B005HFI0X2 EBOK (25 page)

Gentlemen:

Please do not use my name in any way. Please do not even divulge the fact that I own a machine. I have entirely stopped using the Type-Writer, for the reason that I never could write a letter with it to anybody without receiving a request by return mail that I would not only describe the machine but state what progress I had made in the use of it, etc, etc. I don’t like to write letters, and so I don’t want people to know that I own this curiosity breeding little joker.

Yours truly,

Saml. L. Clemens
³⁶

By the 1920s, electricity and the automobile were reshaping the geography of American production, distribution, consumption, and residence. Thanks to electrical power, factories no longer needed to be located near coal mines or waterways that carried the coal that powered steam engines. Railroads were eclipsed by long-distance trucking, as canals earlier had been eclipsed by railroads. And the migration of Americans from the farms to the cities gave way to the migration from the cities to the suburbs.

While the visible transformation of the American landscape by the second industrial revolution was dramatic, the transformation of the landscape of American business and politics would prove to be even more consequential.

Once admitted that the machine must be efficient, society might dispute in what social interest it should be run, but in any case it must work concentration.

—Henry Adams, 1905
¹

The day of combination is here to stay. Individualism has gone, never to return.

—John D. Rockefeller, 1880
²

R
epeatedly in American history, waves of technological innovation have led to the reorganization of business and markets, before the political order could catch up. By the first years of the twentieth century, the second industrial revolution of the late nineteenth century, based on the new technologies of electricity and automobility, was already outgrowing the structures of American economic life that had been inherited from the last wave of reform in the United States during the Civil War and Reconstruction.

In 1901, the economist John Bates Clark wrote: “If the carboniferous age were to return and the earth were to repeople itself with dinosaurs, the change that would be made in animal life would scarcely seem greater than that which had been made in business life by these monster-like corporations.”
³
By 1932, according to Adolf A. Berle and Gardiner C. Means in
The Modern Corporation and Private Property
, half of the assets of nonfinancial corporations in the United States were controlled by only two hundred firms.
⁴
“The day of combination is here to stay,” John D. Rockefeller declared. “Individualism has gone, never to return.”
⁵

The second industrial era that began in the 1870s and 1880s was an age of giantism in production as well as invention. By 1890 the assets of US manufacturing, at $6.5 billion, were approaching those of US railroads, at $10 billion, although while each of the ten largest railroads had assets of $100 million each, few manufacturing corporations were worth more than $10 million.
⁶
The “great merger wave” of 1895–1904 created giant corporations in industries ranging from steel to tobacco.

The new industrial leviathans existed in a country whose political institutions, despite the reforms of the Civil War and Reconstruction, were still those of a decentralized, agrarian society. The misalignment between the emerging technological and economic order and the archaic political system was a challenge that different groups of reformers sought to meet in different ways.

ANTITRUST AND THE SUPREME COURT

One historian observes that around 1900 “a big majority of the economists conceded that the combination movement was to be expected, that high fixed costs made larger scale enterprise economical, that rivalry under these circumstances frequently resulted in cutthroat competition, that agreements among producers were a natural consequence, and the stability of prices usually brought more benefit than harm to the society.”
⁷
A number of American economists argued that older notions of laissez-faire were irrelevant in an economy transformed by the use of steam power in transportation and manufacturing. For example, Richard T. Ely wrote that “owing to discoveries and inventions, especially the application of steam to industry and transportation, it became necessary to prosecute enterprises of great magnitude.”
⁸
In 1889, another leading American economist, David Ames Wells, argued that the application of steam engines to manufacturing made possible “excessive competition” and losses that could only be avoided if firms combined to limit output.
⁹
As a result, he declared: “Society has practically abandoned—and from the very necessity of the case has got to abandon, unless it proposes to war against progress and civilization—the prohibition of concentrations and combinations.”
¹⁰
John Bates Clark wrote that large industrial combinations “are the result of an evolution, and the happy outcome of a competition so abnormal that the continuance of it would have meant widespread ruin. A successful attempt to suppress them by law would involve the reversion of industrial systems to a cast-off type, the renewal of abuses from which society has escaped by a step in development.”
¹¹

In addition to recognizing the legitimacy of large corporations in industries with increasing returns to scale, by the 1890s, many otherwise conservative economists argued for the reality of “ruinous competition” in railroads and other industries with high fixed costs and variable operating costs. According to this argument, too many firms competing in a capital-intensive industry could drive prices below the minimum prices needed to recoup long-term, fixed investments in railroads or factories. As a result, most or all of the competing firms could be plunged into bankruptcy. Traditional free-market competition could not work in such industries, it was argued. What was needed instead was either cartelization among firms that agreed upon minimum prices or consolidation of entire industries by monopoly or oligopoly.

Both methods were tried by entrepreneurs and financiers in the railroads and other industries. Informal price-fixing cartels, known as “pools,” tended to fail, because there was no penalty to prevent one or more firms from undercutting the agreed-upon minimum prices. In other countries, including Britain, Germany, and Japan, cartels were tolerated or legal and allowed to enforce price agreements upon all firms in an industry. But in its interpretations of the vague language of the Sherman Antitrust Act of 1890, which prohibited combinations to create monopolies, the Supreme Court, clinging to preindustrial economic theory, ruled repeatedly in the late nineteenth and early twentieth centuries that avoiding ruinous competition was not a defense of price-fixing or other forms of collaboration among firms in the same industry.

THE GREAT MERGER MOVEMENT

Even as it forbade firms in the same industry to collaborate, the Supreme Court permitted mergers that created firms that could dominate particular industries. The court inadvertently reshaped the industrial landscape of the United States, as companies responded to its rulings by abandoning attempts at cartelization and taking part in what has been called “the great merger wave.” The merger wave of the 1890s and 1900s was followed by a second in the 1920s and a third in the period of conglomerate-building in the 1950s and 1960s.

Most companies in the early republic were created by “special incorporation,” specific charters issued by the legislature that detailed their powers and responsibilities. The Supreme Court struck a blow to the practice of chartering corporations as monopolies in 1837 in the
Charles River Bridge
case, in which it held that a corporate charter did not imply a monopoly in that industry. Hostility to special incorporation was part of the ideology of Jacksonian populists, for whom it was a source of political corruption and a violation of the principle, “Equal rights for all, special privileges for none.” The revulsion against special incorporation by state governments increased when state fiscal crises followed canal and railroad bubbles in the 1830s and 1840s. By the mid-nineteenth century, most states had enacted general incorporation laws that no longer required special action by the state legislature.

Even so, corporations usually were not allowed to own stock in other corporations. In 1889, in order to encourage companies to incorporate in the state, the New Jersey legislature passed a law that allowed any corporation chartered in New Jersey to own stock in the corporations of any other state. This permitted enormous corporations to be created as holding companies. In 1901, for example, J. P. Morgan incorporated US Steel as a New Jersey holding company. New Jersey was succeeded by Delaware, which still has the leading position among states as a home for American companies.

The combination of the outlawing of cartels and new corporate laws like that of New Jersey resulted in the great merger movement of 1895–1904. In that brief period, eighteen hundred firms were combined into 157 companies, most of them in manufacturing. New Jersey’s 1888 general incorporation law for holding companies of national businesses stimulated a wave of consolidations that grew from four in 1895 and six in 1897 to sixteen in 1898. The wave peaked in 1899, with sixty-three consolidations, followed by twenty-one in 1901, seventeen in 1902, and three in 1904.
¹²

Of ninety-three consolidations studied by the historian Naomi Lamoreaux, seventy-two created companies that controlled at least 40 percent of their industries and forty-two controlled at least 70 percent.
¹³
Among the corporations that dominated 40 percent or more of their industries were the familiar (Eastman Kodak; Otis Elevator; United Steel; National Biscuit, now known as Nabisco) and the forgotten (National Candy, United States Envelope, and American Stogie).
¹⁴
The new giants included General Electric, which was formed from eight firms and controlled 90 percent of its market; International Harvester, formed from four companies and controlling 70 percent of its market; DuPont, formed from sixty-four firms and controlling 65 to 75 percent of its market; and American Tobacco, which controlled 90 percent of its market after forming from the merger of 162 firms.
¹⁵

The Wall Street publisher John Moody, founder of Moody’s ratings service, a defender of industrial concentration, claimed that the US economy in the first years of the twentieth century was dominated by seven “Great Industrial Trusts”: United States Steel, Amalgamated Copper, American Smelting and Refining, American Sugar Refining, Consolidated Tobacco, International Mercantile Marine, and Standard Oil.
¹⁶
In 1894, three-fourths of the output of the entire US steel industry came from Carnegie Steel and Illinois Steel.
¹⁷
In the chronically troubled railroad industry, consolidation around 1900 resulted in the ownership of 62 percent of the US railway network by seven corporations.
¹⁸
The period also witnessed the emergence of giant firms in extractive industries like lumber. Economies of scale that permitted upgrades in milling technology were costly and led to the replacement of small operators by large companies like those of Frederick Weyerhaeuser, Charles Stimson, and D. A. Blodgett.

MORGANIZATION

The great merger wave produced enormous firms that confronted a fragmented system of nearly thirty thousand unit banks in the early 1900s. In Germany, large universal banks were able to help a firm throughout its life cycle, by making loans in its early years, underwriting shares as it expanded, and policing and monitoring the firm in its maturity, as a proxy for the firm’s shareholders. The growing importance of the stock market in financing large corporations was the result in part of the inability of America’s mostly small unit banks to grow in scale along with businesses, because of state and federal anti–branch-banking laws. Until the 1890s, railroads dominated the stock and bond markets. Then companies representing the industries of the second industrial revolution, like General Electric and US Steel, became important.

As the new corporate leviathans turned to other sources of financing, banks increasingly made loans to small local businesses. The share of corporate debt in the form of bank loans plunged from 32.1 percent in 1920 to 23.3 percent in 1929. America’s small unit banks also lost out in consumer lending to specialized consumer lenders and corporate vendor financing, like that of the General Motors Acceptance Corporation. Many banks were forbidden by law to branch even within their home states.
¹⁹

Investment banks in the United States performed the functions of underwriting and monitoring large corporations by the same method of corporate board memberships that was used in Germany by large universal banks. Investment banking costs were high, however, in the United States, compared to Germany, with its universal banks. Restrictions on the size and resources of banks raised the costs of underwriting securities and bank lending to industrial corporations.
²⁰

The need for giant corporations to raise enormous sums increased the importance of investment bankers as intermediaries between the shareholding public and individual companies. In 1912, five American banks—J. P. Morgan and Company, First National Bank, National City Bank, Guaranty Trust Company, and Bankers’ Trust—had representatives on the boards of sixty-eight corporations whose combined assets added up to more than half of US gross national product.
²¹

The dominant figure in American investment banking around 1900 was John Pierpont Morgan, a Europe-educated patrician from a wealthy American banking dynasty. A dedicated art collector, a pillar of the Episcopal Church, an adulterer who supported Anthony Comstock’s Society for the Suppression of Vice, with a nose discolored by the skin disease rosacea and an impressive stature and girth, Morgan was a larger-than-life figure. Morgan’s grandfather Joseph was a founding investor in the Hartford and Aetna insurance companies. His father, Junius, worked in business in Hartford and Boston for a few years before joining the merchant bank of George Peabody, a Baltimore expatriate living in London. On Peabody’s retirement, Junius changed the name of the firm to J. S. Morgan & Co.

Morgan was born to Junius and his wife in 1837 in Hartford, Connecticut. A sickly youth, Morgan grew into an unhealthy adult who never exercised, saying, when his son began to play squash every morning before work, “Rather he than I.”
²²
Educated in Boston, Switzerland, and Germany, and with a degree in art history from the University of Göttingen in Germany, Morgan turned down an offer to stay as an assistant to a mathematics professor at the University of Göttingen and moved to New York, where he worked for a Wall Street firm, Duncan, Sherman & Co., surprising them when, during a trip to New Orleans, he bought a shipload of coffee and sold it for a profit on the firm’s account, without asking permission. His first wife, Amelia “Memie” Sturges, was suffering from tuberculosis when he wed her; too weak to stand during their wedding, she died four months later in Nice, leaving Morgan a widower at twenty-four. Toward the end of the Civil War he married his second wife, Frances Tracy, with whom he had three daughters and a son, Jack Morgan Jr., who inherited the leadership of J. P. Morgan and Company.