Last week we took you through the story of Cornelius Vanderbilt and Daniel Drew. This week we are talking about Erie's stock crash.
Vanderbilt couldn’t immediately oust Drew from the board, despite wanting to. He needed to wait until the next board election, but what he could do was stop him from flooding the market with shares. The judge (who was Vanderbilt’s rookie) froze the Erie share count at 2,50,000 shares, which was the share count from two years before. The order ensured that Vanderbilt could buy a majority of Erie’s shares without the fear of Drew fabricating more stocks and diluting his ownership. Vanderbilt instructed his stockbroker to keep buying until he had a majority.
There were two ways to operate a railroad. There was a Vanderbilt way of running the train on time, keeping the rolling stock in top condition, charging a fair price, winning customers with good service, and paying a steady dividend to shareholders. And then, there was Drew’s way. The transportation of freight and passengers was not as important as the insider trading to make himself a profit.
He was least interested in building a sustainable commercial enterprise. His focus was to manipulate the stock price and profit from the moves. Stock jobbing had after all made him the most successful businessman of the country after Vanderbilt.
When Jay Gould joined the Erie board, he had a choice. He could go back to Vanderbilt and be a builder. Or he could back Drew and be a speculative director. In the great Erie war, Gould decided to partner with Drew.
Now enter Jim Fisk, the fourth character in the Erie drama. Fisk started his career by selling circus tickets, he took over his father’s peddling business selling linens door to door. He got a job in Boston with the retailer Jordan & Marsh. During the civil war he snuck over enemy lines to buy confederate cotton for Union Army uniforms. Daniel Drew got to know him and hired him to sell a steamboat. Fisk got a good price. Impressed by Fisk’s promotional skills, Drew invited him to New York and set him up as a stockbroker.
Drew put Fisk on the Erie board where he became friendly with Jay Gould. Vanderbilt and Drew were role models for Gould. Jim Fisk wasn’t a role model, quite the reverse in fact. With the injunction from Judge Barnard that blocked Erie from issuing more shares, Vanderbilt cornered up the stock on the open market, trying to gain a majority. Drew fought back with injunctions. Vanderbilt was so fixated on taking Erie away from Drew that he broke his own commandment and borrowed money to buy more shares. The banks would give it to him if he put up shares of New York Central as collateral.
But they refused to loan it on Erie, rejecting the shares as too risky. Vanderbilt sent his lieutenant to negotiate with the banks, telling them that if they didn’t take loan on Erie, Vanderbilt would sell all his shares in New York Central and the price of Central would crash. If that happened the banks that had it as collateral would go down with it. The banks gave in, and Vanderbilt commanded his brokers to buy every share of Erie they could get their hands on. Erie went from $68 to $80 in a week. Gould was making money but the profit offered no comfort. He thought if Vanderbilt took over the railroad after ousting Drew, and bought in his own people, he would be out of job, hence Gould joined Drew.
At Erie, Gould noticed that Judge Bernard’s injunction against new share issuance enjoined the Erie board and only the board. What if another entity, say Erie’s executive committee – a group composed of Drew, Gould and Fisk- issued the stock instead of the board? Would that work? The Erie lawyers liked the idea and followed up by finding a judge who signed an order expressly empowering the executive committee to issue shares.
Before Vanderbilt knew about the order, printing presses began to roll out fresh Erie certificates. Fisk wanted the job done right. He grabbed the shares and headed to Wall Street to deliver them to the broker personally. Soon Erie shares were readily available but Vanderbilt, believing the shares count was fixed, kept buying. Vanderbilt became suspicious when he noticed that his buying wasn’t affecting the share price. The prices should have skyrocketed as shares became scarce. Instead the price held steady. Vanderbilt looked at the certificates. The certificates looked new. They felt new, they smelled new. Then it hit him. These were new shares being issued. Vanderbilt stopped buying. If the supply of shares was infinite, there was no point. He’d never get a majority.
The executive committee had reasons to celebrate. They had just tricked America’s richest man into giving the Erie treasury $7 million and he was no closer to controlling the railroad than before he bought the shares. As they lifted their glasses to toast to their victory over Vanderbilt, a messenger came with news. Judge Barnard, ignoring the ruling of the other judge, had cited them for contempt. The sheriff was on his way to Erie headquarters to arrest them
A beat cop happened to be walking down Duane street a few minutes later and saw men running in and out of Erie building hauling boxes from inside and dropping them on the sidewalk. Was Erie being looted? No need for concern the men said, they said they were relocating the Erie’s offices. The men were Jay Gould, Jim Fisk and Daniel Drew, the executive committee of the Erie railroad.
They were preparing an escape. Drew grabbed a ferry to Jersey City. Gould and Fisk said they would catch up later and went to have dinner. At the restaurant Gould had at his feet a bag of cash, cash from selling new Erie shares to Vanderbilt. Fisk, aware their meal could be interrupted, had a lookout at the door and an escape plan in his head. Someone had tipped the cops, as the cops barged in through the front door, handcuffs in hand. Gould and Fisk ran out the back and escaped to Jersey City.
Drew hid in his room trying to figure out how to resolve the situation. He wanted to make peace. He wanted to go home. Gould and Fisk all but forced him to stay, promising to find a way to keep Vanderbilt’s money. Gould and Fisk hatched a plan. They’d lobby Albany to sanction their heist with a law to permit the share issuance. So, Gould went to New York. Hearing that Gould was in New York, Judge Barnard wired Albany an arrest order.
Gould was one step ahead and had pre-arranged bail. When the trial date for the contempt charge came two weeks later, he won a delay by faking illness. Gould had decided that if forced, he would spend all of the money extracted from Vanderbilt in Erie in bribes.
The Senate proceedings were an auction. Whatever Tweed (Vanderbilt’s counsel) offered, Gould offered more. If Tweed bought a vote, Gould bought it back. His trunk of cash seemed bottomless.
The Senate voted with Gould and the bill went back to the assembly for final approval. Hearings were held. Witnesses testified. Then, before bidding commenced for the final stretch, Vanderbilt bowed out. He’d pay no more. He was done with bribery. Furious lawmakers expressed their wrath with a 106 to 6 vote for Erie. They gave the commodore another kick by making it illegal for him to ever own Erie. The governor signed the order. Shares in Vanderbilt’s New York Central, the stock he pledged as collateral to buy his Erie shares plunged 20 percent. Bankers fretted that he was finished. The market was full of rumours about the solvency of Vanderbilt.
Vanderbilt wasn’t finished, he was only changing tactics. Vanderbilt knew this about Drew. Drew, as he told friends, had “no backbone”. While Gould was in Albany, Vanderbilt commanded Drew back to New York for peace talks. The great bear was desperate to come home. When he met the commodore, he offered unconditional surrender. If Vanderbilt dropped the criminal charges, he’d make sure Erie would buy back the shares and the commodore would come out whole. Vanderbilt attached two conditions.
First Drew, Gould and Fisk had to leave the Erie board. And to make sure they would never trouble him again, they could never, absolutely never, have anything more to do with the railroad. When Gould heard about the deal he and Fisk were Flabbergasted. What was Drew thinking? The governor had just signed a law legalising what they had done. The following Sunday, Gould and Fisk went to Vanderbilt’s mansion to seek a better deal. They offered to let Erie keep some of the money. Vanderbilt refused. He demanded the plotters return every penny or else he’d keep his bloodhounds on their tracks.
A week later Drew met Vanderbilt in the home of Vanderbilt’s judge. Gould and Fisk got wind of the meeting and ran to the Judge’s house. Gould made an offer. Erie would give Vanderbilt his money back and Drew would leave the board, but he and Fisk could stay. Vanderbilt had nothing to lose as the board election would be in October which was seven months away. If Vanderbilt had the votes and still wanted them out, he could kick them out then. In the meantime, he’d get his money back right away, without having to go to court. Vanderbilt took up the offer.
When Gould walked through the Erie office on his first day as president, he was thinking about how he could now buy Erie stock before he could make it go up and how he could short Erie stock before he made it go down. The first order of business was keeping Erie afloat. Erie wasn’t earning enough to cover its interest payments. Although it had bought back Vanderbilt’s share and promptly resold the shares to raise money, it still fell short and if it missed an interest payment, bankruptcy wouldn’t be far off.
Where to get money? Banks were out of question because Erie had pledged all its assets. Wall Street was out, too, because Drew had burned too many bridges. Gould managed to catch hold of Joseph Seligman, a German banker. With his help, Gould raised $10 million in London and filled the Erie treasury.
Next for Gould was keeping himself in office. Vanderbilt had yet to amass enough shares to oust Gould, but there was still time. As per Erie by laws, anyone with stock on the day of board election could vote. One share, one vote. Gould stumbled on an idea. He had read about an Indiana railroad that changed its bylaws and advanced the cutoff date for voter eligibility.
Gould took the idea to the Erie board, and the board accelerated the cutoff date to the same day, making it impossible for Vanderbilt to vote shares bought later. Gould followed up by getting the legislature to let Erie directors keep their job for five years instead of having to face annual re-elections. The moves blindsided the commodore.
The money he raised, $10 million in all, gave him another club to bash Erie’s stock price. To execute the scheme known as Lock up, he’d deposit the money in a bank and then have Erie write a certified check on it. The bank would have to hold in reserve an equal amount of cash in case the check got cashed. Ten million back then was a lot of money, comprising a significant share of the ready cash in the city’s banking system. By locking it up and making cash scarce, banks would charge higher interest rates for cash they still had to lend. Whenever interest rates go up stocks go down.
Gould was confident the share prices would crash. The interest rate to buy stocks on margin back then was six per cent. Erie sold for $48 before the lockup, it barely moved after Erie wrote its certified check. Gould then persuaded Drew to join his bear cartel and take more money out of circulation. A week later the interest rate hit seven per cent and Erie sold for $44 down $4 from where they started. It became a full panic a few days later when interest rates hit 10 per cent. Desperation took over.
Banks relieved their wants by throwing their stocks on the market for cash, Erie hit $38, down $10 from the start of the lockup. Drew quit Gould’s pool and bounded back into the market shorting Erie for his own account. He made a huge bet. A week after Drew’s short, Erie fell to $35. Drew was cleaning up. He let his bet ride.
In every bear raid, there comes a time when a stock price becomes so untethered from reality that it can fall no more. Gould decided $35 was as low as Erie should go. It was time to shift gears. When the banks and the exchange opened on Monday, Gould closed his own short position by buying Erie stock to return to lenders. He had to pay up to get the shares, but it was worth it. He cancelled Erie’s certified check and terminated the lockup.
Everything that had blown north - interest rates, the money supply, the availability of bank credit - instantly blew south towards friendlier waters. Erie moved from $36 to $52, a bracing 44 per cent advance. In this advance Drew was caught on the wrong foot, he immediately went to Erie’s office to meet Gould who was there sitting with Fisk. “I am a ruined man,” he told them. Gould stayed quiet. Fisk replied that Drew should be the last man that should whine.
Drew suggested getting the team together and doing another bear raid on Erie. He’d give his big profits to Gould. Gould demurred. Drew offered to pay an enormous interest rate if Gould let him repay over time. Gould held firm.
Finally when Drew felt nothing was working, he said unless Gould gave him a break, he’d blow the whistle on Gould’s deception. Drew reached into his pocket and pulled out a sworn statement he had written for the occasion. It detailed every questionable activity Gould had done since joining Erie. The self-dealing, the undisclosed share sales, the looting of the treasury to execute the lock up. Drew in fact threatened Gould by saying “I swear I will do all the harm I can do if you do not help me” and he left the office.
Something occurred to Gould. In Drew’s desperation to save himself, he had unwittingly given away ammunition. If the court accepted Drew’s charge, it would deliver Erie to a receiver. The judge would take away Erie from Gould before he could steal again. What if Erie was already under receivership? And what if Gould himself was named receiver? He could retain his executive privileges and business could go on as usual. Next morning Gould, Fisk and his lawyers went to Judge Barnard and he signed the receivership order after being bribed.
Expecting Drew’s judge to send his own receiver at any moment, Gould raced to Erie headquarters, barred the doors, and posted guards. He was huddled with Fisk and the lawyers when they spotted an intruder who had penetrated the defences. The intruder was none other than Drew’s lawyer and said he was now the receiver of Erie railroad. Fisk had arranged goons which scared Drew’s lawyer and he fled. Gould, now the lone receiver of the Erie railroad, remained in charge.
Drew settled with Gould at a loss of $1.3 million. Drew returned to his farm. After a few more failed speculations, he eventually went bankrupt. Later when asked about Gould, Drew gave a short reply. “His touch is death,” he said.
(To be continued in the next column.)
American Rascal: How Jay Gould Built Wall Street’s Biggest Fortune by Greg Steinmetz, published by Simon & Schuster August 2022
Kirit Manral is a professional trader, and has been running a mentorship program in trading since 2019, with mentees from around the globe. He can be found on Twitter at @KiritManral