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Wall Street History
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10/06/2000
Jay Cooke, Part III
As a result of his success in helping to finance the Civil War, Jay
Cooke was thought to be the nation''s most prestigious banker.
But we earlier explored the fact that he really hadn''t made a ton
of money and Cooke had the desire to become a true titan. And
in those boom times which followed the war, there seemed to be
only one investment, railroads.
Between 1865 and 1873, the rail system in America doubled, with
the addition of some 30,000 miles of track, at a cost of nearly
$1.5 billion. In the end it was just a giant land play; the feeling
being that the railroads would produce rapid settlement of the
uninhabited west, which in turn would lead to a spectacular rise in
the value of the railroads landholdings.
In his book "Devil Take the Hindmost," historian Edward
Chancellor describes the come-on for a Union Pacific plot in
Columbus, Nebraska.
"A $50 lot may prove a $5,000.Would you make money easy?
Find, then, the site of a city and buy the farm it is built on! How
many regret the non-purchase of that lot in New York; that block
in Buffalo; that acre in Chicago; that quarter section in Omaha."
The postwar period was one of vulgar display and extravagance.
An editorial of the time in the New York Herald contained the
following.
"The world has seen its iron age, its silver age, its golden age and
its brazen age. This is the age of shoddy.shoddy brokers on
Wall Street, or shoddy manufacturers of shoddy goods, or shoddy
contractors for shoddy articles for shoddy government. Six days
a week they are shoddy businessmen. On the seventh day they
are shoddy Christians." Ouch!
In 1869, Jay Cooke purchased the Northern Pacific Railroad.
NPR had a land grant larger than the entire territory of New
England, nearly 50 million acres in the Northwest. And Cooke
used his old bond salesman techniques in financing the acquisition.
Using a network of agents, just as he had done in the war, he sold
$100 million in bonds. His chief publicist described the property
as a "vast Wilderness waiting like a rich heiress to be
appropriated and enjoyed."
Immediately, however, Cooke had problems. The railroad itself
was eating through the capital as quickly as he could raise it.
Bridges collapsed and roadbeds washed out. By early 1873, NPR
was paying its workers in scrip and was deeply overdrawn at its
banks. As the year progressed, fears of a financial crisis mounted.
And at the same time, trading volume on the New York Stock
Exchange soared and margin activity picked up. One publication
of the time decried that the latter was fostering a "growing mania
for gambling." Another called the Northern Pacific a South Sea
Bubble (the 18th century scheme that ruined tons of British
investors).
[But I must include this diversion. On June 15, 1873, the amateur
archaeologist Heinrich Schliemann announced his discovery (near
Hissarlik, Turkey) of the ruins of the legendary city of Troy.
Schliemann''s reckless excavations, however, nearly destroyed the
site. We now resume our regularly scheduled programming.]
The summer of 1873 was also a time when President Grant''s
administration was reeling from reports of political corruption.
The reckless speculation in railroads and wholesale stock
manipulation, coupled with increasingly hard times in Europe fed
the fear. You could say that America had mortgaged itself to the
future; only now it was finding it difficult to pay the interest and
principal.
By August, several railroads were experiencing trouble
refinancing outstanding loans and newspapers also carried stories
of forged bonds and shares finding their way into circulation.
But Jay Cooke thought he had a solution to his problems. He had
been marketing a $300 million government bond issue in 1873
with J.P. Morgan, mostly to European investors. While the
underwriting fee was minimal, the proceeds of the sale didn''t
have to be turned over to the government until the end of 1873.
Thus, the sooner they sold the bonds, the quicker they would
have use of the money. The offering meant little to Morgan who
wasn''t crying for cash at the time. But Cooke was desperate and,
much to his chagrin, the bonds sold slowly as Europeans began to
doubt that the American success story could continue. [Need I
spell out the interesting "potential" parallels to today''s investment
environment?]
A crisis was imminent. On September 13, trader Daniel Drew''s
firm, Kenyon, Cox and Company declared bankruptcy. On
September 17, stocks began declining and short-selling picked up
considerably. Insiders were exiting the scene. Panic hit the next
day.
At 11:00 a.m. on September 18, Jay Cooke''s New York partner,
H.C. Fahnstock, announced suspension of their New York office.
Ironically, Cooke was entertaining President Grant at his mansion
in Pennsylvania. At 2:30 p.m., Jay Cooke & Co. announced that
it, too, had failed. Unable to sell its railroad bonds, the creditors
slammed the door. The most prominent banker in the country
was bankrupt.
Historian John Steele Gordon describes that when the news was
announced, "a monstrous yell went up and seemed to literally
shake the building in which all these mad brokers were for the
moment confined."
The initial reaction to the collapse of America''s leading bank was
disbelief. A paper boy in Pittsburgh was arrested for shouting out
the news. The stock market collapsed.
On September 19, rumors were rampant that Cornelius
Vanderbilt was the next to go under. While this proved not to be
true, others did have to suspend operations. The contagion
quickly spread to Europe where markets crashed as well. [An
example of globalization, 125 years before the real thing.the
Asian and Russian crises of 1997 and 1998.]
On September 20, the New York Stock Exchange announced that
it would close for the first time in its history.for a period of 10
days. President Grant went to New York to try and figure out for
himself what to do. Cornelius Vanderbilt told Grant and his
treasury secretary that the real cause of the problem was the
overexpansion of the railroads, much of it financed by federal
bonds. Said Cornelius, "Building railroads from nowhere to
nowhere at public expense is not a legitimate undertaking."
The Nation magazine reported the following on the 20th.
"Anyone who stood on Wall Street or in the gallery of the Stock
Exchange last Thursday, or Friday, and Saturday, and saw the
mad terror, we might almost say brute terror (like that by which a
horse is devoured by a pair of broken shafts hanging to his heels,
or a dog flying from a tin saucepan attached to his tail) with
which great crowds of men rushed to and fro trying to get rid of
their property, almost begging people to take it from them at any
price, could hardly avoid feeling that a new plague had been sent
among men, that there was an impalpable, invisible force in the
air, robbing them of their wits, of which philosophy had not yet
dreamt." [Chancellor: "Devil Take the Hindmost"]
After the panic, industrial plants and commercial establishments
shut down, to the tune of 5,000 by the end of 1873. Railway
construction virtually halted in its tracks and over half of the
railroads defaulted on their bonds. A depression quickly followed
which would last the rest of the decade. Long bread lines began
to appear in the larger cities - there was no notion of public relief
back then - and the destitute roamed the countryside. By 1877, it
was estimated that only 20% of the labor force was in regular
employment.
Due to the Panic of 1873, foreign investment dropped from $242
million to zero by 1875.
Author Jean Strouse, "Morgan: American Financier," summed up
the scene.
"The panic touched off by Cooke''s failure exposed the
weaknesses in the economy as a whole. With no central bank, the
country had no way to increase its currency supply or make cash
available to faltering firms. The recent boom had been fueled by
too much unsecured debt, and speculation had driven stock prices
far beyond rational valuations. Moreover, the U.S. still depended
heavily on capital that could vanish overnight," as was the case
with European investment.
And so ends our story of Jay Cooke; perhaps the first modern
investment banker in our nation''s history. To be honest, I don''t
know how Cooke spent his last 32 years as he didn''t die until
1905. He obviously had lots of time to ponder his mistakes.
Unfortunately, many more were to follow in his footsteps.
Sources:
Charles Morris, "Money, Greed, and Risk"
John Steele Gordon, "The Great Game"
Charles Geisst, "Wall Street: A History"
Robert Sobel, "The Pursuit of Wealth"
Edward Chancellor, "Devil Take the Hindmost"
Morison, Commager, Leuchtenburg, "The Growth of the
American Republic"
George Brown Tindall and David Shi, "America: A Narrative
History"
Jean Strouse, "Morgan: American Financier"
Brian Trumbore
Next week, Teapot Dome.
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