CHAPTER XXVI.OUR RAILROAD METHODS.
Deceptive Financiering.—Over-Capitalization.—Stock “Watering.”—Financial Reconstructions.—Losses to the Public.—Profits of Constructors.—Bad Reputation of our Railroad Securities.—Unjust and Dangerous Distribution of the Public Wealth.
The following chapter, on the subject of “Our Railroad Methods,” was delivered by me as a Fourth of July address at Mr. H. C. Bowen’s Annual Symposium at Woodstock, Conn., to an assemblage of over 3,000 people. It was so favorably received by the press and the public in general, that I have been encouraged to publish it in this book without any material changes:
In the whole range of our law-making there is no one branch in which there has been such an utter lack of judgment, foresight and just regard for the rights of the citizen, as in the legislation provided for our railroads and railroad companies. For the most part, the statutes relating to this class of corporations are a set of general enactments, loosely defining the large powers granted to the incorporators, comparatively silent on the duties and obligations of the companies to the public, and conferring upon them a virtualcarte blancheas to their methods of finance and of conducting their business.
In a country whose products are mainly bulky, and have to be carried to markets hundreds or thousands of miles distant, it is of the first moment that its railroads should be built with the strictest economy and on the lowest possible capitalization. The low cost of land and the cheapness of material for road-bed are especially favorable to our securing this advantage; but the laws have permitted a system of inflated financiering which neutralizes these natural adaptations and immensely increases the cost of transportation.
As railroads have to be largely built with borrowedmoney, their construction in this country afforded an opportunity for establishing credit relations with the great lending centres of Europe, which might have been of incalculable value in promoting the development of our vast resources in various directions. England, Holland and Germany have indeed loaned us very large amounts for railroad enterprises; but the law has permitted these undertakings to be conducted with so much concealment, misrepresentation and actual fraud, and has so disregarded the rights of the bondholders, that American credit has become a scandal and a by-word on the European bourses. The result is, that foreign capitalists are seeking other fields of investment; and their respective Governments are encouraging them by opening up new colonies, and thus getting fresh sources for the supply of products which otherwise would have continued to be readily taken from the United States. Such are the rewards of immoral financiering; and these bad methods are directly traceable to the encouragements afforded by our negligently constructed railroad laws.
Perhaps I may best succeed in making myself understood on this subject by illustrating the way in which our railroads are usually built. Under the laws of the State of New York—which are a fair sample of the laws of most other States—a number of persons form a company under the general railroad laws, registering at Albany the proposed route of the road, the amount of capital stock and bonds to be issued, and a few other particulars required in the papers of incorporation. The incorporators then proceed to form themselves into a syndicate or company, for the purpose of contracting to build and equip the road. Here comes the first step in the system of “crooked” financiering. In their capacity of incorporators, the same men make a contract with themselves, in the capacity of constructors. Of course, they do not fail to make a bargain to suit their own interests. They would be more than human if they did. Usually, the bargain is that the construction company undertakesto build the road for 80 to 100 per cent. of the face value of the first mortgage bonds, with an equal amount of stock, and sometimes also a certain amount of second mortgages thrown in, virtually without consideration. The first mortgages are supposed to represent the real cash outlay on the construction and equipment; but, as a matter of fact, the true cash cost of the work done and materials furnished ranges from 60 to 80 per cent. of the amount of first lien transferred to the constructors. The Construction Company disposes of the bonds, partly by negotiating their sale to the public through bankers, at an advance upon the valuation at which they had received them, and partly by using them in payment for rails and equipment. Beyond the profits made from building the road for the first mortgage bonds, there remains in the hands of the constructors the entire capital stock and any second mortgage bonds they may have received,as a clear bonus, to be held for future appreciation, and to keep control of the Company and be ultimately sold on a market deftly manipulated for that purpose.
This is the way in which a large majority of our railroads have been and others are still constructed. It will thus be seen that the actual cash cost of a railroad is ordinarily less than 60 per cent. of the stock and bonds issued against the property, and that its first mortgage exceeds the amount of the legitimate actual cost of the road.
The basis of all the discredit, the embarrassments, the bankruptcies and the robberies of our railroad system is thus laid at the inception of the enterprises. They rest upon an intrinsically rotten and dishonest foundation; and the evil is far from having reached the end of its mischief to the financial, political and social interests of the country. In some few cases, railroads thus exorbitantly capitalized have proved able to earn the interest on their debt, provide for additional outlays on construction and betterments, and even to pay dividends on their stock; but, ina large majority of cases, they have had to undergo a process of financial reconstruction, in order to bring the debts of the Company within its ability to meet its fixed charges. It is not a risky estimate to suppose that of our present 125,000 miles of railroad, with its $7,500,000,000 of stock and debts, 60 per cent. has undergone this process of debt-scaling and rehabilitation. Were it not that the new roads have opened up new country for settlement, which has become an immediate source of traffic, these bad financial results would have been more general and worse than they have proved to be. The risks attending the building of lines into unsettled regions ought to have been a reason why they should be constructed upon conservative principles; but, in reality, the prospects of settling new populations and of tapping new sources of wealth, have been so magnified to the eyes of distant and credulous lenders as to enable the speculative constructors to easily consummate their illegitimate schemes.
The general result of this system of financiering has been to deprive the legitimate original investors of their chances of making a fair return out of their investment. As a rule, the bondholders have provided all the capital expended, and the stockholders have invested nothing. The bondholders incur all the risks; the stockholders have no responsibilities. If the enterprise proves a success, the bondholders get their interest, while the stockholders, without a dollar of original outlay, get vastly more than ever falls to the mortgage creditors through the stock becoming an instrument of profitable speculation. If the enterprise is a failure, the bondholder has to forego interest and finally to accept a new mortgage for a less amount and at a lower rate of interest; whilst the original stockholder has, in the meantime, made money out of artificially “booming” the shares in Wall Street.
The profits realized on these speculative constructions are enormous, and have constituted the chief source of thephenomenal fortunes piled up by our railroad millionaires within the last twenty years. It is no exaggeration to characterize these transactions as direct frauds upon the public. They may not be such in a sense recognized by the law, for legislation has strangely neglected to provide against their perpetration; but, morally, they are nothing less, for they are essentially deceptive and unjust, and involve an oppressive taxation of the public at large for the benefit of a few individuals, who have given no equivalent for what they get. The result of this system is that, on an average, the railroads of the country are capitalized at probably fully 50 per cent. in excess of their actual cost. The managers of the roads claim the right to earn dividends upon this fictitious capital, and it is their constant effort to accomplish that object. So far as they succeed, they exercise an utterly unjust taxation upon the public, by exacting a compensation in excess of a fair return upon the capital actually invested. This unjust exaction amounts to a direct charge and burthen on the trade of the country, which limits the ability of the American producer and merchant to compete with those of foreign nations, and checks the development of our vast natural resources. In a country of “magnificent distances,” like ours, the cost of transportation is one of the foremost factors affecting its capacity for progress; and the artificial enhancement of freight and passenger rates due to this false capitalization has been a far more serious bar to our material development than public opinion has yet realized. The hundreds of millions of wealth so suddenly accumulated by our railroad monarchs is the measure of this iniquitous taxation, this perverted distribution of wealth.
This creation of a powerful aristocracy of wealth, which originated in a diseased system of finance, must ultimately become a source of very serious social and political disorder. The descendants of the mushroom millionaires of the present generation will consolidate into a broad and almost omnipotent money power, whose sympathies and influencewill conflict with our political institutions at every point of contact. They will exercise a vast control over the larger organizations and movements of capital; monopolies will seek protection under their wing; and, by the ascendancy which wealth always confers, they will steadily broaden their grasp upon the legislation, the banking and the commerce of the nation.
The illegitimate methods by which the wealth of this class has been accumulated cannot always remain a mystery to the masses. The time will come when every citizen will clearly perceive how his interests have been sacrificed for the creation of this abnormal class; and, when that time comes, a series of public questions will arise that will strain our political institutions to their very foundations. Already the working masses begin to see the dim outline of the gigantic wrong that has been inflicted upon them in common with all other classes. If they do not understand the exact method by which a portion of the rewards of labor has thus been diverted from them, they clearly comprehend which is the class responsible. The labor troubles that have so seriously shaken confidence during the spring of this year have been largely stimulated by an idea that a serious wrong has been done to the workman in the creation of these abnormal fortunes. It is not surprising—although it may lead to disappointing results—if workingmen should reason that, if railroads can afford to make a few men so wonderfully rich, they can afford to pay their employees higher wages and for shorter hours. Nor can we wonder if, when capitalists are on every hand piling up their wealth by the tens of millions, the laborer should conclude that he ought to be able to get a few dollars a week more, or deduct an hour or two off his day’s work, without very seriously hurting the employing class. This may be and is very fallacious reasoning; but it is what might very naturally be expected under these circumstances, from a class who are not trained to think beyond surface depth. It will be of no avail totell the workmen that this unjust distribution of wealth is final and irrevocable; that there is no power of redress by which a wrong of this nature can be righted; or that, as voting citizens, they are as much responsible as anybody else for permitting the neglects and defects of legislation that have made these inequalities possible. This class never reason either calmly or logically, and it will take a great deal of fruitless agitation to satisfy them of the hopelessness of their methods of seeking reparation.
The Socialistic seductions which have captivated such large masses of the working population of Europe will all the more readily find acceptance among our millions of laborers because they have before their eyes such conspicuous instances of the unequal division of wealth and of the overwhelming power of organized capital. Certainly, if any facts could be supposed to justify the doctrines of Socialism and Communism, it would be the sudden creation of such fortunes as those which, within a very few years, have come into the hands of our railroad magnates. A few years later, the public will understand much better than it now does how facts like these have contributed to the raising of questions of government which will dangerously test the cohesion and endurance of our political institutions.
Artificial methods of establishing our railroad corporations have naturally led to artificial methods of regulating their operations. Over-capitalization incapacitates the roads for competition; for it necessarily holds out a temptation to parallel existing roads by others at a lower capitalization. As roads running between the same points were multiplied, competition for “through” business became more active, until not only were dividends threatened on some of the best lines, but some roads were driven into default on their mortgages. At this point the “pool” was introduced—a device by which all lines running between the same points agree to put their business from through traffic into a common aggregate, to be distributed among the several members accordingto certain accepted percentages. It was hoped that, in this way, uniformity of charges could be maintained, at such rates as were necessary to make the business satisfactory to each member. This, however, was soon found to be a step “from the mud into the mire.” The pool was discovered to operate as a premium on the construction of new parallels.
Speculators were quick to perceive that they could build new lines on the same routes for much less cost than the old ones, and that, with a lower capitalization, they could easily compel the pool to admit them to membership, with all the privileges of a ready-made traffic and with all the guarantees the pool could afford of exemption from competition, and of ample charges. Thus, the pools that, in the first instance, were made necessary through the evils of speculative methods of construction, became, in turn, the source of a new and even worse form of the same evil. New roads were built, or sets of old detached ones were connected, so as to afford additional parallels to the existing trunk lines, with no other object than to compel the latter to support them by dividing with them a portion of their traffic, or to accept the alternative of a reckless cutting down of rates. The end to this viciously excessive system of construction can only come when the pools have been reduced to such a low condition that they will no longer care to take newcomers into their co-partnership; in which case speculative builders will see no chance for profit in such ventures. The fate of the “Nickel Plate” and of the West Shore speculations, by which nearly 1,000 miles of needless road was built to divide traffic with the Vanderbilt system, serves as a warning against the danger of building roads to live upon pool support; but, nevertheless, the Eastern trunk pool still stands exposed to a great deal of harassing outside competition from possible and contemplated new combinations of existing detached links. Routes of the latter kind are even more formidable competitors than new lines, because theycan be provided at a lower capitalization, and have already the support of an established way traffic. It would not be surprising if, within the next three or four years, several new routes should in this way be established between New York and Chicago.
It will thus be seen that the very contrivance intended to stave off the vicious effects of artificial capitalization is contributing, by a sort of punitive process, towards the end of reducing earnings to a just ratio to the true value of the properties. The weakness of the pool, arising from its temptations to new competitors to enter the field, is not the only cause of its failure. Up to this time it has been found impossible to find a form of pool stringent enough to restrain the members from cutting rates against each other. The modes of possible evasion are so numerous, the sacrifices of special advantages that each member has to make are so galling, the small share that remains to each road in a numerously divided business is so small, and the temptations of agents to get freight “by hook or by crook,” in dull times are so irresistible, that the strictest watching and the severest penalties fail to secure a faithful observance of the pool agreements. Much forbearance is shown towards transgressions, and deliberate violations have to be condoned or connived at; but, all the time, the pools are in imminent danger of jealousies and breaches of faith causing their disruption. No sooner have they won public confidence by maintaining harmony through a period of prosperous business, than the public wake up to find that some member has been secretly “cutting,” and the agreements are torn to pieces.
The result is, that the public have lost all confidence in the ability of the pool to regulate competition; and, still worse for the railroads, their managers are losing faith in them also. The great crucial test of this expedient so far as respects the Eastern lines, is likely to come when the number of smaller outside competitors, of the characterjust alluded to, comes to be increased. The pool will not be likely to admit them into its fold, which already includes too many diverse interests to permit of harmony; and if it did, the danger of disagreements and disruption would be only thereby increased. And yet, if those routes are shut out, they will act as so many free lances, attacking the older lines in every direction, and doing business at rates which will leave the pool companies no alternative but to follow suit. In this dilemma, the outlook for some time ahead is not an encouraging one for the older companies. To my view, it seems very probable that their original sins of construction and their subsequent transgressions of stock “watering” are about to find them out. The natural law of competition is a terrible foe to the violators of commercial justice. It is the inevitable police power of trade. Its working may be evaded for a time; its final conquest over wrongs and monopolies may sometimes be delayed beyond the limits of human patience, and men may at such times lose confidence in its power to right the wrongs of society; but its ultimate success in the restoration of equity and fair-play is as certain as the rising of the sun.
My absolute confidence in the ultimate triumph of this principle prompts me to venture the assertion that,at no very distant period, the wrongs practised in the original construction of our railroads and in the subsequent “waterings” of their stocks, will be compensated through competition adjusting the profits of the companies to the equivalent of a fair return upon atrue valuationof the properties; that is, a value measured by what they are able to earn under the conditions of free competition and the now current cash cost of providing like facilities. That, it appears to me, is the solution towards which our railroad problem is now steadily working; and neither Congressional legislation, nor State regulation, nor the resistance of organized capital, can be expected much longer to stave off that result.
It may, however, be very properly asked, whether legislationhas no duty in the premises? To me, it appears that it has a very weighty one. The consequences of the original neglect to prescribe proper regulations for the construction, capitalization and financial management of railroads has been so fully exposed by their past history, that the Legislatures will greatly err if they neglect to impose restrictions upon future corporations that will prevent farther repetition or perpetuation of the evils. When the Government bestows upon railroads important privileges and franchises, under which fundamental private rights are held in abeyance for the common good, it is due to the public protection that the recipients of these favors should be held under restrictions which will prevent them from abusing the privilege to the public disadvantage.
When a railroad company capitalizes its property at double its actual cost, and seeks to collect charges calculated to yield dividends upon such false capital, it grossly perverts and abuses the privileges conferred by its charter, and virtually perpetrates a public robbery. This appears to be a perfectly plain proposition, and yet this glaring wrong has been so long tolerated that not only the railroads, but a portion of the public even, have come to regard it as a sort of right inherent in these corporations. One of the first duties of the State Legislatures, therefore, is to enact laws requiring that the stocks and bonds issued against any railroad hereafter built shall, in no case, exceed in the aggregate thetrue cash costof the property; the penalty for the violation of this restriction to be forfeiture of charter. The responsibility of managers should be definitely fixed. All extensions, betterments or improvements should be provided for by issues of stock or bonds on like conditions. The issue of mortgages should be restricted within 60 per cent. of the true cost of the property.
In order to prevent wrongful speculative profits being realized by the incorporators, they should be prevented from becoming the constructors of their road, directly or indirectly; and all contracts for construction, equipment, extensionsor improvements should be made upon open competitive bids, the lowest bid to be accepted, with substantial guarantees for the faithful performance of the contract. Also, it should be made the duty of a board of State railroad commissioners to see to it that all these conditions are strictly complied with. Regulations should be provided prohibiting issues of stock for any other than construction or equipment purposes, forbidding the payment of dividends not actually earned, and enforcing the amplest publicity of details relating to current traffic and the financial affairs of the companies.
Had our original railroad laws incorporated provisions of this character, our railroads would have all along ranked as the safest and most stable investments of the country; the discredit that hangs over our corporate enterprises would have been averted; transportation would have been done at lower rates with steadier charges, and we should have been saved the social and political excrescence of an aristocracy based upon ill-gotten wealth. After our bitter experience of the dangerous results of neglecting to guard the railroad interest by some such restraints as the foregoing it surely is not too early now to apply these safer methods to all future enterprises of this character. Not only is such legislation due as a measure necessary for the protection of our commerce and investors, but it would go very far towards remedying the evils that have grown up under the old and badly regulated system. To a man of business it is hardly necessary to point out what would be the competitive advantages of roads constructed under the proposed regulations. As a rule, their capitalization would not exceed 50 to 60 per cent. of that of the older companies, and they could, therefore, be run upon a much lower rate of charges.
The thoroughly conservative nature of their organization would bespeak fer them a degree of public confidence which would enable them to get all the capital needed for really legitimate undertakings, whilst purely speculative ventures would be put under conservative check. Under these circumstancesnew roads could do a profitable business, and yet compete disastrously with the old excessively capitalized companies. The ultimate result of this competition from the new order of roads would inevitably be to reduce the earnings of the older class to a point which would admit of interest and dividends being earnedonly on the same rate of capitalization as existed among the new-system companies. In other words, the effect of the honest method of capitalization here suggested would be to squeeze all the “water” out of the old companies, and to bring them in effect, though possibly not in form, to the same financial level as the new.
If my reasoning here is correct, there is cause for our great railroad capitalists to look out for the security of their investments. The basis for their wealth may prove far less certain than they have imagined it to be. With the prevailing and steadily increasing public feeling against the methods of railroad capitalists and the working of our railroad system, what assurance can there be that, when a remedy for these corporate wrongs comes to be clearly propounded, it will not be eagerly urged upon the attention of the Legislatures and adopted without much ceremony? The dash of a Governor’s pen is, therefore, all that stands between the railroad millionaire and the sudden extinction of a large portion of his inflated paper wealth. Is this a chimerical conclusion? The question, it seems to me, deserves a far more serious consideration than those most vitally concerned have yet bestowed upon it. No man can confidently deny the possibility of such a result as is here indicated. No one familiar with the present public temper on the subject of railroad monopoly can reasonably questionthe probability evenof a settlement of this kind being ere long resorted to. Under these circumstances, it is a question very pertinent to the times, whether the foundation of our railroad aristocracy is as broad or as firm as it has been supposed to be, and whether a healthy solution of the great railroad problem is as difficult and as remote as some despondent people have represented it to be.
A ONE THOUSAND DOLLAR BOND OF THE STATE OF GEORGIA.Repudiated.
A ONE THOUSAND DOLLAR BOND OF THE STATE OF GEORGIA.Repudiated.
A ONE THOUSAND DOLLAR BOND OF THE STATE OF GEORGIA.Repudiated.