The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould, and J. P. Morgan Invented the American Supercompany

by Charles R. Morris

  The Reading restructuring was one of the first to be managed by Charles Coster, a new Morgan partner who was to become the era’s greatest financial engineer, a veritable walking spreadsheet. Coster became very wealthy from his work at Morgan, but had little time to enjoy it. The market analyst John Moody described him as “a white-faced, nervous man, hurrying from meeting to meeting and at evenings carrying home his portfolios.” Morgan relied on him for the analytics and pricing on all of his railroad deals, and Coster sat on dozens of finance committees and boards until he died in 1907, still in full harness at fifty-six. Although his death was ascribed to an untreated cold, few doubted that it was the consequence of years of overwork.

  The denouement of the Reading refinancing, however, was a salutary lesson in the limits of banker power. The restructured property naturally remained a Morgan banking client, and as the road appeared to make a strong recovery, it was released from the voting trust requirement in less than two years. A few months later, in the spring of 1888, the Philadelphia and London houses proudly issued two new tranches of Reading debt, prompting a warm encomium from Morgan to the new Reading management. Astonishingly, hardly a year and a half after that, the Reading was once again on the brink of insolvency, prompting howls of outrage from the London investors. The anger in London is understandable; that the Morgan bank did not see it coming is less so. The new management had embarked on an aggressive expansion program, including the unpardonable sin of challenging another of Morgan’s troubled roads, the New Haven—in other words, precisely the behavior that the oversight mechanisms and reporting requirements were supposed to flag.

  It took almost five years to work out yet another restructuring. When the Reading proposed a new bailout on lenient terms, Morgan would have nothing to do with it; but the Philadelphia branch eventually arranged several tranches of tide-over financing, which were embarrassingly difficult to place. If the 1893 market panic wasn’t enough to eliminate any disposition toward leniency, Tony Drexel’s death that same year certainly did—the Drexels were Philadelphia stalwarts, and had long been identified with the Reading. Morgan finally took over the deal himself and eventually forced a harsh restructuring, including a wholesale replacement of the offending managers and strict terms of parole. The word that Morgan was managing the transaction himself was enough to attract investor interest, and as the economy ticked back up, the road embarked on a long period of stability.

  The Reading’s difficulties were just one more confirmation of Morgan’s settled conviction that reckless expansion was the root of all railroads’ troubles. Morgan was a bull on the United States; he was an early backer of Thomas Edison, and a primary banker to the nascent telephone industry, so he was no Luddite. Intellectually he fully understood that disruptive price and technology competitions expanded markets and speeded growth. But given a choice, he came down on the side of cartels and stability every time.

  The Unbearable Elusiveness of Peace

  We still struggle with the challenge of managing competition among essential high-fixed-cost industries. The core problem is that a railroad, a telephone company, or an airline must invest huge amounts of capital before it can earn a dime. Then once the infrastructure is in place, it makes sense to sell services at almost any price to help cover the fixed-cost overhang. Free competition therefore quickly leads to cutthroat pricing and financial turmoil, as in the scorched-earth competition among AT&T, Worldcom, and MCI in the 1990s, or the continuing wave of bankruptcies in the airline industry. Unfortunately, the uniformly dismal experience with regulated monopolies makes the nasty Darwinism of unfettered competition almost attractive. Just consider the appallingly bad performance of regulated companies like the electrical utilities on almost any measure.

  Our own murky understanding of the dynamics of big business competition, despite the doctrines du jour generated by consultants and academics, should temper our judgments of Morgan and his contemporaries. In the 1960s and 1970s, for example, the business historian Alfred Chandler and others noted the remarkable stability of the ranks of big American companies over the previous half century. He and his students identified the large, stable, perennial leaders as “Center” firms, with common characteristics: they were “integrate[d] vertically” and enjoyed “lower unit costs achieved through long production runs,” as one 1984 study had it. That statement, unfortunately, was published at a time when American long-production-run companies were being thoroughly routed by the Japanese rapid model change style of manufacturing. The long production run, it turns out, was an Achilles’ heel, a lazy adaptation to the days of consumer scarcity, when everyone was happy with one black phone, and overseas competitors were regularly destroyed by war. Its last redoubts today are in Russia and the state-owned companies of China. Twenty years later, the largest American company, with a quarter trillion dollars in annual sales, is Wal-Mart, which is neither vertically integrated in Chandler’s sense nor has any production runs. America’s fastest growing steel company, with a market value about twice that of U. S. Steel, is Nucor, a company that expressly eschews vertical integration. Finally, who would have guessed in 1984 that a small Seattle-area software contractor would soon pose one of the gnarliest of global monopoly challenges? In short, if Morgan didn’t always get it right, he’s since acquired a lot of company.

  By the late 1880s, even Jay Gould was showing signs of exhaustion from twenty years of unrelenting railroad warfare—although in Gould’s case the exhaustion was abetted by a losing, if carefully concealed, battle with tuberculosis. But the fact remains that even so intrepid a warrior as Gould was attracted by the notion of a large-scale cartel. Just then he also happened to be on relatively good terms with Morgan. Morgan had managed the sale of the Baltimore & Ohio’s telegraph company to Gould, and he sat on Gould’s Western Union board. He was also a director and occasional banker for Gould’s Manhattan street railway interests, and helped broker Gould’s dramatic reemergence as the control party of the Union Pacific in 1890.

  The day’s leading thinker about regulatory issues was Charles Francis Adams, Jr., brother of the historians Henry and Brook, and descendant of the two presidents. After serving with distinction as a wartime Union officer, and with no necessity of earning a living, Adams cast about for something useful to do and finally settled on railroads. His 1869 magazine article, “Chapters of Erie,” is still the classic retelling of the Erie railroad wars, and a main source of the dark legend of Jay Gould. Adams was a primary force in the creation of the Massachusetts Railroad Commission that same year, serving a full decade as a commissioner, and later as a director of the eastern railroad rate-setting pool run by Albert Fink, whom he greatly admired. Close to the Boston Ameses, who were still major shareholders in the Union Pacific, he had been a government director of the UP and was elected to the board in his own right in 1883. That was just about the time Gould and Sidney Dillon, Gould’s partner and the UP president, were withdrawing from the UP to concentrate on their southwestern lines. With the strong backing from the Boston shareholders, and his outstanding reputation for integrity, Adams was the natural choice for the UP presidency in 1884.

  Adams was the quintessential rational man; his faith in the power of information and the intelligence of elites anticipated the Progressive reformers of the early twentieth century. Although he worried about the unsupervised power of large corporations, he accepted that railroads were probably a natural monopoly, and was intrigued by the challenge of constructing an effective supervisory regime. His preferred solution, and the model for the Massachusetts body, was the “sunshine commission.” Collect good data, be sure that everyone is working from the same base of information, and the fairest and most efficient solutions will inevitably suggest themselves. He once commented that if all railroad presidents lived on the same street and walked to work together each morning, they would not embark on their wasteful wars. Nor, presumably, would they ever have built the gross over-capacity so uniformly lamented by the wisest contemporari
es and by generations of subsequent scholars.

  Adams and Gould detested each other, so their working together to rein in the railroad wars attests to the importance they attached to it. It was Gould who made the first moves. In 1888, he and Collis Huntington, the powerful western railroad magnate, with whom he had long had a kind of scorpions in a bottle working truce, worked out a tentative clearinghouse arrangement to allocate traffic and regulate rates among the western roads. But they hoped to go even further and create a true joint executive authority over the roads. Gould deferred the initiative to Morgan as the honest broker, and Morgan convened all the western railroad leadership at his house in New York late in the year. Together, Adams and Gould pushed a plan that Adams called the “Interstate Commerce Association,” a cartel arrangement that he hoped would operate with the express cooperation of the new Interstate Commerce Commission.* Morgan did his best, but after considerable haggling he was able to cobble together only the weakest of pools. Gould was very disappointed, but still signed on in the spring, when the pool was already collapsing. He inquired of one of his executives whether they should attend the next meeting, or “simply send flowers for the corpse?”

  The competitive landscape shifted dramatically when Gould returned to the control of the Union Pacific in 1890. Adams’s tenure had been a rocky one; all of his theories ran aground on the same financial shoals that had sunk his predecessors. A stock market break after the Barings crash in 1890 found both Adams and his road badly overextended. To everyone’s astonishment, Gould used the opportunity to snap up large blocks of shares in the UP and other western roads. Headlines blared: “Jay Gould Once Again the Master Spirit in Wall Street.” Morgan went to see Gould about his intentions, and brought the bad news to Adams that he was expected to hand over the line. When they met to seal the bargain, Gould, as always, treated Adams with impeccable manners, while Adams, with his Adams-centric view of the world, could interpret Gould’s maneuvering only as an instance of the lower classes striking back at their betters. Not knowing that Gould was dying, he noted that he looked,

  Smaller, meaner, more haggard and lined in the face, and more shrivelled up and ashamed of himself than usual;—his clothes seemed too big for him, and his eyes did not seek mine, but were fixed on the upper buttons of my waist-coat. I felt as if in the hour of my defeat I was over-awing him,—and as if he felt so, too.

  An exhausted-looking Jay Gould, not long before his death in 1892. After twenty years of triggering railroad wars, Gould spent his last years trying to broker a peace.

  Although Gould must have enjoyed seeing off the pompous Adams, he wasn’t indulging in a personal vendetta. Instead, he was strengthening his position in the hope of forcing a concordance among the western lines. It was the first order of business he turned himself to, and he prevailed upon Morgan to sponsor another assembly of railroad presidents late in the year, only to be disappointed again when the gathering quickly collapsed into bickering. It was Gould’s last important appearance on the railroad stage. The tuberculosis was already in a critical stage; his capacity for work declined steadily throughout the next year, and he died in 1892.

  For Morgan’s part, the failure of the rate-setting forays soured him on the usefulness of pools, and from that point the stock merger became his preferred route to market rationalization. What all the cartel plans overlooked—which is surprising for Gould, if not for Adams—is the essential streak of irrationality in the entrepreneurial mind. The fact that railroads had so irrationally spread themselves over the empty plains, in stark defiance of every tenet of conventional economics and common sense, was a major factor in the explosive rate of American growth. That lesson was brought home yet again by E. H. Harriman, whose meteoric career in the first decade of the twentieth century—he died of cancer in 1909—establishes him as the natural heir to Gould. As much as anyone, he completed the rail network that Gould had originally laid out. Like Gould, he was usually at odds with Morgan, and was on the other side of the table in Morgan’s biggest rail merger, the Northern Securities Co.

  Harriman and Morgan

  Edward Henry Harriman—his friends called him Henry—was a highly successful stockbroker who became fascinated with railroads after serving on several railroad boards and executive committees. But he was fifty before he actually managed a road. As the economic recovery began to gather steam in the late 1890s, and the pace of western development noticeably quickened, he had identified the Union Pacific, in receivership after Gould’s death, as one of the most undervalued of American roads. A bantam of a man, tough and athletic, with an abrasive personality and a lightning-quick mind, Harriman acquired enough UP stock to leverage himself into the reorganization process, and as his talents became obvious, became chief executive when the road emerged from bankruptcy in 1898. Crucially for Harriman, given his relationship with Morgan, Morgan had lost interest in the UP and was happy to cede the business to Jacob Schiff.

  Harriman was one of the first to divine that the plague of overcapacity so loudly lamented by all knowledgeable railroad managers and bankers was about to be swept away by a surge of new development. One of his first acts on assuming the UP presidency was to push through a $25 million improvement program, in an era when bankers regarded $1 million as a large sum to spend on a recently insolvent road. As the investment quickly paid for itself with much higher volumes, lower rates, and excellent profits, Harriman and Schiff used the resulting cash flow and Harriman’s growing reputation for profitable operations to “Harrimanize” an ever-wider swathe of western roads. Together, they lavished sums on a scale that Gould had never dreamed of: $160 million on the Union Pacific in the decade after he took over in 1898, then a quarter billion dollars on the Southern Pacific in just eight years after 1901—representing annual spending rates up to twenty times higher than ever before. For the most part, he was not building new lines but investing in heavier rails, better grades, stronger bridges, and the giant new locomotives and freight cars needed to meet the demands of the high-intensity western development—development that would have been years behind if the roads had not been waiting for it. By 1903, as he expanded his railroad interests into steamships and other enterprises both at home and abroad, he controlled the largest transportation empire in the world. By the time of his death, at only sixty-one, he had invested more than a half billion dollars to bring his roads to the highest of current standards. He was also a superb manager, and more than any other individual he was responsible for the first-class national system that the country enjoyed at the eve of World War I.

  The Northern Securities Co. grew out of a fight for control of the rail traffic in the Pacific Northwest between Harriman’s UP and two Morgan lines, James Hill’s Great Northern and the Northern Pacific, Jay Cooke’s old line, all of them running essentially parallel routes from the Great Lakes to the Washington and Oregon coasts. When the Morgan lines attempted to squeeze out Harriman, he quietly mounted a very Gouldlike, heavily camouflaged attack on the Northern Pacific. As Harriman and Schiff approached a control position in the Northern Pacific, their purchases led to large fluctuations in railroad securities, but they masked their moves so well that Wall Street assumed that it was the UP that was under attack. Since the Northern Pacific was controlled through a Morgan voting trust, the Morgan bank itself was unwittingly making large sales to Harriman and Schiff.

  But just as Harriman was on the point of winning control, he may have been betrayed by Schiff, who was very worried about a direct confrontation with Morgan. Extraordinarily, Schiff disclosed Harriman’s strong position in the Northern Pacific to Hill, who had had no idea what was afoot. The very next day it dawned on Harriman, who was home sick with a cold, that his stock position wasn’t yet invulnerable. He owned enough preferred stock to control management, but still needed a majority of the common, since they could remove management rights from the preferred. He was only 40,000 shares short of a common majority, however, so he called Schiff’s office and ordered the purchase. I
t was Saturday and Schiff was at synagogue. When an associate tracked him down to sign off on the order, Schiff told him not to proceed, that he would take responsibility. By that time an anxious Hill had warned a Morgan partner, who cabled Morgan in Europe for authority to defend the Northern Pacific. The cable reached Morgan only on Sunday, which would have been too late if Schiff had not held up Harriman’s order.

  On Monday, the Morgan bank launched an all-out buying campaign in competition with Harriman and a now-panicked Schiff. Both sides had almost unlimited war chests, and by midweek, Northern Pacific shares had jumped from the low 100s, which was already very high, to more than 1000. Since no one but the principals knew what was going on, many brokerage houses sold the Northern Pacific short, only to realize to their horror that Morgan and Kuhn, Loeb had locked up literally all the outstanding shares. With no way to cover their shorts, firms up and down Wall Street faced bankruptcy, as did the banks who had been financing their positions; Harriman had no choice but to back off the fight, so Morgan and Schiff could unwind their positions and forestall a crash. The eventual compromise was the Northern Securities Co., a New Jersey corporation to hold the shares of the contested roads; Harriman had board seats, but Hill was left in control. When the Supreme Court declared the arrangement to be a violation of the Sherman Antitrust Act, Hill and Morgan used the subsequent dissolution process to exclude Harriman almost completely.

  Harriman came out the loser in the Northwest, but it was one of his rare setbacks—and even in this case, he eventually made a killing on the stock he retained from the dissolution. As he steadily expanded his very profitable position through the center of the country, he became not only the most powerful railroad magnate but arguably also the country’s most important railroad banker, with major positions in a host of other lines. Less adept at politics than at railroading, he fell afoul of Theodore Roosevelt, and became a major target of Roosevelt’s trust-busting forays. As much as anything, it was Harriman’s burgeoning power that led Congress to expand the Interstate Commerce Commission’s enforcement authority in 1906, and to bring rate-setting within its purview. Harriman was already dead by the time the commission began to experiment with its new powers; but by that time even Morgan had become resigned to the fact that it was time for the government to have a try at delivering the “stability” he had so signally failed to create by persuasion.