Dark Genius of Wall Street

by Edward J Renehan Jr

  Elected to the board of the Erie Railroad in 1853, Daniel Drew was made treasurer in 1854 after lending the troubled Erie a desperately needed $1.5 million, this amount being secured with a mortgage on the line’s rundown engines and rolling stock. Intent on recouping his Erie investment and then some in short order, Drew quickly became adept, under the General Railroad Act of 1850, at using the convertibility of Erie bonds to manipulate the amount of Erie common stock, and thereby the stock’s price. With the Erie being traded in several venues on Wall Street–the Exchange, the Open Board, Gallagher’s, and elsewhere–Drew (who was quickly nicknamed the Erie’s “speculative director”) routinely benefited from confusion. He developed the habit of dumping Erie stock and driving down the price in one market while shorting the same stock in another exchange, after which he’d buy back some of the shares on the cheap in preparation for a repeat performance. Drew’s interest in the Erie extended only as far as manipulation of its stock. His ambition was to loot his own corporation, squeezing out cash while reducing the firm’s equity and allowing the line itself to remain in shambles. Financial pundits soon took to calling Erie stock “the scarlet woman of Wall Street,” a whore serving Drew’s purposes.

  The year 1859 found the company’s stock at $8, down $25 from its all-time high of $33, this depreciation largely due to the Panic of 1857 and the games played by the speculative director. As well, the virtually bankrupt firm was in receivership. Numerous creditors stood at the gates, the mercurial and mercenary Drew first in line among these unequals. Given this state of affairs, Erie shareholders breathed a unified sigh of relief in 1861, when the line hired the no-nonsense Nathaniel Marsh as its president. Marsh reined in Drew’s speculations and also reorganized the firm in January 1862. Early in his tenure, Marsh converted the Erie’s numerous unsecured bonds, together with the accumulated unpaid interest on those notes, into preferred stock. This left the struggling concern with a funded debt of nearly $20 mil- lion, common stock in excess of $11 million, and new preferred stock in the amount of $8.536 million. With his financial house in order for the short term, Marsh next began to increase his business: acquiring a new short line to Buffalo, completing an essential “long dock” at Piermont to facilitate freight transfer, and securing an entrance to the rich market of Pennsylvania’s coalfields.

  More important, Marsh also positioned the Erie to help service the western Pennsylvania fields where oil had been discovered in 1859. Although the Erie did not reach to that region, it connected to the new Atlantic & Great Western Railway (A&GW), which ran close by the oil reserves and thus–it seemed–would be in a position, over time, to greatly impact the business and value of the Erie. Very early in 1864, Marsh contracted to pay the A&GW a bonus for all flow-through eastbound traffic. Additionally, as part of the agreement, he promised to provide the A&GW with some $5 million in rolling stock to increase the A&GW’s overall capacity and thus the amount of traffic the firm would be able to route east via the Erie.

  In all of these endeavors Marsh was helped–just as Gould had been helped during his eighteen-month-long resuscitation of the Rutland & Washington–by war inflation and the war economy generally, which increased traffic for railroads overall and reversed the extended rate cutting that had cannibalized trunk line earnings nationwide between 1857 and 1860. By the spring of 1864, when the savior Marsh suddenly died, he’d tripled traffic on the Erie and had the firm headed toward long-term solvency. But in the wake of Marsh’s demise, and with the end of the Civil War boom, the Erie eventually (in 1866) was forced to borrow almost $2 million in order to fulfill its rolling stock commitment to the A&GW. The lender was none other than Daniel Drew, who demanded that the capital he extended be secured with 28,000 shares in the corporation and $3 million, face value, in bonds convertible to 30,000 shares of stock.

  The Erie’s floating debt now stood at a massive $3.624 million, and well-founded rumor suggested a general relapse into malfeasance by its treasurer. As early as 1865, the Erie was said to have made a mysterious payment of several million dollars abroad to settle its debt to an unnamed director, most likely Drew. The most astute analysts and commentators of the Street suspected Drew of other pilfering as well. “It is really remarkable,” commented the editor of American Railroad Journal, “that this road, doubled in value by its connection with the Atlantic & Great Western, should flounder around as it does notwithstanding its enormous receipts.”1

  The editor, although correctly skeptical of the Erie’s accounting, had overestimated the value of the Erie’s link with the A&GW. The two railroads severed friendly connections in 1866. Directors of each line anticipated an eventual break in all business relations and interchange traffic, when the A&GW–counting on promised foreign investment capital–decided to create its own rival route to the sea. Soon, however, the London financial crisis of that year caused the A&GW’s plans to fall through and left it dangerously close to bankruptcy. Worse still for both roads, the A&GW’s monopoly on oil traffic was shortly lost when the Pennsylvania Railroad linked Pennsylvania’s Oil City with the East Coast via a controlled line, the Philadelphia & Erie. This took a direct route from the oil country to New York City that was far shorter and more cost-effective than the A&GW/Erie route.

  To maintain its oil business, the A&GW–and, by extension, the Erie–was forced to slash oil drayage fees and start a price war with the Pennsylvania Railroad. The average rate per ton on the A&GW dropped from $3.70 in 1865 to $2.87 in 1866. Although this drop occasioned nearly a 50 percent increase in the amount of oil shipped via A&GW/Erie, the earnings of both firms suffered severe declines. Rates and earnings dropped even further in 1867, despite another rise in volume, raising concern among Erie shareholders and bondholders that their railroad–which now nursed a floating debt of some $6 million–was on a collision course with disaster. “It cannot be disguised,” wrote one industry observer, “that very great uneasiness prevails in interested circles with regard to the condition of this road.”2

  Given the tentative state of the Erie’s finances and market position, the firm’s executive committee was understandably dubious when Boston banker John S. Eldridge, eager to build a direct line running from Boston to the Hudson, proposed that the Erie guarantee interest on $6 million in bonds for the fledgling Boston, Hartford and Erie (BH&E). As inducement, Eldridge dangled the possibility of the Erie’s gaining an annual gross of some $2 million from business linked to the new road, which, he emphasized, would be very direct and efficient, with few short curves and excellent grades overall. As Eldridge pointed out, his line would cross no fewer than eleven other roads, offering maximum potential for delivering the Erie’s freight, most especially Pennsylvania coal and oil, to central New England. He added that the line would prove an efficient route for eastbound cargo headed for the port of Boston. What Eldridge left unsaid–and what the Erie directors surely realized–was that the newly proposed line faced established and well-funded competition from the existing Boston & Albany Railroad. Running to the north of and parallel with Eldridge’s proposed line, the B&A linked through to one of the best-financed railroads in the country, Cornelius Vanderbilt’s New York Central. Efficient and highly regarded, the B&A and the New York Central together represented a total investment of some $17 million, whereas the total capital liability Eldridge proposed for the Boston, Hartford & Erie was an enormous $40 million.

  The Erie board hesitated to support the proposed BH&E. When they finally–after much lobbying on the part of Eldridge–voted in June of 1867 to guarantee interest payments of $140,000 annually for $4 million of the BH&E’s bonds through 1867 and 1868, their offer included a maze of asterisks. The Erie required that the BH&E must itself sell enough bonds to finish the line to the Hudson and make its own arrangements for satisfying interest on those notes; that it must set aside enough of its gross revenue to match Erie’s guarantee, thereby guaranteeing Erie’s guarantee, so to speak; and that it must allow the Erie to set rates and fares on interchange business
moving eastward.

  Unhappy with these caveats, Eldridge began buying Erie stock in order to take control of the corporation. This maneuver, in turn, led to a fascinating conflagration of competing titans.

  As early as 1857, Cornelius Vanderbilt had begun to buy heavily into the depressed stock of the struggling Erie. His long-term but by no means urgent ambition was to eventually gain a dominant interest in the line. By 1859, Vanderbilt had gotten himself elected to the Erie board, on which he would serve until 1866. After that year, he installed his nephew Frank Work, a devoted if unbrilliant model of diligence and loyalty who would, generations later, gain minor fame as the American great-great-grandfather of Diana, Princess of Wales.

  By mid-1867, when Vanderbilt at last decided to make his dominance of the Erie complete, he stood at a very interesting angle to the weary Scarlet Woman. The Harlem Railroad (acquired in a cornering move by Vanderbilt, one avidly fought by Drew) had given the Commodore a terminal in Manhattan; the Hudson River Railroad (acquired, again, in a hard-fought battle against Drew) extended Vanderbilt’s rail empire up the river’s eastern shore all the way to Albany; and from Albany, Vanderbilt’s New York Central shot up the Mohawk Valley to Buffalo, connecting with the Lake Shore Railroad (of which Vanderbilt owned a significant piece) as far as Toledo. In this way Vanderbilt’s combined properties–well financed, well managed, and well maintained–offered shippers and passengers what the Erie could not: a reliable, cost-effective route from Manhattan to the Great Lakes. Through most of 1867, Vanderbilt was largely focused on the next phase of his expansion: gaining control of the Michigan Southern Railroad and its Chicago terminal.

  Born just three years apart, Vanderbilt and his Erie colleague Drew were alike in that neither made any pretense of being a gentleman. Each was considered vulgar by New York Society. As well, each was voracious about acquiring wealth. “I have been insane,” Vanderbilt once told a reporter, quite unapologetically, “on the subject of moneymaking all my life.”3 But there all similarity ended. A genuine thief when it came to business, the ostensibly devout Drew was pleasant enough in person: gracious, amusing, able to tell a good story. Vanderbilt, although enjoying a well-earned reputation for honesty, was mean-spirited, vain, and blatantly irreligious. He grew increasingly and unaccountably more miserable and bitter with every lurch forward of his fortune, and he delighted in making life torture for everyone around him: not just his employees but also his family. Ironically, the closest thing Vanderbilt had to friends were the old operators–such as the deceitful Drew–with whom he alternately warred and allied himself through the decades, and for whom he eventually developed a certain twisted and quite nonsensical loyalty. Vanderbilt had a long history of chastising such sharp players as Drew one day and then rehabilitating them the next, granting forgiveness and forging new deals.

  Born into poor circumstances at Port Richmond, Staten Island, in 1794, Vanderbilt quit school at age eleven to work for his father, a farmer and ferryman. When Cornelius turned sixteen he persuaded his mother to give him a hundred dollars for a boat, with which he launched his own ferry and freight service between New York City and Staten Island, a successful venture that allowed him to pay back his mother the hundred dollars plus a bonus of $1,000 within the year. During the War of 1812, Vanderbilt received a government contract to carry supplies to the forts around New York. Large profits from this venture allowed him to build a schooner and two other vessels for coastal trade. He got his nickname, “Commodore,” by commanding the largest schooner on the Hudson River.

  By 1817 he possessed $9,000 in addition to his interest in the sailing vessels. Shortly thereafter, however, he sold his sailing ships and–looking toward the future–embarked upon a career in steamboating. During 1818 he placed himself under the employ of one Thomas Gibbons and began operating a steam-ferry service between New Brunswick, New Jersey, and New York City, this being an important link on the New York-Philadelphia freight, mail, and passenger route. Vanderbilt charged his customers one dollar, whereas his rivals–Robert Fulton and Fulton’s sponsor in invention, Robert Livingston–charged four dollars for the same trip.

  Fulton and Livingston soon sued Gibbons and Vanderbilt, protesting that they had a legal monopoly on Hudson River traffic. The case, now a famous one, eventually reached the U.S. Supreme Court. The 1824 decision in Gibbons v. Ogden struck a blow for free trade by nullifying the navigation monopoly New York State had granted Fulton and Livingston and by giving teeth to the constitutional principle that interstate commerce came under the authority of the federal government. Vanderbilt subsequently gained control of much of the shipping business along the Hudson River. During the next eleven years, the Commodore made himself and Gibbons a fortune. Vanderbilt’s wife also made money managing the New Brunswick halfway house where all travelers on the Gibbons line had to stay.

  Near the end of 1829 Vanderbilt decided to go on his own, giving new competition to Daniel Drew’s Peoples Line between New York and Peekskill. Embarking on a price war with Drew, Vanderbilt eventually forced him to withdraw from the New York–Peekskill market. Next Vanderbilt challenged the Hudson River Association in the Albany trade. Once again he cut rates, but this time his competitors paid him to move his operations elsewhere. So he opened service on Long Island Sound to Providence, Boston, and points in Connecticut, once again entering into direct competition against Drew. The Commodore’s vessels offered passengers not only comfort but often luxury. By the 1840s Vanderbilt was running more than a hundred steamboats, and his company had more employees than any other business in the United States. Vanderbilt is credited with bringing about a great and rapid advance in the size, comfort, and elegance of steamboats, creating the vessels that were shortly dubbed “floating palaces.”

  Never satisfied, Vanderbilt always looked for new opportunities, and found them. During the California Gold Rush of 1849, people traveled by boat to Panama, then by land across the Isthmus, after which they boarded steamers for the California coast. Vanderbilt challenged the Pacific Steamship Company by offering similar service via an overland route across Nicaragua, which saved six hundred miles and cut the going price by half. This move netted him over $1 million a year. In the process he improved the channel of the San Juan River, built docks on the east and west coasts of Nicaragua and at Virgin Bay on Lake Nicaragua, and made a twelve-mile macadam road to his west coast port. He also began construction of a fleet of eight new steamers. Vanderbilt’s route was not only less expensive but two days shorter than that via Panama. He soon owned that market.

  Throughout the 1850s, Vanderbilt also dabbled in the North Atlantic trade, attempting to compete with the Cunard and Collins lines for passenger traffic between New York and Le Havre. When this venture proved unprofitable, he sold his Atlantic line for $3 million just as the first guns of the Civil War sounded. At the same time, he expanded his railroad holdings, having become intent upon building a rail empire to Chicago and points beyond. As Maury Klein wrote, Vanderbilt’s strategy in railroading was “as elemental as it was effective: buy a road, put in honest management, improve its operation, consolidate it with other roads when they [could] be run together economically, water the stock, and still make it pay dividends.”4

  Given this straitlaced methodology and his fairly upright (though cutthroat) business practices, it is surprising that Vanderbilt would sit still for Drew as long as he did. Indeed, as the 1867 elections for the Erie board approached, Vanderbilt at one point resolved to remove Drew from the Erie and busily set about marshaling the votes to oust his old compatriot. At the same time, John Eldridge, intent on seizing control of the Erie board for his own purposes, was beating the bushes for the same votes.

  Much of the Erie’s stock at this time was in the hands of British investors, who, as was the habit, left their shares registered in the “street name” of their New York brokers, this being the most efficient way for brokers to buy and sell shares quickly on their clients’ behalf, without undue paperwork. Thus most Wall
Street brokers were largely free–unless instructed otherwise–to vote stocks as they saw fit, not to vote them at all, or to sell their proxies in auctions during times of peak demand, times such as those involving wars for the control of company boards.

  The thirty-one-year-old Jay Gould and the firm of Smith, Gould & Martin did not possess enough proxies to ensure control of the Erie Railroad. Gould did, however, oversee a large enough bundle of votes to attract the attention of John Eldridge, who made sure to line up his support during August 1867. At the same time, Eldridge allied himself in a partnership with Vanderbilt (the latter very much the senior partner) aimed at decapitating Drew. The net result was to disenfranchise Drew, who was voted from the Erie board, and from his treasurer’s post, on 8 October.

  Abuzz with gossip about this overthrow and the installation of Eldridge as president of the Erie, the financial press was even more astonished by what happened the next day, as was Eldridge. Early on the 9th, Vanderbilt–after a tearful reconciliation with the apologetic Drew–forgave all, arranged for a nonentity on the board to step down, and reinstalled Drew not only to the board but to his treasurer’s perch. On the heels of this event, a reporter for the Herald speculated about the possibility of future intrigues among the three lions: Vanderbilt (represented by Work on the Erie board), Drew, and the newly elected president, Eldridge. Only these three, in the Herald’s estimate, bore watching. The balance of the board were nothing more than “a batch of nobodies.”5

  One of those new board members was Gould. Another was an equally obscure player, a small broker by the name of James Fisk, Jr. No one, not even the men themselves, could have guessed that these two unknowns would soon be notorious as the all-time greatest tag team ever to wrestle Wall Street to its knees.