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Crooks: An Inevitable Part Of Any Financial Market

No one likes recessions, but no one dislikes them more than the crooks who are an inevitable part of any financial market. As the economy goes south, companies seeking to cut costs scrutinize their books more carefully and bring embezzlements to light. Investors take money out of higher-earning (and therefore inherently more risky) funds and put them into safer ones, and Ponzi schemes collapse as a result. Credit becomes tighter, and loan requests are more carefully investigated, so businesses with cooked books find their insolvency revealed.

The current recession brought to light one of the longest-running and biggest frauds in the history of Wall Street: Bernard Madoff’s fantastic $50 billion Ponzi scheme, which apparently ran for more than 20 years. Madoff’s fraud may be unmatched in scale and scope, but it’s just the latest of a long string of felonious schemes to hit Wall Street over the more than two centuries of its existence.

The stock market we call Wall Street can trace its beginnings to 1792 and the “Buttonwood Agreement” made among brokers who wanted to give preference to each other in trading securities. From those modest beginnings, Wall Street has become a magnet for people hoping to make their fortunes. The overwhelming majority have been honest, but large amounts of money always attract large numbers of crooks. After all, that’s why people rob banks.

But not all the famous rogues of Wall Street broke the law. Often they exploited weaknesses in the law or the rules of the exchange. Once exposed, their shenanigans brought these weaknesses to light and spurred remedies, making the market work better in the long run. Paradoxically then, the crooks have helped make Wall Street an ever safer place in which to invest money.

In 1790 only two private banks operated in the United States. But the establishment of the Constitution and the regularization of federal finances helped increase that number to 29 by 1800. Speculation in bank stocks, and in the rights to buy stock in new banks, began to increase. William Duer was among the most active speculators.

Born in England in 1747, Duer had managed his father’s estates in the West Indies before coming to the mainland colonies. He sided with the new United States during the Revolution and was elected to the Continental Congress. Under the Articles of Confederation he served as secretary to the Treasury Board, a position that provided him with much inside information. Duer later served for a short time as an assistant secretary under Treasury Secretary Alexander Hamilton. Federal law forbade Treasury officials from speculating in federal securities, so Duer resigned, preferring speculation to public service. At the end of 1791 he formed a partnership with the wealthy Alexander Macomb to speculate in stocks. Macomb provided the money, Duer made the investment decisions, and they split the profits. (This is not unlike how a modern hedge fund works, only with many investors instead of one.)

Duer’s favorite means of speculation was the Bank of New York, the state’s sole bank at the time. Rumors abounded that the Bank of the United States, which Hamilton intended to be the nation’s central bank, would take it over, a move that would cause the stock to rise. Duer used Macomb’s money to buy Bank of New York stock and let that fact be known publicly. Unbeknownst to Macomb, Duer was also shorting the stock on his own account. If the merger failed, Macomb would lose money and Duer his share of the nonexistent profits. But Duer would make money on his own account. In other words, he was hedging at his partner’s expense.

The rise in new bank charters created a bubble in bank stocks. When the newly created Tammany Bank announced that it was issuing 4,000 shares, it received subscriptions for 21,740. Duer was at the center of this frenzy. He saw to it that his trades quickly became public knowledge. When other speculators duplicated them, it looked as though he could do no wrong.

Duer apparently began to believe as much himself and started to use leverage to increase his profits. He borrowed from banks and individuals, including $203,000 (a huge sum at the time) from Walter Livingston, of one of New York’s most powerful families. He also began to buy stock for future delivery, hoping that rising prices would allow him to pay for it when the time came.

Other members of the Livingston family had shorted Bank of New York stock and thus had an interest in seeing the price fall. To help it along, they began withdrawing specie (gold and silver) from their bank deposits. This contracted the local money supply, forcing the banks to call in loans and causing a credit squeeze. This proved ruinous for the speculators, especially Duer, as interest rates soared to as much as 1 percent a day. By March 1792 he was desperate. On March 22 he wrote to Walter Livingston that “I am now secure from my enemies, and feeling the purity of my heart I defy the world.”

He was, of course, no more secure than his heart was pure. Just one day later, in fact, he was in debtors’ prison, from which he never emerged alive. Duer’s fall precipitated a panic. Bank stocks that had been flying high now fell to earth. The day after Duer’s incarceration, 25 brokers announced their insolvency. Walter Livingston, one of New York’s richest men, was broke. Alexander Macomb also went to debtors’ prison, unable to pay his obligations.

By the 1850s the American economy had both flourished and diversified, 13 states had grown into 31, and the population had increased by a factor of five. The discovery of California gold in 1848 started a great boom that powered the American economy for several years.

But nothing changed the economy more than railroads. By 1850 more than 9,000 miles of railroad track crisscrossed the country, predominantly in the Northeast. But railroads were expensive to build, averaging around $30,000 a mile. Locally raised capital built some short, early lines, but longer routes needed financing from Wall Street or London. Railroad mileage tripled in the 1850s, and activity on Wall Street also increased markedly. By 1854 volume on the New York Stock and Exchange Board, a name shortened in 1863 to the New York Stock Exchange, often exceeded 7,000 shares a day.

One prominent member of the Wall Street community was Robert Schuyler, from one of New York’s most distinguished families of the old Knickerbocker aristocracy. His grandfather had been a major general in the Continental Army, and his aunt had married Alexander Hamilton. In 1836 Robert became a founding member of what swiftly became New York’s most exclusive social organization, the Union Club.

Educated (Harvard, class of 1817), personable, and well connected, Schuyler opened a brokerage firm and became interested in railroads. He served successively as president of the Illinois Central and the New York and New Haven railroads and of the much smaller Harlem Railroad.

The boom began to falter in 1854, threatening some weaker Wall Street firms, including Schuyler’s. That July a regular audit of the books of the New York and New Haven Railroad revealed some minor discrepancies. Schuyler assured the press and stockholders that they could be explained. No one doubted him. When Schuyler’s brokerage firm failed, several friends offered assistance, including “Commodore” Cornelius Vanderbilt—nobody’s fool—who loaned him $600,000 on the security of New York and New Haven stock.

But the directors of the railroad soon reported a huge shortfall. It turned out that Schuyler had privately printed 20,000 shares of stock and sold the bogus securities (or used them for collateral on loans) for nearly $2 million—in a year when the entire federal government had total revenues of only $74 million. By the time this news became public, however, Schuyler had fled the country.

Further revelations scandalized not only Wall Street but society as well. The secretary of the Harlem Railroad admitted forging 5,000 shares of railroad stock and swapping them for New York and New Haven securities. He had even helped Schuyler find an apartment for Schuyler’s mistress. It eventually turned out that Schuyler not only had a mistress but also a secret wife and several children, living a few doors away under the name of Spicer.

Schuyler was never captured, nor was the money he had stolen recovered. A year after he fled, he mailed a letter from England that said he was much weakened in body and disturbed in mind. The New York Times noted drily that this condition was “what we might expect.”

Daniel Drew was raised in a family of hardscrabble farmers 60 miles north of New York City and received hardly any education. By the time he was in his teens he was working for a circus—perhaps where he learned the arts of flimflam he was to practice for so long.

But while Drew seldom missed a chance to separate the unwary from their money during the week, on Sundays he seems to have been a genuinely religious man. One contemporary wrote that “he seemed actually to draw aid and inspiration from his faith for the execution of the schemes in which he appeared at his worst.”

By the 1850s Drew had made a fortune in steamboats and Wall Street speculation and served on the board and as treasurer of the Erie Railway, one of the nation’s largest railroads. During the Civil War, the price of Erie stock moved up and down almost without regard to its profits or prospects. Instead it moved according to Drew’s manipulation. It is impossible to trace Drew’s complex speculations in Erie stock in any detail, but one maneuver will illustrate his techniques.

In 1868 Drew, several fellow directors, and a few others formed a pool to bull the price of Erie upward. The members of a stock pool—a speculative technique subsequently outlawed in the 1930s—bought and sold stock among themselves to make it look as though the stock was rising, thus luring in outsiders. If the timing was right, the pool would unload its stock at a profit and then the artificial price would collapse.

Drew was in charge of the pool’s funds. But the stock did not move the way some pool members thought it should. While the early acquisition phase of the pool was supposedly still in progress, and the price should have been rising, it broke suddenly from 79 to 71. It looked as if a bear raid—one of Drew’s favorite tactics—was in progress. (In a bear raid, short sales of stock cause the price to drop, causing others to dump the stock as well, making the price decline further. The bears aim to buy in at the bottom, closing out their shorts and making a tidy profit.)

One pool member had borrowed pool funds from Drew so he could buy Erie stock, but he became suspicious and investigated the origins of the stock he had purchased. It had come from the pool’s own brokers. In other words, Drew was dumping the stock on one of the pool’s own members.

The pool members demanded that Drew put the price of Erie up as agreed. “I sold all our Erie at a profit,” Drew told his partners, “and am now ready to divide the profits.” As Charles Francis Adams explained in a newspaper article, “The controller of the pool had actually lent the money of the pool to one of the members of the pool to enable him to buy up the stock of the pool; and having thus quietly saddled him with it, the controller proceeded to divide the profits, and calmly returned to the victim a portion of his own money as his share of the proceeds.”

In 1869 the New York Stock Exchange issued rules forbidding many of the practices Drew had pioneered. Wall Street’s Wild West days, which Drew had personified, soon ended. A few years later Drew was himself outmaneuvered in Erie stock and lost a fortune. The panic of 1873 took much of the rest, except those assets he had transferred to his son. In March 1876 he was forced into personal bankruptcy. It was a sad, if hardly undeserved, end for a man who had once been among the richest in the country.

Jay Gould was quiet, unhealthy, small, and thin (he would die of tuberculosis at the age of 56), with eyes “that freeze and fascinate.” But he combined a fierce ambition to succeed with perhaps Wall Street’s best brain ever. Born in upstate New York, he had come to Wall Street in the early 1860s, having worked as a surveyor and in the leather tanning business. By 1869 he was the president of the Erie Railway. That’s when he decided to corner gold.

In the mid-19th century, gold was the same as money: legal tender throughout the world. The value of all major currencies were figured in gold, and the British pound, then the world’s most important currency, had been on the gold standard since 1819. The United States, however, had gone off the gold standard in the Civil War when it issued about $450 million in “greenbacks” to help finance the war. This “fiat money” was money only because the government said it was, and it could not be converted into gold.

Thus there were two forms of money circulating in America: gold (in the form of coins) and greenbacks. Wall Street soon created a market, the so-called Gold Room, in which the two forms of money could be traded. Just before the Battle of Gettysburg it took nearly $280 in greenbacks to buy $100 in gold. After the end of the war, the price of greenbacks settled down to about $130 for $100 gold dollars. Speculators flocked to the Gold Room to gamble on the movement of gold, but respectable businessmen also had no option but to trade there and often be short of gold.

The reason was that foreign commerce was conducted strictly on a gold basis, and tariffs had to be paid in gold, not greenbacks. To protect themselves from losing money, merchants would short gold, knowing that if the price of gold went up, they would make up the loss when the transaction was completed; if the price went down, they made money on the short while losing it on the transaction. In either case, they were sure of a net profit.

While the amount of gold traded in the Gold Room was often $70 million or more a day, most was bought on paper-thin margins. Gould knew that the amount of actual gold available in the New York market was quite small—no more than $20 million. Cornering it long enough to squeeze the merchants who were short would be relatively easy. They couldn’t afford to risk their reputations with a default, however brief.

But there was one big if. The federal government held tons of gold in the Treasury. So a single telegram from Washington could break a corner in seconds. To make sure that didn’t happen, Gould tried to convince President Ulysses S. Grant of the need not to interfere with movements in the gold market so as not to interrupt foreign trade, especially the grain that flowed every fall to Europe. Grant, economically naive and too trusting of operators such as Gould, seemed to go along. To make sure, Gould in effect bribed two others so as to know in advance of any action on the part of the president. The first was Grant’s brother-in-law, for whom he bought $1.5 million in gold on no margin whatever. The second was Gen. Daniel Butterfield, whom Gould arranged to be appointed subtreasurer in New York. It would be the subtreasurer who would receive any orders from Washington to break a corner in gold. Gould loaned Butterfield $10,000 at no interest.

Gould and his allies began to buy gold during the summer, and by September they held many times the total floating supply. Gould’s associate, Jim Fisk, began to put his world-class histrionic talents to work, bulling the price of gold. “Gold! Gold!” he exhorted one writer, “Sell it short and invite me to your funeral.” The price began to rise inexorably. Around 130 at the end of August, it was at 136 by September 14. By Wednesday, September 19, it was at 141½, and the shorts were feeling the pressure. By the close on Thursday it was at 1433/8 and volume was huge, three times normal. Everyone knew that the next day—soon known as Black Friday—would be the climax.

By 10:30 the next morning, gold was at 150 and Wall Street was in utter bedlam. Thousands of people jammed Broad Street, outside the Gold Room: “staid businessmen, coatless, collarless, and some hatless, raged in the street, as if the inmates of a dozen lunatic asylums had been turned loose. Up the price of gold went steadily amid shouts, screams, and the wringing of hands,” reported Charles T. Harris, an eye witness, in his memoirs.

But Gould knew that the jig was up. Grant’s brother-in-law had warned him that the president knew what Gould was up to, and Gould had been quietly settling with men who were short gold all morning, while Fisk had stayed on the floor of the Gold Room, loudly bulling the price upward.

At 11:20 the price of gold reached 158; at 11:40 it reached 160. Businessmen who had made comfortable livings for years faced imminent ruin. But then, just as a telegram was sent from Washington instructing Butterfield to sell $4 million in gold, a broker on the floor sensed a turning tide and sold $5 million in gold at 160. The market instantly turned, and by noon Butterfield was able to telegraph Washington that the price had dropped to 140. The gold corner—and the single most exciting day in the history of Wall Street—was over.

The mess created by Gould and Fisk was never really cleared up but instead more or less swept under the rug and so we will never know if they made or lost money. Three years later, Jim Fisk would be murdered in a love triangle. Jay Gould would live on, getting richer and sicker by the year until 1893. But the great corner in gold had shown that having two currencies, one backed by gold and one not, was an invitation to market instability. By 1897 the nation was back on the gold standard, and the greenbacks disappeared.

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