Freaks of Fortune

4/5/2021

See review by Gary Kornblith in 2016 fall edition of Canadian Journal of History (here)

Freaks of Fortune is a book on insurance, broadly defined. Historian Jonathan Levy walks through seven overlapping episodes from 19th century America that illustrate how American individualism emerged alongside a corporate financial system to tame the insecurities of capitalism. Framing the seven episodes are a few terms defined at the outset. Levy invokes Karl Polanyi's dialectical concept of a "countermovement" whereby capitalism, through its commodifying tendency, serves first to destabilize markets before it eventually re-stabilizes them just the same. And he describes how the "perilous" contingencies or "freaks" that arise from the "risks" people assume as free individuals can be priced and "enclosed" into the commodities we call "insurance," just as land is enclosed as property with a "hedge."[1]

In the first episode, Levy goes back to the Antebellum years when self-ownership was reserved for particular classes in America. As Levy puts it, "before men became the proprietors of risks on their own free selves, they first owned the risks on the bodies of their slaves." Or did they? Levy points to the Creole Revolt of 1841 when a group of slaves bound for Louisiana staged a mutiny and navigated their ship to the British Bahamas where slavery had been abolished a few years prior and where they knew they would find freedom. The owners of these slaves sought repayment for their "lost property" while their insurers balked. It was a question of worldviews: was the revolt an insurable act of God or was it an act of man? Premeditated as it was, the revolt voided the insurance contracts owned by the slave masters. This conclusion however was not reached without a fight. The Creole Revolt was addressed in the 1845 Louisiana Supreme Court case of Thomas McCargo v. New Orleans Insurance Company. Attorney Judah P. Benjamin argued and Justice Henry Adams Bullard ruled that the proximate cause of the slave owners' loss was not the British seizure of American property, a peril of the seas and hence an act of God, but the mutiny itself, a consequence of the slaves' foresight and volition and hence an act of man. While the Old South clung to slavery, a budding antithetical institution took hold in the North.

The rise of life insurance as an industry and institution is the focus of Levy's second episode. It unfolded in the aftermath of the 1837 financial crisis in tandem with the anti-slavery movement in which the Northern-born abolitionist actuary Elizur Wright was a key protagonist. Security through land ownership was a common goal for rural dwellers across America. However, while Southern slaveholders found in their soon-to-be-abolished institution providential security against peril for both master and slave, the increasingly urbanized Northern freeholders—leveraging mortality statistics, probability theory, and the liberal axiom of self-ownership—found in life insurance not a "distrust of Providence" or a "commodification of death," but a voluntary yet morally imperative security against peril, the commodification of a productive life. The history of slavery as an institution is known, but life insurance was not an ideal alternative. Throughout his life, Wright argued in vain against the "forfeiture clause" in life insurance contracts. He held that it was a form of theft because "levelled premiums" and the increasing risk of death with age meant that yearly payments were higher than necessary in the early years of a policy. Thus "forfeited" premiums on contracts surrendered before their expiration amounted to savings forfeited to an insurer's growing capital reserves. These reserves grew considerably in the postbellum years, but a parallel and more established financial institution provided yet another form of economic security.

Elizur Wright believed life insurance would provide security for newly emancipated slaves in postbellum America, but as Levy points out in the third episode, other Yankees the likes of John Alvord and industrialist Edward Atkinson found in the more established savings banks a worthy form of security for interested Freedmen. Of the total amount of private money savings in America at the close of the Civil War, half was held as savings bank deposits compared to a meager one-tenth as life insurance reserves. Witnessing this functioning model for both blacks and whites in the North, in 1865 the Select Committee on Slavery and Freedom pushed and President Lincoln signed into law an act that would charter the Freedman's Bank. It was a federal attempt to support newly emancipated slaves, but it did not gain traction immediately. Freedpeople naturally sought independence and security through land-ownership, although they generally could not yet afford to purchase land outright. William T. Sherman's Field Order 15 was an attempt to fulfill this desire for land among emancipated families but political Restoration overruled and rendered Sherman's plan futile. Sharecropping soon replaced the plantation system, putting money in people's pockets. With landed independence in sight, black sharecropper savings rose steadily so that deposits at the Freedman's Bank would swell to $50 million by 1873. But 1873 was a bad year. Jay Cooke & Co, the investment bank that managed most of Freedman's savings, had made a bad bet promising to sell Northern Pacific railroad bonds and failed.[2] The Freedman's Bank closed in 1874 and 41% of the $3 million it owed depositors was never repaid. Through savings banks, sharecroppers effectively funded the railroads in America's westward expansion setting the stage for Levy's fourth episode.

With landed independence still in sight among people with Jeffersonian ambitions, the Homestead Act of 1862 sets the stage for Levy's fourth episode, fueling westward immigration by promoting land ownership and thus a growth in agriculture. Private banks and government land offices a la colonial land banks undergirded this expansion by granting mortgages to farmers against their land as collateral. Farmers fared well and lending to them became less risky. Over time, investors who did not necessarily know much about farming sliced, diced, and securitized farm mortgages just as home mortgages were sliced and diced in the early 2000s. Mortgaged farmers grew increasingly disconnected from the owners of their land, yet they had to make their payments in good times and bad. This setup tied farmers to increasingly globalized markets and subjected them to fluctuations in the price of their produce. Many farmers thus turned to life insurance to "offset" the uncertainty of a mortgage and by extension the uncertainty of their very livelihoods. And so a circular, symbiotic, self-perpetuating mortgage-insurance complex took hold whereby it was not unheard of for the same agent to come "to inspect both your farm and your life as viable capital assets." Mortgages ate into the farmers' and their families' psyches, increasing their productivity before tractors entered the scene but keeping them always on edge. Competition between farmers intensified and so they increasingly left subsistence farming behind, dedicating their plots instead to single cash crops. In this precarious context, life insurance did not suffice and so accident insurance, after taking hold in factories, and crop insurance, leveraging new weather data provided by the National Weather Service, was introduced to farmers. All this made farmers in their farming more comparable to industrial wage workers than with the urban mercantile class, rendering security via landed independence all but impossible. Jefferson turned in his grave while debates ensued as to whether farming was a business or a way of life. The agrarian Populist Revolt that preceded the presidential elections of 1896 revolved around this and other questions, but it failed, dealing a blow to security via land ownership and trapping farmers in an expanding American financial system.

Levy's fifth episode runs parallel to the fourth and features the evolution of fraternal societies after the railroad bond crisis of 1873 and before the Panic of 1893. In an increasingly industrialized America, people (mostly men) chose between life insurance policies and fraternal certificates to hedge against the uncertainties of capitalism. New societies were established in this period deriving rituals from older societies but also introducing the "assessment system." Founded on social trust, the assessment system was a more active and personal bond and countermovement than the insurance policy. It was also more affordable: regardless of age, a $1 entry fee, $1 payments upon the deaths of other members, and yearly payments of $20 promised members a $2000 benefit. Fraternal brothers lacked the profit motive and were especially skeptical of capital accumulation, arguing that they had "no accumulations to be squandered" or speculated away. In Max Weber's words, it was a "triumph of modern individualism." But insurers disagreed and argued that a fraternal certificate was the real speculation since fraternal payouts were not legally enforceable owing to the societies' distinction between certificates and contracts. An 1885 lawsuit that was raised against the Ancient Order of United Workmen dealt fraternal societies a hard blow, requiring them to raise capital reserves to meet payments at a moment's notice. Capital reserves were mushrooming anyway as tontines[3] and industrial policies[4], two new forms of insurance, evolved in this same period and gained legitimacy despite popular concern. 1885 was a busy year for it also saw the creation of the National Fraternal Congress which gathered to establish an actuarial basis to fraternal assessments. And so it was that the fraternal spirit converged with the insurance principle as the statistical method came into vogue. Corporate risk management had "co-opted the fraternal countermovement."

If mortgages in Levy's fourth episode blurred financial linkages between economic actors, the rise of futures trading in this sixth episode abstracted linkages even further. By 1890, most commodity trades took the form of futures contracts. Tens of commodities exchanges such as the Chicago Board of Trade were chartered and hundreds of smaller, more accessible "bucket shops" sprouted across the country, snaffling other people's risks. By "setting off" the difference between a commodity's price in their contracts and its price in the market on a given day, futures traders eliminated the need for actual delivery of any physical goods. They closed their positions from afar. Trading on agreed prices for the future delivery of goods was not a new practice, but the widespread lack of "interest" in actually receiving the goods was a new phenomenon that conflated naked speculation and productive hedging against price fluctuations. Disputes between exchange board members and their clients spilled into the courts and eventually required that traders must "contemplate delivery." But ascertaining a trader's intention was futile. Agrarian populists in the 1880s and 1890s challenged the futures traders and led Congress into a hearing on Fictitious Dealings in Agricultural Products. Farmers resented ceding control over the price of their produce to far-removed traders. Sure, they said, people are free to risk their money, but futures traders stole the farmers' profits by tapping into his proprietary upside risk. The traders retorted and said the "average opinion'' on their board stabilized prices and actually served farmers by carrying some of their risks. The Hatch Bill that led to these hearings failed to pass between 1892-1894 as the agrarian Populist Revolt quieted down. In the years after the 1896 election, exchange traders faced one more adversary: the bucket shops that ran similar transactions just without the fees, membership, or record-keeping. Forty-six court cases involving C.C. Christie of the Christie and Grain Stock Company culminated in 1905 in the Supreme Court under Board of Trade v. Christie. Justice Oliver Wendell Holmes ruled that trades at incorporated exchanges were hedges for the purpose of business while, at bucket shops, they were mere gambling. It did not help the bucket shops that they were leeching prices determined at the incorporated exchanges. Holmes was aided in this view by fellow pragmatists such as philosopher William James who wrote on the intersubjective truth that undergirds the price mechanism. Also vindicating the speculation of "competent" men on the exchanges were contemporary economists such as Henry Crosby Emery, Allan Willett, and Arthur T. Hadley who argued that such trading insured society at large against price fluctuations. Thus, the argument against bucket shops was weak but effective. Incorporated traders triumphed and eventually diversified their products in yet another organized countermovement against the insecurities of capitalism.

Mention Perkins early on as the whole chapter is about him.

Levy's final episode covers the Great Merger Movement (1895-1905) which coincided with the previous episode on futures trading. The decade culminated in the 1907 failure of the Knickerbocker Trust when JP Morgan famously calmed the panic and reaped a fortune by playing the role of the Federal Reserve which was established shortly after this episode to prevent such chaos from falling again into the hands of private citizens. America witnessed in that decade the largest consolidation of corporate power in its history. Monopolies swelled thereby taming the economic chance world while also fanning the flames of populism. Two behemoths, US Steel in 1901 and International Harvester in 1902, were products of this decade and George Perkins, a partner at JP Morgan & Co., set them up not as trusts which the 1890 anti-trust act would disfavor but as holding companies.[5] Large corporations were better risk managers but people wanted to own their own risks and monopolies prevented them from doing so. Perkins was taken to court for his insider dealings as both a partner at JP Morgan and as the head of the finance committee at the New York Life Insurance Corporation. Perkins set up riskless transactions between the insurer who had money from deposits and the bank which needed funds to carry out the Great Merger Movement consolidations. Perkins's actions were soon to be proven illegal but he believed his actions were righteous. In his defense, he and other companies such as Proctor and Gamble laid the foundations of 21st Century American corporate welfare capitalism. In 1902, he set up a profit-sharing plan at US Steel that meshed the interests of employer and employee (both wage workers and salaried employees). As chairman of the finance committee, he had a large say in how exactly the profits were shared. Economist Arthur Hadley warned Perkins against such control, and Louis Brandies called it "strike insurance." The Bureau of Corporations, set up by Roosevelt in 1913, called it "insurance against the effects of local disturbances." Riots did happen, but Perkins believed that since wage workers sought a fixed wage and not the risks of enterprise, if they did their part to stabilize operations, they deserved a share of profits. In 1908, he inaugurated the Employee Benefit Association at International Harvester which set the stage for future corporate pensions and benefit programs. The individual risks of wage earners had been incorporated. Labor strife receded and Perkins was in control. With William Taft replacing Theodore Roosevelt in office, Perkins's worries about antitrust allegations resurfaced and culminated in two 1911 lawsuits against both US Steel and International Harvester. He had resigned as a partner from JP Morgan in 1910 but he was still on the boards of the two behemoths. He gradually lost influence over those companies but he also shifted his attention to politics and, with rising questions about unemployment, he began to see government as the best provider of social insurance. That did not matter, however, because Americans perceived compulsory social insurance of the European sort as tyrannical and autocratic. Thus again corporate America tamed the freaks of fortune as WWI erupted in 1917 and wartime policy took precedence.

Corporations were driven by their finances in 1900. So was the case in the 1970s when the gospel of "shareholder value" gained footing and leveraged buyouts became commonplace. Moral thought in the Gilded Age (1870-1900) evolved with these chance events and people were eventually convinced that capitalism cannot stabilize itself since it spurs our speculative tendencies. Newspaper stories citing the biblical "freaks of fortune" abounded in the Gilded Age but they disappeared as America emerged from WWII. In the four years between 1932 and 1935, the Glass-Steagall Act, the Securities Act, the Exchange Act, the Social Security Act, and others were signed into law. These New Deal laws federally insured bank deposits and separated them from a bank's investments, regulated futures trading, outlawed insider trading, sponsored mortgage insurance, and set the stage for future developments in social insurance covering old-age, disability, and unemployment. Financial volatility subsided, but only for some time. Americans seemed to long for freedom, self-ownership, and the personal assumption of risk. In closing, Levy asks whether the freaks of fortune, though no longer mentioned, are still among us.

General notes:

• Each chapter presents a distinct form of societal insecurity and describes the financial innovation that tamed it

• Legal cases are also featured in each chapter as they highlight, formalize, and immortalize the arguments put forward in the moral debates at the heart of each episode

• Pivotal moments in the book include the civil war, the 1896 elections and the failed agrarian Populist Revolt, and bank failures and crises

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[1] Relatedly, on page 12 of House of Debt (see my summary here) Atif Mian and Amir Sufi argue that "we want the financial system to insure us against shocks." Also related to this book is Elizabeth Holt's Fictitious Capital about the history of the Arabic novel where she describes how financializing the silk and cotton trade in the eastern Mediterranean. Holt describes financial tools that "posed as securing the economy" while also introducing risk and uncertainty. It is no surprise that Holt cites Levy in that book.

[2] Jay Cooke & Co held Treasury deposits from war bonds for which it was the main agent during the Civil War. As the federal government paid off its liabilities, however, JC&C shifted its business and became heavily invested in Northern Pacific's railroad bonds. The Freedman's Bank had invested most of its deposits in safe Treasuries as per its original charter, but in 1870 Henry Cooke of JC&C who was in charge of Freedman's finances lobbied for and secured a congressional change in its charter that allowed for investments across a wider range of assets, hence its exposure to railroad bonds.

[3] Tontines were introduced as an add-on to life insurance policies whereby policyholders split the tontine proceeds if they outlived the tontine's term or, more optimistically, when they entered old age. It was purely speculative and used for capital accumulation, but it also guaranteed some form of old-age security before pensions were a thing. Debates and investigations on the speculative nature of these schemes concluded that all business is speculative and that individuals are free to gauge their commercial risks in a productive expression of liberal self-ownership. There were attempts at regulation but the insurers were too convincing (read lobbying) so these policies became popular as did insurance executives who were eventually swimming in capital. John Oller (2019) describes these accumulated insurance premiums in The White Shoe highlighting that, at the turn of the 20th century, the Equitable, New York Life Insurance, and the Mutual Life Insurance Company together took in more money than the federal government. Their combined assets of $1.2 billion equaled almost half the deposits in the nation's savings banks. And in an age before the social safety net, life insurance was the main form of protection for individuals against death or disability.

[4] Collecting more data, insurers introduced industrial insurance by bucketing accident insurance policyholders into risk groups and offering them policies with lower premiums. Lapse rates on these industrial policies were so high and insurance corporations accumulated so much capital that New York insurance corporations bailed out investment houses when wheat prices plummeted and unleashed the Panic of 1893. With all this capital, industrial insurers sought yields on their investments and circulated capital back into an expanding American industry. This drew in more wage laborers and created an industry-insurance complex analogous to the farm mortgage-insurance complex of episode four.

[5] See here for my very brief review of The House of Morgan, a book that dives deep into this episode.

General Notes:

Q: what happened to the forfeiture clause by the end of the book and by now?

Q: since people didn't flock to life insurance corporations at the outset and rather preferred savings banks where their contributions were not at risk of forfeiture, when and how did life insurance gain momentum? I forget. Was there a turning point mentioned in the text? AH.

References

Oller, J. (2019). White Shoe: How a New Breed of Wall Street Lawyers Changed Big Business and the American Century. Dutton. p. 83.