I just watched an episode of The Gilded Age that has a narrative involving wealthy characters bankrupting other wealthy characters with shady stock dealings inspired by events of the Erie War for railroads between Jay Gould & Cornelius Vanderbilt. I’m trying to better understand how this bad deal worked, how is cornering the market & then selling watered down stock such a dramatic, high risk business dealing?
In: 30
Say you have a bunch of cookies and other kids have coupons for free ice cream cones. Most days you can trade 3 cookies for 1 coupon.
But the price will change based on the weather. On a cold day, people aren’t going to want ice cream cones and the rate will change to 1 cookie for 1 coupon. But on hot days, lots of people want ice cream, so they will want 5 cookies for 1 coupon.
Now lets say you have a magical ability to select the weather on a particular day. And you want to get as many cookies as possible. Well, you would make the weather cold on the first day, buy coupons at a low rate, then make the weather hot the next day and sell the coupons at a high rate. And thus you get lots more cookies.
But lets say, you are even more greedy. Lets say you make a deal with kids on the second day that if they gave you 4 cookies on that day, you would give them a coupon on the third day. Now you could sell coupons you don’t have and get even more cookies. But how are you going to keep up your end of the bargain? Simple, you will make it cold on the third day and buy coupons for just 1 cookie tomorrow.
The third day comes, you make the weather cold, and you wait for the price to go down. But it doesn’t. Instead, a man with a whole lot of cookies comes and buys all the coupons. He buys so many that he can set the price, even though the weather is cold, ice cream coupons are going for 6, then 7, then 8 cookies. And you, being force to buy the coupons that day to fulfill the promises you made, must buy the coupons at inflated prices. You will not only loose all the cookies you got in the last few days, you may not have any cookies left.
In the episode, the aldermen have the ability to “change the weather” in their ability to change the law and zoning allowances and thus make a business’s future prospects bright by having a station being built or a business’s prospects poor by blocking the station’s construction.
Selling tomorrow’s coupons today is called short selling. And its a legal practice and does come with a lot of risks, but most economists agree it has its place in the market.
Watered down stocks is selling coupons at high prices when the weather is hot even though you made it hot and it won’t stay hot. It can be done by changing laws, like in the show, but there are many other methods to water down stock prices. This is illegal these days, but not so much in the gilded age.
Cornering the market is when you are the buying out all the stocks so you can set the price by insuring there are no other offers for coupons.
In the show, George Russell bribes the alderman buy giving him stock at a low price so he has a monetary reason to change the law that allows the rail station to be built. Warning Spoiler if you haven’t seen the episode: >!The alderman, sees an opportunity to not just cash in once, but two or more times and maybe get rid of the upstart in the process. He decides to allow the rail station, sell his stock at a high price and then short the stock, change the law so the stock prices crashes, and cash in a second time. And then possible repeat as many times as he wants or until Russell is bankrupt. But the alderman underestimates the size of Russell’s pocket book. Russell instead corners the market and makes sure the stock price doesn’t go down after the law is changed and forces the alderman into bankruptcy and suicide.!<
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