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i
Third Edition
Alan N. Rechtschaffen
1
Capital Markets, Derivatives, and the Law. Alan N. Rechtschaffen.
© Alan N. Rechtschaffen 2019. Published 2019 by Oxford University Press.
1
Oxford University Press is a department of the University of Oxford. It furthers the University’s
objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is
a registered trademark of Oxford University Press in the UK and certain other countries.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means, without the prior permission in writing of
Oxford University Press, or as expressly permitted by law, by license, or under terms agreed
with the appropriate reproduction rights organization. Inquiries concerning reproduction
outside the scope of the above should be sent to the Rights Department, Oxford University Press,
at the address above.
9 8 7 6 5 4 3 2 1
Note to Readers
This publication is designed to provide accurate and authoritative information in regard to the subject
matter covered. It is based upon sources believed to be accurate and reliable and is intended to be
current as of the time it was written. It is sold with the understanding that the publisher is not engaged
in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is
required, the services of a competent professional person should be sought. Also, to confirm that the
information has not been affected or changed by recent developments, traditional legal research
techniques should be used, including checking primary sources where appropriate.
You may order this or any other Oxford University Press publication
by visiting the Oxford University Press website at www.oup.com.
v
B’H
Thank you for Miera, Ronit, Evie, Sarah, Emunah, my mother, my father,
and my teachers. Thank you to Miera for more things than I could ever say.
Thank you Josh, Tevi, Jason, and R. Green for your friendship.
Alan Rechtschaffen
vi
vi
Contents
Acknowledgments xix
Preface xxiii
Introduction xxv
vii
vi
viii Contents
4. Using Financial Instruments 37
I. Goal-Oriented Investing 37
A. Using Financial Instruments to Hedge Risk 39
B. Using Financial Instruments to Enhance Yield 39
C. The Economy’s Impact on Financial Instruments 40
II. Achieving Investment Goals 41
A. The Investor’s Perspective 41
B. Financial Instrument Objectives 43
III. Managing Risk 45
Contents ix
V. The Judicial BCFP Structures under President Trump’s Administration 77
A. Constitutionality of the Bureau 77
B. Single Directorship 77
VI. Ongoing Enforcement Action Status 78
A. Wells Fargo Case 78
x Contents
2. Treasury Notes and Bonds 126
B. Pricing 126
1. Discounts and Premiums 126
2. Factors Affecting Yield 127
III. Bond Auctions and Price 128
A. Interruption of Supply: SEC v. Davis et al. 129
B. Manipulation of the Auction Process: United States v. Salomon
Brothers 130
IV. Interest Rates 132
A. Fixed-versus Floating-Rate Securities 132
B. Treasury Inflation-Protected Securities (TIPS) 132
V. STRIPS 134
A. Description 134
B. Valuation 134
C. Uses 135
D. Abuses: In the Matter of Orlando Joseph Jett 136
Contents xi
C. Municipal Securities 154
1. SEC Disclosure Requirements 154
2. MSRB Disclosure Requirements 154
D. Corporate Debt Securities 155
1. Securities Act Requirements 155
2. Trust Indenture Act Requirements 155
E. Private Placements of Debt Securities 156
xii Contents
B. ISDA Master Agreement 206
C. Importance of Clearly Defined Terms 206
1. Credit Event 207
2. Reference Entity 209
D. Collateralized Debt Obligations 214
E. OTC Derivatives and the Financial Crisis 215
IV. The Move toward Regulatory Reform 220
A. The Central Clearing Model 221
B. The OTC Model 222
C. Confidence in the New Regulatory Regime: The Case of MF Global 223
Contents xiii
C. Clearing Requirements, Exchange Requirements, and the End-User
Exemption 254
D. Capital and Margin Requirements 259
E. Reporting Requirements 260
1. Commodity Position Limits 261
F. Futures Commission Merchants, Dodd-Frank, and Regulation 1.25 262
1. Title VII Enforcement 263
2. Updated Enforcement Advisory on Self-Reporting and Full
Cooperation 263
3. Enforcement Actions for Data Reporting Violations 265
4. Action for Failure to Submit Accurate Large-Trader Commodity Swap
Reports 266
5. Increase of CFTC’s Enforcement Actions following the Change of CFTC
Chairman 267
6. Reduction of Counterparty and Systemic Risk 267
a. Counterparty Risk 268
b. Systemic Risk 270
G. Rationale behind Exemptions and Exclusions 271
1. The End-User Exemption 271
2. Physical Settlement Exclusion 273
3. Customization Exceptions 273
H. The Lincoln Rule 274
1. Futures Commission Merchants 275
I. Criticisms of Dodd-Frank’s Derivatives Trading Provisions 276
1. Concentration of Systemic Risk in Clearinghouse and “Too Big to Fail” 276
2. Exceptions Swallowing the Rule: Incentivizing of Customization and De
Minimis Exceptions 277
3. Lack of Global Harmonization 278
4. The Impact of the Change of U.S. Administration 279
5. The Change of CFTC Chairman 279
a. CFTC’s New Priorities 280
b. Improving SEF rules 280
c. Fixing Data Reporting 280
d. Achieving Cross-Border Harmonization 281
e. Project KISS 281
6. Recent Actions of the CFTC and Announcements of Further Actions
to Come 282
a. Amendment of Swap Trading Rules 282
b. Review of Swap Dealers De Minimis Threshold 283
xvi
xiv Contents
c. Review of Position Limits 283
d. Improvement of Clearinghouse Stress Testing 283
7. Propositions of Reforms from the U.S. Treasury Report on Capital
Markets 284
Contents xv
F. Control and Enforceability 330
G. Basis of the Suitability Doctrine 331
H. Special Circumstances 333
I. FINRA and Self-Regulated Organizations (SROs) 334
1. Financial Industry Regulatory Authority Creation of the Agency 334
J. Rule: A Suitability and Know-Your-Customer Duty 335
K. Scope and Applicability 336
L. Control and Enforceability 337
M. NYSE Know-Your-Customer Rule 337
1. Consumer Financial Protection Bureau 339
2. Scope and Applicability 340
3. Control and Enforceability 341
4. Department of Labor 342
a. Employee Retirement Income Security Act 342
5. Scope and Applicability 343
a. The Antifraud Provisions of the Federal Securities Laws—Section 10b
Cause of Action 343
II. Futures and Options: Suitability 345
A. Commodity Futures Trading Commission Disclosure Rules 345
1. Commodity Futures Trading Commission 345
a. Commodity Exchange Act 345
b. Rule: A Suitability and Fair-Dealing Duty 346
c. Scope and Applicability 348
d. Control and Enforceability 348
B. National Futures Association 349
1. Rule: Suitability and Know-Your-Customer Duty 349
a. Scope and Applicability 350
b. Control and Enforceability 350
C. CEA Antifraud Provision 351
D. Municipal Securities Rule-Making Board 351
Appendix A: Various Suitability Rules and Diagrams of Applicability 352
Appendix B: Survey of Rules Adopted by the SEC under Dodd-Frank 360
xvi Contents
B. Commodity Futures Modernization Act (CFMA) of 2000 372
C. Jurisdictional Disputes 373
D. The Commodity Futures Modernization Act 373
E. Exclusions 374
F. Forwards 375
G. Options 376
H. Futures 376
I. Regulatory Distinctions between Forwards and Futures 378
J. Swaps 381
K. Hybrid Instruments 383
L. Foreign Exchange Products 384
1. The Treasury Amendment 384
2. CFTC Reauthorization 385
Appendix A: Enforcement Case Study: CFTC v. Amaranth Advisors, LLC 388
Appendix B: Case Study: CFTC v. Zelener 391
Appendix C: Structure of CFTC 393
Appendix D: Case Study: CFTC v. Patrick McDonnell 394
Contents xvii
1. Compensation 412
2. Code of Conduct 413
3. Free Flow of Information 414
H. Flexibility 414
III. Executive Protection 414
A. Responsibility for Risk Management 415
B. Business Judgment Rule 415
C. Education at Financial Institutions 416
D. Disclosure under Sarbanes-Oxley Act 416
1. Disclosures in Management’s Discussion and Analysis (MD&A) 416
2. Off-Balance-Sheet Transactions 417
Appendix A: Case Study: JPMorgan and the London Whale 419
xviii Contents
A. Interest Rate Risk 455
B. Liquidity Risk 455
C. Reinvestment Risk 456
D. OCC Warning 456
Index 459
xi
Acknowledgments
xx Acknowledgments
Michael Jaroslawicz earned his JD in 2018 from NYU Law School. While
at NYU, he was my teaching assistant and demonstrated depth and under-
standing in conveying information to others. He simultaneously earned his
MBA in 2018 from NYU Stern School of Business, specializing in financial
instruments and markets, quantitative finance, and economics. In 2014, he re-
ceived his BA in economics, magna cum laude, from Yeshiva University.
Maria Khan worked as an attorney in India and the United Arab Emirates,
advising on corporate and commercial law, banking and financial law, sec-
ondary market transactions, and syndicated financing of aircraft, vessels, and
mega-infrastructure projects. Her experience advising clients from India,
Singapore, the United Arab Emirates, the European Union, and the United
States gives her a unique perspective in global capital markets and regulations.
Giovanni Patti holds an LLM in corporate law from NYU Law School and
a PhD in corporate law from the University of Roma Tor Vergata. He served
as a graduate editor of the NYU Journal of Law & Business and as a research
assistant at the NYU Pollack Center for Law & Business and at the University
of Roma Tre.
Alexandre Reignier attended the University of Law of Nancy in France
and NYU Law School. He will start his legal career at Cleary Gottlieb Steen
& Hamilton, in Paris, with a practice focusing on corporate and financial
transactions.
Melanie Simon interned with the capital markets practices of Allen &
Overy and White & Case in Paris. She graduated from the banking and finan-
cial law master's degree program at Paris II—Pantheon-Assas University. She
won the Spitz & Poulle prize for best student in financial services (regulatory)
before coming to NYU Law School.
Masahiro Suzuki works as an attorney at Nagashima Ohno & Tsunematsu
in Tokyo, specializing in capital market, structured finance, real estate, banking
and financial law. He attended Kyoto University and NYU Law School.
Vinca Vinenska contributed a portion relating to the passage covering the
current state of the Consumer Financial Protection Bureau. She worked as an
attorney at Hiswara Bunjamin & Tandjung, in association with Herbert Smith
Freehills in Jakarta, Indonesia, for more than four years, specializing in cap-
ital market law, corporate law, mergers and acquisitions, banking, and financial
law. In 2018, she received an LLM from NYU Law School in corporation law.
Prachi Tadsare was an incredible help with writing and editing sections of
this book. Prachi works as a legal consultant in the Operations Policy Group of
the World Bank in Washington, DC, advising on operational issues in finance,
specifically in the areas of fragility, conflict, and violence. She received an LLM
xxi
Acknowledgments xxi
from NYU Law School after completing her legal education in India. As a stu-
dent in my class on financial instruments at NYU, Prachi researched capital
markets and disruptive technologies, some aspects of which we are excited to
incorporate into this edition of the book.
Much of the fine work from former students for the second edition of this
book survives in this latest iteration. I wish to once again thank, acknowledge,
and send my personal regards to:
Andraz Jadek, who, at the time of the second edition, worked as an attorney
in Ljubljana, Slovenia, specializing in corporate and commercial law, mergers
and acquisitions, venture capital, securities regulation, banking, and financial
law. His experience advising clients from the European Union and the United
States, among them large financial institutions, gave him a unique perspective
on U.S. capital markets and regulation.
Richard Kim, who contributed portions relating to the passage of Dodd-
Frank and the regulatory developments that ensued. He attended Binghamton
University and NYU Law School. While at NYU he was a student in my sem-
inar on financial instruments.
Grant Munyon, who graduated Phi Beta Kappa and with honors from
Stanford University with a B.A. in international relations. He graduated in
May 2013 from NYU Law School, where he acted as a notes editor for the
Journal of Law and Business and participated in the Children’s Rights Clinic.
Omar Radawi, who attended Princeton University and majored in the
Woodrow Wilson School of Public and International Affairs. After Princeton,
Omar earned a master’s degree in international political economy from the
London School of Economics and a J.D. from NYU Law School. His academic
background proved invaluable in doing research for this work.
Daniel Wolf, who received his B.A. in economics from the Johns Hopkins
University and earned his J.D. (magna cum laude, Order of the Coif ) from
NYU Law School. His ability to synthesize regulation and economic reality
helped me immensely as we reviewed new legislation and the evolution of the
capital markets.
And to the students who participated in the first edition, we once again ex-
press our gratitude:
Colin Addy, Boriana A. Anguelova, Andrew Arons, Alice Dullaghan, Steven
Eichorn, Lee J. Goldberg, David E. Gravelle, Sarah Hayes, Robert A. Johnston,
Jim Kelly, Michael Kuzmicz, Benchen Li, Gabriel Mass, Katie McDonald,
Robert Pierson, Jr., Justin Quinn, Joshua Riezman, Adam J. Tarkan, and
Marshall Yuan.
xxi
xxi
Preface
This book provides the basic knowledge necessary to understand the financial
markets. Much of the work contained in this treatise is adapted from outstanding
research by others.
Under my guidance, a group of some of my finest students assembled cases and
commentary to explain the capital markets and their evolving regulation.
The structure of this work is based predominantly on the lectures of the author.
However, where a regulator, judge, government official or economist describes a
financial instrument or a situation better than the author might have, that com-
mentary has been included in its entirety (or paraphrased for editorial consistency)
without regard to political affiliation or philosophic disposition.
In synthesizing materials such as the speeches of the Chairman of the Board of
Governors of the Federal Reserve System, leading judicial rulings, and government
sources from disparate administrations, the book is designed to immerse the reader
in the structure and regulatory history of the capital markets. This treatise offers
real-world examples of how financial instruments actually work. The outline and
methodology is unique. The treatise is designed to cover the functioning of the
markets and the various applicable regulatory regimes.
The subject matter cuts across a number of legal disciplines, including securities,
corporate finance, banking, financial institutions, and commodities. Cases describe
the subject matter and demonstrate to the reader the functioning of the capital
xvi
xxiv Preface
markets. The pedagogical approach is to describe financial instruments in a way that
everyone can understand.
As capital market events evolve, it is impossible to freeze time. The treatise seeks
to serve as a foundation for understanding world economic events as they unfold.
This book covers the basic issues affecting capital markets trading, regulation, litiga-
tion, risk management, and internal controls.
It further outlines the basic knowledge that every participant in the capital
markets should have of the complexity of the role of the Federal Reserve in U.S. cap-
ital markets, the use of financial instruments to manage risk and to enhance yield,
and the steps regulators take to address systemic vulnerabilities.
xv
Introduction
xxvi Introduction
system, we can make the U.S. capital markets a true source of economic growth which
will harness American ingenuity and allow small businesses to grow.”1
In this period of positivity, it is important to reassess the effectiveness of crisis-era
legislation to prevent systemic risk in the future. The overwhelming goal of Dodd-
Frank was to address the causes of the financial crisis.
While there may have been many early warning signs and lessons about frailties
within the system that could have prevented the events of 2008, Dodd-Frank
attempted to fill in the gaps that existed at the time of the genesis of the Great
Recession. The vulnerabilities that came to the fore in 2008 serve as powerful
guideposts for the evolution of regulation for generations to come.
As markets respond to monetary and fiscal policy that has enhanced economies
around the globe, regulators and legislators continue to devote an enormous amount
of attention to ensuring that we have robust financial systems that promote respon-
sible risk-taking and efficient allocation of resources. Despite success, financial sta-
bility cannot be taken for granted. While some financial vulnerability is cyclical in
nature, rising and falling over time, others are structural, stemming from longer-term
forces shaping the nature of credit intermediation.2 Much of the regulation that has
evolved in the wake of the financial crisis focuses on four areas of vulnerability that
came to the fore during the financial crisis:3
1. Macroeconomic Imbalances
In the context of the financial crisis, macroeconomic imbalances resulted when low in-
terest rates forced investors to create instruments to enhance yield. Foreign investors sent
large flows of cash into America seeking higher returns. Such an inflow of cash created
financial bubbles as investors abandoned traditional risk–reward analysis in pursuit of
disproportional benefit. One area in particular that attracted foreign and domestic in-
vestment was real estate. Capitalizing on this “yield chasing,” financial engineers created
products that were highly leveraged and often opaque in terms of pricing structure.
2. Unrestrained Entities
Entities such as Fannie Mae and Freddie Mac encouraged investment in real estate by
creating inexpensive financing opportunities for home investors by purchasing and
1
Treasury Releases Second Report On The Administration’s Core Principles Of Financial Regulation 10/6/2017 avail-
able at https://www.treasury.gov/press-center/press-releases/Pages/sm0173.aspx (last visited February 24, 2019).
2
See: An Assessment of Financial Stability in the United States, June 27, 2017 Vice Chairman Stanley Fischer avail-
able at https://www.federalreserve.gov/newsevents/speech/fischer20170627a.htm.
3
Ken Raisler, head of the derivatives group at Sullivan and Cromwell, LLP joined me in a class at New York
University School of Law in identifying four key areas leading to the financial crisis.
xxvi
Introduction xxvii
aggregating mortgages to increase liquidity. Increased liquidity drove the market for
real estate higher. As the real estate market rose, financial engineers structured real
estate–related investments linked to the underlying mortgages. These instruments
were often detached from the underlying asset except in the sense that a small move
in the price of the underlying real estate would have far-reaching effects on the
economy beyond the initial home price.
At the same time, entities not sponsored by the government such as American
International Group (AIG) sold insurance look-alike products (derivatives) that
made investors overly confident in taking on risk. Emboldened by the idea that AIG
would take the loss in the event of financial default, investors took risks with little
consideration of the repercussions of a decline in asset prices that might impact the
insuring entity and might actually lead to counterparty failure when AIG was called
upon to pay under the terms of its agreements.
As there were no capital requirements for entities such as AIG to engage in this
financial engineering, there were no safeguards in place to address the counterparty
risk inherent in its contracts. These derivatives contracts looked like tools that could
virtually eliminate the risks of an investment.
3. Complex Products
4. Regulators
Regulatory constructs did not evolve as rapidly as the capital markets. As a result,
the fragmented regulatory construct of the pre-crisis area allowed transactions and
entities to slip through the cracks.
xxvii
xxviii Introduction
In addition, there was no formal regulatory process for the oversight of the
unwinding of systemically important institutions. When the time came and all the
coins came up heads, there was no one regulator to oversee the orderly liquidation
of systemically important market players.
In summing up the vulnerabilities that existed at the time of the crisis, Ben
Bernanke, the crisis-era Chairman of the Federal Reserve, observed:4
4
Ben S. Bernanke, The Federal Reserve and the Financial Crisis, The Federal Reserve's Response to the Financial
Crisis, Lecture 3, George Washington University School of Business (Mar. 27, 2012), available at http://www.
federalreserve.gov/newsevents/files/chairman-bernanke-lecture3-20120327.pdf.
Another random document with
no related content on Scribd:
Americans have known the French only superficially, and that, in
thinking and speaking of them, we have indulged in the careless and
inaccurate habit of generalization. We have subscribed to the
tradition of the superficiality and frivolity of the French people. We
have believed them lacking in seriousness and perseverance, a
strange misunderstanding of the race which has produced Richelieu
and Talleyrand and Robespierre, La Salle and Marquette and
Champlain. We thought them volatile and temperamental, these
countrymen of Bossuet and Montesquieu, of Pascal and Corneille.
We were wont to say quite patronizingly that French soldiers, though
they possessed verve and élan, were not stayers and “last-
ditchers”—this of the men of the Marne and Verdun! The trouble has
always been not with France, but with ourselves. The France that we
knew before this war gave us a broader vision was the France of
Rue de la Paix and the Champs Élysées, of Montmartre and the
Latin Quarter, of the Louvre and the Luxembourg, of Longchamps
and Auteuil, of Poiret and Paquin, of Giro’s and Voisin’s, of the Bon
Marché and the Galeries Lafayette, of the Opéra and the Comédie
Française, of the Riviera and Trouville and Aix-les-Bains. What have
we known of the sober, simple-hearted, industrious, frugal, plain-
living, deeply religious people who are the real France? France has
not been reborn. It is an affront to her to say it. She has but cast
aside the glittering garment which she wore for the gratification of
strangers in order to free her sword arm.
If you would understand the spirit which animates the French people,
read this letter which was written by a French cook to his wife the
day before he was killed in action. It is but a sample of thousands.
My dear Yvonne:—
Do not worry. I have good hope of seeing you again, as
well as our Raymond. I beg you to take care of yourself
and also of my son, for you know that I should never
forgive you if anything should happen to you or to him.
Now, if by chance anything should happen to me,—for,
after all, we are in war, and of course we are running
some risk,—I hope you will be courageous, and be sure
that if I die I put all my confidence in you, and I ask you to
live in order to bring up my son to be a man—a man of
spirit—and give him a good education as far as your
means will permit.
And above all you shall tell him when he is grown up that
his father died for him, or at least for a cause which should
serve him, as well as all the generations to come.
Now, my dear Yvonne, all this is but a precaution, and I
expect to be there to aid you in this task; but as I have
said, one never knows what may happen. In any case we
are leaving (for the front) all in good spirits and in the firm
belief that we shall conquer.
As to you, my dear Yvonne, know that I have always loved
you and that I will love you always no matter what
happens. As soon as you can, leave for Fontenay, for on
my return I should prefer to find you there; and once more
let me say that I count on you, and that you will be brave.
I will give you no more advice, for I believe that would be
superfluous.
Your little husband, who embraces you tenderly, as well as
dear Raymond—
Georges
America’s entrance into the war is the surest guarantee that the
world can have for a peaceful future. Our practically inexhaustible
military, financial, industrial, and agricultural resources give us all the
trump cards. We can double and, if necessary, redouble, every bid
that Germany makes. We must beware, however, of one pitfall: of
assuming that the war is going to be a short one. England,
notwithstanding the solemn warnings of Lord Kitchener, made that
mistake at the beginning of the war, and she has paid for it in blood
and tears. Though we are warned with all earnestness by the men
who are best qualified to know that peace is not in sight, and
probably will not be in sight for many, many months to come, one
nevertheless hears on every hand the confident assertion that
Germany is on her last legs, that the morale of her armies is
weakening, that her supply of men is almost exhausted, that her
people are starving, and that American troops will never get within
sound of the guns because the war will be over before they can be
made ready to send to France. There is no surer way to prolong the
war than to indulge in such talk as this. Why deceive ourselves? Let
us look the facts in the face. Germany is not starving, nor is there
any prospect of her being brought to that point for a long time to
come, if, indeed, at all. Her man-power, though greatly depleted, is
not giving out. Her morale apparently remains unimpaired; in short,
her military machine still seems impregnable. Remember, moreover,
that she is everywhere fighting on the enemy’s soil and that her own
frontiers remain intact. The extreme gravity of the situation was
recently made plain to the Canadian Parliament by the Premier, Sir
Robert Borden, in these words: “A great struggle still lies before us,
and I cannot put it before you more forcibly than by stating that at the
commencement of this spring’s campaign Germany put into the field
a million more men than she put into the field last spring. And that
million was provided by Germany alone and not by the whole of the
Central Powers.” There is, indeed, nothing to indicate at this time
that the German Government is prepared to negotiate peace save
on impossible terms. It has been a fallacy, and nearly a fatal one for
the Allies, this underestimating the power of Germany. She has, as
some one has truthfully said, made of war “a national industry.” She
is a professional, while the rest of us are, after all, but amateurs, and
she has repeatedly shown, moreover, that she has not the slightest
intention of adhering to the rules laid down by civilized nations for the
conduct of the game. She has spikes on her boots and brass
knuckles on her fingers, and she will not hesitate to gouge or kick or
strike below the belt. She is a ferocious, formidable, and desperate
adversary, possessed of immense staying power, and the only way
we can hope to crush her in reasonable time is by intelligent
coördination of effort, by the fullest and most painstaking
preparation, and by the exertion of every ounce of our strength.
Don’t let us be deceived by the made-in-Germany talk of an early
peace. In accepting it we are only playing the enemy’s game. In
every possible way Germany is throwing out the idea that the end of
the war is in sight. She is doing this because she knows that she has
reached the crest of her military strength. She is at “the peak of the
load.” She knows that every day she is weaker by so many men, and
that she no longer has any considerable reserves from which to
replace these losses. She is ready and anxious to quit—upon her
own terms. But she is prepared to fight a long, long time yet before
accepting the terms that we and our allies must insist upon in order
to safeguard the future peace of the world. The mere appearance of
American troops upon the battle-line is not going to end the war, as
so many of our people seem to think. Not until America begins
making war as though she was facing Germany alone will it be
possible to predict with any certainty when the end will come.
The truth of the matter is that the American people utterly fail to
realize the seriousness of our situation. In fact, the Government itself
did not realize its gravity until from the lips of the French and British
commissioners it learned the startling truth. Up to the moment of our
entrance into the war the Allied Governments, controlling all the
channels of information, had so successfully fostered the impression
that they had the Germans on the run, that all of our people, save a
handful who were in possession of the facts, looked to see the war
end in a sweeping victory for the Allies before the close of the
present year. The truth of the matter is that, had we remained aloof,
the war would in all probability have ended before this year was over,
but not in a victory for the Allies. The almost pathetic eagerness with
which the Allied Governments welcomed our proffered aid in money
and men is the best proof of how desperate was their plight. Here
are the facts: Germany’s submarine campaign is an almost
unqualified success. Unless we can successfully and immediately
combat this menace, England is in grave danger of being brought
within measurable distance of starvation. France is rapidly
approaching complete military and economic exhaustion. The drain
upon her vitality of nearly three years of war has left her faint and
gasping. Though she has inflicted huge losses upon the enemy, her
own losses have been enormous, and, with her much smaller
population, she is less able to stand them. It is not the slightest
exaggeration to say that France is in as crying need of American
assistance as were the American Colonies when Rochambeau and
his soldiery disembarked upon these shores. Should the Russian
Republic be betrayed into making a separate peace—and, at the
moment of writing, the Russian prospect is anything but cheering—
the Central Powers would have released for use upon the Western
Front not less than two million veterans. The war has become,
indeed, a race between ourselves and Germany. Can we build food-
ships faster than Germany can sink them? Can we raise enough
food to feed our allies as well as ourselves? Can we put more men
and guns upon the Western Front than Germany can? Upon the
answers to these questions depends the duration and decision of the
war.
If we are to win this war it will be necessary for us to practise self-
denials, to endure hardships, perhaps to know sorrows of which we
have never dreamed. We must hold back nothing. Our sheltered,
ordered, comfortable lives will be turned topsy-turvy. There will be no
man, woman, or child between the oceans which this war will not in
some way affect. It will impose burdens alike on the rich and the
poor, on the old no less than on the young, on women as well as on
men. It will entail innumerable sacrifices, many of which will be hard
and some of which will seem unjust, yet we must accept them
cheerfully.
If millions of our young men are prepared to give up their lives for
their country, is it too much to ask the rest of us to give up for a time
our comforts and our pleasures?
The civilian must do his duty no less than the man in khaki. And
“duty,” at this time, has many meanings. It is a duty to pay taxes.
These will, without doubt, be increased again and again and yet
again before this war is over, and in many cases they will be directly
felt. The man who dodges taxes when his country is at war is more
deserving of contempt than the soldier who shows the white feather
on the firing-line, for whereas the one fears for his life the other fears
only for his pocketbook. It is a duty to raise foodstuffs and to give
every possible encouragement to others to do so. The householder
who refuses to plough his yard and plant it to vegetables because it
would spoil the looks of his place is as much a slacker as the man
who attempts to evade his military obligations. It is a duty to refrain
from every form of extravagance. By this I do not mean to imply that
people should suddenly stop buying, but only that they should stop
buying things that they do not need or that they can get along
without. For how, pray, are we to place some seven billion dollars of
purchasing power at the disposal of the Government unless we
curtail our individual expenditures? And it is the duty of our
merchants and business men to promptly cease their gloomy
prophecies that an era of national economy will bring on a paralysis
of trade and industry. As a matter of fact, it will do nothing of the sort.
There is far more danger of there being a lack of workers than there
is of there being a lack of work. Already there is more work in sight
than can possibly be done. The shipyards, the steel-mills, the
clothing-factories, the munitions plants, the mines, the farms, the
railways are all clamoring for it, and they will clamor for labor still
more insistently when a million or so men have been taken out of
industry for the army. It is a duty to keep cool, to think sanely, to
avoid hysteria. It is a duty to refrain from giving circulation to
sensational rumors. It is a duty to refrain from nagging the
Government, for the Government is, you may be sure, doing the best
it can. And finally, it is a duty to buy your country’s bonds. Buy all you
can. Take that ten or hundred or thousand dollars that you have
been saving for some cherished personal purpose and invest it in the
Liberty Loan. That is the most practical way I know of showing that
your patriotism is not confined to words.
There is another form of sacrifice which the American people will
inevitably be called upon to make, and that is to accept without
complaint the heavy restrictions which the Government will find it
necessary to put on their private activities. The Government must
have the first call on coal, iron, steel, timber, chemicals, on supplies
of every kind, and particularly on transportation and labor. The
sooner the public gets over the idea that we must have “business as
usual,” the better. The country must immediately awake to the fact
that we cannot carry on a war like this with one hand and continue to
do all the business we did before with the other. We can no more
expect to change from peace conditions to war conditions without
business inconvenience and loss than we can expect to send an
army into battle without having killed and wounded. We must,
therefore, adjust our business and personal affairs so as to support
the army with the greatest possible efficiency, and we must do it with
the least possible delay. The woman who orders a gown which she
does not need is not helping labor to find employment, as she likes
to think; she is preventing a soldier from having a uniform—for how
is labor to be had for making uniforms unless it is released from
making other clothes? Our soldiers must have blankets—but how
are those blankets to be had unless the looms are released from
something else? How is steel to be had for food-ships and field-guns
and destroyers unless there is a prompt curtailment of its use for
other purposes? If one of your pet trains is suddenly discontinued,
don’t grumble, but just stop to remember that the Government needs
that train and its crew for the purpose of moving troops and
munitions. If your favorite restaurant curtails its menu, bear in mind
that it has been done by order of the Government, which recognizes
the imperative necessity for food control. It is a stupendous task that
we have undertaken, and it will require every particle of grit and
staying power that we possess to see it through.
I would that every man and woman in these United States might
show the spirit which led the third-year cadets at West Point, who
were this summer entitled by law and custom to the one furlough a
cadet has in four years, to unite in waiving their right to these two
months to which they had looked forward so long and so eagerly and
for the spending of which they had made so many plans, and to offer
their services to the Secretary of War in any work for which he thinks
them fitted. In writing to his parents to explain why he would probably
not be home on the long-talked-of furlough, one of these cadets said:
—
“You know, as cadets, we haven’t anything but these two months to
give, so we thought if we offered all we had it would maybe be worth
while, even if it wasn’t much.”
How about it, my friend? Have you offered your country all you have
to give?
There are doubtless those who sometimes ask themselves, though
they may deem it the part of wisdom not to ask others, “Even if the
Germans were to win this war, what difference would it make
anyway?” Well, just for the sake of argument, suppose that our
European allies had been forced to sign a separate peace and that
Germany, thus left free to give us her undivided attention, had
landed an army on these shores (which she could do with
comparatively little trouble, the military experts agree) and held a
portion of our Eastern seaboard. And suppose that one evening a
column of men in gray came tramping into the little town where you
live—Quincy or Tarrytown or Plainfield or New Rochelle, which it
doesn’t matter. And suppose that the first thing they did after
establishing themselves in your town was to arrest the mayor and a
score or so of the leading citizens—some of your closest friends,
members of your own family, perhaps, among them—and lock them
up in the jail or the town hall. And suppose that the next morning,
when you start down town, your eye is caught by a notice tacked to a
tree. The notice, which is headed by the Prussian eagle, reads
something like this:—
PROCLAMATION
In future the inhabitants of places situated near railways
and telegraph lines which have been destroyed will be
punished without mercy (whether they are guilty of this
destruction or not). For this purpose hostages have been
taken in all places in the vicinity of railways in danger of
similar attacks; and at the first attempt to destroy any
railway, telegraph, or telephone line, they will be shot
immediately.
The Governor
And supposing, still for the sake of argument, that that same evening
some one, ignorant of the German threat or wishful to hamper the
invaders at any cost, succeeds in destroying a bridge or cutting a
telegraph line. And that, early the next morning, you are awakened
by a sudden crash, as though many rifles were fired in unison. And
that, hurriedly dressing, you hasten down town to learn what has
happened. And that, turning into the main street, you see a row of
bodies—the bodies of men some of whom you had known all your
life, men with whom you had gone to college, men who were fellow
lodge-members, men with whom you had played bridge at the club,
the body of your father or your son or your brother perhaps among
them—sprawled on the asphalt in grotesque and horrid attitudes
amid a slowly widening lake of crimson. Suppose that this dreadful
thing happened, not in some European town of which you had but
vaguely heard, but in your own town—in Newburyport or Yonkers or
Princeton, which it doesn’t matter. Then would you ask “Even if the
Germans were to win this war, what difference would it make
anyway?” The proclamation just quoted is not imaginary. It was
signed by Field Marshal von der Goltz when German governor of
Belgium and was posted on the walls of Brussels in October, 1914. I
saw it there myself. It is to destroy the monstrous system which
permits and approves the execution of people “whether they are
guilty or not” that we have gone to war. For if we don’t destroy it, it
will most certainly destroy us. The trouble is that we stubbornly shut
our eyes to the gravity of the situation which confronts us; we have
not aroused ourselves to the colossal magnitude of our task.
Sacrifices and sorrows without number await us. Before this
business is over with, we must expect to be deprived of many of our
comforts and most of our pleasures. We must be prepared to accept
without grumbling the imposition of very burdensome taxes. We
must be prepared to make countless personal sacrifices, to submit to
innumerable annoying restrictions. We must expect months of
discouragement and heart-breaking anxiety and gloom. We must
gird ourselves for those dark days when the lists of the wounded and
the dead begin to come in. For such will be the price of victory.
The surest way to bring about an early peace is to convince
Germany, beyond the possibility of misunderstanding, that we stand
behind the Government to the last cent in our purses and the last
breath in our bodies; that in our vocabulary there is no such word as
“quit”; that, no matter how appalling the price that may be exacted
from us, we shall not relax our efforts by one iota until the world has
been “made free for Democracy” forever.
THE END
The Riverside Press
CAMBRIDGE . MASSACHUSETTS
U.S.A
TRANSCRIBER’S NOTES:
Obvious typographical errors have been corrected.
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