The Impact of the Railroads on Construction and Finance in 1850s-1860s

Any detailed analysis of the history of modern business enterprise in the United States must, therefore, pay particular attention to the 1850s. There was some preliminary activity in the 1840s. Not until the 1850s, however, did the processes of production and distribution start to respond in strength to the swift expansion of the new forms of transportation and communication and the increasing availability of a new source of energy— coal. During the 1850s, railroad and telegraph enterprises began to devise the organizational structures and accounting procedures so central to the operation of the modern firm. In that decade, too, the demands of railroad building led to a fundamental change in the nation’s financial and construction industries. Before considering the broader impact of the railroad and telegraph on transportation, communication, production, and distribution, it seems well to indicate how the railroads helped to centralize the American capital market in New York City and at the same time revolutionize the construction industry.

The demands of the railroads during the 1850s on American financial intermediaries and on construction contractors were unprecedented. Rail- roads required far larger amounts of capital to build than did canals. The total expenditures for canals between 1815 and 1860 reached $ 188 million, of which 73 percent was supplied by state and local governments with funds raised through sales of state and municipal bonds.14 By 1859 the in- vestment in the securities of private railroad corporations had passed the $1,100 million mark; and of this amount close to $700 million had been raised in the previous ten years. In that decade many large railroads were being constructed simultaneously. Before 1850 the largest railroad enter- prise, the Western Railroad between Worcester and Albany, had cost $8 million to build. In the short period between 1849 and 1854 more than thirty large railroads were completed. Many cost more than the Western. The great east-west trunk lines—the Erie, the Pennsylvania, the Baltimore and Ohio, and the New York Central—were capitalized at from $17 to $35 million.15 Major roads in the west—the Michigan Central, the Michigan Southern, and the Illinois Central—cost from $10 to $17 million. Other roads in the west and those in the south that went through less populated territory rarely required less than $2 million and often more than $5 million. By comparison, during the same decade of the 1850s, only a few of the largest textile mills or ironmaking and metalworking factories were jcapitalized at over $1 million. In fact, during the 1850s there were only forty-one textile companies capitalized at $250,000 or more; and these mills had been financed over a thirty-year period.16

The railroads were the first private business enterprises in the United States to acquire large amounts of capital from outside their own regions. The textile mills of New England, and the iron and other metalmaking enterprises of Pennsylvania, had been financed locally or in Boston or Philadelphia. The state and municipal bonds used to finance canals were sold abroad through large mercantile houses, through the Second Bank of the United States, and by personal visits of canal commissioners to Europe.

With the coming of the railroad boom of the late 1840s, capital required for railroad construction could no longer be raised, as it had been earlier, from farmers, merchants, and manufacturers living along the line of the road or by having the railroad president go to European money markets. This was particularly true in the transallegheny west, where much of the territory had only recently been opened to settlement. Funds for the simultaneous construction of so many large railroads had to come from the older commercial centers of the east. Soon only the largest financial communities of Europe could provide the vast amount of capital required.

Those seeking funds for the new roads in the late 1840s came increas- ingly to New York City. After the demise of the Second Bank in 1836, Boston replaced Philadelphia as the major source of capital for the modest railroad construction of that time. During the 1840s Boston capital supplied funds to build New England roads, the first roads in the west, and even those in the Philadelphia area. By 1847, however, Boston merchants had little more surplus to invest. As a result, money rates were higher in Boston than in New York. By the early 1850s even the largest and most prosperous Massachusetts roads were relying on New York for capital for new construction.17

At the same time Europeans, troubled by the political unrest which culminated in the Revolution of 1848, began for the first time since the depression of the late 1830s to look for investment opportunities in the United States. First they purchased United States government bonds— those issued to finance the Mexican War. Next they began to buy state bonds. Then finally in 1851 and 1852 the Germans and the French, and a little later the British, began to purchase American railroad securities in quantity. To meet the needs of American railroads seeking funds and those of Europeans looking for investments, a number of importing and exporting firms located in New York, particularly those concentrating on the buying and selling of foreign exchange, began to specialize in handling railroad securities. By the mid-fifties such partnerships as Winslow, Lanier-

, Duncan, Sherman; Meyer and Stucken; De Coppet and Company; Cammann and Whitehouse; De Launay, Islin and Clark; and De Rham and Moore were on their way to becoming the nation’s first specialized investment banking firms. As agents for a railroad they sold its securities for a straight fee or on commission, acted as its transfer agent in New York, and advised their railroad client on financial matters. Occasionally they even purchased rails, locomotives, and other equipment. At the same time, they became agents for larger European investors who had purchased or were planning to buy American railroad stocks and bonds.

As soon as the American capital market became centralized and institu- tionalized in New York City, all the present-day instruments of finance were perfected; so too were nearly all the techniques of modern securities marketing and speculation. Bonds became the primary instrument to fi- nance railroad construction. The promoters of the American roads and those initial investors who lived along their lines preferred to maintain control over their investment by owning stock; the eastern and European money men, however, believed that bonds assured a safer and more regular income. Railroad builders inevitably underestimated the cost of construc- tion, causing first mortgage bonds to be followed by second and third mortgage bonds. Then came income and debenture bonds. At the same time, to attract a somewhat different set of customers, bonds which could be converted into stock appeared, as did a variety of preferred stocks.

The great increase in railroad securities brought trading and speculation on the New York Stock Exchange in its modern form. Before the railroads the volume of stocks in banks, insurance companies, and state and federal bonds was tiny. One day in March 1830 only thirty-one shares were traded on the New York Stock Exchange.18 By the mid-1850s the securities of railroads, banks, and also municipalities from all parts of the United States were being traded in New York. Where earlier hundreds of shares had been traded weekly, hundreds of thousands of shares changed hands weekly in the 1850s. In a four-week period in the 1850s transactions totaled close to a million shares.

The new volume of business brought modern speculative techniques to the buying and selling of securities. Traders sold “long” and “short” for future delivery. The use of puts and calls was perfected. Trading came to be done on margin. Indeed, the modern call loan market began in the 1850s, as New York banks began to loan to speculators on call in order to provide funds to cover the interest they were beginning to pay on their deposit accounts. In the 1850s skillful securities manipulators were becoming nationally known figures. Jacob Barker, Daniel Drew, Jim Fiske, and Jay Gould, all made their dubious reputations by dealing in railroad securities.

By the outbreak of the Civil War, the New York financial district, by responding to the needs of railroad financing, had become one of the larg- est and most sophisticated capital markets in the world. The only signifi- cant innovations after the Civil War were the coming of the telegraphic stock ticker to record sales and the development of the cooperative syndi- cate of several investment bankers to market large blocks of securities. For more than a generation this market was used almost wholly by the railroads and allied enterprises, such as the telegraph, express, and sleeping car companies. As soon as American manufacturers had comparable needs for funds, they too began to rely on the New York markets. However, except for the makers of electrical equipment, few manufacturers felt such a need until the 1890s. When they did begin to seek outside funds, the institutions to provide such capital were fully developed. No further innovation was needed. New York provided an even more efficient national market for industrials than it did for railroads. In American industry the lack of a well-organized national capital market cannot be considered a constraint on the rise of modern business enterprise.

The simultaneous construction of many large railroads during the 1850s modernized the construction trade as much as it did the business of finance. Before the railroad boom of that period, construction companies were still small partnerships. The earlier railroads, built in much the same manner as turnpikes and canals, were largely constructed by local parttime contractors: usually farmers, merchants, or even professional men who lived along the line of the road. Each contracted to build a small section, working under the supervision of the road’s chief engineer. By the 1840s more full-time professional contractors began to make a career of railroad and canal construction. Their enterprises, however, remained small. They continued to rely on local labor and materials. The building of one road required the services of many small firms.

The railroad boom created new needs and opportunities. On the large roads it became increasingly difficult for the engineer and his assistants to oversee the work of many small contractors. Labor and equipment often became hard to find at the time they were most critically needed. As a result, in the late 1840s and early 1850s engineers like Horatio C. Seymour (the former state engineer of New York), Alvah C. Morton of Maine, and Joseph Sheffield and Henry Farnum from Connecticut formed companies to build railroads.19 These great contractors handled all aspects of construction and were often engaged in building more than one road. They supplied all necessary equipment, including rails and even locomotives and rolling stock. They recruited labor and often subcontracted parts of the construction. They did all this for a flat fee, either on a per mile or total cost basis, receiving at least part of their payment in railroad stocks or bonds. One contractor, Horatio Seymour, on his premature death in 1853, was reported to have on hand more than $30 million worth of business.20 Such contractors thus became heavily involved in railroad finance. Some railroad promoters used the contracting firm as a way to make higher profits than they might by simply operating the road. These large contractors relied increasingly on immigrant labor. Even though the Irish and German famines had brought a flood of immigrants into the United States in the late 1840s and early 1850s, these firms soon had agents overseas recruiting workers in Britain and western Europe.

The new labor supply and the railroad experience brought the large contracting company quickly into urban construction. After the 1840s, mayors and councils in the growing American cities let out contracts similar to those of the railroads (though usually smaller) for the paving of streets, the building of schools, and the construction of water and sewage systems. By the Civil War the letting of such contracts had become a val- uable piece of political patronage, and urban contractors were becoming ever more closely tied to city politics.

In these ways, then, the nation’s first railroad boom provided a basic impetus to the rise of the large-scale construction firm and the modern investment banking house. However, these firms created no new problems of internal management in their operation. Neither the construction company nor the investment banking house built a large geographically extended administrative network of operating units. They were not yet full- fledged modern business enterprises. Although the investment banking houses had partners and occasionally salaried managers in other American cities and European financial centers, most of their day-to-day buying and selling activities were handled in a small office near or on Wall Street. And although construction companies carried out a number of multimillion dollar jobs in different parts of the country, each project was managed locally by a handful of managers. None was permanent. When the road was completed that contracting unit moved on to another job in another place. Only the home office had a permanent staff. There the senior partner of the firm with one or two associates negotiated contracts and provided general supervision of operations from a single office. That office too was normally located in New York City. The management of such enterprises did not require the constant, almost minute-to-minute supervision that operation of the railroads demanded.

Source: Chandler Alfred D. Jr. (1977), The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.

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