Chapters on the History of the Southern Pacific

by Stuart Daggett

We must therefore recognize that the government advances to the Central Pacific did not constitute a subsidy in the ordinary meaning of that term. At the same time it should be observed that the Pacific railroads occupied a peculiarly advantageous position in respect to the loans which the government made to them. As will presently appear, although interest on this loan was charged, the companies were not obliged to pay a cent of this interest until the maturity of the bonds. This unusual concession was declared by the Supreme Court to be the necessary result of the absence of a precise stipulation to the contrary in the Acts of 1862 and 1864. The court said:

It is one thing to be required to pay principal and interest when the bonds have reached maturity, and a wholly different thing to be required to pay the interest every six months, and the principal at the end of thirty years. The obligations are so different, that they cannot both grow out of the words employed, and it is necessary to superadd other words in order to include the payment of semiannual interest as it falls due.[517]

Payment of Simple Interest at Maturity

A second concession to the Pacific railroads was made when no interest on deferred interest payments was exacted. Ordinarily in such cases interest is compounded at intervals of six months. On a thirty-year loan of $27,855,680, issued under the conditions which characterized the subsidies to the Central and Western Pacific railroads, the difference between simple interest and interest compounded semiannually would be $113,974,300. That is to say, simple interest would amount to $50,140,224 at the end of thirty years, while compound interest would equal the materially greater sum of $164,114,524. Put another way, the value in January, 1865, of the right to receive the principal of the government loan increased by simple interest according to the terms and at the dates contemplated by the Acts of 1862 and 1864, was only $13,000,000. This was the value of the monetary consideration which the federal government accepted from the Central and Western Pacific railroads. On the other hand, the value of the advance made by the government to the same railroads as of the same date was $23,000,000, or a difference of $10,000,000. This computation assumes that government bonds were sold at par, and that the current rate of interest was 6 per cent. The difference indicated would be reduced if government bonds were assumed to have sold for less than par, and it would be increased were a higher rate of interest than 6 per cent used in the calculation. Discussions of the Acts of 1862 and 1864 usually fail to make clear that the government demanded simple interest only on its loan, but as a matter of fact this was a feature of the contract which was of substantial value to the beneficiary.

Claims for Indemnity

It was of course expected by Congress that the Pacific railroads would make adequate provisions during the life of the bonds to meet the interest and principal due at their maturity. Before discussing the disputes concerning the size and nature of the sinking funds which should have been erected, a few words may be said regarding certain equities to which the Stanford-Huntington group repeatedly alluded as constituting reasons for not paying the bonds at all. These equities may be briefly enumerated as follows:

The first equity was said to have arisen out of the loss which it was claimed the Central Pacific had sustained through failure to sell the bonds received by it from the government at par. This loss was estimated at $7,120,074, a sum which was raised by accrued interest up to the time of the maturity of the bonds to the very considerable figure of $19,936,206. According to Stanford, the government loan netted the company only 65 cents on the dollar. He said:

Indeed, if the company had taken advantage of the time allowed by Congress for the completion of the road, they could not only have sold the government bonds at par, but could also have disposed of their own first mortgage bonds at their face value, which would have been a net gain, over and above what was actually received, of $7,120,074, the interest on which for thirty years would have been $12,816,132, which would make an aggregate saving on the government bonds and the bonds issued by the company, principal and interest in round numbers, of about $40,000,000.[518]

In the second place the Central Pacific insisted that there should be credited to it a portion of the amount which the government saved in the transportation of government employees and freight as a result of the rapid construction of its railroad. Under the terms of the Acts of 1862 and 1864, the Central Pacific and Union Pacific might have delayed completion of their road until July, 1876. As a matter of fact the through line from Sacramento to Ogden was opened in May, 1869. The consequent saving to the government was estimated at $47,763,178, of which the Central Pacific proportion was set at $21,971,062. A similar calculation laid before the United States Pacific Railway Commission in 1886 reached the conclusion that the total saving to the government up to January 1 of that year had reached the sum of $139,347,741 on the Union and Central Pacific combined. The basis for these estimates was found in a comparison of the rates which the government had paid for rail movement and the rates which it would have had to pay for ox team and mule team transportation.