The market for railway company bonds grew quickly in the mid-to-late 19th century. Laying new track was very expensive and the returns would not come until a line was completed. For larger projects, such as those rail links crossing an entire continent, this could be years away. Thus, financing was as important an input for railways as steel, lumber, or locomotives. Because the bond markets provided much of this financing, investment banks were crucial partners of railway companies, providing advances to railways, marketing their bonds, and taking any unsold bonds for themselves so that the companies could be assured of receiving sufficient funds. Jay Cooke & Co. was one such investment bank, perhaps the most important in America, until it was ruined in the Panic of 1873.
Jay Cooke was a Philadelphia-based banker born in 1821. He advanced from bookkeeper to clerk to the chief executive of a bank by 1856. After a brief retirement from banking, he returned to start his own firm, Jay Cooke & Co., formed in 1861. The company was arguably the first investment bank in America and gained fame and fortunes selling vast amounts of Union government bonds during the American Civil War.
Jay Cooke & Co. sold $1.6 billion in bonds, a sum equal to one-fourth of wartime spending, and thus became the leading investment bank in the country. After the war ended, the firm remained a dealer in government bonds but also expanded into financing railways and other industries, from mining to oil. Cooke’s bank placed railway company bonds with individual investors in the manner it had earlier done with government bonds.
Between the end of the Civil War and 1873, some 30,000 miles of track doubled the nation’s railway network; 1870-72 were particularly busy years for new construction. The newly installed track cost $1.5 billion to build. This sum was largely funded by sales of land and bonds. With respect to land sales, grants of land to companies building out a proposed route gave railways a valuable asset to auction off for funds. With respect to bond financing, the market for railway company bonds grew from $416 million in 1867 to $2.23 billion in 1874.
Investing in a railway was not a sure bet, even considering all the benefits the railway system as a whole brought to the country. Building a new line required substantial initial investment while the success of the venture would remain uncertain for years as construction was underway. Even when a line started operating, most of its revenues were made during brief harvest seasons which always stood a chance of disappointing. Besides laying track, completion of a line required installing expensive locomotives, train cars, stations, yards, and other structures and equipment.
As for Jay Cooke, he became involved in a new railway project called the Northern Pacific Railway Company, which would operate a second transcontinental route connecting Duluth to Seattle, linking the Pacific to the Great Lakes. However, he initially turned down an opportunity to support the new railway in 1866 for fear it would require his bank to provide excessively large advances to finance the construction of the line. Soon afterward though, Cooke was encountering a great deal of success placing bonds for other railways with investors. So, he eventually threw his support behind the Northern Pacific project, becoming its financial agent in 1870.
Jay Cooke & Co. placed an initial $5.5 million in Northern Pacific bonds relatively easily. However, individual investors were crucial since no major subscriptions were received from other banks or railway companies. Cooke raised a further $13.5 million for the railway in 1871. In all, Cooke’s firm was responsible for raising $100 million in 30-year bonds at 7.3% for Northern Pacific. The bank would receive the bonds at $88, ensuring a healthy margin if they could be sold anywhere near par value.
To attempt to pull off this distribution, Cooke’s firm employed 1,500 salespeople and placed advertisements in 1,300 newspapers. They amassed a group of prestigious investors which included the Vice President of the United States, Schuyler Colfax, and other prominent figures. Still, this was going to be difficult. Northern Pacific Railway was not well received by the press and Jay Cooke & Co. found the market for such bonds saturated.
Construction delays, caused in part by wars between the Sioux tribe and the U.S. government, meant more money needed to be raised for the venture and there were far too few eager investors. Jay Cooke & Co. thus had to provide more direct financing to the Northern Pacific. To find other sources of capital for the company, Cooke named Bismarck, North Dakota after the German chancellor; the city was established on land granted to the railway. This was done in hopes of encouraging German immigration to the area. In any case, Cooke’s bank became very exposed to this one firm, just as Cooke feared when initially turning down the opportunity to secure Northern Pacific’s business. These unsold bonds were financed by Jay Cooke & Co.’s deposits.
It was not an easy time to be distributing railway company bonds in late-1872 and 1873. Firstly, in September 1872, the Credit Mobilier scandal, in which the Union Pacific Railroad was inflating construction costs to secure more subsidies, had come to light. This weakened government support for subsidizing railway construction. Now, foreign investors were skittish about American railway companies as firms began to face growing stress. Railway company failures were already mounting in 1872.
Cooke had hoped to sell Northern Pacific bonds, half of the $100 million underwritten, in Europe. He estimated that as early as 1869, foreign investors had held over $1 billion in American bonds. Foreign buying of railway securities had grown five-fold to $250 million per year by then. However, financial crisis in Europe, which began in Austria in May 1873, weakened demand for American railway bonds though European investors had been some of the most reliable buyers before. Capital flow into the United States was a cumulative $1.14 billion between the end of the Civil War and 1873. Now there was less money to go around and more European capital was being kept at home.
This meant that banks were saddled with railway company bonds they could not sell. With banks unable to increase their exposure or promise substantial bond sales, railways thus struggled to raise more money on a long-term basis. So, they resorted to borrowing in the short-term money market. Unfortunately, lending conditions tightened in 1873, so much so that margin loan rates to stock market speculators rose to as much as 0.5% per day. Railways were having trouble refinancing their debts by August. Railway companies had been failing in droves even before the coming financial panic ensued. Some fifty-three had failed in just the nine months preceding the Panic of 1873 as compared to eighteen in 1872 and just six in the entire period 1868-71.
In September 1873, financial firms with worrying exposure to problematic railway companies were coming under pressure. Among them, Jay Cooke & Co. was experiencing elevated demands for withdrawals. On September 15, Cooke met with the President, Ulysses S. Grant. What was discussed isn’t known, but it may have involved requests for help because help was certainly needed. Cooke was hoping to secure a loan from the government and launch one more bond sale to offload the risky exposure to Northern Pacific that it held. However, the situation at the bank was deteriorating quickly and assistance was not forthcoming. On September 18, Jay Cooke & Co. suspended withdrawals of deposits
Despite its troubles, the closure of Cooke’s bank was unexpected. Many didn’t believe the news, believing word of its demise to be a mere unsubstantiated rumor. But it was true. Perhaps more than any other firm, the failure of Jay Cooke & Co. launched the Panic of 1873 which in turn inaugurated a long depression. Other bank runs ensued and stock prices fell. Speculators were squeezed by margin loan rates that rose to 5% per day. The New York Stock Exchange chose to close for ten days, the first closure of this sort in its history. Meanwhile, the New York Clearing House arranged a scheme by which a new form of banknote, called loan certificates, would circulate as a joint liability of all member banks. This provided some limited relief against particularly severe runs on specific banks but overall, withdrawals continued.
Bankruptcies and bank failures came; 18,000 businesses were bankrupted across the country. Brokerage houses also suspended operations. Factories closed and railways shed employees, creating mass unemployment. Some 25% of New York City workers became unemployed, or about 14% nationally. Strikes and other labor unrest became more common.
Cooke himself was bankrupt as was the Northern Pacific Railway Company. The Panic of 1873 kickstarted a five-year long depression which was known as the ‘Great Depression’ at the time and until the depression of the 1930s arrived. What eventually became known as the ‘Long Depression’ instead was prolonged by efforts to reduce the nation’s money supply with the intent to restore the gold standard which was earlier suspended with the Civil War. This tightening money supply may have helped contribute to the scarcity of short-term capital that helped cause the panic in the first place as well.
The gold standard was eventually restored, but only in 1879. Jay Cooke himself restored his fortune through successful investments in a Utah gold mine. This allowed him to repurchase his island home on Lake Erie, called Gibraltar, which had to be boarded up after his earlier troubles. The Northern Pacific Railway was also completed, albeit only in 1883.
The story of Jay Cooke & Co. in the months leading to the Panic of 1873 shows how investment banking can range from a very safe business to a very risky one. Selling bonds on a commission basis with no obligation to take unsold bonds in inventory is rather riskless; no money is tied up holding unappealing securities. However, investment banks win more business when they can commit to taking an entire issue or any part of it that goes unsold.
For the bankers, this presents a large risk. They could very well wind up with unsold bonds and considering bonds are less likely to fly off the shelf when people are nervous or the issue is unappealing, this could happen at the worst time. Jay Cooke & Co. was stuck with large volumes of unsold bonds, exposed to the risk of a single company, in a disfavored industry, at a time of dwindling liquidity and rising business failures, causing the firm’s demise.
More from the Tontine Coffee-House
Read about Jay Cooke’s role in financing the Union’s war spending during the American Civil War and how bond financing was crucial in constructing America’s railway network. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
1. Butts, Mickey. “How One Robber Baron’s Gamble on Railroads Brought down His Bank and Plunged the U.S. into the First Great Depression.” Smithsonian Magazine, Smithsonian Institution, 18 Sept. 2023.
2. Chancellor, Edward. Devil Take the Hindmost: A History of Financial Speculation. Farrar, Straus, Giroux, 2000.
3. Markham, Jerry W. A Financial History of the United States. Sharpe, 2002.
4. Munden, Christopher P. “Jay Cooke: Banks, railroads, and the panic of 1873.” Pennsylvania Legacies, vol. 11, no. 1, May 2011, pp. 3–5.
5. Narron, James, and Thomas Klitgaard. “Crisis Chronicles: The Long Depression and the Panic of 1873.” Liberty Street Economics, Federal Reserve Bank of New York, 5 Feb. 2016.
6. Nitschke, Christoph. “Theory and history of financial crises: Explaining the panic of 1873.” The Journal of the Gilded Age and Progressive Era, vol. 17, no. 2, Apr. 2018, pp. 221–240.