Fifty years in Wall Street

by Henry Clews

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, in a 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 the phenomenal 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 influence will 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 to tell 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 according to 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 they can 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.