Jay Cooke was the best known and most prestigious banker in the country. But his weakness was investing in railroads.
By John Steele GordonImagine what would be the reaction of the American financial system if people woke up tomorrow to learn that, say, a firm the size of JPMorgan Chase had declared itself insolvent.
Something like that actually did happen once, back in September 1873, when Jay Cooke and Co. announced its failure.
Jay Cooke was the best known and most prestigious banker in the country, thanks to his herculean efforts to sell federal bonds in unprecedented amounts to help fund the Civil War. It is not too much to say that he invented the bond drive, a feature of every major war since.
But after the war Jay Cooke and Co. was not as prosperous as it seemed. It still had a large share of the government bond business, but the government was now paying down the debt not building it up. The total federal debt declined by almost 20 percent between 1865 and 1873.
His biggest problem, however, was in his railroad investments. The eastern railroads had been built in populated territory and had a market more than willing to exploit the new technology that greatly reduced freight rates and travel times. But between the states bordering the Mississippi and the new Pacific states of California and Oregon was a vast area still empty of settlers.
The federal government, anxious to knit the country together, offered land grants and subsidies, but it was not enough. As ‘Commodore’ Cornelius Vanderbilt, who knew a thing or two about running a railroad, said: “Building railroads from nowhere to nowhere . . . is not a legitimate business.”
Cooke had sold $100 million in bonds to finance the Northern Pacific, but it wasn’t nearly enough. In hopes of interesting German investors (and immigrants), he had proactively named what would become the capital of North Dakota after German Chancellor Otto von Bismarck.
Problems persisted along the line, with washed out roadbeds and collapsed bridges. By the spring of 1873, the railroad was paying its workers with scrip.
At this time, Cooke and Morgan were in a syndicate to sell a $300 million government bond issue. The underwriters’ fee was a paltry $150,000. But the proceeds of the sale didn’t have to turned over to the government until the end of the year and the banks could use the money as they pleased.
Had the sale of the bonds gone well, Cooke might have muddled through. But it did not. With the economy in general declining, money tight, and short selling markedly increasing, Wall Street was poised for a crash. On Thursday, Sept. 18, H. C. Fahnstock, the New York partner of Cooke, announced its suspension. Cooke had no choice but to follow suit.
The news hit Wall Street like a bomb, and the “cold-black steed named Panic” thundered riderless through the American financial world. Rumors swirled that even Vanderbilt was on the edge of ruin. Numerous other banks suspended as well, and the panic spread to European markets, a sign of Wall Street’s swiftly growing world influence. On Saturday, the New York Stock Exchange announced it would close for an undetermined period.
Matters began to settle down when the federal government began buying federal bonds on the open market, injecting new money into the system. By Sept. 31, the NYSE was able to reopen. But it would be six years long years before prosperity returned. (The panic of 1873 triggered the formation of the American Bankers Association two years later as bankers sought camaraderie amid crisis.)
Forced into personal bankruptcy, Cooke had paid off his debts by 1880. A lucky investment in a Utah silver mine made him, once again, a very rich man by the time he died in 1905. But he was never again to be at the center of the American financial world.
John Steele Gordon is the author of An Empire of Wealth, The Great Game and Hamilton’s Blessing.