Other People's Money, and How the Bankers Use It

by Louis Dembitz Brandeis

CHAPTER IX
THE FAILURE OF BANKER-MANAGEMENT

There is not one moral, but many, to be drawn from the Decline of the New Haven and the Fall of Mellen. That history offers texts for many sermons. It illustrates the Evils of Monopoly, the Curse of Bigness, the Futility of Lying, and the Pitfalls of Law-Breaking. But perhaps the most impressive lesson that it should teach to investors is the failure of banker-management.

BANKER CONTROL

For years J. P. Morgan & Co. were the fiscal agents of the New Haven. For years Mr. Morgan was the director of the Company. He gave to that property probably closer personal attention than to any other of his many interests. Stockholders’ meetings are rarely interesting or important; and few indeed must have been the occasions when Mr. Morgan attended any stockholders’ meeting of other companies in which he was a director. But it was his habit, when in America, to be present at meetings of the New Haven. In 1907, when the policy of monopolistic expansion was first challenged, and again at the meeting in 1909 (after Massachusetts had unwisely accorded its sanction to the Boston & Maine merger), Mr. Morgan himself moved the large increases of stock which were unanimously voted. Of course, he attended the important directors’ meetings. His will was law. President Mellen indicated this in his statement before Interstate Commerce Commissioner Prouty, while discussing the New York, Westchester & Boston—the railroad without a terminal in New York, which cost the New Haven $1,500,000 a mile to acquire, and was then costing it, in operating deficits and interest charges, $100,000 a month to run:

“I am in a very embarrassing position, Mr. Commissioner, regarding the New York, Westchester & Boston. I have never been enthusiastic or at all optimistic of its being a good investment for our company in the present, or in the immediate future; but people in whom I had greater confidence than I have in myself thought it was wise and desirable; I yielded my judgment; indeed, I don’t know that it would have made much difference whether I yielded or not.”

THE BANKERS’ RESPONSIBILITY

Bankers are credited with being a conservative force in the community. The tradition lingers that they are preëminently “safe and sane.” And yet, the most grievous fault of this banker-managed railroad has been its financial recklessness—a fault that has already brought heavy losses to many thousands of small investors throughout New England for whom bankers are supposed to be natural guardians. In a community where its railroad stocks have for generations been deemed absolutely safe investments, the passing of the New Haven and of the Boston & Maine dividends after an unbroken dividend record of generations comes as a disaster.

This disaster is due mainly to enterprises outside the legitimate operation of these railroads; for no railroad company has equaled the New Haven in the quantity and extravagance of its outside enterprises. But it must be remembered, that neither the president of the New Haven nor any other railroad manager could engage in such transactions without the sanction of the Board of Directors. It is the directors, not Mr. Mellen, who should bear the responsibility.

Close scrutiny of the transactions discloses no justification. On the contrary, scrutiny serves only to make more clear the gravity of the errors committed. Not merely were recklessly extravagant acquisitions made in mad pursuit of monopoly; but the financial judgment, the financiering itself, was conspicuously bad. To pay for property several times what it is worth, to engage in grossly unwise enterprises, are errors of which no conservative directors should be found guilty; for perhaps the most important function of directors is to test the conclusions and curb by calm counsel the excessive zeal of too ambitious managers. But while we have no right to expect from bankers exceptionally good judgment in ordinary business matters; we do have a right to expect from them prudence, reasonably good financiering, and insistence upon straightforward accounting. And it is just the lack of these qualities in the New Haven management to which the severe criticism of the Interstate Commerce Commission is particularly directed.

Commissioner Prouty calls attention to the vast increase of capitalization. During the nine years beginning July 1, 1903, the capital of the New York, New Haven & Hartford Railroad Company itself increased from $93,000,000 to about $417,000,000 (excluding premiums). That fact alone would not convict the management of reckless financiering; but the fact that so little of the new capital was represented by stock might well raise a question as to its conservativeness. For the indebtedness (including guaranties) was increased over twenty times (from about $14,000,000 to $300,000,000), while the stock outstanding in the hands of the public was not doubled ($80,000,000 to $158,000,000). Still, in these days of large things, even such growth of corporate liabilities might be consistent with “safe and sane management.”