The financial success of railroads soon attracted the cupidity of financial adventurers—men of great energy, but small means—whose aim was to secure the greatest possible returns with the least possible outlay of money. With the introduction of these elements into railroad circles the era of speculation commenced. Take the line just referred to. In 1852 the average number of miles operated was 62, and the year following, 90. But while the number of miles operated increased less than 50 per cent., the capital stock of the company grew from $444,193 to $1,362,559, and its debt from $60,145 to $542,287. The capitalization of the road was thereby increased from $8,000 to $21,000 per mile, and this was done for the purpose of making the capital appear adequate to its earnings. Nearly all railroads became in time the foot-balls of shrewd manipulators. They were bonded before they were constructed, and often for more than the value of the completed road. Stocks at the best only represented nominal values and were given as premiums to the bondholders or promoters of the road.
But the science of stock-watering did not reach its fullest development until during the period of railroad consolidation. Fictitious values were now created as often as a new consolidation took place. Watered stocks and bonds were watered again and again, until they represented little more than a purely imaginary capital upon the basis of which dividends might be declared. Take the case of the New York Central and Hudson River Railroad companies, which consolidated in 1869 with a capital of $103,110,137.31. The former of these roads was organized in 1853 by the consolidation of ten smaller roads connecting the cities of Albany and Buffalo. The capital stock of these companies amounted to $20,799,800, of which $16,852,870 was claimed to have been paid in. Their funded debt was $2,497,526. It is impossible at this day to ascertain the original cost of all these roads, but it is certain that the above sums represent about three times the amount actually expended for their construction.
One of the roads entering into the consolidation was the Utica and Schenectady. It was 78 miles long and formed about one-fourth of the consolidated line. It had the heaviest grading and rock-cutting, was the best-equipped and undoubtedly the most expensive, in proportion to its extent, of the ten roads out of which the New York Central was created. The original cost of this line was $2,000,000. Bonds were never issued by the company. The line was profitable from the very beginning, paid regularly ten per cent. dividends,—the limit to which railroad companies were then restricted,—and had a large surplus, which it expended mainly for improvements. No assessment was ever made on the stock beyond the $1,500,000 which was originally paid in by the shareholders and upon which they had drawn regular and liberal dividends. Taking the original cost of this line as a basis, it is but fair to presume that the entire line from Albany to Buffalo, covering a distance of 297 miles, did not cost to exceed $6,000,000. These roads, however, entered into the consolidation with a capital stock of $15,274,800 and a bonded indebtedness of $1,696,326.
Estimating the cost of the branches upon the same basis upon which we have estimated that of the main line, we shall find that the total original cost of the consolidated lines cannot have exceeded $8,000,000. The Mohawk Valley road was put in at $2,000,000 and the Syracuse and Utica direct at $600,000, though the roads only existed on paper and did not represent any value whatever. The Schenectady and Troy road, which went into the consolidation with $650,000 stock and $90,000 bonds, had been bought for less than $100,000 two months previous to the consolidation.
It will thus be seen that already nearly one-third of the stocks and bonds of the consolidated companies was water. The consolidation agreement fixed the capital stock of the New York Central at $23,085,600 and its funded debt at $11,564,033.62, increasing the stock over $2,000,000, and the bonded debt over $9,000,000. The latter was more than quadrupled, and $8,000,000 worth of bonds were, under the name of consolidation certificates, given as a present to the stockholders of the new road. The capital stock of the New York Central grew steadily up to the time of its consolidation with the Hudson River road, when it was $28,795,000. All improvements made during this time were paid for out of its surplus earnings, with the single exception of the Athens branch, for which the company issued $2,000,000 of its stock.
The gross earnings of the New York Central in 1854 were $5,000,000, and its net earnings $2,830,000. In 1863 its gross earnings were in round numbers $10,000,000, and in 1869 they reached $15,000,000. The dividends paid during that year amounted to $4,300,000, and the interest to $894,000. In view of the fact that the bonded indebtedness of the road was from two to three million dollars more than the original cost, this dividend of 15 per cent. upon a wholly fictitious capital must be regarded as an unwarranted tribute levied upon the commerce of the country. But we shall soon see that in railroad hydraulics, as well as in other branches of human industry, success stimulates to still greater energy.
The Hudson River Railroad Company was organized in 1847. It extended from New York City to East Albany and was 144 miles long. There are no data extant upon which could be based a reliable estimate of its original cost. Estimating it upon the basis of that of the Utica and Schenectady, we should have to place it somewhat below $3,000,000. While such an estimate may be too low, the amount of its funded indebtedness in 1851, which was $5,640,000, probably more than covers the amount actually expended in the construction of the road. In 1851 the capital stock of the Hudson River road was $4,000,000. In 1853 the funded debt had increased to $7,000,000, and in 1862 to $9,000,000. In 1869 the bonded indebtedness had decreased to $4,309,000, but the capital stock had grown to over $16,000,000. Between 1853 and 1869 the company increased its stock and bonded indebtedness nearly $11,000,000, while the assessments paid by its stock and bondholders during this time did not exceed $1,000,000. Improvements were made, but these were chiefly paid for out of the surplus earnings of the road. It has been shown by experts that $6,640,000 is a high estimate of the actual original cost of the Hudson River road to its stock-and bondholders, and that securities to the amount of more than $13,000,000 represented surplus earnings and water. At the time of the consolidation of the Hudson River and New York Central railroads the capital stock of the two roads had grown to $44,800,000. Under the consolidation agreement the stock was fixed at $45,000,000. The new company also assumed all the bonded and other indebtedness of both roads. If the consolidation manipulators had paused here, the capital of the new company would have been somewhat less than $60,000,000, or more than three times the cost of the property. But the road was, under existing rates, capable of earning dividends on a much larger capital, and this emergency was met by the issuance of consolidation certificates to the amount of $45,000,000. The total capital of the road was thus increased to and made to pay dividends on over $103,000,000, while the total cost of the road and its equipment, as claimed by the company in 1870, was less than $60,000,000, their estimate being based upon assumed consolidation values and the expenditures made from surplus earnings. During the same year the gross earnings of the company were $22,363,320, and their net earnings $8,295,240. In 1880 the gross earnings had increased to $33,175,913, and the net earnings to $15,326,019. The company was able to declare in that year 11.82 per cent. dividend on its $89,500,000 of fictitious stock. In 1890 its gross earnings were $37,008,403, or $26,050 per mile, while its total net earnings were $12,516,273. The gross earnings have largely increased during the years 1891 and 1892. It is safe to say that $2,000,000 per annum would pay very liberal interest and dividends on the amount of money expended upon the construction of the New York Central and Hudson River Railroad from the proceeds of its bonds and stocks. By the creation of fictitious values the managers of the company have attempted to impose an exorbitant tax upon the commerce and travel of the country for all time to come. The Government guarantees an inventor a monopoly only for a limited space of time, upon the expiration of which his invention becomes the common property of the people; but railroad managers endeavor to collect, under the protection of our laws, an exorbitant royalty from our people forever.
The case of the New York Central and Hudson River Railroad Company is only one of the innumerable instances of stock watering in the history of American railroads. Indeed, it can be shown that stock-watering reached a still higher degree of development in the case of the Erie road. It has been demonstrated that the actual original cost to the stock-and bondholders of the New York Central Railroad Company, which was, with its branch lines, 593 miles long, did not, including the Athens branch, exceed $10,000,000. Its cost to its owners, in 1869, including the bonuses, premiums, commissions and fictitious equalization values of several transfers, was reported by them to be only $37,600,000, or about $63,400 per mile. At about the same time the main stem of the Erie Railway, extending from New York to Dunkirk, a distance of 459 miles, was represented by a capital of $108,807,687, or $237,000 per mile. Considering the inferiority of this road to the New York Central, we are forced to the conclusion that nearly 85 per cent. of the capital of the road represented water, or, in other words, that the commerce of the United States was taxed to pay dividends on about $90,000,000 of watered securities. In 1863 the Erie Railroad had outstanding $11,437,500 of common stock. In 1864 this had been increased to $15,693,000, in 1868 to $37,765,000, and in 1869 to $70,000,000. Not one-tenth of this enormous increase of capital was ever expended on the property of the road. The stock was sold at from 20 to 40 cents on the dollar, and the proceeds disappeared in the hands of its managers. To what extent this freebootery was carried will probably never be known. An idea of the rottenness of the Erie management may be had from the fact that the courts at one time ordered its president to restore to the company $9,000,000 of diverted securities, which order was complied with. Vast private fortunes were amassed by nearly all the men who directed the affairs of the road, and the mismanagement became in time so notorious that the legislature of the State of New York was appealed to, to remove the directors of the road for the protection of its stockholders, and to reduce the capital stock of the company to the amount actually paid for it. This movement failed, however, because it was opposed by the very stockholders whose interests were supposed to have suffered by directorial mismanagement. They preferred to continue to draw dividends on the face value of stocks which they had purchased at 20 cents on the dollar. The capitalization of the company has since been increased to $163,679,825, and it is by no means a secret among those familiar with railroad values that the bonded indebtedness of the Erie road represents alone many millions more than the total amount that was ever invested in the property.
The principal competitor for through traffic of the two companies whose financial operations we have just reviewed is the Pennsylvania Central Company. It has often been asserted by the managers and friends of this company that its capital is free from water; but this is not true. In 1864 a dividend of $4,130,760 was made out of the surplus earnings of the road. This dividend was payable in capital stock and was equal to 30 per cent. of the then outstanding capital. Similar surplus dividends, each equal to 5 per cent. of the company's outstanding stock, were declared in 1867 and 1868. The people were thus taxed to pay dividends on a capitalized surplus which had been derived from excessive charges previously imposed on them. I shall not attempt here to determine whether the capital represented by the Pennsylvania Railroad Company has been honestly invested. A committee of Congress has expressed the opinion that the capitalization of its main line exceeds the amount of the actual cost of the property by more than eleven million dollars. There is, however, a system of inflation practiced by the Pennsylvania Railroad Company which is simply a new form of bond and stock watering. More than one-half of the capital of this company has been invested in the stocks and bonds of other corporations. In 1891 the amount so invested was $154,319,240, and the income derived from it $4,852,181. This does not only cause the stocks and bonds of certain companies to be counted twice, but exacts a double tax from the commerce of the country, interests and dividends upon the same capital being paid both to the bond- and stockholders of the Pennsylvania Central and to the bond-and stockholders of the roads in whose securities it has made investments. The income of the company is thus swelled far beyond the amount which the traffic reports indicate. It will be seen that, to perpetuate extortionate rates, this process of manifolding securities might be continued indefinitely.
The cost to its stock-and bondholders of the Baltimore and Chicago line of the Baltimore and Ohio Railroad, which has a length of 795 miles, was estimated by the company's officers at about $57,000,000. The actual cost of this road, owing to its expensive mountain grades, was probably greater than that of any of the other through lines between the sea-coast and Chicago, but there can be no doubt that the capitalization of this road represents from one-half to one-third pure water. At the time of the completion of this road to Chicago the surplus earnings of the company, after the payment of interest and dividends, amounted to over $29,000,000. This had been charged to "profit and loss" and used in the construction of branch lines. Thus an amount equal to more than half of the reported cost of this line had at the time of its completion been returned to its owners in other railroad values.