How would the American and global financial system react if people woke up today to learn that a powerful investment giant the size of JPMorgan Chase had gone bankrupt? The shock would be even greater than that of Lehman Brothers. Something like that happened once with the “cannon” of Jay Cooke and Co.
It was a cool Monday afternoon when legendary stockbroker Jay Cooke invited President Ulysses Grant to tour his estate and spectacular 53-room mansion in a suburb north of Philadelphia. The 200-acre grounds contained streams, a deer park, an aquarium, stables and a private telegraph system.
Cook had founded the first investment bank in the United States, Jay Cooke & Company, a decade earlier. And he financed the construction of the Northern Pacific Railroad, a transcontinental railroad that would eventually connect Lake Superior in the Midwest to Puget Sound on the West Coast. The thundering “iron horses” covered a route of 6,800 miles. Historians are uncertain exactly what Cook and Grant discussed on that fateful September night.
But the president was not exactly keen on hearing what Cook had to say, even though Cook had donated millions of dollars to support his re-election as president. Cook became extremely wealthy by building an investment network that sold more than $1.6 billion in Civil War bonds to small investors across the North.
Three days after the two men met, on Thursday, September 18, 1873, Cook’s company would declare bankruptcy, causing conditions of absolute panic. Before we look at exactly what happened that day, let’s look at how we got there.
From an accountant…founder of the first investment bank
Cook was a Philadelphia-based banker born in 1821. He began as a simple bookkeeper and rose to the position of managing director of a bank in 1856. After a brief retirement from banking, he returned to form his own firm, Jay Cooke & Co., which he founded in 1861. He often referred to it as the “Gibraltar of economics” to emphasize its importance. The firm was arguably the first investment bank in America, and gained fame and fortune by selling huge amounts of Union government bonds during the American Civil War.
It is estimated that Jay Cooke & Co. sold a total of $1.6 billion in bonds—a sum equivalent to a quarter of wartime spending. It thus became the nation’s leading financial organization. After the war, the firm continued to be a dealer in government bonds, but it also expanded into financing railroads and other industries, from mining to oil. It even made a large opening in railroad bonds to individual investors, just as it had done in government bonds.
The bet on railways
From the end of the Civil War to 1873, the nation’s railroad network more than doubled. Its rapid expansion was financed largely by land and bond sales. In terms of land sales, concessions to companies building a proposed route gave railroads a valuable asset to auction for capital. As for the bond market, railroad bonds rose from $416 million in 1867 to $2.23 billion in 1874.
Investing in a railroad was not a safe bet, even considering all the benefits that the railway system brought to commerce, the economy, and the country. This was because building a new line required a substantial initial investment, while the success of the venture would remain uncertain for years. Even once a line was up and running, revenue was not guaranteed. In addition, locomotives, railcars, stations, and other expensive equipment had to be purchased.
As for Jay Cook, he was involved in a new railroad project called the Northern Pacific Railway Company, which would operate a second transcontinental route connecting Duluth to Seattle. Jay Cooke & Co. secured the sale of $100 million in 30-year bonds. He employed 1,500 salesmen and advertised in 1,300 newspapers. He assembled a group of famous investors that included the Vice President of the United States and other prominent figures. However, the Northern Pacific Railroad project was not well received by either the press or the market.
Panic
It was not an easy time to issue railroad bonds in late 1872 and 1873. First came the Credit Mobilier scandal in September 1872, in which the Union Pacific Railroad inflated construction costs in order to secure more subsidies. This weakened government support for subsidizing railroad construction.
Somehow, Jay Cooke found himself facing enormous exposures that exploded in September 1873. The day he declared bankruptcy, we had a crash on the New York Stock Exchange and other major markets as well. In one day, 37 banks in the United States failed. The economy plunged into a prolonged recession. In the six years following the Panic of 1873, some 10,000 American businesses went into lockdown.
