from the NYSE. The NYSE sold his seat in July 1920 for $98,000, but by November, the Exchange was still withholding the proceeds from Ryan on a technicality. Ryan’s main problem remained the banks he had borrowed from who were pressing him for their money. The stock market had continued to decline and the prices of the other companies Ryan owned shares in, Stromberg Carburetor, Continental Candy, Chicago Pneumatic Tool, and Hayden Chemical, were falling in price dramatically. By November, Ryan was “cleaned out” and Ryan’s creditors turned to the Guaranty Trust Company, of which Ryan’s father was the largest shareholder, to see if his father would support Ryan. Unfortunately, Ryan and his son had been at odds for several years, and Ryan showed no interest in helping his son. In November the banks formed a committee to take charge of Ryan’s affairs. Ryan fought a losing battle until he was forced to declare bankruptcy on July 21, 1922. It turned out that Ryan owed over $1 million to Harry Payne Whitney, son of his father’s old partner, about $3.5 million to the Chase National Bank and $8.66 million to the Guaranty Trust Co. Ryan’s salvation lay in the shares he owned in Stutz Motor Co., which were to be sold at auction. A lawyer for Guaranty Trust estimated that if Stutz stock sold above $60, Ryan would probably be able to cover his debts and avoid bankruptcy. Stutz stock traded on the Curb, since it was not permitted to trade on the NYSE, and the stock had fallen in price dramatically in the intervening two years. The stock, which had been at $180 at the end of 1920, had fallen to $50 at the end of 1921 and was trading at $15 when Stutz declared bankruptcy.   Ryan never recovered from the collapse of Stutz Motor Co. and he died in 1940. Unfortunately, Ryan never made up with his father, and when Thomas Fortune Ryan died in 1928, although he left millions to Allan Ryan’s siblings and sons, the only thing Allan Ryan received out of his father’s estimated $150 million estate was his father’s white pearl shirt studs.

Berkshire Fine Spinning Associates is Formed

Berkshire Fine Spinning Associates Inc. incorporated under Massachusetts laws in 1929 as a consolidation of Berkshire Cotton Manufacturing Co., Valley Falls Co., Coventry Co., the Greylock Mills, and Fort Dummer Mills. The company changed its name to Berkshire Hathaway in 1955 when it acquired Hathaway Manufacturing Co. Berkshire Fine Spinning Associates Inc. manufactured fine grades of cotton textiles and specialized in fine lawns, batistes, nainsooks, organdies, dimities, handkerchief cloths, broadcloths, oxfords, sateens, rayon and silk mixtures. Plants were located in New Bedford, Massachusetts. Berkshire offered 33,000 shares of common stock in 1929 at $40 per share as well as 4,860 shares of 7% Preferred stock, also at $40 per share. Unfortunately, the shares were offered in the middle of the 1929 bull market, and the share price collapsed soon after. In November 1929, the ask price for Berkshire stock was still at $40, but in November of 1931, shares sank to $0.50. Sales for the company declined and Berkshire ran losses until 1936. As late as 1940, shares traded as low as $3, but profits and the share price picked up with the war. Berkshire did well enough that it was able to reinitiate a regular dividend in 1942 (the dividend had been suspended in March 1930), and in September 1947, the company had a 3-for-1 split. Of course, the split marked the high mark for Berkshire and the stock began a downward trend that lasted until 1962. The graph below shows the performance of Berkshire Hathaway Inc. stock from 1929 until 1967 when Warren Buffett took over the company. As you can see, there was little change in the stock price in the forty years before then. Berkshire lost money between 1930 and 1936, and it lost money in 1957, 1958 and 1961 to 1963. Despite the fact that sales had tripled between the 1930s and the 1960s, there was no comparable increase in profits. In 1963, Berkshire stock was still trading below the price it had been offered at in 1929!   Berkshire Hathaway paid a regular dividend between 1942 and 1960 when the dividend was suspended due to losses. Buffett paid a $0.10 dividend in November 1967, but that was the only dividend the company ever paid under Buffett. Thenceforward, profits were reinvested in the company to allow the share price to grow. Buffett lived off of his $50,000 salary and outside investment income. Berkshire Hathaway stock continued to trade OTC until October 1976 when it listed on NASDAQ. The shares moved to the New York Stock Exchange in November 1988 and in May 1996, Berkshire issued lower-priced Class B shares to investors who could no longer afford to buy a share of Berkshire Hathaway, Class A shares, which by that time had risen in price to $35,000.  

Berkshire Booms

The impact of Buffett on Berkshire was incredible. Shares in Berkshire which had gone nowhere for 40 years began increasing at a rapid pace. The stock closed at $18.625 in 1966. Shares first broke the $100 mark in 1977, the $1000 mark in 1983, the $10,000 mark in 1992 and the $100,000 mark 2006. Shares now trade around $200,000. Buffett could have bought any company and the results would have been the same. As soon as Buffett took over Berkshire Hathaway, he began to focus on other businesses and ignore the company’s core manufacturing business. In fact, at one point, Buffett said that buying the textile business had been the worst trade of his life. I guess everyone is allowed one mistake.  

One question I often receive about the data for the Germany is why the German stock and bond indices had a 90% decline in June 1948. At first, people think there is an error in the data, but German shareholders actually did lose 90% of their capital as a result of the Currency Reform of June 20, 1948 when Reichsmark were converted into Deutschemark. Despite the loss, the reform benefitted shareholders. who were unable to sell their stocks at the fixed prices the Nazis had imposed during the war. Although the Currency Reform imposed an immediate loss on all shareholders and bondholders, the Reform helped West Germany to emerge from the economic collapse of World War II and begin the Wirtschaftswunder (Economic Miracle) that enabled Germany to enjoy the economic growth that occurred in the decades that followed.  

Nazi Economics

During the 1940s, the German government organized its economy with one goal in mind: to win the war. As in the United States, the government made sure that all goods essential to the war were acquired by the government at a reduced cost. The prices of consumer goods were controlled in order to limit inflation, but the inevitable result was a black market in scarce consumer goods.Not only were price controls imposed upon goods, but price floors were introduced for stocks and bonds, preventing securities from declining in value. A bombed out factory isn’t worth as much as a fully functioning factory, and industry was run to aid the war effort, not to make profits. If markets had been left to themselves, stock prices would have declined as the tide of the war turned against the Nazis. Since prices didn’t reflect the values of the shares, stock markets froze and trading dwindled until it was almost non-existent. Price floors had been introduced during World War I in London, New York, Berlin and other countries for good reason. Although stocks traded at full price, market makers only had to put up a fraction of the cost of stocks, waiting until settlement days to balance their accounts. A steep decline in prices would have bankrupted many of the stock market’s traders, so the price floors were introduced to prevent panic selling. As a result of the price floors, trading in many securities stopped since no one was willing to buy shares for less than they were worth. Consequently, between January 1943 and June 1948 there was virtually no change in the German stock market index. The Nazi government remained in default on its own bonds until 1953, introduced multiple exchange rates, and imposed capital controls to stem the flow of money out of Nazi Germany.  

The War Ends and the Economy Collapses

After the war ended in Germany, the economic situation got even worse. The money supply had expanded five-fold between 1939 and 1945, but prices of many goods were fixed. Although ration coupons were used to allocate some goods, the amounts rationed were insufficient to meet daily needs, and consumers were forced to turn to black markets.

After the war ended, the occupying powers replaced the Reichsmark and Rentenmark with a Military Mark. Although the western Allies tried to limit the issue of Military Marks to control inflation, the Soviets were more than willing to print extra marks to pay for the rising costs of occupation. For political, rather than for economic reasons, the Western Allies gave copies of the plates for the Military Mark to the Soviets who began printing excessive amounts of the notes generating inflation. Having suffered from economic collapse and inflation after World War I, Germany was facing a second collapse that might have been worse than the hyperinflationary death spiral of the 1920s.

By the spring of 1948, the German economy was collapsing. Food production was half what it had been in 1938 and industrial production was one-third of its pre-war level. With salaries controlled by the government, wages were low, and many workers failed to show up, contributing to the decline in production. Instead, people devoted their time to finding the food they needed to survive. Anywhere from one-third to one-half of all transactions were on the black market or through barter. American cigarettes were used as a more reliable currency than paper money since cigarettes held their value. Many soldiers sold their cigarettes on the black market to add to the meager salary they were receiving. Food was so scarce that on weekends, many Germans left the cities for the countryside to try and buy food directly from farmers since the shelves of stores in the city were bare. Some Germans grew food in their back yards to keep themselves from starving.  

Replacing Nazi Economics with the Free Market

With the growing tension between the western Allies and the Soviet Union, the need to revive the German economy superseded the need to pacify Germany. The reform of the German currency and economy was overseen by Ludwig Erhard who wanted to replace the government-controlled Nazi economy with one based upon the market. Erhard had refused to support the idea of a centralized economy under Hitler, and his anti-Nazi credentials helped him to secure the support of the Allies over other German economists who wanted to maintain the government controls and rationing which clearly were impoverishing the nation. Erhard advocated the ending of price controls and a currency reform which would replace the Military Mark with a new currency with a limited money supply called the Deutschemark.By eliminating the Military Mark and replacing it with a smaller supply of Deutschemark while simultaneously eliminating all price controls, Erhard hoped to end both inflation and the shortages that plagued the economy. The Deutschemark were secretly printed in the United States and put in boxes that were innocuously labelled “doorknobs” so they wouldn’t arouse suspicion. Meanwhile, factories were instructed to withhold the distribution of their goods until the currency reform was introduced so the flood of goods into stores would help the economy to revive as quickly as possible. On June 20, 1948, the currency reform was introduced. Germans, who had gone to bureaucratic offices to pick up their ration coupons, instead received 40 Deutschemark in the new currency and an additional 20 Deutschemark soon after. Germans were allowed to exchange a limited amount of their Military Marks into Deutschemarks, but most of their money was lost. Now goods would be rationed by Deutschemark, not by ration coupons.

Stocks and bonds were converted from Reichsmark into Deutschemark at the rate of 1 to 10. A bond or stock that had been worth 100 Reichsmark was now worth 10 Deutschemark. In effect, the government imposed a 90% loss on all securities. This is why GFD’s German stock and bond indices show a 90% drop in 1948. Though investors suffered losses, consumers were ecstatic. The effect of the currency reform was immediate. Within a week, store shelves were full, black markets were eliminated, and economic stability returned to Germany. The politics, however, were not so simple.  

Germany Separates into West Germany and East Germany

The United States and Britain had not informed the Soviet Union of their plans to reform the German economy and introduce a currency reform. The Reichsmark and Military Mark became worthless overnight in the Bizone (areas controlled by the U.S. and the U.K.), so the old marks began to flood into the Soviet Zone. This forced the Soviets’ hand, and a couple days later, the Soviets introduced their own currency reform, first adding a stamp to currency to validate it, and several months later, introducing new banknotes into circulation.

The Ostmark was introduced in East Germany and continued to circulate in East Germany for the next forty years. Although the official exchange rate between the Ostmark and Deutschemark was set at one-to-one, the Ostmark always traded at a discount. I remember when I visited East Berlin in 1986, the black market rate was 5 Ostmark to the Deutschemark, but visitors to East Berlin had to exchange 25 Deutschemarks for 25 Ostmarks (which looked like monopoly money) as the price of entering East Berlin to see the walls of Babylon at the Pergamum Museum. The Ostmarks had to be spent in East Berlin, and since I was thirsty, I bought a glass of Vita Cola, the East German version of Coca-Cola, a drink which made cod liver oil taste delicious by comparison. Vita Cola kept the formula for their soft drink secret, but more likely to protect the rest of the world rather than to hide trade secrets.

The currency reform only applied to the three zones occupied by the United States, Britain and France, but not West Berlin. The Soviets followed the currency reform with a blockade of all roads into the Soviet zone making West Berlin inaccessible. The Currency Reform of June 1948 led directly to the Berlin Blockade and the airlift that saved the people of West Berlin from starvation. Along with the airlift came the Deutschemark which became the official currency within West Berlin. After June 1948, the economic and political separation of Germany became a reality and continued until the fall of the Berlin Wall in 1989. The currency reform was a success. As the economy recovered, the stock market quickly rose in value as well. The German stock index recovered its pre-Currency Reform level by 1952. On February 27, 1953 Germany officially defaulted on its foreign debts, replacing old bonds with new ones which had a lower interest rate and an extended maturity. Capital controls were soon lifted and the Deutschemark became a strong currency that enabled Germany to recover. Of course, stocks were never allowed to trade in East Germany. Its citizens would have been happy to have temporarily lost 90% of the value of their investments and see their capital eventually be returned in whole. Instead, East Germans lost everything, and had to wait forty years before their currency was replaced by the Deutschemark.