Bernard Baruch: Master Speculator

The word "speculator," Baruch frequently noted, is derived from the Latin speculari, which means to observe. Baruch was an advocate of careful observation of economic events.

Experiment in arbitrage

Baruch made his first stock market "killing" in 1898, during the Spanish-American War. On July 3, a Sunday, he learned about a major US naval victory. This victory made clear that the war would soon end with a resounding triumph for the United States, and would cause American stock prices to surge when the stock market opened on the Tuesday following the Independence Day holiday. This afforded Baruch an opportunity to profit by buying shares before others could react to the news.

First, Baruch had to solve a riddle: How could he buy shares of US corporations before the opening of trading on Tuesday if all of the stock markets in the US were closed until then? Baruch's solution was to place buy orders for American securities on the London Stock Exchange, where little attention was being paid to American developments. He reaped a bonanza when the New York Stock Exchange resumed trading a day later.

By buying stock in London on Monday in order to sell in New York the following day, Baruch was engaging in arbitrage, which is the process of taking advantage of price differences in different markets for the same asset.

Northern Pacific Railroad

Another huge payday came in 1901 for Baruch, during the stock market panic triggered by E.H. Harriman's attempt to gain control from James Hill of the Northern Pacific Railroad. Harriman who was backed by banker/financier Jacob Schiff battled with Hill who was backed by J.P. Morgan to get a majority of the outstanding shares of the Northern Pacific. This caused the price of the stock to skyrocket.

However, even after Morgan succeeded in obtaining 51% of the common stock (while Harriman had a majority of the preferred stock) and the two sides declared a truce, the stock price continued to increase, rising from about $150 per share to $180. This was caused by speculators plunging into the market without knowledge of the underlying causes of the price change.

The Northern Pacific's abrupt price rise attracted short-sellers, but because Harriman and Morgan controlled virtually all of the railroad's shares, and neither was selling, the stock price for the few remaining shares leaped to $1,000 per share. This had the effect of sucking the oxygen out of the market, as many speculators, including many major players, dumped their holdings in order to raise the money needed to cover their short sales of Northern Pacific. In Baruch's words, "all sense of value and sanity was gone," and many on Wall Street fled the market.

Fortunately for Baruch, he was a friend of the son-in-law of James Keene, who led Morgan's activities on the floor of the New York Stock Exchange. Keene's son-in-law warned Baruch of the impending Northern Pacific debacle. Baruch was astute enough to understand that it would lead to a widespread price collapse of all shares except the Northern Pacific, and so he assembled a large portfolio of stocks that he sold short.

Both Morgan and Schiff were upstanding bankers with a sense of responsibility to the wider community. They had no interest in destroying the stock market; on the contrary, they both had a vested interest in stability on Wall Street.

They agreed to allow the short-sellers to cover at $150 per share, the approximate price of the stock when Morgan and Schiff stopped accumulating shares. They also came to an arrangement whereby Hill would retain control of the railroad, but Harriman would have representation on the board of directors. He would also have assurances that Hill would not attempt to use his control to cut off Harriman's railroad, the Union Pacific, from access to Chicago via the Burlington Railroad (which was a subsidiary of the Northern Pacific).

The stock market soon settled down and returned to normal, but many speculators were wiped out. In contrast, Baruch, by selling short before the Northern Pacific battle began, was now very wealthy.

World War I

Actual war broke out in Europe in 1914. As the stock market hates uncertainty, and the fighting between the great powers of Europe caused great insecurity and doubt about the future, US stock prices buckled when war was declared. But Baruch realized that World War I meant a surge in demand for American products. He repeatedly bought shares when the market declined in reaction to Allied defeats, and sold when the market surged in response to Allied victories, racking up huge gains.

In 1916, President Wilson appointed Baruch to the Advisory Commission of National Defense, an agency that was set up to prepare the country for the possible entry of the US into the conflict. When the US declared war in 1917, Baruch was appointed chairman of the War Industries Board, which oversaw much of the US economy. To avoid conflicts of interest, Baruch closed his brokerage firm, ceased all speculative activities, and sold the bulk of his stock portfolio, forgoing sizable profits in order to serve his country.

Baruch became a national hero because his efficient work greatly contributed to the national mobilization for war. He was subsequently a member of the US delegation to the Versailles Peace Conference after the end of the war and was a top advisor to President Woodrow Wilson.

After World War I, Baruch resumed his speculative activities, but by the late 1920s, he was troubled by the overvaluation of the market. He noted that in 1928, he "sold [several times], feeling that a break was imminent, only to have the market continue upward." In 1929, however, Baruch sold out virtually all of his holdings and stayed out of the market, avoiding the crash. Thereafter, he remained a cautious investor, more concerned about preserving his wealth than augmenting it.

Later, Baruch was a top advisor to President Franklin Roosevelt and was influential in the 1940s with regard to American policy about the United Nations and about international control of atomic energy.

Although Baruch benefited greatly from timely tips early in his career, he also lost large amounts when speculating based on tips, and eventually he grew disdainful of them. He recounted his stock market victories in loving detail in his autobiography, My Own Story, but unfortunately was much more circumspect when discussing his disappointments.

Nobody's fool

I have always thought that if, in the lamentable era . . . culminating in [the Crash of] 1929, even in the very presence of dizzily spiraling prices, we had all continually repeated "two and two still make four," much of the evil might have been averted. Similarly, even in the general moment of gloom in which this foreword is written, when many begin to wonder if the decline will never halt, the appropriate abracadabra may be: "They always do."

Baruch repeatedly recommended Mackay's book, originally published in 1841, to anyone interested in the stock market because of its cautionary tales about the extent to which conventional thinking can be wrong. Considering Baruch's career, it is clear that like all successful speculators, he was nobody's fool.

James Maccaro is an attorney and freelance writer. He has written articles for Newsday, Ideas On Liberty, the Massachusetts Law Review, and other magazines. He may be reached at jam@juno.com.

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