OPERATING CHARACTERISTICS OF THE SOUTHERN PACIFIC LINES
Proprietary and Leased Properties
Let us now leave the general questions of rates and competition in California, and return again to the more intimate history of Southern Pacific development, and particularly to the story of the later years. The present chapter describes the organization and operating characteristics of the Southern Pacific system after 1885; the chapters next following take up that all-important financial problem which faced the Central Pacific in the later nineties—the repayment of the government debt.
A glance at the annual report of the Huntington lines shows that from the point of view of ownership the system, as early as 1885, was divided into two parts. The first of these was known as the “proprietary companies,” and included the Southern Pacific Railroad of California, the Southern Pacific Railroad of New Mexico, the Southern Pacific Railroad of Arizona, Morgan’s Louisiana and Texas Railroad and Steamship Company, the Louisiana and Western Railroad, the Texas and New Orleans Railroad, the Galveston, Harrisburg and San Antonio Railway, and the Northern Railway. The second was known as the “leased companies,” and its principal components were the Central Pacific Railroad, the California Pacific Railroad, and the Oregon and California Railroad.
The difference between leased and proprietary lines was not in the operating relations between the two groups and the Southern Pacific Company, for as a matter of fact all were “leased lines” in this regard, but in the circumstance that the Southern Pacific Company held substantially all the stock of the proprietary companies in its treasury as the result of the issue of its own stock in exchange; this was not true of the so-called leased companies. In December, 1896, the Southern Pacific reported 5,250 miles of proprietary lines, and 2,128 miles of leased properties.[497]
From the standpoint of operation the distinction between proprietary and leased lines was completely disregarded, and naturally so because, as has been said, both kinds of properties were operated after the same general fashion. Instead of being classed as proprietary or leased companies, the Southern Pacific lines were divided for operating purposes between the Pacific system including the mileage south of and including Portland, Oregon, and west of Ogden and El Paso, and the Atlantic system, including the railroads east of El Paso. In 1889 local legislation compelled the separate operation of the lines in Texas. In 1896 there were 4,966 miles of main line in the Pacific system, 1,967 miles in Texas, and 445 miles in Louisiana. Mention should also be made of over 3,500 miles of water routes, chiefly those connecting New Orleans and Morgan City with the West Indies and with New York.
Bigness of System
The fact concerning Southern Pacific properties that seems to have most impressed observers was their sheer size. A company controlling 7,300 miles of railroad and 3,500 miles of water lines, and operating between Portland, New Orleans, and New York, was unusually large even to men accustomed to the great eastern corporations which operated in the nineties. The railroad mileage of the Southern Pacific in 1896 exceeded that of the Union Pacific by 2,600 miles, that of the Santa Fé by 940 miles, and that of the Northern Pacific by 2,800 miles. Even the Pennsylvania Railroad operated only 6,700 miles in 1896, including lines both east and west of Pittsburgh, while the reported mileage of the New York Central and Hudson River Railroad was but 2,395 miles in the same year.
In respect to earnings also, the Southern Pacific bulked large among its contemporaries. In the single year 1892, with its affiliated railroads and ferries, it took in nearly $49,000,000 on 6,486 miles of line, or more than half the earnings of the Santa Fé, Union Pacific, and Northern Pacific combined. In 1896 the earnings of the Southern Pacific were about the same as in 1892 upon a substantially greater mileage, but the earnings of its competitors had also greatly declined. Naturally enough, the great extent of the Southern Pacific system made its problems those of extensive rather than of intensive operation. Locomotive runs were longer on the Southern Pacific than elsewhere, and more attention was paid to questions of organization, particularly in later years.
There were other features about the Southern Pacific lines, however, besides their length, which deserve at least a passing mention. The system enjoyed, for example, the advantage of a highly diversified traffic. The year 1900 was not exceptional in this regard, yet in 1900, 22 per cent of the freight carried by the Southern Pacific fell in the class of products of agriculture, 17 per cent was manufactures, 15 per cent was products of the forest, 10 per cent products of mines, 8 per cent merchandise, and 4 per cent animal products. When we recall that in the same year 47 per cent of all the freight carried by the Pennsylvania Railroad Company consisted of anthracite and bituminous coal, and that nearly half of the freight transported over the Chicago, Milwaukee and St. Paul Railroad consisted of products of agriculture and of the forest, we can understand the unusual position in which the Southern Pacific was placed.[498]
High Average Earnings
Generally speaking, on a railroad system which handles a large traffic in manufactured goods, the average return per ton per mile will be large. This is particularly true when the company’s coal tonnage is of small proportions. In the case of the Southern Pacific, the effect of such a distribution of business was increased by the fact that the company possessed the well-nigh exclusive control of a large local business on the Pacific Coast, on which high rates could be charged. This was where the efforts of the associates to maintain a monopoly of rail transportation in California bore fruit. Eighty-two per cent in weight of the commercial freight handled in 1883 by the Central Pacific Railroad was classified as local, and almost two-thirds of this company’s earnings were derived from local business. Indeed, the local freight during the early years of operation exceeded expectations as much as the through freight fell behind what was thought would be its probable development. Prior to the construction of the Union and Central Pacific railroads, it was supposed that for many years the through business of the new lines would constitute by far their principal source of revenue. It was also supposed that the traffic of the companies would consist very largely in the transportation across the continent of the products of Asia in transit to the states situated east of the Mississippi River and to Europe. Both of these anticipations proved entirely mistaken.
Partly, then, because of the character of the freight which it handled, and partly because of the fact that a large proportion of its business was local, the average rate upon the Southern Pacific was very high. The average freight receipts of the Central Pacific in 1872 were 3.66 cents per ton per mile. While they declined in subsequent years, the figure was still 2.75 cents in 1878, and 2.14 cents in 1881. In 1878, while the Central Pacific was earning 2.75 cents per ton per mile, the Santa Fé received only 2.12 cents, the Union Pacific 2.27 cents, the Chicago and Northwestern 1.72 cents, the Pennsylvania .92 cents, and the Lake Shore and Michigan Southern .73 cents.[499] Fourteen years later, the average receipts on the entire Southern Pacific system were exactly twice the average receipts per ton per mile on the Illinois Central, and materially greater than those of most roads in other parts of the country.
It is evident that the average earnings of the Southern Pacific system were superior to those of the other transcontinental railroads, to say nothing of such eastern properties as the Illinois Central and the Chicago and Northwestern. To break the force of the comparison, Mr. Huntington was wont to compare Southern Pacific figures with the averages reported by the Interstate Commerce Commission for the so-called Group X, which included the Pacific Coast. These statistics showed, for example, in 1894, that the average receipts per ton per mile of railroads in Group X were 1.343 cents, while those of the Southern Pacific (Pacific system) were 1.316 cents. Territorial averages, however, made up of returns from small companies and from large, from local and from through concerns, may reasonably be expected to be higher than averages which apply only to large systems. The Southern Pacific received more on the average than its competitors, and almost as much as the group in which it lay, in spite of the fact that it enjoyed a through business in which a great many of the small western lines had no share.
Long Average Haul
The influence of through business on the Southern Pacific lines was, on the whole, opposed to that of the local business. Not only was the through business highly competitive, but, as might be anticipated, it was characterized by an extremely long haul. Indeed, in the year 1895 the average length of haul on the through freight transported over the Pacific system of the Southern Pacific was 844 miles. The average haul of freight on the entire business of the company was 279 miles. During the same year the New York Central Railroad reported an average haul of 169 miles, and the Erie one of 156 miles.
The reason for the extraordinary length of haul on the Southern Pacific lay in the fact that the company served a rich community far removed from eastern centers of population, yet relying to a considerable extent upon these centers both as a market for its produce and as a source for its supplies. Moreover, the commodities of California, such as fruit and lumber, wool, fish, and wine, and the imports through the port of San Francisco, such as tea, sugar, and silk, were sufficiently distinct in character from the typical products of the East to give something of the stability of international division of labor to the movements between the Pacific Coast and the eastern states. Much the same can be said of the transportation of manufactured goods westbound in view of the high price of labor in the West and the scarcity of coal.
These matters have been considered in a preceding chapter. Their effect was to make it easy to secure a great many full cars, or even trainloads, and to reduce terminal expenses to a minimum. Inasmuch, however, as the raw products of California were heavier and took up more space than the manufactured goods received in exchange for them, a very considerable excess of eastbound tonnage often existed. In 1888, to take a year at random for purposes of illustration, the tons of through freight carried one mile eastward on the Pacific system were reported as amounting to 335,330,035, while the through westbound freight amounted to only 232,682,578. This meant light loads and empty mileage on the westbound traffic. The difference would doubtless have been greater had it not been for the large westward moving company freight. Such a tendency called for constant effort on the part of the officials of the Southern Pacific to secure eastern manufactures for westbound transportation, and this effort in turn gave rise to friction between the railroad and the manufacturing interests upon the Pacific Coast.
On the other hand, the tendency of the passenger traffic was in the direction of an excess of westbound business, because of the migration of permanent settlers to California. During the three years from 1888 to 1890, 328,892 through passengers were reported as moving westward on the Pacific system alone, and only 241,643 as moving eastward, or an excess of 36 per cent in favor of the West. The excess of westbound passenger traffic during these three years reached the large total of 76,580,470 passengers, or more than the total eastbound movement in any one year of the period.
Earnings Density
The greatest density of earnings on the Southern Pacific system was on properties such as the Central Pacific and the California Pacific, which together with the Northern Railway formed the main trunk line from San Francisco to the East. In 1895 the Central Pacific earned $9,537 per mile and the California Pacific $9,266, amounts which were far inferior to the results of the operation of railroads in thickly settled districts east of the Mississippi River, but which yet exceeded the returns on the Santa Fé, the Illinois Central, and even those reported on the western portions of such a railroad as the Baltimore and Ohio.
Next to the California Pacific in the Southern Pacific system, in respect to earnings, came, in 1895, the South Pacific Coast Railroad, with gross earnings of $8,000 per mile; the Southern Pacific railroads of New Mexico, California, and Arizona, with earnings ranging from $6,500 to $5,800; the Northern Railway with $5,177; and finally the Northern California and the Oregon and California Railroad companies, with earnings per mile of $2,600 and $2,400, respectively. The figures so far given all relate to the Pacific system. In general it may be said that the earnings of Atlantic system lines were slightly greater per mile than those of the western properties. This statement does not, however, hold good of all the Atlantic companies, nor, on the average, for the Texas roads, statistics for which are given separately.
Diversion of Traffic to El Paso Route
Unquestionably there was a difference in interest between different parts of the Southern Pacific system, particularly between the Central Pacific or Ogden route, and the Southern Pacific or El Paso route. When the Southern Pacific was first completed to El Paso, the question was raised as to whether it would be the policy of the management of the whole system to divert all transcontinental freight via the southern route. In a letter to a bureau of the United States Treasury Department, Mr. Huntington observed that it would be necessary to continue to do a large part of the through business over the Central Pacific in order that that road might be enabled to meet its interest charges and the requirements of the government indebtedness. The point was evidently regarded as one which called for a decision as to policy. Mr. Huntington further pointed out that it would be injudicious for the Southern Pacific to push any advantage too strongly which it might have, lest it provoke retaliatory action by other lines.[500]
The early practice of the Southern Pacific did not, however, altogether accord with this counsel of moderation, and the company seems not only to have been very active, but actually to have succeeded in capturing as much as 90 per cent of the New York-San Francisco business; also, while it did not permanently retain so large a share of the through freight which moved by rail, it continued to carry the major portion of the westbound traffic from the Atlantic seaboard to California until perhaps the year 1887.[501] Some of the freight which the Southern Pacific handled during this period was new business, but a considerable portion of it was taken from the Central Pacific.
There is more or less evidence that it was the practice of the Southern Pacific management to lay special emphasis upon the advantages of the southern route, in the attempt to divert as much business as possible to what was known as a 100 per cent line. That shippers believed such a policy was being followed, is evident from statements which appeared in the public press. It was currently asserted, for instance, that ticket and traveling agents of the Southern Pacific all over the state of California were instructed to use their best endeavors to induce passengers to move by way of the southern line instead of by way of Ogden.[502] It was claimed that better time was made over the Southern Pacific than over the Central Pacific, and that freight shipments were more easily traced.
Speaking of westbound freight, a San Francisco merchant was quoted in 1896 as stating that the Southern Pacific delivered freight from New York to San Francisco in from twelve to twenty days. Should the freight not come to hand promptly, officials of the company were said to be exceedingly careful to discover the causes of the delay and to see that the goods were pushed forward as rapidly as possible. On the other hand, if freight came via Chicago and Ogden, all the way from 18 to 28 days might be spent upon the journey, while information as to the causes of delay was difficult to obtain.[503]
Testimony of Employees and Officials
One may readily concede that complaints of the character referred to are to be accepted only with reservations; yet there is later information which bears out the substance of the charges in convincing fashion. When the Southern Pacific system was attacked in 1914 as a combination in restraint of trade, a great many railroad employees were put upon the stand, and testimony was secured which related not only to current policy, but also to practices which had been followed by members of the Southern Pacific staff for a number of years in the past.
It appears without substantial contradiction from the testimony in this case, that Southern Pacific, and even Central Pacific employees, solicited for the Sunset route before its combination with the Union Pacific in preference to the route via Ogden in order to obtain the long haul, even when the Sunset route was very roundabout. Mr. Connor, commercial agent of the Southern Pacific at Cincinnati from 1889 to 1901, testified that his office had directed its exclusive time and attention to securing traffic from California points for the New Orleans gateway. Shipments moving via Ogden he regarded as lost and reported them accordingly.[504] Mr. Sproule said that the same was true of the whole Central Freight Association territory, from Buffalo and Pittsburgh on the east, to Chicago and St. Louis on the west.[505]
Mr. Spence, director of traffic of the Southern Pacific Company, admitted that effort was made to send business to California via New Orleans when the point of origin was in territory east of a line drawn from Toledo through Indianapolis and Terre Haute to St. Louis.[506] Mr. Lovett thought that Southern Pacific solicitors even in Chicago did not work against the solicitation of lines leading to New Orleans, though acting independently they would solicit business via Ogden.[507] It is in the record, also, that Southern Pacific solicitors in 1914 sought freight from the Atlantic seaboard to Oregon and Nevada through the New Orleans gateway,[508] and that the great bulk of wool from western and central Nevada destined to the Atlantic seaboard actually moved west to Sacramento and then south and east over the Sunset line, instead of taking the direct route via Ogden.[509]
Complaints of Others
This direct testimony of Southern Pacific employees is in harmony with repeated assertions made by persons outside of the organization, and seems to indicate that some discrimination against the Central Pacific and in favor of the Southern Pacific on transcontinental business was encouraged by those in control of the Southern Pacific Company’s affairs. As well informed a man as P. P. Shelby, traffic manager of the Union Pacific, declared in 1887 that he knew by conversation with shippers that the Central Pacific had diverted all the traffic they could control to the Sunset route ever since the Southern Pacific was completed, commencing in 1882. All kinds of merchandise had been diverted, especially such goods as canned fruits, canned fish, and wool. Asked whether the Union Pacific would carry 25 per cent more freight if the Central Pacific were separated from the Southern Pacific, Mr. Shelby qualified his statement by saying that it was hard to answer the question. The Southern Pacific gave the Central Pacific a good deal of freight which that company would not have received were the two lines segregated. Had they been two independent lines, under independent management, the Southern Pacific would not have given the Central Pacific any freight at all.[510]
Similar charges were made by representatives of interests such as those of the English stockholders of the Central Pacific, who asserted that Mr. Huntington wished to ruin the Central Pacific, and dwelt upon the advantages of bankruptcy to a company from which the United States government was about to attempt to collect a debt. Knowing as we do that the Huntington-Stanford group shifted the weight of their investments from the Central to the Southern Pacific in the eighties, there is of course ground for suspicion that the diversion of freight, to which the evidence that has been quoted refers, was part of a carefully thought-out plan, and that more than traffic matters were involved.
Real Reasons for Traffic Diversion
Yet the truth of the matter probably is that while some diversion from the Central to the Southern route occurred, this diversion, although looked upon with equanimity by Mr. Huntington, was not part of an attack upon the Central Pacific, but may be explained by certain simple traffic considerations. There were at least two good reasons why an attempt should have been made to handle business from New York over the Southern Pacific rather than over the Central Pacific. The first reason was that it was more profitable for the Southern Pacific to take freight from New York by a route which it entirely controlled, than to divide the earnings on such business with the direct lines between New York and Ogden. The second reason was that the Southern Pacific could offer better service on the Sunset route than over the Central Pacific because of the indifference of the lines east of Omaha. The Central Pacific business was done on a different classification from that in use in the East. Also, many classes of freight were taken at low rates because of water competition, so that the divisions accruing to eastern lines were very small, and their interest in the traffic correspondingly slight.
Finally, to the eastern roads the whole business was unimportant compared with the volume of other kinds of goods which they were handling. The result was that Mr. Stubbs, of the Southern Pacific, complained very vigorously that eastern lines neglected transcontinental business. It took four to six days he said, to get freight through the city of Chicago, and often thirty to thirty-five days to transport it from Omaha to New York. Freight had to be way-billed three times via Ogden as compared with one billing via El Paso. In fact, in 1885 and 1886 the trunk lines practically withdrew from the transcontinental business, and to this withdrawal should be attributed the large proportion of the traffic between San Francisco and New York which was handled by the Sunset route during these years.[511]
These two reasons, of which one still has force, and the other was important for a number of years, are sufficient to account for most of the diversions complained of, and it is not necessary to attribute additional motives to the Huntington management.
As a matter of fact, in spite of the traffic policy described, the gross earnings per mile of the Southern Pacific did not move very differently from those of the Central Pacific during the years from 1886 to 1895, when the data are distinguishable in the companies’ reports. The advances and recessions in volume of traffic were not identical for the two companies during these years, nor did they occur at exactly the same times, but the figures seem to offer no support to the charge that the prosperity of either company was being sacrificed.
It may also be observed that the policy of freight diversion was not confined to the period when the Central Pacific was negotiating with the government for the payment of its debt and with the English stockholders for the adjustment of their claims, nor to the years when the management of the Southern Pacific Company owned Southern Pacific shares and did not own a corresponding amount of the shares of the Central Pacific. In fact, as has been said, the policy of seeking to obtain the benefits of the long haul is still followed by the Southern Pacific Company, and its agents still take credit for sending freight all the way to New York by company lines, although the financial control of both the Southern and the Central Pacific has long been in one set of hands.
Traffic in Early Eighties
Like other systems in the United States, the earnings of the Southern and Central Pacific railroads fluctuated considerably from year to year. It has been pointed out in a previous chapter that during the period from 1870 to 1879 the rapid extension of the Southern Pacific in the South West, and the temporarily unproductive character of the new mileage built, well-nigh caused the bankruptcy of the entire concern. The associates were then saved by the completion of the Southern Pacific main line to The Needles, and by an improvement in general stock market conditions which enabled them to sell securities in New York. In 1885 the Central Pacific retired the greater part of a floating debt of $12,873,946 by an issue of bonds, and for the first time in many years was freed from what had always been a pressing danger.
In spite of this important relief, the years 1882, 1883, 1884, and 1885 were still years of considerable difficulty. Although the mileage of the system now increased but slowly, the revenue per mile declined. Thus the Central Pacific earned $9,449 per mile of line in 1881, $8,437 in 1882, $8,253 in 1883, and $7,496 in 1884. In three years gross earnings per mile dropped 21 per cent. This decline was due to a number of causes. The Central Pacific suffered greatly, for one thing, from the falling off in the tonnage supplied by the Nevada mines. Roads like the Eureka and Palisade, the Nevada Central, the Nevada and California, and the Virginia and Truckee railroads, which were at one time lucrative feeders to the Central Pacific main line, all showed a considerable decline in earnings and business between 1875 and 1885 because of the failure of the mines. The freight received at Palisade, the terminus of the Eureka and Palisade Railroad, declined 74 per cent between 1875 and 1888. The freight received at Battle Mountain, the terminus of the Nevada Central, fell off 78 per cent, while that arriving at Virginia City over the Virginia and Truckee Railroad dropped 86 per cent.
It was estimated that the shrinkage of traffic between 1876 and 1885 was not less than $2,000,000 per annum as compared with the period of highest prosperity of the Nevada country. The decrease was due in the first instance to the working out of the ore deposits, not only of the Comstock lode but of nearly all other camps within the states of Nevada and Utah west of Ogden which were tributary to the Central Pacific line. Following this, there was a large falling off in traffic, consisting of mining machinery and all kinds of supplies previously required by the miners at the mining camps, and also a large falling off in passenger travel as compared with the first and prosperous years of operation.[512]
Besides the loss of the Nevada mining traffic in the late seventies and early eighties, the Central Pacific also had to reckon with a certain loss of business by reason of the opening of transcontinental competing routes such as the Santa Fé in 1881 and the Northern Pacific in 1883. In the early part of the period the decline in business seems to have been due mainly to local conditions; in 1884, however, as was to be expected, a serious decrease in the earnings from through business occurred.
Later Earnings
As a contrast to the unsatisfactory character of the returns for the years 1883, 1884, and 1885, the reports of the companies show that, taking the Central Pacific-Southern Pacific system as a whole, the total earnings from 1885 to 1891 steadily increased, both in the aggregate and per mile of line. If we compare the condition of the system in 1891 with its condition in 1885, we find a progress which may be summarized as follows:
Comparative Statement of Mileage, Capitalization, Earnings, and Expenses of the Southern Pacific System, 1885,(*) 1886, and 1891
| Item | 1885 | 1886 | 1891 |
| Mileage operated | 4,698 | 4,847 | 6,376 |
| Capital stock | $171,036,160 | $198,668,170 | $264,375,066 |
| Funded debt | 158,970,716 | 181,041,680 | 205,621,373 |
| Gross earnings | 25,006,106 | 31,797,882 | 50,449,816 |
| Operating expenses | 12,149,824 | 18,514,656 | 31,163,612 |
| Net earnings | 12,856,282 | 13,283,226 | 19,286,214 |
(*) The figures of earnings for 1885 represent the results of from nine to ten months’
operation only.
This was a satisfactory showing. The total mileage operated by the Southern Pacific Company and by the Southern Pacific Railroad, Northern Division, increased between 1885 and 1891 from 4,698 miles to 6,376 miles, not including the mileage of the steamship routes between New Orleans and Galveston and New York. The principal elements of new mileage added were certain lines in Oregon, including the property of the Oregon and California Railroad from Portland to the California state line (650 miles); a second road down the San Joaquin Valley on the west bank of the river (190 miles); and additional construction on the Coast Division (150 miles). Comparatively little was added during these years to the Central Pacific main line, or to the properties east of El Paso.
While the mileage operated thus increased by 1,678 miles, or 36 per cent, gross earnings became greater by the sum of $25,000,000, or approximately 100 per cent, and net earnings by $6,429,921, or about 50 per cent. This was accomplished with an increase in bonded indebtedness of only 30 per cent. The increase in stock outstanding was greater, it is true, than the increase in the funded debt, but the new stock issue did not increase the fixed charges of the road, and therefore in no way imperiled its solvency. In none of the figures cited are the so-called subsidy bonds issued by the United States government or the accrued interest upon the same included.
Decline Following 1893
Unfortunately, the progress of the Southern Pacific toward prosperity, which was so considerable between 1885 and 1891, was interrupted by the difficult commercial and industrial years between 1891 and 1897. The effect of world-wide depression upon American railroads is apparent when we observe that in the eastern part of the United States the gross earnings of companies like the New York Central fell off during this period from $21,000 per mile in 1892 to $18,000 per mile in 1897. The Pennsylvania lines west of Pittsburgh earned $44,210,000 in 1891 on a mileage of 3,502 miles. Six years later they hardly equaled this record on a mileage 500 miles greater. Even the protected system of the New York, New Haven and Hartford saw its gross earnings decline from $22,000 per mile in 1891 to $20,000 per mile in 1897.
It was scarcely to be expected that the relatively new system of the Southern Pacific would not suffer with the rest. The figures seem to show, however, that the Huntington lines suffered more than most eastern railroads from the depression in business following the panic of 1893. While it is true that the portion of the roads operated by the Southern Pacific Company which was known as the Atlantic system, comprising the lines east of El Paso, escaped with a decline of earnings from $7,700 per mile to $7,400, or only 43 per cent, the Pacific system, including the Central Pacific and the Southern Pacific Railroad of California, witnessed a decline in its returns from $8,000 per mile in 1891 to $6,400 per mile in 1897, or a loss of from five to six times as much in gross, and a still greater relative decline in net, receipts.
The following table shows the earnings and expenses of the Central Pacific Railroad per mile of road from 1885 to the reorganization of the company in 1898:
Operating Receipts and Expenses of the Central Pacific Railroad of California, 1885-98 per Mile of Road
| Year | Gross Earnings | Operating Expenses | Net Earnings |
| 1885 | $ 8,383.26 | $3,712.93 | $4,670.33 |
| 1886 | 9,135.18 | 4,445.62 | 4,689.56 |
| 1887 | 10,092.27 | 5,394.48 | 4,697.79 |
| 1888 | 11,641.24 | 7,079.38 | 4,561.86 |
| 1889 | 11,416.92 | 7,178.13 | 4,238.79 |
| 1890 | 11,715.97 | 7,259.55 | 4,456.42 |
| 1891 | 12,224.76 | 6,771.95 | 5,452.81 |
| 1892 | 10,745.16 | 6,548.29 | 4,196.87 |
| 1893 | 10,488.89 | 6,267.71 | 4,221.18 |
| 1894 | 9,578.18 | 6,008.06 | 3,570.12 |
| 1895 | 9,534.31 | 5,990.94 | 3,543.37 |
| 1896 | 9,159.68 | 5,706.59 | 3,453.09 |
| 1897 | 4,270.75(*) | 2,715.62(*) | 1,555.13(*) |
| 1898 | 11,595.87 | 6,769.00 | 4,826.87 |
(*) Six months only.
These figures show very clearly that the gross receipts of the Ogden route increased on the average per mile of road from 1885 to 1891, but that they fell off largely and persistently from 1891 to 1897. Indeed, the net earnings per mile each year from 1894 to 1897 inclusive, were less than those for any of the nine preceding years.
Suspension of Central Pacific Dividends
It seems very likely that this unusual falling off in the receipts of the Central Pacific Railroad Company is to be associated with the exceptionally disturbed traffic conditions on the Pacific Coast during the four or five years beginning in the latter part of 1891. These were the years when the Traffic Association of California was conducting its violent attack upon the Huntington interests. The period was also marked by the dissolution of the Transcontinental Association, and by the construction of the San Francisco and San Joaquin Valley Railroad. It was not to be expected that a campaign such as has been described in previous chapters would fail to have an influence upon the receipts of a company interested in business in, to, and from the state of California, so that a disproportionate decrease in Central Pacific earnings was not surprising. However this may be, the effect of the decline in earnings was to force the Central Pacific to stop the payment of dividends; and the cessation of dividends, together with other elements of uncertainty in the situation to which reference will be made, eventually caused the price of Central Pacific and of Southern Pacific stock to decline.[513]
Dividend Policy
In respect to dividends a word should be said here, enough at least to make clear that the whole dividend policy of the Central Pacific was a matter which provoked criticism, and that this criticism grew acute at the close of the period we are discussing. As a general matter it was charged that the Central Pacific had no business to pay any dividends at all while its indebtedness to the United States government remained uncanceled. It was further alleged, with more show of reason, that the dividends of the eighties were declared in order to assist the associates in disposing of Central Pacific stock in Europe, and not because there existed any surplus to which they could be properly and wisely charged. Finally, enemies of the company asserted, and showed ground for believing, that the dividends set forth in the annual reports of the Central Pacific to its stockholders did not represent all dividends actually declared; they asserted that, in addition, by special arrangement, considerable sums were paid out in unreported dividends, which may or may not have reached all holders of the stock.
It appeared in this connection that a gentleman named Sir Rivers Wilson had come to the United States in 1894 as a representative of English shareholders.[514] Sir Rivers interviewed officers of the Central Pacific, inspected the property, and it was reported in the newspapers after his return to the East that he had arrived at a compromise with Mr. Huntington. The terms of the compromise were at first only vaguely understood, but the London Economist, in its issue of March 23, 1895, declared specifically that Mr. Huntington had undertaken to pay 1 per cent per annum in the shape of dividends until satisfactory legislation had been obtained for the adjustment of the Central Pacific’s debt to the government, and that he had also agreed to pay 2 per cent per annum for two years after the debt question had been settled, during which time the shareholders would have opportunity to review their position and to consider effecting an arrangement of a more permanent character.
Mr. Huntington’s attention was called to this statement of the Economist, but he made no denial of the facts stated. Three years later Mr. Huntington went further, and admitted that he had agreed with Sir Rivers Wilson to pay shareholders—all shareholders—an annual dividend of 1 per cent upon their stock.[515] It was understood that the money for the secret Central Pacific dividends was loaned to the Central Pacific by the Southern Pacific, although this detail was not authoritatively established.
Market Prices of Stock Shares
Neither the Central Pacific nor the Southern Pacific were ever investment properties under the Huntington régime, in the sense that a stable return could be expected by holders of their stock, or even in the sense that the selling price of their shares remained reasonably uniform or ever reached a quotation in the neighborhood of par. Central Pacific stock sold at 34 in January, 1885. It rose to 51 in 1886, fluctuated principally between 26½ and 42 during the years from 1887 to 1892, and then proceeded to fall in value until in the spring of 1897 it was quoted on the New York Stock Exchange at the nominal figure of 7⅛ per share. The stock was ordinarily not traded in to any extent probably because so much of it was held abroad.
Southern Pacific stock was listed on the New York market in 1885, but as has been explained in a previous chapter, quotations on the shares were for several years artificial. In 1890 the stock sold mostly between 25 and 35. It declined slightly during the latter part of 1890 and the early part of 1891, but from September, 1891, to August, 1892, most of the sales were between 35 and 40. Beginning in 1893 the price of Southern Pacific stock began to decline. In 1894 it reached 17½, in 1895, 16¾; and in 1897 it touched the low point of 13½. After 1898 Central Pacific stock left the market, but Southern Pacific stock recovered to about 50 in the middle of 1901, at which approximate price 46 per cent of it was purchased by the Oregon Short Line.
It is not without interest that the fluctuations in the quotations of the stock of the Central Pacific were quite as extreme between 1885 and 1890 as were those of the Southern Pacific shares, although one stock was occasionally a dividend payer and the other was not, and that the Central Pacific stock was quoted at a distinctly lower figure between 1894 and 1898 than was the stock of its apparently more speculative associate. The reason is not to be found in the different natures of the properties represented by the two stocks, nor in any difference in operating conditions. It was plainly due to the gradually approaching maturity of the debt which the Central Pacific owed to the United States government, and to the complete uncertainty as to the effect which government action might have upon the solvency of the Central Pacific Railroad. So long as there seemed a possibility that the Central Pacific would be called upon to make good, in cash, an advance which by 1898 would amount to nearly $60,000,000—a sum which few persons believed that the Central Pacific would be able to pay—the stock certificates of this company could have only a speculative value.
The question of the best way to meet the huge obligation which had grown out of the assistance tendered to the Central Pacific Railroad by the federal government under the Pacific Railroad Acts of 1862 and 1864, was indeed the most important financial problem which the company had to solve after Mr. Stanford’s death. The two following chapters will be devoted to an exposition of the points involved in this transaction, and to a description of the solution finally reached in the year 1898.
THE THURMAN ACT
A Loan, Not a Subsidy
The original loan of the United States government to the Central and Western Pacific railroads amounted to $27,855,680. The bonds which were issued to the companies were United States currency bonds, bearing 6 per cent interest, payable semiannually and maturing at the end of thirty years. They fell due therefore between 1895 and 1899. Some question has been raised as to whether these bonds were to be regarded as a loan or as a donation to the corporations which received them. Setting aside the fact that a loan at a critical moment may be almost as serviceable to the recipient as a gift, the evidence shows that the unquestionable purpose of Congress in 1862 and 1864 was that principal and interest of the bonds should be met by the railroads for the benefit of which they were issued. It follows that this bond issue constituted an advance to the Central and Western Pacific railroads, not a gift; a loan, not a donation. It was the contention of Mr. Huntington, indeed, that the very name “subsidy” was a misnomer. He said:
The Central Pacific never got a subsidy; they got the loan of a small subsidy. The government loaned money at six per cent and they expected and did receive direct benefits from the time the road was built. It was not a subsidy in any way.... A subsidy as I believe is where you give ... For instance if you will build a railroad I will give you $10,000 as a subsidy; as to being a loan of money it is no such thing. It is only a business negotiation.[516]
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.
Still a third claim was based upon an alleged loss of business consequent upon government subsidies to other transcontinental roads. The loss of earnings to the two roads from this cause was set at $37,000,000, of which the Central Pacific share was put at 46 per cent, or $17,000,000. Stanford did not deny that the government had a right in its discretion to aid other lines of railroad, but he took the position that if Congress found it in the interest of the country to do something which deprived the Central Pacific of the means of paying its debts, then it should compensate the Central Pacific for this action.[519]
No Basis for Claims
These three principal claims for indemnity were set up by officials of the Southern Pacific at one time or another as complete offsets to the obligations laid upon the company by the Acts of 1862 and 1864. Among minor equities should be mentioned also an alleged loss to the Southern Pacific by reason of the government’s slowness in issuing patents to land. Another claim was based on a loss in respect to sinking fund investments of the company; and still another on the shipment of United States mails by other than bond-aided lines when the use of the latter was possible.
There was no real reason, however, why the government should have reduced its claims against the Pacific companies because of any of the equities mentioned. The administration certainly gave no guaranty in 1864 that the subsidy bonds would sell at par. The government offered the bonds for what they were worth, and the companies accepted them on that basis. Nor did the government at any time agree to preserve a monopoly of transcontinental business for the Central route, or to send its own freight over the Central and Union Pacific railroads to any greater extent than might prove convenient. On these points the facts are perfectly clear. It would seem clear, also, that the government was under no obligation to share with the companies any saving which it had made by reason of the early construction of the transcontinental line. The companies had built more rapidly than had been expected, it is true, but the construction was pushed in their own interest, not in that of the government, and gave rise to no proper claim against the latter. The other points in the companies’ contentions do not deserve special mention.
Sinking Fund Provisions
We may now return to the question of the government debt and its repayment. The Laws of 1862 and 1864 contained two provisions intended to enforce the original stipulation that principal and interest of the subsidy bonds should be paid by the beneficiaries. These laws required that 5 per cent of the net earnings of the Central Pacific after the completion of the road,[520] and second, that one-half of the compensation for services rendered to the government should be annually applied to the payment of interest and principal of the subsidy bonds until the whole amount was fully paid. It was then expected that these two sources of income would provide a fund sufficient to meet both principal and interest in full.[521]
This expectation was not, however, fulfilled. On the contrary, it was already apparent in the seventies that the amount which the companies would be called upon to repay was mounting up much more rapidly than the credits designed to meet it. Six per cent interest upon $27,855,680 of bonds called for an annual interest of $1,671,340.80. From 1867 to October 31, 1877, the one-half of transportation account for carrying mails, troops, supplies, etc., withheld by the government and credited to the Central Pacific sinking fund was only $1,423,555.74, or less than $200,000 a year.[522] The 5 per cent of net earnings account averaged $331,481 from 1872 to 1876.[523] The total annual payment by the Central and Western Pacific railroad companies, therefore, approximated $530,000, leaving a deficit of over $1,100,000 a year. At this rate it was not unreasonable to suppose that the Central Pacific would be much more heavily in debt to the government at the maturity of the bonds than it was at the time of their original issue.
Right of “Set-Off”
Alarmed at the probable failure of the sinking fund provisions, the Secretary of the Treasury, on advice of the Attorney-General, withheld from the Central Pacific Railroad all the compensation due it for services rendered to the government. The same action was taken with respect to the other bond-aided lines. This was clearly illegal, and Congress accordingly passed the Act of March 3, 1871, directing payment of the sums withheld.[524] On passage of the Act of 1871, the Secretary of the Treasury began to pay to the Central Pacific and to the other bond-aided companies, the 50 per cent of compensation for services rendered to the government which the statutes required. Since, however, there seemed to be a legitimate difference of opinion as to whether the government should continue to pay money to companies already heavily in debt to it, Congress proceeded two years later to pass the Act of March 3, 1873, which, in effect, remitted the whole controversy to the court.
The terms of the Act of 1873 were as follows:
That the Secretary of the Treasury is directed to withhold all payments to any railroad company and its assigns, on account of freights or transportation, over their respective roads, of any kind, to the amount of payments made by the United States for interest upon bonds of the United States issued to any such company, and which shall not have been reimbursed together with the five per cent. of net earnings due and unapplied as provided by law; and any such company may bring suit in the court of claims to recover the price of such freight and transportation; and in such suit the right of such company to recover the same upon the law and the facts of the case shall be determined and also the rights of the United States upon the merits of all the points presented by it in answer thereto by them and either party to such suit may appeal to the Supreme Court; and both said courts shall give such cause or causes precedence of all other business.[525]
The intent of Congress in 1873 was that, in order to make a case, the Secretary of the Treasury should withhold the sums demanded by the bond-aided railroads including the Central Pacific, that the companies should sue, and that the court should then decide. In pursuance of this idea, the Union Pacific promptly brought suit against the government in the Court of Claims to recover the amount due from the United States for transportation of government passengers and property after deducting one-half of the amount as required by law. A decision being rendered in favor of the company, the United States appealed to the Supreme Court, where the judgment was affirmed.
The foundation of the government position was that the United States could legitimately offset the interest on subsidy bonds which it was paying currently against the sums due the bond-aided railroads for government transportation. The reply of the court was, first, that the general principles of “set-off” did not apply in the case at bar; and second, that the United States had no claim in any event because the law did not require the Union Pacific (and the same principles applied to other bond-aided railroads) to meet the interest charges on the government advances until the maturity of the bond.[526] A later case added the ruling that the United States had in the matter only the right of a creditor growing out of contract, and could not fall back upon its sovereign rights in order to protect its financial claim.[527]
Not only did the Supreme Court decide completely in favor of the companies in the important matter of “set-off,” and in that relating to the date upon which the Pacific railroads became liable for the payment of accruing interest on the subsidy bonds, but it diminished also the sinking fund payments of the companies by holding that under existing legislation it was proper for the companies, in calculating net earnings, to deduct from gross earnings expenses incurred for enlarging and improving their property. The particular account involved was that of expenditure for station buildings, shops, and fixtures. Such expenditures are not ordinarily charged to operating expenses, and the court admitted that “theoretically” they should not be so charged. The practice was nevertheless justified on the ground of general policy, as likely to encourage a liberal application of earnings to improvements. The same decision also authorized the Central and the Union Pacific to deduct interest on first mortgage bonds from earnings before computing the 5 per cent of net earnings which was to be credited to the sinking fund. This ruling was defended as a legitimate consequence of the concession of priority to the first mortgage bonds.[528]
Need of Governmental Action
While Congress was considering ways and means for enforcing some adequate provision for the eventual repayment of the government’s advance to the Pacific railroads, the Central Pacific declared dividends which amounted to no less than $18,453,670 in the five years from September 13, 1873, to October 1, 1877. In 1873, 3 per cent was declared; in 1874, 5 per cent; in 1875, 10 per cent; and in 1876 and 1877, 8 per cent. To see earnings divided among a group of financiers who were believed to be already overpaid, while the unpaid interest on the government subsidy bonds piled up, was all the more exasperating because of the apparent helplessness of Congress. Some action, however, was presently to be taken. In 1874 a bill was introduced in the Senate to alter and amend the Acts of 1862 and 1864 so as to safeguard the government equity. In 1876 Mr. Thurman, of Ohio, presented another bill, which was reintroduced in 1877, referred to the Committee on Judiciary, and ultimately reached the Senate in March, 1878. This bill ultimately became the Thurman Act of 1878.[529]
The situation as it appeared in 1878 was succinctly presented by Mr. Thurman on the floor of the Senate. The government’s loan to the Central and Western Pacific amounted to $27,855,680. The interest upon that sum for thirty years would be $50,140,224, making a total of $77,995,904. The probable reimbursement from the 5 per cent of net earnings and the half of the transportation accounts would be about $15,000,000, leaving probably due at the maturity of the government loan, should the laws remain unchanged, the sum of $62,995,904, which, added to the amount that would probably be due from the Union Pacific, made an aggregate of $119,248,979.[530] To this amount there was also to be added in estimating the payments which the Central Pacific, Western Pacific, and Union Pacific would be called upon to make in the late nineties, the amount of the first mortgage bonds of the three companies, the lien of which was prior to the lien of the subsidy bonds.
It seemed manifest to Mr. Thurman in March, 1878, that the bare statement of the amount for which the government would be the creditor of the Pacific railroad companies ought to satisfy anyone that some step should be taken by Congress to secure the government from loss. This point of view was not seriously contested. Objection to any action there was, indeed, but not based on any denial of the assertion that the security of the government was becoming impaired.
Thurman Bill
On the basis of the admitted need, Mr. Thurman, in behalf of the Committee on the Judiciary of the United States Senate, made a series of concrete proposals. The essence of the Thurman plan was that the annual payments of the Pacific railroads for the eventual retirement of the government debt should be largely increased. It was contemplated that 5 per cent of the net earnings of these railroads, together with half of the sums due to the companies for government transportation, should continue to be applied to the retirement of the subsidy bonds. This annual appropriation Mr. Thurman estimated at $531,000. But it was now intended that in addition to this sum there should be retained by the government and credited to a sinking fund, the other half of the sums due to the companies for government transportation; proceeding still further, the Thurman bill provided that in case the whole of the government transportation accounts, added to the 5 per cent of net earnings, did not make a sum equal to 25 per cent of net earnings, then the Pacific railroads should pay into the sinking fund such sums not exceeding $1,200,000 for the Central Pacific and $850,000 for the Union Pacific, as would bring the companies’ payment up to 25 per cent.
Textually, the section of the Thurman bill relating to the Central Pacific sinking fund read as follows:
Sec. 4. That there shall be carried to the credit of the said fund, on the first day of February in each year, the one-half of the compensation for service hereinbefore named, rendered for the Government by said Central Pacific Railroad Company, not applied in liquidation of interest; and, in addition thereto, the said company shall, on said day in each year, pay into the Treasury, to the credit of said sinking fund the sum of one million, two hundred thousand dollars, or so much thereof as shall be necessary to make the five per centum of the net earnings of its said road payable to the United States under said act of eighteen hundred and sixty-two, and the whole sum earned by it as compensation for service rendered for the United States, together with the sum by this section required to be paid, amount in the aggregate to twenty-five per cent of the whole net earnings of said railroad company, ascertained and defined as hereinbefore provided, for the year ending on the thirty-first day of December next preceding.[531]
Mr. Thurman estimated the total payments which the Central Pacific would have to make under his bill at $1,900,000 annually, or substantially more than the accruing 6 per cent on the subsidy loans.[532] In case earnings should be insufficient to meet interest charges on underlying first mortgage bonds after the deduction of 25 per cent, the Secretary of the Treasury was authorized to remit as much of the 25 per cent as might be necessary to avoid default.
Disappointing Results
From the point of view of the government, the clauses of the Thurman bill relating to the annual payments of the companies were of the first importance, because upon them depended the adequacy of the provision for the eventual cancellation of the government debt. As a matter of fact, the payments were less than Senator Thurman anticipated, because the earnings of the Pacific railroads proved disappointing. Instead of $1,900,000 annually, the average contribution up to 1897 was only $629,690. In particular, the clauses requiring the companies to add to the sums earned from government transportation and that measured by 5 per cent of net earnings sufficient to bring the total up to 25 per cent of net earnings, were ineffective. In but one year after 1883 was anything paid on this last account. Indeed, the earnings of the Central Pacific fell so low that the government transportation and 5 per cent accounts at times amounted to 50 per cent of net earnings without any addition from other sources.
It was assumed by some speakers on the Thurman bill in the Senate, that under the proposed plan the total contribution of the Pacific railroads toward the reduction of the government debt was to be paid into a sinking fund. This was not, however, the case, as a careful reading of the statement already made will make clear. Instead, the payments which these railroads had been making under the Acts of 1862 and 1864 were to be continued, and were to be credited directly to the railroad debt as before. The money was to be held in the United States Treasury, and no interest was to be allowed upon it.[533] It was only the balance, comprising the half of the payment due the companies for government transportation which they had received under the Act of 1864, and such additional payment, not exceeding $1,200,000 or $850,000 respectively, as would be necessary to bring the whole contribution of the companies under the proposed law up to 25 per cent of net earnings, which was credited to the sinking fund. The distinction is important, because the sums paid into the sinking fund earned compound interest, whereas the sums credited to bond and interest account earned no interest at all. That is to say, the contributions to the sinking fund were to be invested in government bonds, and the interest on these bonds was to be reinvested semiannually in the same security, but other payments merely gave rise to credits on the government books.
Sinking Fund Investments
The mention of the sinking fund leads naturally, however, to a reference to the provisions of the Thurman bill relating to sinking fund investments. Mr. Thurman proposed in 1878 that the sums credited to the Pacific railroads’ sinking funds be used to purchase United States bonds, preferably 5 per cent bonds because other outstanding issues were either insufficient in amount or had only a short time to run. Up to June 30, 1897, about $6,000,000 were available for such purchases. But this limitation of the field of investment seriously crippled the earning power of the fund by requiring the purchase of securities of classes which either bore low rates of interest or which commanded considerable premiums in the market. The average premium paid by the Central Pacific up to 1883 was approximately 13 per cent.[534] In 1891 the Commissioner of Railroads reported that between the date of the creation of the sinking fund in 1878 and the date of his report, on June 30, 1891, the government had bought bonds with a par value of $6,138,800 for the Central Pacific, for which it had paid a premium of $1,110,409.62, or an average of 18 per cent. At times the premium paid had gone as high as 35 per cent,[535] and in the earlier years the payments on account of premiums materially exceeded the earnings of the sinking fund in the way of interest. This excess disappeared, of course, as the fund grew larger, but the absolute amount of the premium continued to grow.
The principal bonds in which the sinking funds were invested up to 1882 were the United States currency sixes, the 5 per cent funded loan of 1881, and the 4 per cent funded loan of 1907. In 1881 the funded fives matured and were continued at 3½ per cent. In 1882 the Treasurer of the United States exchanged these bonds for a new 3 per cent issue. Inasmuch as the bonds which bore the higher interest rates all commanded a premium, the actual yield of the fund up to 1886 was only from 2½ to 3 per cent. This condition was recognized as disadvantageous by all concerned. The Commissioner of Railroads declared in 1883 that it would require a century or more at the rate provided in the Thurman Act to accumulate a fund sufficient to discharge the railroad debt, with a strong probability that even then it could not be done.[536] The Auditor of Railroads in 1879, the Secretary of the Treasury in 1881, and the Commissioner of Railroads, in various reports, all urged that the field for investment of the sinking funds be widened, at least to include the first mortgage bonds of the Pacific railroads. Since the lien of these bonds was prior to that of the sinking fund itself, it seemed appropriate to allow the Secretary of the Treasury to buy them with sinking fund money. The suggestion was adopted by Congress in 1887,[537] with the result that interest on the funds placed in this new investment amounted to 4.15 per cent. This was a substantial increase from the 2½ or 3 per cent realized from government bonds, though still less than the 6 per cent carried by the subsidy bonds themselves.[538]
Passage of Bill
The Thurman bill was carefully considered by the Senate before its enactment, and may fairly be said to embody the best judgment of Congress at the time of its enactment. The final vote in the Senate was taken on April 9, 1879. Forty Senators voted for the bill, and twenty against it.[539] If paired votes for and against the act be included, the vote was forty-four to twenty-six. Twenty-seven Democrats voted for the bill, and six against it. Yet in spite of this strong Democratic party support and the opposition of Senators Blaine and Conkling, nearly as many Republicans went on record for the bill as voted or were paired against it. In the House there were but two votes against the bill compared with 243 in favor of it.[540]
In neither house was there marked party or sectional division. Doubtless the passage of the act was made easier by the general unpopularity of railroad enterprise in 1878, although adequate reasons for additional legislation undoubtedly existed. It was the period of the aftermath of the panic of 1873—the epoch of Granger legislation and railroad control bills, of revelations regarding rebates and construction frauds. Sentiment ran strongly against great railroad corporations. Railroads still had stalwart supporters, but it is putting it mildly to say that the presumption in doubtful cases was against them.
Feeling of Railroad Men
There is plenty of evidence, nevertheless, that railroad men felt very bitter that the Thurman bill should ever have been passed. Stanford declared that no act so destructive to private right had ever before been attempted in this country, and that only two examples of such atrocity could be found in English history; one being the suppression of the order of Templars in the time of Edward the Second, and the other, the suppression of the religious houses in the time of Henry the Eighth. Undoubtedly, also, the railroads were active in Congress in the attempt to prevent the passage of the Thurman Act. The reader’s attention has already been directed in a previous chapter to correspondence relating to the Thurman bill which passed between Huntington and Colton in 1877 and 1878. It will be recalled that in January, 1878, Huntington wrote that matters did not look well at Washington. He thought, however, that the railroad would not be much hurt, although “the boys are very hungry, and it will cost considerably to be saved.” Some time before this, in May, 1877, Huntington wrote:
We must have friends in Congress from the West Coast, as it is very important. I think that we can kill the open highway, and get a fair sinking fund bill by which we can get time beyond the maturity of the bonds that the Government loaned us, to pay the indebtedness.[541]
Again, in November, Huntington said:
Some parties are making great efforts to pass a bill through Congress that will compel the Union Pacific and Central Pacific to pay large sums into a sinking fund, and I have some fears that such a bill will pass.... The temper of Congress is not good and I fear we may be hurt.[542]
A letter from Colton dated March 5, 1878, reads:
By the telegraph this morning in the papers I see outline of Thurman’s Sinking Fund Bill, etc. It does seem as though the whole world, Courts and all, were determined to rob us.
·················
I know you are having a terrible struggle on that side, and think of you very often, but, Huntington, I see no way but to fight it out on these lines, and fight them inch by inch while we last; let’s look to paying our debts, incurring no more, and stand by the wreck to the last. We can at least die game.[543]
When the Thurman bill passed the Senate, the correspondence took a still more gloomy turn. Huntington wrote Colton on April 19, 1878, that in his judgment the House would follow the Senate’s lead. He had made some mistakes, of which the greatest was Gould’s going to Washington. Colton replied, on April 29:
We all agree with you that this Congress is simply a band of robbers. They were such a set of cowards they dare not go onto the highway and give the man they rob an even show with them, but went to Congress and did it through that channel. But Huntington, we will live to see many of these fellows come to grief. I trust the day will soon come that we can get in a shape that you can avoid going to Washington during a session of Congress. A few sessions like the present one and the last will wear you out....
·················
I think you will remember I wrote you once or twice that in my opinion Jay Gould would be a heavy load for us to carry in Washington or elsewhere, whenever we had connections with him that would affect our interests, on account of the general feeling against him. So I am not surprised to read what you say of him and the Funding bill, but it was a thing we could not help, as I understand it....
·················
I hope Congress will adjourn soon, and that you will be able to get out here as early as possible, for I want very much to see you again. There is much for us all to talk over and look after. I do not think you will find anyone to buy you out, nor do I want you to. I think we must stick to the wreck.[544]
Letters such as those quoted display the state of mind of the Central Pacific associates during the months when the Thurman bill was under discussion. It was perhaps natural that they should have opposed sinking fund legislation, for this cut into the surplus which the Central Pacific would otherwise have had for dividends, and depressed the price of the railroad’s securities. Nor, indeed, was it perfectly clear that the new legislation did not constitute a breach of the contract between the Pacific railroad companies and the government which could be deduced from the Acts of 1862 and 1864. The legislation in these acts had, it is true, reserved to subsequent Congresses the right of amendment and repeal, but it was uncertain, nevertheless, to what extent this right could properly be exercised. On this point a decision of the Supreme Court was had in 1878, upholding the constitutionality of the Thurman Law on broad grounds, but by a divided court.[545]
Charge Against Railroad
The unfortunate fact about the Thurman Act, however, was not that it excited the anger of representatives of the railroad companies to which it applied, but that it proved a failure in its primary purpose of providing for the eventual retirement of the subsidy bonds. But before summarizing the workings of the law in this respect, a word may be said regarding certain disputes which occurred in the course of its administration.
In February, 1881, Thomas French, Auditor of Railroads, made the charge that the Central Pacific was diverting business from the subsidized portions of its line to its leased properties in order to lessen the payments required under the Thurman law. The basis for this charge, so far as reported, appeared to lie in the fact that the net earnings of the Central Pacific were decreasing, while those of the Union Pacific were going up. Mr. French suggested that the Pacific railroads be required to contribute up to 50 per cent of net earnings for retirement of the government debt, instead of up to 25 per cent as then required by the law.[546]
Mr. French’s suggestion was not adopted, but the government subsequently advanced the claim that it had the right to retain all the compensation for service rendered to the government by the bond-aided companies without regard to the conditions of construction of particular sections of the road. The company took a different view of the matter, but in deference to an opinion of the Attorney-General on this point, the Secretary of the Treasury in 1884 withheld compensation on the entire mileage of the Pacific railroads pending an authoritative decision. The Supreme Court, however, ruled in favor of the companies,[547] and the sums withheld had to be paid over.
In subsequent years the earnings of the portions of the Central and Union Pacific which had received no bond subsidies were credited, in so far as they arose from government business, as a part of the 5 per cent of net earnings which these companies were required to apply to the eventual retirement of the government debt. This meant a considerable amount of bookkeeping, which was increased by other claims of the companies of which no detailed mention is here made. Indeed, when the final settlement was concluded between the Central Pacific and the government, credits to this one company were allowed by the United States to the amount of no less than $1,162,939.48.[548]
Definition of Net Earnings
In addition to the controversy over earnings on government transportation over non-bond-aided lines, there developed a second difference of opinion over the calculation of the net earnings of the Pacific railroads. It has already been observed that the Law of 1862, as interpreted by the Supreme Court, allowed the Pacific railroad companies to charge expenditures for additions and improvements to operating expenses, and thus to reduce their net earnings, upon the size of which the rate of provision for repayment of the government debt depended. The Central Pacific insisted that the same practice was legitimate under the Thurman law. But in this last-named legislation the wording of the clause relating to net earnings had been changed. In 1862 no definition of net earnings had been given. In 1878 it was provided that net earnings should be calculated “by deducting from the gross amount of their [the Pacific railroads’] earnings, respectively, the necessary expenses actually paid within the year in operating the same and keeping the same in a state of repair, and also the sums paid by them respectively within the year in discharge of interest on their first mortgage bonds.” This was deliberately intended as an amendment of the Act of 1862. As Mr. Thurman told the Senate, it was his intention to leave the question of the nature of the net earnings, so far as the past was concerned, for the decision of the Supreme Court without any retroactive legislation at all, but to define net earnings for the future.
In spite of the apparently clear wording of the law, and the definite expression of the views of the Senate Committee on the Judiciary at the time the act was passed, the Central Pacific still maintained that it possessed the right to deduct expenditures for improvements and betterments from gross earnings, in the process of arriving at the figure of net earnings upon which its contributions toward the retirement of government indebtedness were in part based. A decision of the Court of Claims and another by the Supreme Court of the United States were necessary before this position was abandoned.[549]
Still other controversies arose between the Union Pacific and the United States government over earnings from the operation of the bridge across the Missouri River between Council Bluffs and Omaha, over receipts from the operation of Pullman cars, and over the payments by the Union and Central Pacific railroads to the Pacific Mail Steamship Company according to the terms of contracts described in a preceding chapter.[550]
Inadequacy of Law
The persistent disputes between the government and the railroad companies over the proper interpretation of the Thurman law made the administration of the statute difficult. The primary defect of the act, however, lay in the fact that the contributions which it compelled the companies to make were too small to provide for the retirement of the subsidy bonds with interest at their maturity. How far the ultimate provision under the law fell short of a proper accumulation may be seen from the table given in the next paragraph, in which the debits and credits on account of the government loan to the Central and Western Pacific railroads are given as of June 30, 1897, six months before the greater part of the subsidy bonds fell due.
According to the Commissioner of Railroads, the account between the United States and the Central Pacific Railroad stood on the 30th of June, 1897, as follows:[551]
Statement on the Government Loan to the Central and Western Pacific Railroads, as of June 30, 1897
| Debits: | |
| Principal of subsidy bonds issued | $27,855,680.00 |
| Interest paid by the United States | 47,954,139.78 |
| ——————— | |
| Total debits | $75,809,819.78 |
| ══════════ | |
| Credits: | |
| Applied to bond and interest account: | |
| Transportation | $7,977,535.66 |
| Cash | 658,283.26 |
| Applied to sinking fund account: | |
| Transportation | 5,027,848.71 |
| Cash | 633,992.48 |
| Proceeds of sinking fund investments | 1,683,127.38 |
| ——————— | |
| Total credits | $15,980,787.49 |
| ══════════ | |
| Balance of debt, June 30, 1897 | $59,829,032.29 |
| Excess of interest paid by the United States over all credits | $31,973,352.29 |
The reasons for the inadequacy of the Thurman law were, first, the failure of the net earnings of the Pacific railroads to increase as rapidly as had been expected, and second, the meager results of the sinking fund accumulations. Net earnings were disappointing because of general business conditions, especially after 1893, and because of competition from other transcontinental railroads. The accumulation of the Central Pacific sinking funds proceeded at a slower rate than had been anticipated, for reasons already given. Up to June 30, 1897, the table shows that the total proceeds of sinking fund investments by the Central Pacific Railroad had amounted to only $1,683,127.28. When it is understood that this was less than a third of the sum which the moneys paid into the sinking fund would have earned if invested promptly and continuously at 6 per cent, the loss which resulted from the purchase of government bonds becomes evident.
After thirty years of contention and nineteen years of operation under the Thurman law, the accumulated reserve for the retirement of the subsidy bonds was less than $16,000,000, of which only $7,300,000 was the result of the Thurman sinking fund. On June 30, 1897, the United States had actually paid out in interest on its bonds issued in aid of the Central Pacific Railroad, $31,000,000 more than had been provided against both the interest and the principal of the debt. Except to the extent of $7,300,000, the problem remained substantially as it had been presented in 1878.