Of course, the foregoing figures are not absolutely accurate, for the real net loss in the issue of the 4% rather than the 4½% bonds at these prices would be the difference between the $5,000 annual saving in interest and the amounts which would have to be set aside annually for fifty years to produce $1,000,000, the amount of the discount, at the end of that period. But the table is sufficiently accurate to expose the curious error into which Mr. Riggs has fallen. Perhaps it will convince him that it would be better, hereafter, not to stray so far outside the field of civil engineering.
Mr. Riggs has little sympathy with those railway men who venture to express the opinion that regulation ought not to extend so far as to render it impossible to conduct the railway business in a business-like way. His animadversions on railway men in general have already been illustrated herein. He finds nothing worse with which to characterize a previous utterance of the writer's than to say of it:
"The manifest impatience with all forms of governmental interference with corporations, which so often characterizes the utterances of prominent railway officials, appears in this paper to a marked degree."
At the risk of incurring further displeasure, the writer will not omit now to observe that, in his judgment, the whole question whether railways shall be generally and officially valued, and how and by whom the task shall be performed, is primarily conditioned by the country's need of managing its legislative control of railway methods so as not to restrict unduly the flow of capital into that industry. The steady pressure for legislation during the last five years has so extended legislative regulation that, for the first time, the sturdy, frugal, conservative, "small investor" stands in the forefront of the problem. His views of the stability and future prosperity of the American railway industry now dominate the situation. What they are may be read in the facts attending recent efforts to finance necessary improvements of old and prosperous railways. It developed before the Interstate Commerce Commission during the recent hearings in connection with the proposed partial adjustment of rates to the diminished purchasing power of the money in which they are paid, that one of the greatest of Eastern railway systems, paying 8% annual dividends on its stock, which is very widely distributed, had offered new shares to its stockholders at a premium of 25%, and had found them unsalable at that figure, so that it was obliged to recall the offer and put them out at par. Other testimony disclosed the failure of one great company to obtain an offer of more than 85 for its 4% bonds, while another had been forced to go to France to raise $10,000,000, and many others have been forced to the expedient of issuing short-term notes at relatively high rates of interest. It also appeared that extensive proposals for new branch lines had been abandoned or postponed, in view of the impossibility of obtaining funds on reasonable terms.
Other testimony shows that locomotive shops and car builders are putting out not more than half of their capacity; that the supply trade is receiving no new orders. Never, since the beginnings of the American railway industry, has the American and foreign investor been so reluctant to supply necessary capital, or so doubtful of the future of railway enterprises. This fact is not due to absence of confidence in the industrial future of the American people, but is directly attributable to the unanswered inquiry as to how far the policy of legislative control is to extend. Either this question must be answered in a manner satisfactory to the investor, or the credit of the Government must be made available for the extension and improvement of railway facilities, either through Governmental guaranties of adequate returns to capital, or through Government ownership; for adequate and properly constructed and equipped railways the public must and will have. Thus far, the American public is ready neither for Federal guaranties nor for Federal ownership; it is to be hoped that it will never be ready for either. In this situation, if a Federal valuation is to be undertaken, it is primarily important that it should be under such auspices and by such methods that the investor will not be alarmed as to its consequences. This is not a suitable occasion to attempt to lay down all the considerations applicable to such a valuation, but it ought to be perfectly clear that it must relate to value in use, not to some concept of value limited to replacement cost which excludes some of the most important elements of value (which are also those most worthy of a return, because they represent the highest and most difficult social and industrial services), in order to obtain a means of excluding these same elements from possibilities of adequate reward.
One of the most important items to be considered is the "cost of progress," which is sometimes referred to as "abandoned property," or as "obsolescence." For illustration, in the revision of the grade and line of a road, whereby the capacity of existing track is doubled, the present instructions of the Interstate Commerce Commission require the charge to operating expenses of the cost of that portion of the old line no longer continued in use. If, however, the doubling of the capacity of the line be secured by the construction of a second main track, the entire cost of the new work can be charged to capital account and paid for from the proceeds of the sale of capital securities. The latter method becomes the easier to finance, but what of the comparative results? Say, for example, the original cost of material of existing property, including equipment, stations, yards, etc., was $10,000,000, that the first main track cost $1,000,000, and that to double the capacity of the main track would require a present expenditure of $1,000,000, either for (1) a reduction of the grades and curves of the first main track, or (2) for the construction of a second main track. The increase in capacity is identical, but in the first case the cost of train service to handle the tonnage is decreased 50%, and some reduction in maintenance is secured, while in the second case no economies of operation are effected, but the expenses may be increased. Undoubtedly, Road (1) would be much more favorable than Road (2), yet the Commission says a portion of the cost of perfecting Road (1) must be charged to operating expenses, and cannot be capitalized. What general manager will dare recommend such extensive improvements when the charging of a portion of the cost to operating expenses will show the dividend as unearned, and thus render the securities of the company no longer legal investments for savings banks, trustees of trust funds, etc.? As an alternative, he might permit the old line to remain, and by placing thereon a few cars occasionally, could consider it as still in use, and carry it in his capital account, thus avoiding the charge to operating expenses. Thus, again, is it the method and not the result that is controlled by these instructions. What should be done is to permit the cost to be charged against the surplus accumulated during the years in which the property to be abandoned was used. This would not affect adversely the operating income of the year, and would not impair the credit of the Company.
Plainly, the instructions of the Commission tend to compel a method that is contrary to the economic law.
Obviously, any requirement as to valuation which would impose on the carrier such a result as that shown would compel the continuance of the less efficient service and prevent the progress which such replacements express. The railway business is a continuing one, and an improvement ought to be made whenever it can earn income, not only on its own cost, but on that of the property abandoned, even though it cannot afford income sufficient to wipe out the whole capital charge for the latter in a single year. There is no reason for requiring each item of capital to earn its cost in addition to its interest during its individual life. Such a requirement would cry halt to progress. It is reasonable and proper that such charges to operation should be made as far as the rapid development of the art of transportation permits, and such is the practice of every well-managed railway; but, to make the practice uniform and compulsory, permitting no exceptions and allowing no scope for individual judgment, is quite another thing. When the conditions warrant such a course, the railway ought to be permitted to adjust its accounts in a manner of which the following is typical:
| Replacing. | Not replacing. | |
|---|---|---|
| Capital account | $19,750 | $5,000 |
| Additional net operating income attributable to this item | 1,000 | 250 |
| Charge to operation for abandoned property | 250 | |
| ______ | _____ | |
| Operating gain | $750 | $250 |
A valuation adjusted in recognition of this developmental need would include, in addition to the item of $15,000 for the replacement cost of the new locomotive, an item representing "cost of progress" of $4,750 for the former locomotive. It is not to be overlooked that in actual practice it would be easy to obtain this allowance by cumbering the yards and round-houses with obsolete and superfluous equipment. The plan of Professor Adams places a premium on such a course, and there are many conditions under which it could and would be followed where it would be less obvious and more detrimental. For example, it might be that an additional track over a steep grade and a new alignment which would avoid it would cost the same. The new alignment would give greater operating efficiency, but it would require the charging off of the old line; the new track over the grade would be more costly to operate, but would leave the apparent capital unimpaired. It is such possibilities as this that are giving pause to the investors who would otherwise supply funds for the needed development of the American railway system. How far this development has so far required the abandonment of property capable of further use and having genuine capital value is indicated by available records. The aggregate capacity of all equipment has increased much faster than the increase in number of locomotives and cars. The reports of the Interstate Commerce Commission only show this information for the years 1902 to 1908, both inclusive. The average tractive power of locomotives in 1908 was 26,356 lb., as compared with 20,485 lb. in 1902, being an increase of 5,871 lb., or 28.7% per locomotive. The average capacity of freight cars in 1908 was 35 tons, as compared with 28 tons in 1902, an increase of 7 tons, or 25 per cent. Undoubtedly, the average capacity of locomotives and the average capacity of freight cars in 1908 was not less than 60% above the average capacity of 1890.