“He was to finance what Shakespeare was to poetry and Michelangelo to art.”
Financier and Statesman Russell Sage said these words of Cornelius Vanderbilt after the Commodore laid his enemies low with a brilliant double corner of Harlem and Hudson Rail stocks. The ploy not only made him a small fortune, but also control of the only two rail lines offering service to Manhattan Island. The historian John Steele Gordon described it as such “…Cornelius Vanderbilt played Hannibal at Wall Street’s battle of Canae. His double envelopment of the bears netted him and his allies $3 million and was recognized immediately as a masterpiece of financial manipulation.”
Despite the fact that this is arguably the greatest coup in Wall Street history, it isn’t widely reported in popular history. Here is the story along with a couple of lessons we can take with us a century and a half later.
The Man
“Vanderbilt, then, combined in himself the new and the old social traits at once. Something of a sea-dog and a pioneer, endowed with physical courage and high energy as well as craftiness, he was the Self-Made Man, for whom the earlier, ruder frontier America was the native habitat.” – Matthew Josephson, Robber Barons
Vanderbilt got his start in business as a teenager, working as a ferry-boat captain. He quickly gained a reputation as a slick operator and a ruthless business competitor and started making a fortune. He was constantly hustling, constantly working and competing. As T.J. Stiles reports in his biography The First Tycoon, the New York Times thought Vanderbilt was a destructive force for business as someone who “competed for competition’s sake.” Even his leisure time was taken up with such things as drag racing chariots down the streets of New York and other dangerous, competitive pursuits
He was already the country’s wealthiest man (or close to) by the time he decided to switch his energies towards rail in the 1850’s. John Rockefeller, Andrew Carnegie, Jay Gould, and JP Morgan were all young men just getting started in the world at this time. Vanderbilt’s tough reputation was only enhanced by the fact that he was involved in one of the first deadly rail accidents. Every single passenger aboard that railcar died except him. He was not deterred and continued to acquire rail properties, expanding his venture. In the early 1860’s, he set his sights on a couple lines in New York City.
The Play
The Harlem and the Hudson were both poorly run, lightly traveled rail lines that were not thought of as highly valuable. Vanderbilt saw that these lines were the only rails allowed to come directly onto Manhattan island. Sensing an opportunity, he started to accumulate shares in Harlem.
At the same time Vanderbilt was buying, there was a large contingent of players who were selling the shares short. That is, they were borrowing shares, and selling, with the hope to buy them back at a lower price, netting the difference. This group of sellers (bears, in Wall Street parlance) included members of the New York City council as well as members of the board of directors for Harlem rail! One of those board members was long-time Vanderbilt rival, Daniel Drew.
With all these inside interests betting on the price of Harlem to go down, there had to be something going on. Sure enough, a franchise bill that authorized Harlem to lay a double track was suddenly rescinded. The price dropped suddenly on the news and all the short sellers expected to clean up and declare victory – except that Mr. Vanderbilt was still on the other side, buying everything that was being sold. Not only did the stock stop going down, but it started to rise quickly.
Now for those that do not know, shorting a stock can be a dangerous business. When you buy a stock (go long) you only have your investment to lose. If you pay $100 for a stock, it can only go to $0, thereby wiping out your investment. However, if you borrow a stock and sell it short, there is technically no limit to high it could go before you must buy it back to cover your borrowing. If you borrow shares and sell them at $100 and the price goes to $200, you have lost your entire investment. But if the price goes to $300 or $400, you would be on the hook for more multiple times your initial position.
Now imagine one person owns the entire supply of stock. If you sold it short at $100, and now you have to buy it back to cover your position, what price does the owner set? This is the danger of being caught short when someone has ‘cornered’ the market. As John Brooks explains in his classic “Once in Golconda:
“Since a successful cornerer may theoretically set an infinite price, any finite one is a theoretically a bargain.”
This is what happened to the short sellers of Harlem stock. Vanderbilt and his allies had purchased the entire supply and had them at their mercy. In order to escape complete ruin, the city council gave back Harlem’s franchise which now Vanderbilt owned outright.
Already, this was one of the most successful corners of a market in history and made the Commodore a ton of money in the process. However, this was just the beginning.
Watching this epic battle unfold, some Wall Street speculators decided to attack the neighboring Hudson rail line. This group thought that Vanderbilt must be short of cash (after all that buying) and attention, and so went heavily short hoping to drive the price down and make themselves a tidy profit. What they did not know, was that Vanderbilt was already one step ahead and actually perpetuated the rumor that he was short on cash by weakly buying Hudson shares using futures. This was a common strategy for buyers short on cash because it was merely a promise to buy at a later date. The intermediaries Vanderbilt used were actually part of the short-selling group, who would gladly accept the options from the Commodore and then turned around and sold the stock into the market.
Little did the bears know, they were selling this stock to allies of Vanderbilt, who far from being short on cash, still had plenty of powder left. When, finally, he demanded delivery of the stock he purchased, the sellers had to go into the market to buy it back and found no sellers except Vanderbilt himself. Mercifully, instead of raising the price to infinity, Vanderbilt let the short-sellers off relatively easy. They weren’t ruined, merely badly burned.
Within the span of a couple months, Cornelius Vanderbilt acquired full control of the only two railways with access to Manhattan and made a substantial fortune in the process.
Daniel Drew, still stung from his losses in the failed Harlem short, decided he wanted one more crack. He convinced a few law makers in the state capitol of Albany to revoke the franchise for Harlem, overriding the city council. If they revoked the license and shorted Harlem stock, they could make a bit of money as well. This turned out to be a fateful mistake.
From The Great Game:
“Drew’s scheme was, of course, a carbon copy of what cost the members of the city council so dearly the previous spring. One is at a loss to explain how they could have been tempted. ‘The statesmen at Albany,’ E.C. Stedman, a veteran of Wall Street in the 1860’s, wrote at the turn of the century, ‘in the spring of 1864, were well aware of the misfortune into which the statesmen at New York had plunged themselves, less than a year before, by their bear campaign against this stock. Yet they rushed fatuously into a similar attempt, as if Vanderbilt has proved an easy victim.’”
Interestingly, the timing on this second attempt to ‘bear raid’ Harlem stock was in favor of the shorts. The price went from $140 down to $101. The greed of speculators who always hope to make more money was on full display here. Instead of covering at a net profit of almost $40 per share, the shorts tried to press their advantage. “They held on, hoping to see it drop to $50”
Despite really not being very liquid this time around, the Commodore was still not easily defeated. He rallied his allies and raised cash to buy up the last remaining supply of the stock. The price rose to $109, then to $125, and by the end of April was all the way to $224. Feeling less charitable than the last time, Vanderbilt was asked by his brokers where to set the price. “Asked what to do, he bellowed, ‘Put it to a thousand!’”
Fortunately for the shorts, (and their brokerage houses, who also would have been decimated at that price), Vanderbilt relented and settled at $285.
“The second Harlem corner was over and there would not be another. Indeed, for a full generation on Wall Street, the phrase, ‘short of Harlem’, meant much the same thing as ‘up the creek’”
The Lessons
Obviously, the stock market is a very different entity today than it was 150 years ago. Electronic trading, stronger regulation, mark-to-market, all make bear-raids and corners a much rarer occurrence today than they were then. People, however, have not changed. Fear and greed still very much drive the market.
- Know your risks
Before you enter into any investment, you need to know the upside and the downside. Trying to short a stock may present a good chance for gain, but the downside is technically unlimited. The upside, meanwhile, is capped at 100%. The stock can only drop to $0.00. Even when you have inside information (now very much illegal to act on material, non-public information), there is risk that things do not play out as you hope. The city council members in this story knew they were going to revoke the street car license for the Harlem line, but they still got wiped out because they failed to properly assess all their risks – specifically on the next point –
- Know your opponent
When you enter into a trade, you have to remember that if you are buying, that means someone is selling. There is a counterparty to every transaction that happens. Those city council members under-estimated the pockets and the resolve of the Commodore, to their detriment. If you think a trade is a slam-dunk, try to find out who is on the other side. Why would someone bet in the other direction? If the opposition is strong enough, even if you are right on your thesis, you may be better off to take a pass.
- Know when to take a profit
If the state legislators in the second Harlem corner would have booked their gains when the price fell from $140 down to $101 they would have been able to chalk up a good win with a nice gain. However, they did not know when to stop. When you are long, it can often pay to keep your winners running, because your upside is not capped. On the short-side though, every day you do not cover is another day your position could be crushed. Making a successful trade is so hard because you have to be right twice. You have to be right on when to buy and also when to sell.
History can be a valuable teacher. For those interested in finance and markets, there is much that can be learned from past events. The best place to start is probably from the book where the bulk of this story comes from. The Great Game: the Emergence of Wall Street as a World Power 1653 – 2000 by John Steele Gordon. Vanderbilt’s corner of Harlem and Hudson are but one chapter of a book filled with fascinating episodes of market history. Each has its cast of impressive characters winning and losing fortunes, and all have valuable insights which can be gleaned from them.
Vanderbilt did finally get bested in market manipulation years later in the much more famous ‘Erie War’ over the Erie rail line. Daniel Drew finally got some bit of revenge as he was, per usual, on the opposite side of the Commodore’s. The victory, however, belonged squarely with Drew’s tentative ally, Jay Gould, known as the ‘Dark Genius of Wall Street’. Gould was one of the only people who could match Vanderbilt in stubbornness and the willingness to do whatever it took to win a battle.
Until next time……
“I don’t care half so much about making money as I do about making my point, and coming out ahead” – Cornelius Vanderbilt