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
“Cornering the market” is when you buy either all of an item on the market, or at least enough of it that you can control the supply and price. The simplest example would be to, say, [buy over half of the available silver in the world and hold it until the price goes crazy high, and then try to sell it at that inflated price](https://en.wikipedia.org/wiki/Silver_Thursday). One thing of note is that when you try to corner the market, you usually try to do it slowly and quietly so no one notices and takes action to stop you.
“Watered stock” is stock whose value has been artificially inflated. It generally refers specifically to a particular situation in (when else?) the Gilded Age, when basically people would perform private issuance of stock for a company at an artificially high price and have their buddies buy it (or buy it themselves in disguise). You end up with a sort of financially fraud where the company looks like it has higher assets than it does because of the value of all of the stock that’s been issued – this is like a snake eating its own tail. For example, say that you have a company with $1,000,000 worth of assets and you issue 1,000 shares valued at 1/1000 of the company each – this is $1,000 each, but have your buddies buy them at $2,000. Your company is now valued at $2,000,000!
This artificially expensive stock can then be sold on. Notionally, someone who buys $1,000 worth of assets at $2,000 and then sells it at $2,000 has made no money, but if they’re in cahoots with the company issuing the stock, they’ve just sold $1,000 worth of assets at $2,000.
Even better, if you issue the right kind of stock, purchasers of the stock end up being liable for the company’s debts! This means that you, the company owner, can sell watered stocks, declare bankruptcy, and have your stock-holders liable for the debt! Note that this is similar to the practice of hollowing-out a company and then declaring bankruptcy *without* issuing watered stock, but is a different form of fraud.
What happens when you combine the two concepts? Nothing good. But the good news is that both people involved were trying to be assholes. Our story begins in 1866 when Cornelius Vanderbilt decided that he wanted to buy the Erie Railroad Company – or at least a lot of it. I’m not sure that I would call this cornering the market in the traditional sense, because he didn’t want to manipulate the stock’s price, he just wanted to perform a surprise takeover and get control of the company without having to make a deal with the owners. Daniel Drew, who owned most of the railroad, noticed that someone was quietly buying up shares and decided to make some money on it. He started issuing watered stock knowing that it was going to be purchased immediately by someone who didn’t seem to care too much about the price of the stock as a tradeable asset in its own right.
This was…questionably legal, but not actually openly illegal (the stock market at the time was very much run on the basis of *caveat emptor*). Later, the infamous Boss Tweed was brought to the Company’s board in exchange for arranging for a law in the New York state legislature allowing Drew’s actions. This led to a frenzy of bribery by both sides – later investigations showed that lots of State Senators ended up taking bribes from both sides and then voting however they wanted.
This would not be the end of the Erie Railroad-related shenanigans, whose story is a grand testament to American greed and corruption, but I think that’s the relevant bits.
Incidentally, I don’t see how this is particularly related to what happened in the episode, which was market manipulation of a different variety and a parable about why you should never buy on margin (see also: Black Tuesday).
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