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).

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 here for the moment confined."

The initial reaction to the collapse of America's leading bank was disbelief. A paperboy 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