Politics

IN the last number of the Atlantic we endeavored to explain what seemed to us to be the true cause of the panic, which had, when we wrote, hardly begun. In the events which have since occurred we have seen no reason to change our opinion, then expressed, that the distrust which caused the difficulty was at bottom a well-founded moral distrust. At the outbreak of the panic the country was in a very prosperous condition ; crops were never larger, manufactures never more flourishing, and ordinary business never conducted on a sounder and more conservative footing. There was, however, one black spot on the horizon, which was not of sufficient size to attract the attention of the general public, but was already noticed and dreaded by those whose occupation always makes it necessary for them to keep a sharp lookout for disturbances in the financial atmosphere. That spot was the stock market. During the entire summer, and indeed for much longer, rumors had been spreading affecting the credit of railroad corporations throughout the country. Now that the storm has burst and swept over us it seems a trite thing to say that it was brought about by a panic in stocks. But, as we said last month, it certainly is an interesting thing to know why there should have been a panic in stocks, when there was no reason to anticipate a panic in anything else.

Stocks in theory and stocks in fact are two very different things. In theory the railroad stockholder is a capitalist who, having by some means or other — perhaps by an operation on the “ street,” perhaps, but not probably, by honest industry — accumulated a considerable sum of money, goes to Washington, and by corrupt means secures, in combination with other capitalists, a large land-grant from Congress, then builds his road by means of selling his land, calculates how much the poor farmer ought to be made to pay for transportation, in order to render his stock profitable after it has been thoroughly watered, establishes rates of freight based on the result of this calculation, and then retires from business on the fruits of his fraud. If at any time he needs more money, he makes a new calculation, waters his stock again, and again wrings from the poor farmer his hardearned substance.

Railroad stocks in fact, however, as many people know to their cost from what has happened in the past few weeks, are quite a different thing. So far from its being true that the dividends they yield are certain and easily made, there is hardly in the world any security which is subject to so many risks of a kind so difficult to calculate. There are, it is true, a good many railroads in the older parts of the country the condition of which is thoroughly known and under management entirely trusted, which yield a certain income upon the capital invested in them ; but the income is small, and it is not these roads which even in theory form and support the breed of railroad capitalists. It is the new roads built through the West, with land-grants, by means of bonds, as well as such old roads as find it necessary to extend their business in all directions by the purchase and lease of competing or connecting lines. And these are the roads of which we say that stock in many of them is, and will be for a long time, a dangerous investment ; so dangerous that those who risk their money in the purchase of them are amply entitled to all the returns they ever can make.

It will probably be admitted, even by those who look with suspicion upon what they call capitalists, that an investment which leaves the investor without any means of ascertaining from month to month what income, if any, he will derive from his investment, is hardly to be considered absolutely safe : but this is the case with all that kind of stock of which we are now speaking. There is, in the first place, the land-grant. As one instance of the precarious and speculative nature of property of this sort, we may refer to the ease of the Northern Pacific Railroad, which has one of the most enormous land-grants in the world. Stories have been set afloat damaging to the value of the land in the grant, but it seems unquestionable, from the report of Haas, recently published, that the grant in reality consists of good fertile land ; but land may be the richest in the universe, and if there arc no people on it, it will be of no marketable value. This was the difficulty with the Northern Pacific, and has been the difficulty with many other roads. It is never possible to know in advance what will be the amount of so uncertain a thing as emigration ; and emigration with a new railroad is the one thing which is absolutely necessary.

If we suppose, however, that by some species of prophetic insight the projectors of a new road are able to make reliable calculations as to the product of their land, there is still in the way, so lar as all the stockholders not actually engaged in the management are concerned, the difficulty of understanding the actual financial condition of the road. This difficulty can hardly be over-estimated. Once a year, it is true, the directors make a report to the stockholders, and submit to them an account of the earnings and expenses ; but the directors who submit it are the only men who know what it means. We are not speaking now of fraudulent management, like that of Fisk and Gould, but of an ordinarily honest management. It is of course easy enough to make out from the report of such a road what amount of stock and bonds have been issued, but to the stockholder who is not preternaturally acute of what use is this information ? It is the amount of earnings, compared with the amount of expenses, which he ought to know ; but the net earnings of a road, though they are put down in black and white, are still very likely to be matter of conjecture. What with the “construction account” and the “suspense account,” the managers themselves are very often in doubt as to the true nature of large sums of money, and of course in doubtful cases it would be unreasonable to expect that managers should not have a very strong temptation to divide as earnings any sums which might even by strained construction come under that head, trusting to new loans to make any deficit good. The other day, at a meeting of the Erie stockholders in London, Mr. Peter H. Watson, president of the road, and a skilled railroad manager, made a statement which seemed to be considered satisfactory by those who were present, but which illustrated very well the impossibility of stockholders knowing anything more about the state of their property than their directors choose to tell them. He had been asked by a stockholder whether a balance appearing to be in favor of the road “ was available for division ” ; and he made the following lucid statement in reply: That when he became president of the company, the accounts were in confusion, and it had taken a long time to get them into any approximation to system; indeed, they were not yet entirely organized. Under the charter and laws, before a dividend could be paid on the common stock, the company must first pay seven per cent upon its preferred stock, if its earnings would permit ; that if there were not earnings to that amount in the year, then the right to claim a dividend lapsed and was forever gone. The accounts were made up to the 30th of September, because the company was required to furnish a report specifying certain items to the State engineer, and the reports are made up to the 30th of September, and must be in the office by the following December. It was impossible to make up the report for 1872, the accounts were in such a disorderly state, and the engineer had kindly extended the time for sending in the report till February ; as to the present account, the officers could only swear that it was correct “ so far as they were able to state.” When that report was made out for the engineer, there was a balance of $ 280,000 standing to the credit of profit and loss, and on the 30th of June, to which date the accounts were as correct as possible, there was a balance of $ 290,000 ; but until the account could be completely analyzed, no one could swear whether the balance was net earnings or balance of some other account. “ He was therefore satisfied that it would be safe for them to pay one per cent.” There is no reason to doubt Mr. Watson’s honesty, but there is no reason either to believe that anybody who was present at this meeting knew anything more about the condition of the road than he did before it was called. Here we find a company declaring dividends when they themselves, after careful investigation for a year or two, confess that they do not know in what condition their affairs are, and admit them to be unintelligible. The Erie Road is an exceptional case, it will be said, and this to a certain extent is true ; but it is not an exceptional case that directors should he anxious to declare dividends at all hazards. Indeed, it is hardly worth while to cite examples. Every candid man who has looked into railroad accounts will be willing to admit, that as a guide for investors little or nothing can be made of them; while the tendency apparent in the minds of many brokers engaged in selling and buying railroad securities, to consider the annual statements rather in the light of a joke than as anything else, is not reassuring.

The value of stocks, however, is affected by still other considerations. It is not merely that it is difficult to learn anything about the exact value of the land-grant or the exact condition of the finances from the annual reports (the right of the stockholder to “ inspect the books ” of the corporation long since became valueless and fell into disuse, for the same reason that railroad accounts became mysterious), but that stock in all railroads of importance is used for two different purposes, which gives it two different values, the precise relation between which, in ordinary times, no one knows. Railroad stock is, of all securities, the best to borrow money upon, on account of the ease with which it can be transferred and sold. For this reason it is that millions of stock in roads which are commonly spoken of as good roads for investment are in easy times pledged in Wall Street for millions of debts. This stock may be perfectly good, dividend-paying stock, the management may be honest, and the business of the road increasing, but nevertheless, if money becomes “ tight,” quantities of it are likely to be thrown upon the market by people who have been taking it as a collateral security. This creates an unnaturally large supply, and the price falls. There are really, for all the well-known stocks, two prices, one of which is determined by the actual earnings of the stock, and the other by the condition of the money market. This is what is meant by the phrase “shrinkage of values ” ; there is in such a panic as that of September 20th no shrinkage of real values at all. There was on the 20th of September just as much real value in any one of the stocks quoted on the stock exchange as there had been on the 1st; but the value which had been determined on the 1st, mainly by the dividends or supposed earnings of the stocks, was now determined by the enormous and unnatural supply produced by fear. It may be said, of course, that this fact, not diminishing the real value, therefore does not affect railroad stocks as an investment. But the manner in which it affects them is through the difficulty of finding out in any case how much of the quoted price is due to the condition of the money market, and how much to the present and prospective earnings. Something is clearly due to both, but who shall say how much.

This difficulty does not yet exhaust the subject. The fundamental trouble (and, as we said last month, it was this fundamental trouble which caused the distrust that led to the panic of this autumn) is the enormous opportunities of dishonesty which the present system of railroad management offers. There is very little difference in this respect between a great modern railroad and certain modern political corporations, resting on the same fiction of universal democratic control, vested in a body which never exercises it. Both railroads and large cities like New York rest on universal suffrage, but railroad stockholders are to this degree in a worse condition than the inhabitants of such a city as New York, that they are scattered over the four quarters of the earth, have no acquaintance with each other, and no opportunity for conceited action. It will be remembered that during the Tweed rule in New York, the stockholders in that municipal corporation always voted regularly, or went through the form of voting, just as many stockholders of the Erie Railroad at that time may, for all we know, have been in the habit of sending their proxies to the annual meeting of that corporation for the purpose of keeping Fisk and Gould in office. There was very little difference between the modus operandi of the two cases. By shrewd manœuvres, the purchase in the one case of votes, in the other of proxies, two or three men get control of a majority of the stock or the votes, and after that keep the control by new issues of stock or by fraudulent returns. In how many roads this has been done we do not know, but the facility with which it may be done is now pretty generally understood.

It was becoming a matter of private inquiry and speculation just before the panic. We cannot, for obvious reasons, give the names of the roads the management of which since last January had been the subject of excited discussion, — a discussion not so much about the good sense as about the honesty of the management. We do not refer to the silly proclamations and pronunciamentos of the farmers, but to anxious discussions of a much more private and a much more rational kind. There were roads in Kansas, there were roads in Illinois, there were roads in a dozen other States, about which it was beginning to be asked what were becoming of their dividends, and what was the character of the management. Simple-minded stockholders consoled themselves for the decline in the market value of their stock by the fact that they had always got ten per cent on their stock ; and astute men explained the situation by means of generalizations (to a certain extent true), to the effect that in modern times it was necessary for roads to extend themselves, and that earnings must be used for that purpose rather than for the old-fashioned object of paying dividends on stock. With regard to the Pennsylvania system of roads, it was openly declared not so very long ago, with what truth we do not pretend to know, that the dividends the stockholders continued to receive were paid out of capital instead of income.

It is not our object to inquire into the truth of the stories which filled the air a few months since, and which, in our opinion, naturally and legitimately produced, in connection with the startling revelations of dishonesty in offices of trust of which we have lately been having such a plentiful supply, the distrust which led to the break in stocks in September. Whether the stories about Western roads were true or false, there was enough plausibility in them, when taken in connection with the fact that the accounts of these reads are to the investors in them absolutely unintelligible. to explain what has happened.

Of course there are in cases like these a large number of persons who always wish to know “ what is proposed as a remedy.” For ourselves, we propose no remedy at all. The only remedy for dishonesty is honesty, and the only remedy for absurd investments is safe investments. The remedy proposed by the farmers, of taking away from the stockholders what little profit is left them, hardly seems likely to be carried out; the remedy of handing the railroads over to the State or to the United States is not a practical question among intelligent people ; and there remains nothing but to leave them in the hands which now manage them, to leave freights to be governed by the law of supply and demand, and to leave stockholders to discover that the industry of building railroads in new countries is highly speculative, and that, if they choose to invest in undertakings whose actual condition they have no means of ascertaining, they must take the consequences. Great complaints have been made, and we have ourselves helped to make them, of new roads “built on bonds.” We are obliged so admit, however, that the more this subject of railroads is studied, the more evident it becomes, that while these roads have in many cases been nurseries of fraud and swindling, the dishonesty has been brought about, not by the system of building “on bonds,” but by the general causes which we have tried to indicate here, and which may be summed up in words, — irresponsible power. Roads nowadays must, like everything else, he begun with borrowed capital, and must be controlled by a very small number of men, generally one. There is no objection to such a system, if it is well managed. But when these few men induce the public to believe that they arc a corporation of the old-fashioned democratic kind, and that the public will do wisely to buy their shares, they merely give one more proof of the extreme gullibility of the people, and their own rather dishonest sagacity.

There seems to be reason to hope that this panic will do something to bring people back to their senses on the subject of railroads. In 1857 a pnnic was produced by over-speculation in railroads, which restrained the public for some years from having anything to do with shares. Then the mania began again, and went on with increasing violence till last year. It had reached its height at about the time of the exposure of the Union Pacific Credit Mobilier swindle; though that road, to be sure, had never reached the point at which the public could be induced to take an active interest in its stock certificates. The curious part of this later railroad craze of the public is that, side by side with it, has gone on pari passu a more and more intelligent discussion of the real character of railroad investments, amounting practically to a demonstration that, while investment in bonds might or might not be prudent according to circumstances, there was no question that stock was a thing which, though nominally in the hands of the owner, was practically managed for him by some one at a great distance, who gave no security cither for the honesty or efficiency with which he executed his trust. It is now several years since the exposure of the condition of Erie made a suggestive contribution to the public knowledge of the railroad question, and yet the exposure of Erie has been followed by wilder and still wilder speculation in more and more distant roads. It seemed evident to most people at that time that Fisk and Gould, far from being monstrous productions of unnatural forces, were really natural though exaggerated results of a system which had spread over the entire country. Still people persisted in treating them as “ out of nature,” all railroads other than Erie as well managed, and all stocks other than Erie as perfectly safe.

While the public at large went on investing in all sorts of wild securities, managed by men of very doubtful reputation, and often managed no one knew by whom (for it is one of the peculiarities of the modern railroad that those most interested in the matter are sometimes unable to find out even who the real head of it is), the farmers of the West began to study the railroad problem, and in face of the fact, of which half an hour’s examination of a few railroad tariffs will convince any one, that for years past the rates of transportation have been declining, boldly asserted that the way in which railroads were managed was this: the freight rates were established in a fixed ratio to the stock or debt of the road, and the freight tariff was made to depend, not on the expense of transportation, but on the amount of dividends the directors chose to declare. The farmers, having made this brilliant discovery, determined at once to limit the rates of transportation bylaw, and, without a doubt, greatly contributed, by their insane clamor, in bringing about the depression in all railroad property. Their discussion has certainly had one good effect, that of making it plain that the great farmers’ movement of 1873 grew out of a glut in the grain market, and not out of the iniquities of the unfortunate holders of watered stock.