WHILE THE NATIONAL ECONOMY was exploding in size in the post–Civil War era, monetary and banking regulation did not keep pace. Although the American economy became the largest in the world in these years and would come to rival the economy of all Europe in size, the United States remained without a central bank and thus without a mechanism to regulate the nation’s money supply. The ghost of Thomas Jefferson’s hatred of banks still haunted the American economy, although that economy now bore no resemblance whatever to the nation of yeoman farmers that Jefferson had envisioned.
The state-chartered banks, at first nearly extinguished when they were deprived of the ability to issue banknotes, made a strong comeback at this time. They regained the ability to create money by simply crediting the borrower’s checking account (a British innovation in banking). Reduced to fewer than 200 banks at the end of the Civil War, by 1900 there would be 4,405 state-chartered banks in operation, most of them small and financially weak.
The new national banking system functioned well in the Northeast, where the economy was most developed and liquid capital most available. But because national banks at that time were forbidden to branch or to operate across state lines, their number as well rapidly increased, to 3,731 by the turn of the century. While usually larger and stronger than the state banks, the national banks were often equally dependent on a single local economy. One of the greatest strengths of the American economy, its immense size and diversity, was denied to the banking sector with which all other sectors necessarily had to deal. It would, in time, prove a near fatal weakness.
And in the South and West, many areas lacked the resources to meet the requirements of a national charter. The states of Mississippi and Florida did not have a single national bank between them. Worse, national banks were forbidden to lend money on the collateral of real estate, the one asset these areas had in abundance. The very basis of the money supply became a major political issue in the late nineteenth century as the gold standard divided the country.
With the coming of the Civil War, both the government and the banks had gone off the gold standard, the government issuing millions of nonredeemable greenbacks to help it pay its bills. The National Banking Act, and the tax on banknotes issued by state-chartered banks, gave the country a uniform currency for the first time by the end of the war. But as long as the greenbacks circulated, the United States was not, internally, on a gold standard, as their price could, and did, vary with respect to gold. By the late 1860s it took around $135 in greenbacks to buy $100 in gold.
International trade, however, was on the gold standard. This meant that merchants buying or selling abroad had to buy gold to pay tariffs and had to hedge in the gold market to ensure that fluctuations in the price of greenbacks did not impact their profits. Jay Gould, one of the shrewdest men ever to operate in Wall Street, thought he saw opportunity in this situation. In 1869 he decided to corner gold.
A corner is nothing more than control of the entire supply of a commodity—whether pork bellies, shares of a railroad company, or gold—for a period of time. Anyone needing to buy that commodity during that time must pay the price demanded by the holder of the corner or do without. Traders who have sold short—in other words, sold what they do not own in hopes of a fall in price—have no choice but to buy when they are required to deliver, for, as Daniel Drew is supposed to have famously explained,
He who sells what isn’t his’n
Buys it back or goes to prison.
Attempted corners were commonplace in the Wall Street of the 1860s, and successful ones in various stocks happened every year. But attempting a corner in gold—the heart and soul of the nineteenth-century world monetary system—was an act of financial audacity unequaled before or since. For one thing, the federal government held millions in gold and could break any attempted corner at will. But Gould thought he could handle the honest but hopelessly naive President Grant.
He arranged to have Major General Daniel Butterfield, a Civil War hero (and, incidentally, the composer of “Taps”) appointed subtreasurer at New York and thus the man who would have to order any sale of gold from the government vaults. Asked later if the wires had been tapped to learn of government intentions, Gould’s partner Jim Fisk said, “Tap the wires? Nonsense! It was only necessary to tap Butterfield to find out all we wanted.” Meanwhile, throughout the summer of 1869, Gould lobbied President Grant hard not to authorize any sale of gold, citing the need of American farmers to export their crops at good prices. Meanwhile, he and his allies began accumulating the metal on Wall Street.
There was surprisingly little gold in the floating supply—the amount immediately available to the market at a given time—no more than about $20 million. The Gold Room on Wall Street at that time was doing about $70 million a day in trading, but much of that was what was called “phantom gold,” gold bought on paper-thin margins. As one Wall Streeter testified with some exaggeration, “if a man has a thousand dollars, he can go and buy five millions of gold if he feels so inclined.” Gould, president of one of the largest railroads in the country, had more than enough resources to buy up the floating supply many times over as he lured more and more shorts into his net.
The corner climaxed on September 24, 1869, known ever since as Black Friday. This was the first day in Wall Street history, but not the last, to earn the appellation “Black.” It was perhaps the most exciting single day in the whole history of the Street. The Gold Room itself was pandemonium as traders fought frantically to protect their interests. Around the entire country, business almost halted as men gathered in brokers’ offices and banks to watch the price of gold in New York ratchet upward on the newly invented stock tickers.
Outside, on Broad Street, matters were little better. An eyewitness reported that “Broad Street was thronged by some thousands of men…and within an hour staid businessmen, coatless, collarless, and some hatless, raged in the street, as if the inmates of a dozen lunatic asylums had been turned loose. Up the price of gold went steadily amid shouts, screams, and the wringing of hands.”
But President Grant had finally become aware of what was going on, and the Treasury ordered the sale of $4 million in gold at 11:42 A.M., an order that arrived in Butterfield’s office minutes later. The corner, however, was already broken. The price of gold (in greenbacks) had stood at 160 at 11:40 that morning. By noon it was at 140 and falling. The next day the New York Herald reported that “for the remainder of the day the Gold Room and all the approaches thereto were like the vicinity of a great fire or calamity after the climax has passed. A sudden quiet and calm came over the scene.”
We will never know if Gould made or lost money that day, for the mess was more swept under the rug than straightened out. Contracts that specified payment in gold—as Gold Room contracts necessarily did—were unenforceable at law, so it was possible to default without legal consequence, and many traders did just that. But because the gold corner was a buyers’ panic, as traders tried desperately to cover their short sales, there were no long-term consequences for the economy as a whole. It is sellers’ panics that have so often marked the start of depressions, as people rush to unload stocks and bonds at any price and to take their money out of banks that they see as unsafe.
Sellers’ panics produce, by their nature, a sudden surge in demand for money as investors and depositors seek liquidity, and money, of course, is the ultimately liquid asset. Because there was no central bank empowered to regulate the money supply and to provide the liquidity needed to protect the banking system in times of stress, however, these sellers’ panics greatly exacerbated the downward swings of the business cycle. Basically sound financial institutions collapsed by the hundreds when they were unable to meet the sudden demand for money. Often they took the life savings of families and the liquid assets of businesses with them.
The years immediately following the Civil War were a time of enormous economic expansion, a classic American boom. Railroad mileage doubled in a mere eight years, while wheat production did likewise. But in 1873 Jay Cooke, the Philadelphia banker who had invented the bond drive to help finance the Civil War and became the most famous banker in the country as a result, unexpectedly announced he was insolvent in September.
Panic swept Wall Street, where banks and brokerage houses, unable to convert their assets into cash quickly enough, failed by the dozens and the New York Stock Exchange was forced to close down for ten days because it could not maintain an orderly market. A deep depression stalked the land for the next six years.
The depressions of this time began to reach ever deeper into the American economy because a much larger percentage of the working population had become dependent on regular wages and national markets. Subsistence farmers who sold their surpluses locally could weather financial depressions fairly easily. Industrial workers and farmers who borrowed from banks on crops in the ground and sold to large grain companies could not.
THE NEW INDUSTRIAL and trading corporations were increasingly corporate in form, and the corporation became crucial to the American economy by the last third of the nineteenth century because enterprises dramatically increased in size at that time. In the eighteenth and early nineteenth centuries the economy had been characterized by individually and family-owned and operated enterprises. Organizations with more than a hundred employees were a rarity. By the time of the Civil War, however, several railroads were employing thousands, and industrial companies were growing rapidly as well. The Bath Iron Works of Maine, the largest industrial employer in 1860, had forty-five hundred workers.
Because railroads were very capital-intensive enterprises, they were mostly organized as corporations from the beginning. And as the railroads grew and spread across the land, their suppliers and, increasingly, their freight customers became larger and also became corporations.
In the earliest days of independence, obtaining a corporate charter had required a specific act of a state legislature, with all the politics that involved. But beginning in the early nineteenth century, states began passing general incorporation statutes, allowing companies to obtain charters under certain circumstances automatically. Legislatures began surrendering the power to form corporations not for altruistic reasons, of course, but simply because it was no longer possible for them to handle the demand for corporate charters.
In the entire colonial period, there had been only 7 companies incorporated in the British North American colonies. But in just the last four years of the eighteenth century, 335 businesses incorporated in the new United States. Between 1800 and 1860, the state of Pennsylvania alone incorporated more than 2,000.
In 1811 New York State became the first to pass a general incorporation statute, although it was originally restricted to companies seeking to manufacture particular items, such as anchors and linen goods. The types of businesses eligible to incorporate soon included all forms of transportation and nearly all forms of manufacturing and financial services as well, however.
The corporate form had numerous advantages over partnerships. Partnerships automatically terminated at the death of one of the partners, but corporations could live forever (although early ones were often limited to a term of years). And in a partnership, any partner can sign a contract, binding on all the partners, whereas a corporation could hire management to handle the business of the firm. Most important, a corporation can sue (and be sued) and buy, own, and sell property as an entity. That is why Chief Justice John Marshall described a corporation as “an artificial being,” one that was “invisible, intangible, and existing only in contemplation of the law.”
Corporations can also merge. Many of the original railroads were local affairs, aimed at solving particular transportation bottlenecks. They were often financed by people living in the neighborhood, who bought their stock, chose their management, and kept an eye on things. But these small railroads quickly merged into larger affairs as they sought efficiency and economies of scale. The New York Central, which originally ran from Buffalo to Albany, parallel to the Erie Canal, was formed in 1853 from the merger of nine local roads.
As the railroads became bigger, they also became more remote from their stockholders, who in turn became much more numerous. Many stockholders of the new, larger railroads were more interested in speculative profits on Wall Street than in the company itself. This often allowed management to run the company for its own benefit, as the managers of the Union Pacific had, rather than for the benefit of the stockholders. Devising ways to force corporate management to act as the fiduciaries they had become would fall largely to the private sector at this time.
AS THE NINETEENTH CENTURY began to draw to a close, an ancient problem in corporate affairs became more and more acute: accounting. As enterprises became larger and more complex, accountants began devising more and more tools to keep track of the money and to enable managers to see exactly where and how it was being spent (or misspent). The great corporate enterprises of the Gilded Age were only possible because of these new accounting tools. And this evolution of accountancy continues unabated today. Cash flow, for instance, is now regarded as one of the most important indicators of corporate prospects. But the very phrase cash flow was coined only in 1954.
As the distance between managers and owners increased, their interests in accounting diverged as well. The stockholders wanted timely information so they could evaluate the worth of their holdings and compare the results of their company with the competition to determine how good a job the management was doing. The managers, naturally, wanted to make the books, and thus themselves, look as good as possible. It was common in the nineteenth century for managers to part company with the truth and lurch over into fraud. It is hardly unknown today.
Many publicly traded companies did not release figures at all. When the New York Stock Exchange asked the Delaware, Lackawanna, and Western Railroad for information about its finances, it was told to mind its own business. The “Railroad makes no report,” it curtly informed the exchange, and “publishes no statements.”
Even when a railroad issued a report, it was likely to be, in the words of a contemporary, “a very blind document, and the average shareholder…generally gives up before he begins.” The Erie Railway, because some of its many bond issues were backed by New York State, was required to file an annual report with Albany. But it could frame that report pretty much as it chose. The managers of the Erie—one of the most mismanaged railroads in history—had no hesitation in using very creative accounting indeed to hide their own shenanigans. Horace Greeley in 1870 harrumphed in the New York Tribune that if the new annual report of the Erie was accurate, then “Alaska has a tropical climate and strawberries in their season.”
The weekly Commercial and Financial Chronicle put its finger on the problem and foretold its solution. “The one condition of success in such intrigues,” it noted, “is secrecy. Secure to the public at large the opportunity of knowing all that a director can know of the value and prospects of his own stock, and the occupation of the ‘speculative director’ is gone…. The full balance sheet…showing the sources and amounts of its revenues, the disposition made of every dollar, the earnings of its property, the expenses of working, of supplies, of new construction, and of repairs, the amount and form of its debt, and the disposition made of all its funds, ought to be made up and published every quarter.”
Wall Street took to this new idea immediately. After all, brokers and bankers needed to know the true worth of a company as much as the stockholders did. Henry Clews, a very influential broker in the post–Civil War era, led the push for both regular reports and for independent accountants to certify them as accurate. The big Wall Street banks, which were becoming ever more powerful, and the New York Stock Exchange increasingly required companies that needed capital or wanted to be listed on the exchange to conform to what would come to be called “generally accepted accounting principles” and to have their books certified by independent accountants.
Most accountants had been mere corporate employees before the last third of the nineteenth century. As late as 1884 only 81 self-employed accountants were listed in the city directories (the nineteenth-century equivalent of the phone book) of New York, Philadelphia, and Chicago. Just five years later there were 322. And these accountants were beginning to organize. In 1882 the Institute of Accountants and Bookkeepers was formed in New York and began issuing certificates to those who could pass a strict examination. In 1887 the American Association of Public Accountants came into being, the ancestor of today’s main governing body of the profession.
In 1896 New York State passed legislation establishing the legal basis of this new profession, and, incidentally, using the phrase certified public accountant for the first time to designate those who met the criteria of the law. The legislation, and the phrase, were quickly copied by the other states. By the beginning of the First World War, the system was universal throughout the American capitalist economy.
The one major fiscal area where generally accepted accounting principles and independent accountants have remained rare is in government. Indeed, a century later, most state governments, while often requiring their creatures to adhere to GAAP, do not do so themselves. And the federal government—the largest fiscal entity on earth—still keeps its books in much the same way as it did in the nineteenth century. With no countervailing forces, such as the Wall Street banks and the Stock Exchange, to exert the needed pressure, the “managers” of government—the legislators, governors, and presidents—have been able to put their self-interests ahead of those of the “stockholders.”
AS THE INDUSTRIAL CORPORATIONS grew and proliferated, their need for capital increased as well. Increasingly, it was supplied not by the British, who had been by far the most important suppliers of capital in the pre–Civil War era, but by Wall Street, through its rapidly growing investment banks. No one epitomized the new Wall Street power center more than its most important banker of this time, J. P. Morgan.
Morgan, unlike so many of the financial titans of the Gilded Age, was born rich, in Hartford, Connecticut, in 1836. His grandfather had been a founder of the Aetna Fire Insurance Company and had invested in railroads, steamboats, and real estate as Hartford became one of the wealthiest cities, per capita, in the country. His father, Junius Spencer Morgan, became a partner of the American banking firm of George Peabody and Company in London in the 1850s. He took over the firm on Peabody’s retirement, renaming it J. S. Morgan and Company. It quickly evolved into one of the more important international banking houses.
Morgan traveled frequently in Europe as a child, visiting the great museums that had no equivalent in the United States at the time and acquiring a deep interest in art. Very well educated—Morgan attended the University of Göttingen in Germany when few Americans of his generation who were planning a career in business went to college at all—he spoke both French and German fluently.
Morgan thus grew up in a much wider world than most of his generation and was thoroughly familiar with international banking at its highest levels from childhood. Deeply influenced by his father and Peabody, he believed that personal integrity was central to success in banking. At the end of his life, he was asked at a congressional hearing, “Is not commercial credit based primarily upon money or property?”
“No, sir,” replied Morgan. “The first thing is character.”
“Before money or property?”
“Before money or property or anything else,” Morgan insisted. “Money cannot buy it…. Because a man I do not trust could not get money from me on all the bonds in Christendom.”
By the 1870s Morgan was well established on Wall Street and a partner in the respected firm of Drexel, Morgan and Company, located at the southeast corner of Wall and Broad Streets, where the Morgan Bank has been ever since. Morgan soon set himself apart from the average Wall Street banker.
In 1878 William H. Vanderbilt, who had inherited the bulk of his father’s vast fortune, including no less than 87 percent of the New York Central Railroad, wanted to diversity his holdings. But selling a large chunk of a company as prominent as the New York Central without depressing the price of the stock was no easy task.
Morgan took it on, however, and succeeded in selling 150,000 shares in London at the very good price of $120 a share. And he managed to do it so quietly that no notice was taken. It was regarded as a masterful job of underwriting and, more, it made Morgan a major power in American railroading as he held the proxies of the new English shareholders and represented them on the company board.
Morgan intended to use his new power to bring order to the railroad business, which was greatly in need of it. There were still many small railroads that continued to operate independently, although because of their size they were unable to benefit from economies of scale or to use the latest technology. And because most of the major trunk lines had been assembled out of many smaller lines, they often had bizarrely complex capital structures.
Further, railroads had often engaged in cutthroat competition that resulted in wasteful, sometimes ruinous, overbuilding. Even the mighty Pennsylvania Railroad and the New York Central had been at each other’s throats. The Pennsylvania was building a line on the west side of the Hudson to compete with the Central, whose main tracks were on the east side of the river. The Central, in turn, was building a new line that paralleled the Pennsylvania’s through that state’s Allegheny Mountains.
Morgan won the agreement of both lines to negotiate and invited the company presidents to talks on board his majestic yacht Corsair. As the Corsair steamed up and down the Hudson River between New York and West Point, Morgan got the two lines to abandon their duplicating lines. (The tunnels that had been dug through the Pennsylvania mountains for the New York Central were abandoned, then, seventy years later, were incorporated into the Pennsylvania Turnpike.) Morgan’s prestige soared after the Corsair agreement, and much profitable new business came to his firm as a result.
Although he was a banker, not a railroad man, he quickly became the most powerful force in the industry, as he reorganized the Baltimore and Ohio, the Chesapeake and Ohio, the Erie, and other major railroads in these years. With more rational corporate structures and routes, they became much more economically viable. Morgan put partners of J. P. Morgan and Company on their boards to see to it that the roads did not slip back into the bad old ways of the past. Altogether, fully one-third of the railroad trackage in the United States passed through reorganization and, usually, the control of Wall Street banks, in the last two decades of the century. What emerged was a mature industry.
THE EXPANSION OF AMERICAN RAILROADS after the Civil War was nothing less than extraordinary. With 30,626 miles of track in 1860, the United States already had a larger railroad system than any country in the world. But by 1870 it had 52,922 miles; in 1880, 93,262 miles; in 1890, 166,703 miles. In 1900 it had 193,346 miles, a more than sixfold increase in forty years. While the annual value of manufactured goods in the United States increased by seventeen times between 1865 and 1916, the annual freight ton-mileage of the railroads increased by thirty-five times.
By the turn of the century the railroads tightly knitted together an economy that was now fully national in scope, and nearly every town of any size was served by a railroad. The major cities were usually served by several. This new railroad net presented a new problem, however, one that had been wholly unanticipated. The reckoning of time had always been a local matter, set by local noon, which, at the latitude of New York, is about one minute later for each eleven miles one travels westward. Thus when it was noon in New York, it was 11:55 AM in Philadelphia, 11:47 in Washington, and 11:35 in Pittsburgh. The state of Illinois used twenty-seven different time zones; Wisconsin, thirty-eight.
When travel had been at the speed of a horse, this did not matter, but with railroads it did, as scheduling was a nightmare. Congress, fearing local reaction, had dithered for years about dealing with the problem, so the railroads acted on their own. In 1883 they established standard time, dividing the country into four time zones, Eastern, Central, Mountain, and Pacific, with noon an hour later in each. On November 18, 1883, the nation’s railroads started operating on this standard time. And while there were complaints that the country should operate on “God’s time—not Vanderbilt’s,” within a few years standard time had, indeed, become standard, and it was hard to imagine a world without it.
The ability of the railroads to impose something so fundamental as standard time indicates just how powerful they had become by the late nineteenth century. Railroading was by far the country’s largest industry. It employed more than a million workers in 1900, out of a total population of nearly seventy-six million, earning an annual average of $567 each. Being run by human beings, the railroads, naturally, did not hesitate to exercise their market power to their own advantage.
The railroads had developed a trunk and branch system, with a main line connecting major cities and numerous spurs to smaller communities. Often there was stiff competition on these trunk lines. Between Chicago and New York, for instance, one could choose the New York Central, the Pennsylvania, or the Erie. On the trunk lines, the railroad alternated between competing fiercely for business, cutting rates to the bone, and forming cartels to divide the business and set prices. These cartels usually broke down quickly for lack of an enforcement mechanism.
But most of the branch lines were monopolies, and the railroads could—and most certainly did—increase their profits by charging customers on these branch lines more, sometimes much more.
The customers, not surprisingly, resented it. The Granger movement, the National Grange of the Patrons of Husbandry, which began in 1867 as a social and educational organization, soon evolved into a lobbying organization to represent farmers against the railroads. By 1875 there were twenty thousand local granges throughout the Midwest and eight hundred thousand members, most with an intense dislike of the local railroad.
A movement this big, of course, quickly got the attention of politicians in the state capitals, who started regulating the railroads, often setting up commissions to oversee the business. But these commissions proved ineffective, partly because the very well-heeled railroad lobbyists saw to it that they had very limited powers.
Often they were little more than a political cover for allowing the railroads to do as they pleased. In 1895 one critic of the California Railroad Commission wrote, “The curious fact remains that a body created sixteen years ago for the sole purpose of curbing a single railroad corporation [the Central Pacific] with a strong hand, was found to be uniformly, without a break, during all that period, its apologist and defender.”
It was soon clear that individual states could do little to effectively regulate railroads that now sprawled over many states. And when the Supreme Court ruled in 1886 in Wabash Railway v. Illinois that states had no power over railroads that were carrying goods across a state line, the fight to regulate the railroads moved, of necessity, to Washington.
Congress was now confronted with the same political problem that had faced the state legislatures. They had tens of thousands of votes at stake on the side of the farmers, small merchants, and manufacturers, and hundreds of thousands of dollars at stake on the side of the railroads.
What resulted, after a year of intense political sausage making, was, in the words of one historian, “a bargain in which no one interest predominated except perhaps the legislators’ interest in finally getting the conflict…off their backs and shifting it to a commission and the courts.” A federal railroad commission, similar to the ones that had largely failed at the state level, was the only proposal under serious consideration.
Assuming their interests were properly considered, the railroads had no objections. Indeed, a vice president of the Pennsylvania Railroad said as early as 1884 that “a large majority of the railroads in the United States would be delighted if a railroad commission…could make rates upon their traffic which would insure them six per cent dividends, and I have no doubt, with such a guarantee, they would be very glad to come under the direct supervision and operation of the national government.”
What the railroads wanted, in other words, was a government-sponsored and enforced cartel in place of the many private ones that kept failing.
The bill that finally emerged, establishing the Interstate Commerce Commission, required that “all charges…shall be reasonable and just,” but didn’t define what that might mean. Further, it forbade different rates on trunk lines and branches and for short hauls and long hauls. But the commission had to use the courts to enforce any orders. The railroads had no trouble finding their way around the new rules when they wanted to. Even though the ICC was strengthened in the next decade, it quickly evolved into exactly what the railroads had wanted in the first place, a government-sponsored and enforced cartel. This is not surprising as most of its technical expertise had, necessarily, to be hired from the railroad industry itself, a problem that has plagued all government regulatory bodies since.
But whatever its inadequacies, the Interstate Commerce Commission marked a major turning point in the history of the American economy. For the first time, the federal government was attempting to regulate a portion of that economy.
More was quickly to follow, although, as with the Interstate Commerce Commission, the intent and the results were often not in accord, at least in the short term. In 1890, still pressured to curb the power of the railroads, Congress passed the Sherman Antitrust Act. Both houses of Congress that year were controlled by pro-business Republicans and a Republican, Benjamin Harrison, sat in the White House, but the Sherman Act passed with only a single dissenting vote and was signed into law.
The reason was that it was notably short on specifics. “Every contract, combination in the form of trust or otherwise,” it stated, “or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal.” Further, it made it a crime to “monopolize or attempt to monopolize, or combine or conspire…to monopolize any part of the trade or commerce among the several states.”
The pro-business Harrison, Cleveland, and McKinley administrations, and the deeply conservative Supreme Court of the 1890s, assured that the Sherman Act would be nearly a nullity in its early years. But, in the words of historian Charles Warren, the Sherman Antitrust Act helped awaken “Congress to the realization of the vast power wrapped up in the Commerce Clause,” and an activist president in the next decade would use it to make the federal government a major factor in regulating the American economy.
So much so, in fact, that before his death in 1913, J. P. Morgan, who had been a leader in the movement to require corporations to use standardized bookkeeping and independent accountants to certify their financial reports, would complain that Theodore Roosevelt expected men to conduct business with “glass pockets.” Like most people—in government quite as much as in business—he valued transparency in the affairs of others more than in his own.