Santayana’s Dividend: On Investing in U.S. Financial History

The book kicks off with Alexander Hamilton’s establishment of the newborn nation’s credit and ensuring its survival by assuming the states’ war debts. There follow the twists and turns of early American central banking, culminating in Andrew Jackson’s 1836 euthanasia of the Second Bank of the United States, leaving the nation vulnerable to devastating depressions for nearly a century thereafter. The National Banking Acts of 1863 and 1864 mitigated the chaos somewhat by bringing order to the preexisting bizarre state of paper currency, in which banks printed their own money. These paper bills varied in value according to the bank’s reserves, reputation, and distance between the bank and the actual transaction involved. It’s still possible to find “free banking” enthusiasts today, but fortunately they are few and far between.

The book bursts with obscure but instructive narratives. My favorite was the story of Hetty Green, a true rara avis: a Gilded Age woman and high financier with an instinct for investment value. She abjured the high living and, more importantly, the leverage that ruined nearly all her male peers – testosterone does wonders for muscle mass and reflex speed, but for judgment, not so much.

Green’s long and successful financial career speaks loud and clear to today’s investors. First, she well understood that in the absence of a central bank, the stability of the financial system depended on the ability of those, like herself, with adequate cash reserves to lend in times of trouble, occasionally working with J.P. Morgan to do so. More importantly for the individual investor, to prosper you must first survive, and you can’t survive without maintaining generous cash reserves to see you through the inevitable crashes and panics that Green invested through, and which fill Higgins’ pages. If I could summarize the overriding message of Investing in U.S. Financial History, it would be, “I can tell you what will happen, I just cannot tell you when. But happen it will.”

As an added bonus, Higgins’ prose varies mainly between lapidary and memorable. On the early 2000s housing bubble’s “no income, no job, no assets” (NINJA) mortgages: “The only thing more terrifying than the fact that these loans existed was that fact that they were sufficiently common to warrant a name.”

And on the failure of regulation to throttle the dishonest security practices of the 1920s: “Lawmakers have proposed countless regulations to right these wrongs, but there is no regulation on earth that can replace a rudderless conscience.” Even when the narrative flow inevitably bogs down in necessary detail, the going is still smooth.

On a more abstract level, Higgins brings to life the apocryphal Twain quote that history rhymes rather than repeats, as with the often poorly thought-out immediate responses to financial crises: “The human instinct to simplify problems and isolate a distinct group to blame often leads to incomplete solutions that address only the latest manifestation of a problem rather than the underlying root cause.”

Or when he points out that that the costliest sequelae of financial depressions are measured not in treasure, but rather in blood. Unlike even many professional historians, Higgins understands that the rise of Adolph Hitler and the holocaust of the Second World War can be traced directly to German unemployment during the depression of the early 1930s, and not to the Weimar hyperinflation of a decade earlier, during which the Nazi party vote failed to rise above single digits. (The same is true of trade wars. No, they are not easy to win. In the best case, they lead to inflation, tariff retaliation, and unemployment. In the worst case, they lead to shooting wars, as happened with America’s pre-Pearl Harbor trade sanctions against Japan.)

Higgins’ 30,000-foot perspective on the development of the American semiconductor industry, which began with the military’s need for better anti-aircraft fire control and the early venture capital milieu that financially powered its development, takes the breath away. He compares data, for example, on the success rates of twentieth century venture capital with that of nineteenth-century whaling expedition underwriting. Both are numbers games that carry low success probabilities for individual projects, but which pay off spectacularly when they succeed, and both exhibited strong performance persistence among individual investors. Alas, the finance profession inevitably runs a good thing into the ground, as the past decade has seen ever more capital chasing a fixed number of worthwhile projects, hence the parlous state of today’s VC scene.

Likewise, the author’s treatment of the global financial crisis (GFC) of 2007–2009 is the best I have come across, summarizing in a dozen or so pages the sequence beginning with the subprime crisis, followed by the run on the investment banks, and, critically, Section 13(3) of the Federal Reserve Act. This regulatory roadblock prevented the Fed and Treasury from backstopping Lehman Brothers, which forbade bailing out financial institutions that were both insolvent and not banks under the Fed’s purview. Not until congress surmounted Section 13(3) by passing the Troubled Asset Relief Program (TARP) on October 3, 2008, was the spiral stopped.

The response to the GFC propelled total government debt past 60 percent of GDP; a decade later, the response to Covid 19 pandemic doubled that figure past 120 percent. Higgins is probably correct in pointing out that in both cases, the prompt government economic response prevented financial catastrophe, but worries mightily that the country’s aging population and attendant increasing demands of entitlement programs will inevitably swell the deficit even further and propel the United States directly towards a debt crisis.

How does the nation avoid this looming disaster? This observer’s most salient memory of the GFC came on September 29, 2008, when the House of Representatives’ first effort to pass the TARP failed. As the roll was called and it became apparent that the bill would fall short, the Dow Jones Industrial average fell nearly nine percent within minutes. I suspect that a slow-motion version of this collapse will play out in the initial stages of the looming debt spiral, in which it becomes apparent that the Treasury may no longer be able to service its interest payments, which will spike interest rates, which will further increase servicing costs. As Hemmingway famously said, one goes bankrupt two ways, “gradually, then suddenly.” One hopes that, as on September 29, 2008, the financial markets provide the impetus for corrective action before “suddenly” happens.

Higgins inevitably makes some rookie mistakes. His overenthusiasm for all things historical allows him to drift for the better part of two chapters through the Second World War in both the Pacific and Europe, expositions that seem largely derived from, respectively, the monographs by Toland (The Rising Sun) and Shirer (The Rise and Fall of the Third Reich). Even more oddly, his history of financial manias leaps from the 1920s all the way to the 1990s tech bubble, with nary a mention of the 1960’s “tronics” enthusiasm or the Nifty-Fifty era of the early 1970s, subjects more relevant to U.S. financial history than the details of Admiral Yamamoto’s planning of the Pearl Harbor attack.

Curiously, his otherwise cogent discussion of the tradeoff between economic incentive and inequality focuses on the writings of Raymond Dalio, a choice that will annoy many readers, especially when he could have consulted more reliable inequality authorities like Nobelist Angus Deaton. Worse, he swallows whole Amity Schlaes’s revisionist histories of the Great Depression and of Johnson’s Great Society programs, a misstep that could have been avoided by consulting a few high-profile reviews of her books, or even her Wikipedia page.

Despite these flaws, Investing in U.S. Financial History will mightily entertain, intellectually stimulate, and profit its readers. Mr. Higgins is a talented and agreeable writer; with age and seasoning, he has a bright future in financial writing.

William J. Bernstein is a neurologist, the co-founder of Efficient Frontier Advisors, an investment management firm, and has written several titles on finance and economic history. He has contributed to the peer-reviewed finance literature and has written for several national publications, including Money Magazine and The Wall Street Journal. He has produced several finance titles, and four volumes of history, The Birth of Plenty, A Splendid Exchange, Masters of the Word, and The Delusions of Crowds about, respectively, the economic growth inflection of the early 19th century, the history of world trade, the effects of access to technology on human relations and politics, and financial and religious mass manias. He was also the 2017 winner of the James R. Vertin Award from the CFA Institute.

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