For at this dinner John Pierpont Morgan, by common consent the leader of the financial forces of the day, sat at Schwab’s right hand; and it was Schwab’s irresistible persuasiveness as an after-dinner speaker which convinced Morgan that the time had come to organize the United States Steel Corporation, and thus to strike the resounding keynote of the theme of American financial and economic life for more than thirty years to come.
A new century was beginning; but more than that, a new era for America was beginning. The dragging business depression which had blighted the country after the panic of 1893 had come to an end in 1897; bumper wheat crops in the United States and simultaneous crop failures in Europe had turned the tide that summer-almost precisely as they had turned it in 1879, at the end of a previous span of lean years. (Here is an ironical circumstance for the contemplation of those who preach the economic interdependence of nations: that recovery in America should twice have been hastened by catastrophic conditions abroad!) New industrial processes were ready for development; the age of mass production, the electrical age, were on their way. The amiable William McKinley sat in the White House; Senator Mark Hanna, to whom the welfare of big business and the welfare of the country were almost indistinguishable, stood behind McKinley, ready with encouragement and advice; business men felt sure that the affairs of the United States would be managed with a conservative regard for the rights and privileges of property. The boom which began in 1897 was only momentarily interrupted by the outbreak of the Spanish War. Prosperity had returned.
But it had returned to a very different country from the America of the eighties and early nineties.
The frontier had now for many years been closed. No longer could Americans depend upon hopeful expansion into the free lands beyond the plains as a safety-valve for the pressure of industrial competition. Two alternatives confronted a nation accustomed to restless growth: conquest beyond the seas, and intensive economic development within its natural boundaries.
The idea of outward conquest had been given a powerful impetus by the opera-bouffe victory in the Spanish War, which had bestowed upon a surprised country a group of islands across the Pacific. The troops were hardly back from Cuba, the echoes of “There’ll Be a Hot Time in the Old Town Tonight” were still floating on, the air, and Admiral George Dewey was still the nation’s adored hero, when Rudyard Kipling wrote “The White Man’s Burden,” and its lines became familiar almost overnight. To many enthusiastic citizens it seemed as if American shoulders were built for that burden. President McKinley told a group of Methodists that we must accept sovereignty over the Philippines “to educate the Filipinos, and uplift and civilize and Christianize them”; to another less pious audience he said that the Philippines offered a “commercial opportunity to which American statesmanship could not be indifferent.” Early in 1900 Senator Beveridge was proclaiming that America must follow the judgment of the Master: “Ye have been faithful over a few things; I will make you ruler over many things.” It is true that a considerable body of American opinion was very dubious about our sacred duty to our “little brown brother” and hated the whole imperial conception; but McKinley and his mentors chose “expansion” as the issue of the 1900 campaign against Bryan, and it was a winning issue. The mood of the day was confident; in the flush of victory most Americans probably believed that their country could easily assume dominion over palm and pine if she chose to take the trouble.
As it happened, no further direct expansion of American territory was destined to take place; but the new and intoxicating idea that America was now an imperial power, fit to assume the obligations of a great force in world affairs, had striking financial and economic effects. For the first time in history, America was now lending money to Europe in quantity: between 1899 and 1902, New York took over two hundred million dollars of the British Exchequer loans to finance the Boer War. American foreign trade was growing, the captains of industry had begun to dream extravagant dreams of the capture of foreign markets, and on both sides of the Atlantic there was talk of the possibility that New York might displace London as the financial center of the world. The national ego was enlarging. America was enjoying the responsibilities and releases of maturity.
Meanwhile, however, the intensive development of the national economy was proceeding still more rapidly. In the three or four years immediately preceding that dinner at the University Club when Morgan and Schwab sat cheek by jowl, the organization and character of American business had been undergoing a profound change, with consequences which were to reach into the daily lives of millions.
This change had been in preparation for a very long time. To understand the nature of it and the reasons for it we must go back to the days when the name of Pierpont Morgan was unknown outside of Wall Street and Charles M. Schwab was a little boy playing about his father’s livery stable in a village in the Alleghany Mountains.
2
In the eighteen-seventies and eighteen-eighties the accepted principle of American business was free competition. Almost everybody believed in laissez-faire; the ideal economic order, it was generally thought, was a sort of endless game which anybody could enter, with the government serving as referee and intervening only to prevent flagrant holding and roughing. At the beginning of this period most businesses were small, few did business on a national scale; and if a competitor became crippled in the game, there were always other fields in the West where he could begin again unhandicapped. The standards of fair play were low, for the referee was often not only absent-minded but venal: the economic history of those years is full of stories of piratical methods in the fight for business advantages and markets. But the ideal of free competition was not seriously disputed.
In business as in a game, however, the score does not always remain at a tie; and in this particular game there were sometimes so many players and the play was so fierce that heads were broken. During the eighteen-eighties competition among the railroads, for example, got completely out of hand; it was easy for daring and unscrupulous plungers to build new lines simply as a form of economic blackmail—in order to be bought off by their competitors in self-defense; at one time there were five lines bidding against each other for the traffic between New York and Chicago, two more were under construction, and the passenger fare for the through trip had been beaten down to the ruinous figure of one dollar. During the oil boom in Western Pennsylvania some years earlier, so many fortune-seekers had rushed to sink oil wells that the price of oil dropped to the depths, carrying men down with it to bankruptcy. In such situations, some device for limiting competition seemed to be necessary. It was provided, not by the law, but by agreements among groups of the competitors themselves—agreements to share privileges, maintain prices, and choke off cut-throat attacks on the part of their rivals.
In the oil industry the control of competition was provided by a severe young man named John D. Rockefeller, who had run his little refining business in Cleveland with such calculating efficiency, had bought out his immediate competitors with such boldness, and had wrung secret privileges from the railroads with such shrewdness, that shortly he was able to dictate to the industry. No impartial referee would have sanctioned some of the practices which had enabled Rockefeller to gain supremacy. Early in the eighteen-seventies his Standard Oil Company and a number of others had joined forces in setting up an association euphemistically known as the South Improvement Company, and had thus secured from a number of railroads (by threatening to take their freight business elsewhere) not only rebates on their freight charges but what were known as “drawbacks”; in other words, the Rockefeller group had forced the railroads to hand back to them secretly not only a part of the freight charges which the Rockefeller group themselves had paid (in accordance with the published rates), but also a part of what their competitors had paid! No competitor could long exist under such a crushing handicap. The South Improvement Company was short-lived, for when its devices were discovered there arose a howl of protest which echoes to
this day; but by that time the pious Mr. Rockefeller had become too mighty a force in the oil industry to be resisted. He had the market in his grip; presently he had a large number of refining companies at his mercy; and by 1879 he was ready to deal the principle of free competition a thumping blow.
A lawyer named Samuel C. T. Dodd provided him with the means of doing it. Dodd invented a way of bringing forty separate oil companies into a compact group under unified management. The shareholders in all these forty companies turned their stock over to a group of nine trustees, consisting of Rockefeller and his associates, and received, in return, trust certificates which entitled them to their dividends. The nine trustees, thus having full voting power over each of the forty companies, could do exactly as they pleased with the direction of each, operating them as a gigantic but flexible unit and confronting their competitors with their colossal collective power. Ordinary trade agreements between business rivals on prices and on the division of markets were usually made only to be broken; as a big industrialist testified many years later, they often lasted only until one of the conferees could get to a telegraph office or a telephone; but the decisions of these trustees were unbreakable. The first trust had been born.
Now if there was one thing which American public opinion, devoted as it was to the ideal of free competition, would not tolerate, it was monopoly; and when the truth about this trust leaked out—which of course it did, despite the bland statements of Rockefeller and his associates that they were not connected with any oil concern but the Standard Oil Company of Ohio—there was a great public outcry. The small business man saw with acute dread the possibility that some day he might be forced out of business by such a trust. Consumers realized that trusts might be able to force upward the prices of essential commodities and thus take toll of a helpless population. Lovers of fair play were outraged by the spectacle of an economic game in which one player appeared to be a giant equipped with brass knuckles. During the eighteen-eighties a great many other trusts were formed, for the instinct of self-preservation and the acquisitive instinct combined forces to draw men into such combinations; soon there appeared a sugar trust, a rubber trust, a butcher trust, a whiskey trust, a cottonseed oil trust, and many more; but the outcry grew to such volume that in 1888 all the political parties denounced the trusts in their platforms, and in 1890 Congress passed, with only slight opposition, an act prohibiting “combination in restraint of trade”—the famous Sherman Act.
Shortly afterward the Standard Oil Trust was forced to dissolve (or rather, to appear to dissolve).
Apparently the Dodd form of industrial combination, a rather awkward form at best, was doomed. But the desire for combination remained and became intensified. The score in the game of business refused to remain at a tie. The trend of American economic life was in the direction of integration and consolidation. Business units were becoming larger; more and more businesses were becoming national in scope. How could it be otherwise, with the transportation and communication systems of the country binding Maine and California ever more closely together, and with banks and private fortunes growing, and business ambition rampant? And, as it happened, already a way of achieving combination legally was at hand.
3
In the year 1888 the Governor of New Jersey, becoming concerned over the finances of the state, had consulted a New York lawyer named James B. Dill. What could New Jersey do to bring more income into the state treasury? Dill suggested passing a law which would permit companies incorporated in New Jersey to hold the stock of other corporations. Such a law was duly passed, to the immense benefit of the state treasury, which fattened—as other state treasuries were later to fatten—on the fees resulting from an extension of the privileges of property. Thus, even before the passage of the Sherman Act, holding companies were given legal sanction. (Heretofore it had generally been held illegal for one corporation to own the stock of another except by special legislative permission, and only a few scattered companies had secured such permission.)
If a man wanted to bring forty companies under a central control, he now no longer had to attempt personally to buy 51 per cent of the stock of each (a colossal task). He could induce the owners of the various companies to exchange their shares for the shares of a newly-formed New Jersey holding corporation (or to sell their properties to it); he could induce the public to buy stock in the holding corporation; and thus, with financial assistance from the public, he could bring the forty concerns into an effective centrally-administered unit. Whether such a holding company would be adjudged a conspiracy in restraint of trade by the Federal Government under the Sherman Act was uncertain; but the Government was apparently not taking the enforcement of the Sherman Act very seriously, and anyhow the holding company device was secure against interference by the New Jersey authorities. Presently there was a rush to New Jersey to form holding companies.
It was not necessary for these companies actually to conduct their business in the state; their legal domicile within the boundaries of New Jersey was usually one of those painstaking fictions beloved of lawyers. A corporation needed only to hang its hat there, so to speak: to appoint someone in a trust company in Hoboken or Jersey City as its agent, and to hold its annual stockholders’ meetings in his office. The rush to Hoboken was somewhat delayed by the depression which began in 1893, but by 1897, when the skies cleared, it was under way again in dead earnest. Already other states, jealous of New Jersey’s new-found source of revenue, had moved to emulate her. Combination through the medium of the holding company—or through the medium of a company which bought the properties of its constituents instead of buying their shares—became the order of the day. And thus began that new industrial era which was to approach its maturity on the night when Morgan and Schwab dined together.
It began recklessly and flamboyantly. For not only did the increasing pressure and ferocity of competition make capitalists eager to join forces; the discovery had also been made that the formation and financing of holding companies offered the easiest way to get rich quickly that had ever legally existed in the United States. Accordingly a new species of financier appeared upon the scene, a man part economic statesman and part gambler—the promoter. The promoter made a business of bringing together the owners of competing concerns. He persuaded them to exchange their stock (on very generous terms) for the shares of a new holding company; he distributed the rest of the bonds and shares of the holding company to an eager investing public; and then he often so manipulated these shares on the stock exchanges as to reap fortunes for all those on the inside, including himself (for generally the promoter was assigned a goodly portion of the stock of the holding company for his services in bringing about the alliance).
Many of the promoters had no special knowledge of the industries in which they intervened as matchmakers. A man might bring together a group of steel companies in January, a group of woolen companies in August, and a group of match companies in December. What he needed was not specialized knowledge, but persuasive salesmanship, coupled with the ability to command the millions and the investment-sales machinery of a large banking house, and to command also the services of astute corporation lawyers and stock-market operators. Having launched his holding company, pocketed his stock, and arranged to distribute part or all of it through the stock market, the promoter might pass on to fresh woods and pastures new.
What made these enterprises vastly profitable to the promoters and also to the owners of the various companies which were combined was the lavish way in which it was possible to do the financing. Obviously, the owners of successful businesses would not sell out unless they received a very handsome price. But they need not be paid this price in cash; they could be paid it in stock of the new holding company. Common stock was issued in huge quantities and exchanged on inflated terms. For instance, when the Consolidated Steel and Wire Company (itself a combination of steel companies) was taken over by the American Steel and Wire Company of Illinois, the holder of a single hundred-d
ollar share of Consolidated Steel was handed $175 worth of preferred stock and $175 worth of common stock of the new company—a total of $350 worth; and when the new company in its turn was taken over by a yet larger combination, the American Steel and Wire Company of New Jersey, the stockholder received (for these same shares) $175 worth of preferred and $315 worth of common in the New Jersey concern. His hundred-dollar certificate had in a brief space of time been converted by the legerdemain of the promoter into certificates of a face value of four hundred and ninety dollars!
Now obviously there must have been a joker in such a deal, and there was. It lay in the nature of the “face value” of the certificates. Logically it should have made no difference whatever whether a man held “one hundred dollars’ worth” of stock or “four hundred and ninety dollars’ worth” of stock, provided they represented the same proportionate share in the earnings of the industry. Money is not thus manufactured out of thin air—at least in the realm of logic. But in point of fact the cash gain could be made actual and substantial. For the new combination might be able to earn enough, through the economies and the bargaining power which it was able to bring to its members, to make real the promise implied in that optimistic face value; at any rate, there was always the hope that it might, and at certain rosy seasons hope can be sold for cash in the speculative markets; and anyhow, to a large investing public the phrase “$100 par value” on a certificate meant something a good deal more solid than pure fancy. In the realm of fact, you could sell $490 worth of shares for a good deal more than you could sell a single $100 share. And so the certificates were lavishly printed and handed about, and in due course quantities of them were sold on the exchanges, and the promoter and the other participants cleaned up.
The process of thus “watering” stock was by no means new, of course. It had got its name two generations before. As a young cattle drover, Daniel Drew had been accustomed to give his cattle insufficient water on the way from upper New York State down to the City of New York, and then, just before the metropolitan purchasing agents were to meet him in Harlem to weigh the cattle and pay for them by weight, Drew had led the beasts to the trough and let them drink their fill—and had profited accordingly in the purchase price. Later, when as a notorious speculator and railroad manipulator Drew discovered how much money could be made by printing extra stock and selling it, he wittily called this process “watering the stock.” But though the process was an old one, the formation of holding companies in the late nineties offered the vastest opportunity to take advantage of it yet known—and this time the methods used were perfectly legal. The ultimate value of such stock was, of course, highly problematical; suffice it to say here that a gain in efficiency of operation and a period of prosperity will soak up a great deal of water, or for a time appear to; and that at the turn of the century there were plenty of hopeful buyers ready to take surplus stock off the promoters’ hands.
Lords of Creation Page 2