Lance Davis (1963) showed that British financial markets were quite different from American markets. British industrialists could visit their local branch banks—Lloyd’s, or Westminster’s, or Barclays—and draw capital from a huge international system. American firms, on the other hand, encountered banks with restricted resources, most importantly because branching across state lines was prohibited.
For this reason, investment banking in the United States emerged to provide capital for the expansion of railroads, mining companies, and large-scale manufacturers. Unlike commercial banks, investment banks did not have the power to issue notes or create deposits. Instead they acted as intermediaries, bringing together lenders (stock and bond buyers) and borrowers (firms). J. P. Morgan and Company was a pioneer in investment banking, earning $3 million for services in advising and selling stocks for Cornelius Vanderbilt and his New York Central Railroad in 1879. Charles Schwab, an employee of Andrew Carnegie, carried a note to Morgan in 1900 with an asking price of more than $400 million for Carnegie’s steel holdings. Morgan promptly replied, “I’ll take it”—thus giving birth to the United States Steel Corporation; the first billion-dollar corporation. Forty years earlier, when Carnegie tried to raise financial capital of only a fraction of
Investment banker J. P. Morgan ruled the world of finance. In 1901 he formed the United States Steel Corporation, the world’s first billion-dollar corporation. When asked what the market would do, he answered, “It will fluctuate. ”
The sum Morgan promptly gave him in 1900, Carnegie had to go to England because no U. S. banks could supply his capital needs.
The close links between investment bankers and big business were strengthened by the practice of placing representatives of the investment banks on the boards of directors of the firms. Critics of the investment bankers complained that this practice stifled competition. Morgan and a few smaller investment banking firms such as Kuhn Loeb and Company in New York and Kidder Peabody and Company in Boston seemed to control both the distribution of securities and (through interlocking directorates) the business decisions of the major industrial firms. In 1912, Congress subjected this “money trust” to a detailed and highly critical examination by the Pujo committee. J. Bradford DeLong’s (1991) research has shown that there was also a positive side to Morgan’s links with industrial firms: Investment bankers helped inform investors about how best to invest their funds (Economic Reasoning Proposition 5, evidence matters).
Another important force helping finance industrial growth was the rapid, steady retirement of the national debt. The federal debt had been retired completely by 1835 (for the
First and only time in our history), and only a small debt existed on the eve of the Civil War. By 1865, the debt was $2.32 billion, about 25 percent of gross domestic product (GDP); it was reduced to $648 million by 1877 before increasing for several years. By 1893, $1.73 billion had been retired. Collections of tariffs supplied government with continued surpluses that permitted the debt retirement. This inflow of government funds to buy up old bonds—a type of crowding in, as John James has called it—lowered yields on private assets and stimulated capital formation in the private sector (James 1984).
World History
