The Credit Card Is Born and the Long Depression Begins

On this day in economic and business history...

Jay Cooke & Company failed on Sept. 18, 1873, triggering a financial panic that soon plunged the United States into a "Great Depression." This depression remained the national benchmark for economic woe for decades before the 1930s took over that term.

The basic backstory of this failure should be familiar: A major financier invests heavily into a speculative bubble -- in this case, railroads -- and uses excessive leverage to maximize returns while everything moves in the right direction. Then the bubble pops, and the financier is left without the means to pay back creditors. A sudden lack of liquidity cascades through the financial system as everyone rushes to withdraw money, only to find that in many cases their profits or their savings exist only as notations in their bank's records. Everybody panic!

The particulars of 1873, however, make it worth a closer investigation.

The boom leading up to the 1873 panic was the first true "tech" bubble, driven entirely by the excitement surrounding a promising new industry, rather than by real-estate speculation, trade imbalances, or financial shenanigans. (A boom preceding the Panic of 1857 also involved railroads, but this earlier bubble was driven in large part by Midwestern land speculation.)

The railroad boom kicked into high gear following the completion of the Transcontinental Railroad in 1869. This continent-crossing line finally provided a number of locales west of the Mississippi with a primary connection back to the industrializing coastal cities. Between the Transcontinental Railroad project's approval in 1862 and its completion in 1869, nearly 15,000 new miles of track were built in the United States -- a 45% growth in total mileage. In the four years that followed, more than 23,000 new miles of track were built, averaging roughly 5,900 new miles per year. Despite the emergence of a strong domestic iron industry, this intense pace of construction was too much for American foundries to supply, so the price of rail shot higher, and imports wound up outweighing domestic production by 1872.

Many of these railroad projects took years to complete in the best of circumstances, which made some investors wary of the long-term risk of corporate failure. Jay Cooke, which was the exclusive bond agent for the Northern Pacific Railroad, experienced much of this investor nervousness firsthand. Despite the firm's high prestige -- it had sold more than $500 million in government bonds to help finance the Civil War -- Jay Cooke wound up stuck with most of Northern Pacific's bonds and owned 75% of the company on the eve of the panic. This proved disastrous when the railroad's ambitions exceeded the capability of its construction crews.

Northern Pacific crews had set out from an outpost near Duluth, Minn., in 1870, with the intention of building America's Transcontinental Railroad through the northern states. However, by 1872 it had only reached Fargo, N.D. -- roughly 240 miles by car nowadays. Its terminus, in Tacoma, Wash., lay another 1,400 miles to the west. Jay Cooke, as reluctant majority-owner and holder of millions of dollars in unsalable Northern Pacific bonds, took on debts wherever it could to sustain financing for the railroad's construction. Costs eventually mounted beyond Jay Cooke's ability to maintain funding. With its obligations far exceeding its assets and a huge government loan offer rescinded, the firm had no choice but to declare bankruptcy.

Jay Cooke's insolvency was not entirely unexpected, and yet its impact was entirely underestimated. The Chicago Daily Tribune, writing on the day of the Cooke bankruptcy, remarked:

Prudent business men have predicted for years that Jay Cooke & Co. would fail. Their enterprises were so daring, their scrupulousness so doubtful, their liabilities so large, their exterior so glittering, that among the really heavy men of the country there has long been a belief that sooner or later the firm would go to everlasting smash. Nevertheless, their total suspension when announced today was a surprise. They had stood so long under the Northern Pacific load that even those who predicted their failure fancied that they would somehow pull through. When their collapse was announced, there were probably thousands of business men in all parts of the United States and Canada who exclaimed simultaneously, "I told you so." ...

We do not apprehend that this failure will lead to anything like a financial crisis, or cause any serious disturbance in the business of the country. There will be a clatter of small failures caused immediately by this one, and a smashing of crockery in Wall Street produced by the decline in stocks. But the volume of private indebtedness throughout the country at the present time is not large. The stringency of last autumn and winter led to a vast curtailment of liabilities. People have since then set their affairs in order. There is nothing to make a general panic out of.

This blase optimism is, as always, stunning in its wrong-headedness. The very next day, this same newspaper reported on the failure of 19 financial firms as a result of a railroad-stock bloodbath on Wall Street. On Sept. 20, two hours of catastrophic panic-selling at the New York Stock Exchange forced exchange operators to shut down trading indefinitely. The exchange would not open for another 10 days. Those two hours produced $100 million in losses on railroad stocks alone, which at that time was equivalent to roughly 1.2% of the entire national GDP. The Tribune crowed that "the results of the day are disastrous only to a class of stock-gamblers whom everybody wishes to see overwhelmed," mocking the dozen or so banks that failed that day as inconsequential: "Not a single house of stability, character, or importance has suspended."

The results of the Cooke failure and its resultant panic eventually proved disastrous to the entire country. In the two years that followed, a quarter of the nation's 364 railroads went bankrupt, 18,000 other businesses failed, and unemployment spiked to 14%. Business activity declined to just two-thirds of pre-crash levels. The Long Depression, as it's now called, persisted until 1879, and at 65 months in length (as measured by the National Bureau of Economic Research) it outlasts the Great Depression's initial collapse by nearly two full years.

A new kind of credit
Bank of America
(NYSE: BAC  ) launched the world's first modern credit card, the BankAmericard, on Sept. 18, 1958 .

Bank of America's card was at first a paper card that had a $300 limit. It launched in an environment already well-seeded with credit; many American families were accustomed to installment-plan purchases and early charge cards like the Diners Club card, which required that balances be paid in full every month. Executives at Bank of America, which was then the largest bank in California, had set out to create a unified credit mechanism that might allow consumers to buy all manner of products and services and then make a single monthly payment. This is, of course, the basic credit card model still in use today.

Thousands of BankAmericards were distributed to the residents of Fresno, Calif., in what was intended to be a small, controlled trial. However, competing banks showed an early interest in the credit card model, and Bank of America abandoned its limited trial in a mad dash to gain statewide market share. Within a year, more than 2 million BankAmericards had been distributed across California, and the bank's lack of credit checks caused major headaches for the bank when nearly a quarter of all its credit card accounts turned up delinquent. By the end of the 1950s it was evident that Bank of America had badly botched the launch of the world's first credit card, and estimates later pegged its losses at about $20 million, or about $160 million in present terms.

Despite these early struggles, Bank of America refused to give up its efforts, and a ferocious image-rehabilitation program eventually brought the BankAmericard to profitability. Banking regulations prevented Bank of America from expanding beyond California's borders, but by 1965 its credit card program began to expand nationwide as other banks licensed the BankAmericard system. During these early years, banks would "drop" credit cards to households directly, bypassing the now-standard card application in favor of simply mailing viable consumers a ready-to-use card. As you might expect, this led to a number of problems; credit card fraud and delinquencies ran high until unsolicited "drops" were outlawed by the federal government in 1970.

It was from these humble beginnings that Visa (NYSE: V  ) was born. BankAmericard became an independent corporation in 1970 and later changed its name to Visa in 1976 as a way to broaden its appeal internationally. By this point the Master Charge had been established as a competing credit card network, and it had actually grown larger than the former BankAmericard: In the first quarter of 1976, BankAmericard/Visa claimed 31.8 million cardholders and $2.3 billion in sales volume, while the Master Charge had 37.4 million cardholders and processed $2.9 billion in sales. Master Charge, of course, is the forerunner to MasterCard (NYSE: MA  ) , but it hasn't maintained its early lead over Visa. In 2012, Visa's total U.S. purchase volume clocked in at $981 billion compared to $534 billion for MasterCard, and Visa's 278 million American cardholders far outweigh MasterCard's 180 million American cardholders.

Visa's long wait to go public -- its IPO took place in 2008 -- meant that it would not be the first credit card issuer added to the Dow Jones Industrial Average (DJINDICES: ^DJI  ) . That honor went to American Express (NYSE: AXP  ) , which earned its spot in 1982 by owning the "premium" credit card market -- its 52.5 million card members spent far more in 2012 per card ($8,100 on average!) than either Visa's ($3,500) or MasterCard's ($3,000) card members. However, there was a certain irony in the fact that Visa, on its induction to the Dow in 2013, became one of the few companies ever added to directly replace the company that first spun it off.

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