The Northern Pacific corner of 1901

Michael Sol has set out an interesting alternative to the usual analysis of this episode in Wall Street/railroading history in Another View: The Northern Securities Saga.

The canonical explanation has the forces of Standard Oil attempting to purchase enough voting (common) stock to seize control of the Northern Pacific railroad from J. P. Morgan, but being thwarted in their attempt by Morgan and his ally James J. Hill, who controlled the Great Northern. The rationale for Standard Oil is seen as:

• To mortally wound their old enemy Morgan
• To seize control of a transcontinental railroad
• To make a lot of money into the bargain by manipulations of the markets.

Michael Sol makes note of certain difficulties with the above:

• Standard Oil, by controlling the board of the Milwaukee Road, already had a railroad, albeit not yet a trancontinental. They were also allied with E.H. Harriman, who controlled two transcontinentals, the Union Pacific and the Southern Pacific.

• The odd behavior of bond broker Jacob Schiff in informing Hill that he was in fact buying up Northern Pacific shares, presumably for Standard Oil, and then going off to his synagogue rather than continuing his purchases. Under the canonical explanation these acts should have earned Schiff a permanent place on Henry Rogers sh*t list. Instead, Schiff was rewarded later on.
• Hill then frantically wired Morgan, who was vacationing in Europe, of the situation, triggering frantic BUY instructions back to Morgan's brokers. By this time availability of NP stock was so low that Morgan was buying at very inflated prices. In other words, Morgan was panicked, presumably at the thought of losing his control of the Northern Pacific, into instead losing a great portion of his fortune.

By Schiff's apparent blunder, Morgan was able to secure enough stock to thwart the takeover, but at great expense. Sol contends that this might provide an explanation for the fact that at Morgan's death his estate was found to be significantly smaller than expected. Sol's notion then is that this was really a Standard Oil, hence Henry Rogers, raid on Morgan's fortune, with no intention of actually gaining control of the NP.

In my readings I have found reasons to take some issue with Michael Sol's account, even though I find it much superior to the canonical one. Some points:

• Sol's account presumes that J.P. Morgan was the target of the Standard Oil raid and any effects on the markets were of secondary importance. No mention is made of any significant stock market prepositioning being done by Standard Oil.

• Sol's account relies on J.P. Morgan being induced to panic. It also implies that, at least in the eyes of Henry Rogers and William Rockefeller, money was of primary importance to Morgan, as it was to them. Thus the way to wound their mortal enemy was to take away his money.
• In Part III, Chapter XXV of his Frenzied Finance articles in Everybody's Magazine, 1905, Thomas Lawson remarks on this situation. According to Lawson, between Standard Oil and J.P. Morgan, a 'corner' was achieved on Northern Pacific stock. When a stock was 'cornered' in those times, its normal liquidity suddenly ceased because its only holders would refuse to 'make a market'. Now cornering a stock would only be worthwhile if it were highly valued, widely distributed and considered to be a blue chip investment. Such was Northern Pacific at this time. A stock like this would be widely used for things like margin collateral and short selling because investors and financial institutions relied on its liquidity and relatively stable value to limit their exposure. A corner on the stock caused both of those assumptions to suddenly become invalid. So it was on May 8, 1901.
• According to Lawson, who was positioned to know, Standard Oil had been short selling a broad range of stocks for months, in apparent anticipation of a large and sudden downward movement in stock prices. Elsewhere Lawson notes that the masters of Standard Oil, Henry Rogers and William Rockefeller, were NOT gamblers. They were interested only in 'sure things'. This suggests they regarded a sudden market fall as a 'sure thing'.
• Sol's argument seems to misjudge the character of J.P. Morgan. He was not known as a person who could be easily panicked. Likewise, various sources attest to his preference for power over money. For Morgan, money was the means to power. For Rogers and Rockefeller, power was the means to money. These worthy opponents would not likely have misjudged each other in this way.
• Subsequent to this, Morgan was able to continue his interventions to forestall market panics, including those attempted by Standard Oil. For example, Morgan successfully intervened to forestall panic following the death of President McKinley and was able to moderate the potential devastation of the Panic of 1907. Thus his fortune was not irrecoverably compromised by the events of May 1901. It seems more likely that his market interventions eroded his fortune.

This is my take on the matter:

• This was definitely a raid planned and executed by Henry Rogers and William Rockefeller.
• The purpose was to create a market panic. Any money extracted from J.P. Morgan was icing on the cake.
• The Northern Pacific was chosen because retaining control of it was crucial to J.P. Morgan for retaining his power. It was one financial thing that he valued more than market stability.
• Rogers and Rockefeller had no intention of seizing permanent control of the Northern Pacific. They needed enough stock to, along with what Morgan needed to retain, effect the corner. This also had to be enough to at least throw control of the railroad into doubt. Considering the risk aversion of Rogers and Rockefeller, it is likely they thought they had enough to give them clear control.
• One thing which Michael Sol points out is that much of the stock controlled by Standard Oil was of the preferred type, which could not be voted. However as Sol also notes, there was a device whereby these shares could be converted to common, and therefore voting, shares. This fact was unlikely to be lost on any of the principal players. That may well have been what Rogers and Rockefeller used to threaten Morgan.
• Another factor here was the large amount of short selling. This created a condition where there was quite a bit more stock in play than actually existed! So both sides could plausibly have held more than one-half of the common stock. This would be naked short selling, where the short seller has not first borrowed the stock. While rules have been established at various times to limit this practice, they were and are not reliably enforced. As can be seen, this literally creates stock, which is then destroyed when the position is borrowed or covered, usually within three days.
• It was probably not lost on Henry Rogers that common stock shares could be created in this way for a limited period of time. He may well have directed some of his agents to deliberately short Northern Pacific, with his proxies as the buyers, at the crucial time.
• Rogers and Rockefeller had probably achieved the corner well before anyone else was aware of the fact, and fed stock back into the markets to disguise that until the time was ripe to act. That time came around with Morgan's trip to Europe, ensuring that he could not react quickly enough to foil them.
• On the crucial day, they informed Morgan of the corner. Either both sides held more than one-half of the common stock, or Standard Oil had clear control and delivered an ultimatum to Morgan. Either way, Morgan was enjoined from interfering in the markets for one day. After that, Standard Oil would act to restore Northern Pacific liquidity and end the panic which would ensue on May 9. Morgan's alternative was to risk losing his control of the Northern Pacific.

A perusal of the evening papers from New York on May 9^th and 10^th, 1901, tells the story. When the stock market opened at 10am on May 9^th, some people who were short Northern Pacific noticed that the closing price on May 8^th had moved beyond their buy level, either upward or downward. They then placed buy orders for Northern Pacific in the usual fashion to take either their profits or loses. At about the same time some banks noticed that some loans which had been collateralized using Northern Pacific stock subsequently sold for other purposes required that the stock be repurchased. No doubt there were other situations which also required immediate purchase of NP stock. However there was no NP stock to be had at any reasonable price. When there are buy orders but no stock is offered for sale at the price, the price keeps rising until stock is found for sale. Here is the terrible beauty of the corner – those holding the corner can sell for any price they choose. Until they choose to sell, the price keeps on rising.

Now consider our investor who has sold short 5000 shares of Northern Pacific at the then prevailing price of $100 per share, anticipating a fall in the price. He/she sets a stop-loss in case the market moves adversely, at $110 per share. At market close on May 8^th, Northern Pacific closes at $110 per share. Therefore our investor anticipates a loss of $50,000 on their $500,000 investment. A nasty slap but our investor decided he/she could absorb it when the stop-loss was set at $110. $50,000 also was the margin limit allowed by the brokerage house for the transaction. So our investor is about to receive a margin call anyway. He/she also likely holds a number of other stocks and securities with that brokerage, which is the reason they are willing to extend the $50K margin.

5000 shares are eventually released from the corner to fill our investor's order, but the price has risen to $1100 per share! Our investor's loss has risen from the anticipated $50,000 to $5,000,000! His/her brokerage house is demanding the immediate covering of the $5M loss on their margin. There is nothing to be done but to sell as many other securities as necessary to cover the loss. These are unceremoniously dumped onto the market by the brokerage house. There is a fair chance that our investor is now bankrupt and unable to cover his brokerage loss. And his bankruptcy is the result of what should have been a normal and low risk investment decision. There may be enough defaults to actually bring down the brokerage house itself!

It actually wouldn't have mattered whether the investor had wanted to buy or not. When the buy price had passed the extended margin of $50K, his/her brokerage house would have called the investor, demanding immediate payment of that amount. The margin calls would have continued at each $50K rise so long as 5000 shares of Northern Pacific stock could not be acquired. Thus all investors who were short Northern Pacific would have had margin calls, probably a number of them, as the price of Northern Pacific stock continued to rise without any sellers being found.

Now this is not nearly the only kind of investor facing a margin call. For instance, as the brokerage houses begin to be squeezed by their Northern Pacific short margins, they need cash immediately. So they begin to call in the margins extended on other stocks. Many of their customers are unavailable or not immediately able to produce the required cash. So the brokerage houses dump their securities as well. The sudden avalanche of sell orders across a broad range of securities starts to drive down their prices, as must happen when sell orders outnumber buy orders. This process must continue until prices are such that once again buy and sell orders balance, thus setting a new, probably much lower, price for each of the securities. Other investors just see the falling values and try to escape by dumping their holdings while they can. And so on. This situation is called a 'panic'. It drives the values of many securities to very low figures, and it does this very quickly, in hours or even minutes.

This was the situation appertaining on Wall Street on May 9^th, 1901 at 10:01am. J.P. Morgan was powerless to intervene because doing so would have been financial suicide. Standard Oil was 'short' a broad range of selected securities as well as having effective control of all the stock of the Northern Pacific (and then some!). They had only to wait until values in their selected securities had become absurdly low, and then buy enough to cover their short positions. They also had the capital to purchase much more at rock bottom prices. By the closing gong at 3pm, the markets were a shambles and Standard Oil had stolen tens to hundreds of millions of dollars from the entire financial world outside of Standard Oil, perfectly legally.

When the price of Northern Pacific stock became high enough to fuel the panic, Standard Oil began to sell small amounts, for enormous profits. When the panic was fully triggered they released much more stock, which began the process of re-normalizing the markets, which Standard Oil wanted as much as anyone else, as a prolonged panic would have begun to work against its own interests. On May 10^th Standard Oil and others offered to allow the short sellers to retroactively cover at $150 per share, thus alleviating some of the most extreme situations.

That is what I think happened on May 8-10, 1901.