Before we continue our story of Jay Cooke, America's first investment banker, and his role in helping to finance the Civil War, let's step back and take a look at overall U.S. government budget practices in the decade prior to the great conflict.

Throughout most of the 1850s, the federal budget was a mere $50-$60 million a year and there was little debt on the books. The budget for 1860 then rose to $74 million, with a $10 million deficit. The overall debt level stood at $90 million.

Then the first shot of the war was fired and Kaboom!…Union spending soared, hitting an annual level of $1.3 billion by 1865. The deficit for 1865 was some $964 million and the total public debt was in excess of $2.7 billion.

Meanwhile, Jay Cooke was anxious to serve his country, and make a buck at the same time. At the start of the war, his state of Pennsylvania had decided to sell about $3 million in bonds to provide for a defense against a potential attack from the Confederacy. You'll recall that Jay Cooke and Company had been established in January of 1861 and, despite his firm's small size, he saw an opportunity in the state's offering.

Cooke went to Pennsylvania officials and convinced them that he could sell a significant portion of the bonds using patriotism as a sales tool. The state decided to give Cooke and Company a chance and divided the sale between them and Drexel (some ten times the size of Cooke).

Cooke then used the experience he gained while employed at E.W. Clark in the 1840s and 50s to market the Pennsylvania bonds. He took out advertisements in the newspapers of the day, touting the bond's merits, not only from a patriotic view, but also from a financial angle. Part of his sales campaign read as follows: "But independent of any motives of patriotism, there are considerations of self-interest which may be considered in reference to this Loan. It is a 6 per cent loan free from any taxation."

Believe it or not, any language of this kind was a rarity in those days, so you can conclude that Cooke also deserves credit for being the first major "bond salesman."

From a personal financial standpoint, however, Cooke was not making a bundle on the sale of the paper. In fact, he earned only pennies on each bond his firm sold. But he had convinced Pennsylvania officials to name his firm the official state depository, meaning that Cooke saw large inflows from customers who deposited their funds with Cooke and Co. in order to purchase the paper. This gave him working capital, and that attracted new capital that wasn't bond related. The Pennsylvania offering went well and Cooke's reputation spread.

Before the war, fewer than 1% of Americans owned securities of any kind. The mattress was the place for any surplus cash. By the end of the war, though, Jay Cooke, alone, had sold bonds to about 5% of the total population of the North.

At the start of the war, there was one official who was having a real tough go of it - Treasury Secretary Salmon Chase. You'll recall from Part One that Chase had a relationship with both Jay and his brother Henry, the latter Cooke being firmly ensconced in the treasury department as an aide to Chase.

After the Battle of Bull Run, President Lincoln and Secretary Chase saw the need for immediate funding. The Union raised $50 million in a bond issue but it was a mighty struggle and, clearly, the need existed for far more, specifically, at least $240 million more.

On July 12, 1861, Jay Cooke approached Chase and told him he would open an office in Washington. Cooke then instructed his brother Henry to tell the treasury secretary, "that I hold myself at his service and, pay or no pay, I will do all I can to aid him in Treasury matters. I feel, however, that if he would give me a chance I could show him a way to raise the money."

Cooke opened his Washington office in February of 1862 at a critical time for the Union. England and Europe were turning against the North and military defeat by the Confederacy was not out of the realm of possibility. What this meant, of course, is that any hope of financial support from abroad was mostly a pipe dream. If Lincoln was unsuccessful in holding the Union together, the North wasn't a good investment. It was Jay Cooke time!

Cooke quickly put together a nationwide sale force of some 2,500; comprised of small town bankers, insurance salesmen, and real estate dealers. Now you may be thinking to yourself, how the heck did Jay Cooke maintain such an unwieldy sales force with communication being what it was back then? Glad you asked.

Cooke employed the telegraph to coordinate sales throughout the country. As market historian Charles Geisst thus concludes, Jay Cooke and Company was the first "wirehouse" in using the telegraph to confirm purchases and sales of the bonds; a method that would be employed in the future for all security sales.

Cooke's advertising once again stressed patriotism, the potential for profit if the Union won, as well as the safety of U.S. government obligations. More specifically, Cooke was selling what came to be called "five-twenties," so named because they could be redeemed in not less than five years or more than twenty, meanwhile paying six percent interest in gold. A bond buyer was therefore betting both that the federal government would survive and also that the Treasury would be sitting atop enough gold to pay off its borrowings.

Aside from his innovative advertising efforts, Cooke also convinced Secretary Chase to issue the bonds in denominations as small as $50, helping to ensure that the potential market was the majority of Americans. By early 1864, Cooke and Company had sold some $360 million of government obligations. He had done his duty.

You'll be amazed to learn, however, that for all of his efforts, Jay Cooke made only about $200,000 off of the $360 million he was responsible for selling (one-sixteenth of one percent), but the exposure he gained helped to establish Jay Cooke and Company as a giant in the financial arena. And, as you can imagine, the real money was made in the aftermarket for the bonds, where Cooke was by far the largest player, thus enabling his company to control all facets of it. As we will see next week, though, this same technique was used in his attempt to corner the market on railroad bonds. It proved to be a fatal mistake.

Finally, let me digress a bit to fill you in on the first real federal income tax in history, the Internal Revenue Act of July 1, 1862. This 20,000-word document was meant to create a revenue stream to supplement the funds that were raised mostly from the government's bond offerings.

The Act established a system whereby basic manufacturers were taxed 3%, while luxury goods paid higher taxes. At the same time the income tax was established at 3% on incomes between $600 and $10,000 and 5% on amounts over $10,000. [On June 30, 1864, the rates were raised again to 5% on incomes from $600 to $5,000, 7.5% on incomes from $5,000 to $10,000, and 10% on incomes over $10,000.] But the income tax was less than 20% of total government revenues.

Next week, Jay Cooke and the Panic of 1873.

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"
Russell Weigley, "A Great Civil War"

Brian Trumbore