Investigations into failures When a bank fails it should be the duty of the equity court to institute promptly a thorough investigation to ascertain the causes, even before receivership in cases where a plan of reorganization is adopted. The bank commissioner should have the responsibility of showing that the failure could not have been prevented by proper steps on his part-a reasonable burden after he has been granted broad powers of regulation. Directors An alert and inquiring board is indispensable to the proper protection of the depositors. The depositor relies upon the directors. He recognizes them as the city's leaders-its financial chieftains, men of distinguished rank in the commercial and industrial enterprises of the city, and perhaps also in its political and social life. Their names symbolize protection and security to the depositors. The symbol should not be allowed to become an illusory form. Directors should not be permitted to descend to the role of "financial gigolos." Their names serve to attract depositors and this is entirely proper, provided their personal prestige is not allowed to become a snare. It is not unreasonable to require directors to supervise at least the major transactions of the bank, to familiarize themselves with, to guide and when necessary to modify its policies. It would perhaps be desirable to limit the number of directors and pay them more liberal compensation. Examiners' reports The law should require that when an examiner's report is transmitted to a bank a committee be at once appointed to consider any criticism it may contain. Each director should set forth his views on the question and his explanation or proposal of the remedy for the matter complained of. Outside audits In large banks directors cannot personally examine all the transactions and, therefore, outside audits are indispensable. These audits should show not only book values but the actual value of every asset, and directors should be required to certify that they have read them before being permitted to vote for a dividend. Directors' bonds Under the present law a director who holds $500 worth of stock is qualified to administer tens of millions of dollars of other people's money. In order to insure a higher sense of responsibility directors should be required to give bond for a moderate amount, which would be unconditional in the event of the bank's failure, as the stockholders' liability has been in the past. Bond is now required in more modest calling than that of a bank director; e. g., pawnbrokers, auctioneers, master electricians, boxing promoters, and notaries. Legislation, however helpful, is not a magic panacea. On the other hand, bank failures are not inevitable. An increased sense of responsibility in those who administer other people's money must, in the last analysis, be our chief reliance. The courts, by firmness in appropriate cases, provide a powerful stimulus to that end. [From the Sun, Baltimore, January 25, 1936] SOBELOFF'S SUMMARY OF HIS PRELIMINARY BALTIMORE TRUST REPORT The limitations of a summary of a report approaching in length 500 pages make it possible to sketch only in broadest outline the most significant factors in the failure of the Baltimore Trust Co. Many persons who are intimately connected with certain features of the story will doubtless be dissatisfied because of omissions or emphasis; but any failings in this regard are inherent in the nature of the task, and the full report, which is filed by order of court as a public record, must be referred to for the complete discussion of these matters. THE STATEMENT OF DECEMBER 31, 1932 The last statement published by the Baltimore Trust Co., December 31, 1932, showed capital, surplus, and undivided profits of $10,655,899.33, and general reserves of $7,960,941.25 (p. 11). It indicated that depositors were secure, that the guaranty fund holders could hope for ultimate payment and that the stockholders had a net equity of $2,900,499.33 out of their original capital of $6,250,000 (pp. 12-13). But the members of these three classes, vitally interested in the welfare of the bank, have since had a rude awakening. Mr. Henry B .Thomas, Jr., president of the Baltimore Trust Corp., liquidator of the Baltimore Trust Co., values the entire remaining assets having a book value of $40,614,708.01 at $11,580,836.96. The balance of $29,033,051.03 is lost. Some portion of the loss occurred since December 31, 1932, but the bulk of it was already incurred before that date (p. 13). One should not infer from this that the Baltimore Trust Co. sustained a loss of $29 million on $40 million worth of business transacted by it. If the losses had been at this rate, that is, $3 out of every $4 invested, the performance could not have lasted very long. The losses resulted from operations extending over a number of years. Forty million dollars is the cost of the residue of assets, and their actual and realizable value is $11 million. Justice to Mr. Howard Bruce requires us to bear in mind that nearly all the losses hereinafter considered occurred in respect to loans and investments made before he entered the Baltimore Trust Co. as an officer. His administration will be fully reviewed in the final report. After the guaranty fund was raised an appraisal of the assets was made in October 1931, and a reserve was set up in the amount of $9,400,000 for losses and depreciation. Although subsequent statements showed an account called general reserve in similar accounts, they were based not on a reappraisal to reflect the true condition, but on book figures with the reserve of 1931 less chargeoffs through actual bankruptcies. No additional reserve was set up against investments, though seriously depreciated, and even unsalable, if they were not actually sold (p. 14). The present case is a perfect illustration of how the assets of a bank may have been dissipated without the knowledge of the depositor or stockholder who relies on its published statements (p. 15). Not only did the officers and directors of the Baltimore Trust Co. delude the public as to its financial condition; they even deluded themselves. Never before, nor since the appraisal of October 1931, did they have the curiosity or the caution to take stock of the bank's assets as a merchant would of his inventory (p. 16). QUEST FOR BIGNESS The Baltimore Trust Co., as finally constituted, was the product of the ambition of Baltimore bankers to build a large financial institution through several mergers which are traced in detail in the report (pp. 18, 22-42). The officers of the merging institution were taken over, and the tendency, almost invariably, was for the equalization of salaries of officers of equal rank on the basis of the higher rather than the lower rate. By January 1930, the salary list had grown to $1,044,325 per year, and the bank had a president, an executive vice president, 19 vice presidents, 14 assistant vice presidents, and 17 assistant secretaries and assistant treasurers, beside a chairman of the board and a chairman of the executive committee (p. 45). The policy of sprinkling branch banks over the city was a gross folly, and reminds one of the race for gasoline-filling-station sites. This, too, was a factor in the fall of the Baltimore Trust Co. When the bank had achieved great size, it began to look outside of Baltimore for opportunities to employ its funds. It eyed enviously the huge profits, real or apparent, of banks in other cities which, at that time, were underwriting and selling issues of securities (pp. 19-20). There was pressure for big business to meet the overhead which reached the high of $1,721,174.98 per year in the early part of 1931, and the bank accepted loans and entertained business which, it is reasonable to suppose, they would have scrutinized more carefully under normal conditions (p. 46). A building was erected at a cost of $6,969,010.56, and the bank allocated approximately $300,000 per year as the rent for its own quarters (pp. 47-64). POLICY COMMITMENTS During the presidency of Eugene L. Norton, and that of Donald Symington, loans were extended, especially to out-of-town enterprises, with a profligacy that now seem incomprehensible; capital investments were made in businesses entirely foreign to the ordinary functions of a bank; investment commitments were made with a reckless abandon that is perfectly shocking, and the ambition to be the biggest institution of the South and to teach the people of that part of the country that "Baltimore is their New York" led to egregious follies. Loans were made on equities and second mortgages on real estate and insufficiently secured collateral loans. The confidence of the board of directors in the president blinded them to the wisdom of many of his proposals, which were accepted and approved almost without question (pp. 85-88). At no time except in this period would an unsecured loan have been made for the purpose of purchasing a seat on the New York Stock Exchange. Only in the expansive mood of this unparalleled period could anyone have undertaken or tolerated a commitment of $3 million (later reduced to three-quarters of a million) to launch the Baltimore Mail Steamship Co., or of a million dollars in the common stock of the International Mercantile Marine Co., or of $1,200,000 to supply capital to the Glenn L. Martin Co., without the precaution of definite arrangements for proper distribution of its notes. The harvest of this sowing was nearer at hand then anyone realized (pp. 86-87). BEGINNING OF THE DECLINE The new building which was to overtower the homes of competing institutions, instead of being a symbol of strength and instilling confidence, served as a reminder that the Baltimore Trust Co. had invested in this single property an amount exceeding half of its entire capital and surplus. This striving for size was making an unfavorable impression. The bank's liquidity had been impaired by other investments, notably the investments in the coal properties which, by this time, had attained an aggregate of nearly $3 million (p. 85). BALTIMORE CO. AND BALTIMORE-GILLET CO. The Baltimore Co. plays an important role in the history of the Baltimore Trust Co. Two factors combined to bring this company into being. The first was the desire to have a subsidiary which could handle the purchases of the Baltimore Trust stock which had earlier been made by Donald Symington, syndicate manager, as agent of the Baltimore Trust Co. It was felt that unless the price of this stock was maintained by syndicate operations, public confidence in the institution would suffer, and the subsequent withdrawal of depositors would embarrass the bank. The trust company could not legally acquire its own stock, and the Baltimore Co. was used as the bank's instrument so that it could, with seeming regularity, continue these purchases. The Baltimore Co. served also as the investment banking subsidiary of the Baltimore Trust Co. (pp. 88-89). The Baltimore Co. issued 625,000 shares of its stock which were distributed among the stockholders of the Baltimore Trust Co. share for share. In exchange, the Baltimore Co. received $250,000 of marketable securities and 100,000 newly issued shares of Baltimore Trust stock which were made to appear to be worth $3,750,000, although there was no real market for the stock at this price. Another $1 million appears in the capital structure of the Baltimore Co. which no one connected with it has been able to trace or explain. Apparently it never had any real being (pp. 89–91). The Baltimore Co. borrowed from time to time several million dollars from New York banks with Baltimore Trust Co. stock as collateral on the basis of its inflated value (pp. 91-92). When the New York banks became restive they were paid off by the Baltimore Co. with funds derived from the Baltimore Trust Co. (pp. 106-107). Every director of the Baltimore Trust Co. was also a director of the Baltimore Co. at whose board meetings these transactions were reported, as well as further purchases of Baltimore Trust stock until the Baltimore Co. held an aggregate of 169,000 shares (pp. 98-99). This was in addition to 32,000 shares purchase on the market and later sold to officers and employees under a stock purchase plan (pp. 100-102, 111-114). This stock acquired on the market at a cost of from $35 to $40 per share was, after the collapse of the market for such stock, settled for on the basis of $10 per share paid by officers and $3 per share paid by employees. This alone involved a loss of $1 million (pp. 102–105). BALTIMORE-GILLET DEAL In June 1931, in an effort to disgorge the accumulation of Baltimore Trust Co. stock, the Baltimore-Gillet deal was resorted to. One hundred and fifty thousand shares of Baltimore Trust Co. stock were transferred to Gillet & Co. for securities and property which they valued at $4,500,000. A new company was formed, known as the Baltimore-Gillet Co., whose entire capital stock was issued to the Baltimore Co. and later placed with the Baltimore Trust Co. as security for a loan of $3,250,000. This loan was used to pay the New York banks and debts of Gillet & Co. assumed by the Baltimore Co. under the agreement; also to repay the Baltimore Trust Co. money borrowed by the Baltimore Co., largely for the purchase of Baltimore Trust Co. stock which had, in the meantime, become greatly depreciated in value (pp. 105–107). Other loans, aggregating $2,500,000, were made by the Baltimore Trust Co. to the Baltimore-Gillet Co. for the specific purpose of enabling the latter to engage in operations in the stock market in the hope that it would make a "killing." Unfortunately, the perversity of the market frustrated this hope and a loss of almost $2 million resulted to the bank from this operation alone. The $3,250,000 loan to the Baltimore Co. was also lost. Of the total of $5,750,000 of such loans to the Baltimore Co. and the Baltimore-Gillet Co., not more than $600,000 is expected to be salvaged (pp. 108-110). The foregoing is a frank and untechnical version of the dealings of the Baltimore Trust Co. with the Baltimore Co. and the Baltimore-Gillet Co. The records of these corporations are couched in the sedate language and forms customary in financial manipulations conducted under proper legal guidance. Loans were disguised as repurchase agreements and a number of indirections were resorted to to accomplish the desired purposes (p. 110). EFFORTS AT RETRENCHMENT On June 1, 1931, the directors seemed for the first time to have sensed the necessity for the scaling down of administrative costs. Mr. James Bruce became president on that date and in a short time reduced overhead at the rate of about $500,000 per year, but by the summer of 1931 confidence in the Baltimore Trust Co. had been seriously impaired (p. 119). It had become known that the company settled at a cost of $600,000 a suit in which mismanagement of certain corporate trusts was alleged. The Gillet deal had made an unfavorable impression. During that summer the depositors withdrew $30 million, and in September the withdrawals assumed the proportions of a run (pp. 120, 174). On September 18 the clearinghouse made an ineffectual effort to bolster confidence in the Baltimore Trust Co. by publishing a reassuring advertisement (p. 121). On September 18 the leading bankers of the city were called in to advise with the officers and directors on measures to be taken in the emergency. That night the visiting bankers made an examination of the bank's assets and sanctioned a loan of $15 million from New York banks on condition that a "cushion fund" of $5 million be raised (pp. 121-123). On Sunday, September 20, $7,755,400 was subscribed as a guaranty fund (pp. 125-133). THE VALUATION OF OCTOBER 1931 In October 1931, Messrs. Howard Bruce, Albert H. Dudley, and Edwin G. Baetjer made an independent, comprehensive appraisal of all the assets of the Baltimore Trust Co. and set up a general reserve of $9,400,000 (p. 135). In reviewing the work of this committee I am not unmindful of the vast difference in conditions between then and now. It would be grossly unfair to criticize them for not knowing in 1931 what is only too well known in 1935. But it is not unfair to state what their findings were in 1931 and to compare them with the facts as they have developed, and to call attention, where necessary, to certain conditions which were apparent in 1931, but were overlooked or disregarded by the committee. The assets on which they anticipated a loss of $9,498,000 show a loss (realized and estimated) in the 1936 valuation of approximately $28,900,000. This tabulation will make the comparison more graphic.. The disparity between the two sets of figures is due, in some instances, to incorrect valuation in 1931, and, in others, to subsequent depreciation and it should be borne in mind in fairness to the appraisers that they were not valuing for liquidation purposes but for a going concern (p. 137). There is no question of the good faith of these gentlemen, although in their optimism they misjudged the losses by many millions of dollars. It is, however, proper to say that in some instances that have been pointed out in the report the information available to them in 1931 should reasonably have indicated losses in excess of those recognized by them. Misled by the notion that we were in a "temporary recession" they failed to note declines in the value of many securities, substituting cost for market or intrinsic value in making their appraisal (pp. 137-142). In this they went further than the admittedly lenient standards established during this period by the Comptroller of the Currency and the State banking departments for their examiners (pp. 146-150). Many of the securities they valued at cost would have been worth far less than cost even if general conditions had been more nearly normal, for these securities never had a market and the absence of a market at the time of appraisal was not an important factor. Nevertheless, in appraising certain of these securities the absence of a market was taken as sufficient justification for valuing at cost or even higher (pp. 142-143). The valuation placed on the repurchase agreements with the Baltimore Co. and the Baltimore-Gillet Co. was certainly not justified covering as they did, in large measure, securities such as the common stock of the St. Paul Garage, the Greenway Apartment Co. and others for which there was no market. The complex affairs of the Baltimore Co. and the Baltimore-Gillet Co. cannot be analyzed in this summary, but the matter is treated in detail in the report (pp. 143-145). The present comment is not directed to the fact that they failed to foresee the future. The point is that they failed to take into account events which had already happened. To fail to foresee the future collapse of values is pardonable, for prescience is not to be expected even of experts; but to disregard completely losses already incurred was under the circumstances palpably wrong (pp. 145– 146). They set up no reserve for possible loss on the Baltimore Trust Building, and this is not criticized, because they were valuing a new building for a going concern; but neither did they set up a reserve for the substantial depreciation in other bank properties due to obsolescence, although such deductions had been taken for income-tax purposes (pp. 150-152). Many of the loans appraised at full value were known to be impaired; some of them had been in the bank for a number of years and had been repeatedly criticized by the bank examiners (pp. 138-141). The appraisers think it should be observed that the bank examiner's report of June 1931, only a few months earlier, recommended a chargeoff of only $1,363,010.40. This is a fact to be noted, but because of circumstances discussed in detail in the preliminary and supplemental report (p. 9), the examiner's report of June 1931, has no particular significance as a contemporaneous appraisal. The appraisers also refer to the opinions expressed by the visiting bankers on September 18 and 19, 1931, as a fact to be considered in forming an opinion of their work. There is today no little divergence in the recollection of the gentlemen who participated in the dramatic events of September 18 and 19 as |