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 https://archive.org/details/railroadsfrominvOOfede 
 
An outline of the history of the 
 railroads up to the present time, 
 and of facts to be considered in 
 purchasing railroad investments 
 
Copyrighted 1921 
 Federal Securities Corporation 
 Chicago 
 
3’r5. '73 
 
 ■F3lr 
 
 Federal Securities Corporation 
 
 IMTEODUCTION 
 
 Throughout the country there is manifest a widespread 
 interest in the railroad situation and in railroad invest- 
 ^ ments. It is no new interest for the railroads have always 
 occupied an important place in the activities of the country, 
 ^ but more recently this interest seems to have grown wider. 
 
 This is probably due to two factors — first, to the constantly 
 o changing aspect of the railroad situation during the past 
 ^ four or five years and the changing aspect of the problem 
 ^ which it has been necessary for the railroads to face ; 
 
 CM 
 
 second, to the various railroad ofiferings involving large 
 amounts of money at high rates of interest, which have 
 been so readily absorbed by the investing public. 
 
 During 1921, the railroads of the United States needed 
 approximately $456,000,000 to take care of maturing obliga- 
 tions. It has been estimated by Mr. John J. Esch, who is 
 one of the joint authors of the Transportation Act, passed 
 by Congress early in 1920, that the railroad companies will, 
 in addition, need about $1,500,000,000 of new money each 
 year for a period of from three to five years. This amount 
 of financing will bring before the public a great many issues 
 of bonds of varying degrees of worth. The situation is and 
 has been so complicated and the individual investor so 
 unlikely to have the opportunity to investigate its ramifica- 
 tions fully, that this little booklet is offered in the hope 
 . that it will help the investor choose his investments with 
 '^wisdom. 
 
 ^ Such a booklet should, in our opinion, (1) deal briefly 
 with the past history of the railroads up to the outbreak of 
 the European War; (2) give in more detail the situation 
 
 5 
 
Hailroads From the Investor’s Viewpoint 
 
 since that time up to the present ; and (3) outline to in- 
 vestors the factors which should be considered in choosing 
 railroad investments. In this booklet, we shall endeavor to 
 deal briefly with all three. 
 
Federal Securities Corpokatioi^ 
 
 I 
 
 FEOM CIVIL WAR TO WORLD WAR 
 
 The very early history of the railroads of this country 
 can be passed over very briefly, because the more recent 
 history is more important for our purpose. The story of 
 the railroads of this country is almost kaleidoscopic in 
 retrospect and, therefore, highly interesting. In the early 
 days, before the carriers were placed under the jurisdiction 
 and control of the Interstate Commerce Commission, the 
 situation gave a free reign to shrewd and clever operators 
 to use the railroads for their own ends, either for the pur- 
 pose of manipulation to make profits in the stock market 
 in the manner of Jay Cook and Jay Gould, or to build up a 
 tremendously powerful structure, such as E. H. Harriman 
 built up with the Union Pacific as a nucleus. 
 
 We have said that the story of the roads is one of 
 constantly changing situations. Roads like the New 
 Haven, the stock of which for many years was considered 
 one of the sound investments in the country, in the space 
 of a very few years under the control of Mr. Mellen, was 
 brought to such a pitiable plight that the United States 
 authorities were forced to intervene in an attempt to correct 
 the situation. This road, formerly prosperous, is today 
 going along at a starvation rate, and it would seem as 
 though the prospect of dividends for the stockholders is 
 exceedingly remote. The Boston and Maine, another of 
 the New England roads, paid dividends on its stock unin- 
 terruptedly for a period of practically seventy years until, 
 in 1914, the same influences which wrecked the New Haven 
 involved it also to such an extent that its dividends were 
 passed. The Maine Central, another prosperous New Eng- 
 land road, which had paid dividends practically as long as 
 the Boston and Maine, in the early part of 1921 also passed 
 its dividend. These instances show change from prosperity 
 to starvation which is also duplicated in the histories of the 
 .Alton and the Rock Island. 
 
 7 
 
Railroads From the Investor’s Viewpoint 
 
 But of more general and wider interest is the change 
 from weakness, and even bankruptcy, to great strength. 
 This latter is the history of such splendid properties as the 
 Northern Pacific, the Atchison, the Union Pacific and the 
 Southern Pacific, all of which have thrived and grown 
 wealthy as the new country into which they have reached 
 has developed. 
 
 Again, there are some properties which have not had to 
 learn the folly of early over-expansion or early over-cap- 
 italization, but have had a steady healthy growth with 
 sane financing and sane operation from the very beginning. 
 This group includes such great properties as the Pennsyl- 
 vania, the New York Central Lines, the Louisville and 
 Nashville, and the Illinois Central. 
 
 Again there is that group of roads which have started 
 in weakness, continued in weakness and now remain in 
 weakness. The Erie, the Wabash, the Missouri Pacific, 
 the Frisco, the Seaboard and the Mobile and Ohio are types 
 of this group. 
 
 Roads, as well as individuals, do not stand still. His- 
 tory shows that their fortunes are constantly either as- 
 cending or descending. As the country has grown and 
 population and industry have shifted, the fortunes of the 
 railroad companies have shifted. In the early days one 
 hundred miles of line was considered a maximum for effi- 
 cient operation, and this remained the standard up to about 
 1870. About that time the Illinois Central, with a mileage 
 of perhaps 700 miles was considered, and actually was, one 
 of the greatest railroad systems in the world. We believe 
 the figures show that until after the Civil War, with per- 
 haps one or two exceptions, there was no railroad in the 
 country with a mileage of over 1,000 miles. It is interesting 
 to note that the Chicago and Northwestern Road operated 
 with only a little over 100 miles of road almost up to 1860. 
 By 1866 this had grown to only about 500 miles. It is 
 stated that in traveling from the Mississippi River to New 
 York before the Civil War, it was necessary to change cars 
 at least seven times. Of course, as the country grew, such 
 small transportation units made for great inconvenience in 
 traveling and for this reason, among others, consolidation 
 began to be effected. 
 
 8 
 
Federal Securities Corporation 
 
 The first period of real consolidation of railroads was 
 the twenty years from 1870 to 1890, at which latter date 
 the maximum length of line was about 5,000 miles. About 
 1880 the Pennsylvania had approximately 4,000 miles of 
 line, while in 1886 the Chicago and Northwestern, which 
 we mentioned above, reached about 3,500 miles of line, 
 although this was very shortly increased to about 5,000 
 miles. By 1889 the Union Pacific owned 2,000 miles of 
 line and controlled about 4,000 more. 
 
 The next period of consolidation was in the twenty years 
 between 1890 and 1910, during which time systems of 10,000 
 miles of line or more first began to appear. The last ten 
 years of this period was the greatest era of expansion that 
 this country has ever seen or probably ever will see. Dur- 
 ing this time more than three hundred railroads were added 
 to those that were already operating, but so many con- 
 solidations took place that the actual number of roads 
 operating in 1910 was only 829 as compared with 849 in 
 1900. This shows how rapidly the various operating units 
 in the country were combining into large single systems. 
 This tendency toward consolidation was checked for a 
 time during the years of depression of 1893 to 1897, when 
 occasional dismemberment of some properties took place. 
 The Frisco, for example, was divorced from the Atchison, 
 and the Union Pacific lost the Oregon Short Line. But 
 out of the chaos of this period developed the more or less 
 permanent operating units which we now have in this 
 country. 
 
 The figures in connection with the consolidations of the 
 period from 1890 to 1910 are quite startling. During the 
 four years before the panic of 1903, over four hundred rail- 
 roads, aggregating about 32,000 miles of line, were merged 
 or consolidated. During this period also, the systems 
 which in the 90’s comprised ten thousand miles of line grew 
 to be groups which owned or controlled 15,000 to 20,000 
 miles of line. It is interesting that in the space of a little 
 
 9 
 
Railroads From the Investor’s Viewpoint 
 
 over one year, 1899 to 1900, over 25,000 miles of railroad 
 were absorbed or combined in one fashion or another. As 
 there are now about 200,000 miles of road in the country, we 
 see that more than one-eighth of this entire mileage was, 
 during the space of a little over one year, absorbed or 
 combined in some manner. As an example of growth, we 
 might mention the Rock Island, which grew from 3,800 
 miles in 1901 to 15,000 miles about five years later. But the 
 really spectacular growth was that of the Union Pacific. 
 This road in 1906 actually controlled 25,000 miles of line 
 and through stock ownership Mr. Harriman had influence 
 over 30,000 miles besides. 
 
 This spirit of combination grew to be so strong and 
 seemed to be so permanent that for a time it appeared as 
 though the traffic of the country was definitely and for all 
 time to be divided between certain groups of roads which 
 seemed to have understandings with each other. But the 
 attitude of the public largely counteracted this influence 
 and culminated in the Sherman Anti-Trust Act. The con- 
 solidations which had been built up, began about 1910 to 
 go to pieces. The Gould group, the result of an ambitious 
 but weakly constructed plan for an ocean-to-ocean system, 
 fell apart because of lack of strength. The Rock Island 
 came to grief, and its holding companies were dissolved 
 because of internal corruption. The Union Pacific and the 
 New England monopolies were dissolved by mandate of 
 the Department of Justice of the United States. It is not 
 possible to elaborate within the scope of this pamphlet, but 
 the steps by which these various systems grew into being 
 and into a position of power and then into a period of de- 
 cline are most interesting. The story of the rise and fall 
 of the New England monopoly; the working out of the 
 problems of the Pennsylvania and New York Central in 
 furthering traffic amity between themselves and their com- 
 petitors in their territory; the tremendous expansion of 
 the Union Pacific system under E. H. Harriman, its final 
 dissolution and its subsequent development under saner 
 methods, these are all most interesting stories but involve 
 too much detail to be set down here. 
 
 10 
 
Federal Securities Corporation 
 
 Msi]niipiLiilsi{tn©ini 
 
 There are, however, some phases of the history of the 
 railroads up to the period of Government control, which 
 it seems necessary to dwell on a little further. At one 
 time or another various roads have been made a football 
 of by the men who were running them for their own per- 
 sonal gains. One of the best examples of this practice was 
 the manipulation of the Rock Island lines by the Moore- 
 Reid interests. 
 
 The Rock Island originally was one of the fine prop- 
 erties of the country and had paid dividends on its stock 
 from about the time of the Civil War up to the time 
 when it was taken over by the Moore-Reid interests in 1902. 
 At that time they purchased a large amount of the out- 
 standing stock of the Chicago, Rock Island & Pacific Rail- 
 zuay Company in the open market in order to gain control. 
 Their idea was to manipulate this property in such a way 
 that they could make money out of it for an inside ring, 
 and still to maintain control of the property without ac- 
 tually having any large amount of investment in it. The 
 capital stock of the Raihvay Company, which was the oper- 
 ating company, amounting to about $75,000,000, was 
 pledged as security for a like amount of Collateral Trust 
 Bonds of the Chicago, Rock Island & Pacific Railroad 
 Company, which was organized to own the stock of the 
 Railway company. Capitalized at $145,000,000, it in turn 
 was owned through exchange of shares by the Rock Island 
 Company, chartered with a capital stock of $139,000,000. 
 Thus all three of the companies were bound together and 
 by marketing the Collateral Trust Bonds of the Railroad 
 company, the promoters reimbursed themselves for their 
 outlay in buying up the stock of the operating or Railway 
 company. The control of the whole structure lay in a 
 small amount of the Rock Island Company Preferred Stock, 
 owned by the Moore-Reid interests. 
 
 The road about 4,000 miles long at the time of acquisi- 
 tion was immediately expanded to about 15,000 miles and in 
 the effort to pay dividends was allowed to go to pieces, with 
 
 the result that in 1914 the system went into receivership. 
 
 LIBRARY 
 
 UNIVERSITY jOF ILLINOIS 
 URBANA 
 
Railroads From the Investor’s Viewpoint 
 
 Over-capitalized, over-expanded, highly manipulated and 
 under-maintained, there could have been no other result. 
 The Preferred Stock of the Rock Island Company, which 
 had been originally quoted around 86 had by 1908 reached 
 about 20 and six years later was quoted 1^. 
 
 There were numerous other instances of this same char- 
 acter in the affairs of other lines of the country. At various 
 periods speculation in the railroad shares was tremendous. 
 For example, in 1901 the capital stock of the Union Pacific 
 was sold twenty-one times over, of the St. Paul twenty-two 
 times over, of the Atchison twelve times, of the Erie and 
 the Wabash ten times, while in one single day in April, 
 1901, 652,000 shares of the Union Pacific changed hands in a 
 single session of the Stock Exchange. This represents 
 more than half of the entire capital stock of this company. 
 Again, in 1906, there was another frenzied period of the 
 same character, when during the year 43,000,000 shares of 
 Reading Common Stock changed hands. In fact, the capital 
 stock of the Reading in the past has always been a specu- 
 lative football. In 1904 its Common stock was handled 
 seven and one-half times over, in 1905 sixteen times, and 
 in 1906 (the period mentioned above) thirty-one times. It 
 is reported that during the third week of April, 1909, the 
 sales of its Common stock equaled one-half of the total 
 outstanding. 
 
 Various methods have been used by insiders at different 
 times with the purpose of manipulating markets so as to 
 make profits for themselves. Prior to the jurisdiction of 
 the Interstate Commerce Commission, it was always pos- 
 sible to defer the customary outlays for maintenance, etc., 
 for the purpose of continuing to pay dividends. Orders to 
 get traffic at any cost would be sent out, thereby increasing 
 the revenues of the company without putting the proper 
 amount back into the road. 
 
 Such tactics were charged against the Atchison in 1890 
 at the time when Baring Brothers were heavily inter- 
 ested in this property. In the early 90’s the B. & O. also 
 was said to have been guilty of deliberate falsifications of 
 accounts by insiders in order to create a market to unload 
 securities at high prices. In the case of the B. & O., for 
 
 12 
 
Federal Securities Corporation 
 
 example, during seven years dividends amounting to about 
 $6, 000, OCX) had been paid out, whereas a later accounting 
 showed that probably less than $1,000,000 had actually been 
 earned. 
 
 We are all familiar with the various pools that have at 
 one time or another operated in railroad securities. The 
 famous Keene pool of 1902-3, which was an attempt to pur- 
 chase a large block of stock of the Southern Pacific and by 
 control of the Directorate to force the management to 
 stop its policy of putting money back into the property so 
 that higher earnings would be reported and thus afiford the 
 pool the opportunity of unloading the stock on the public 
 at increased prices. 
 
 There was also the famous Gates pool, which at the 
 time when the L. & N. was about to issue $5,000,000 of new 
 stock, purchased' a majority of the outstanding shares of 
 this road and forced the Morgan interests to repurchase 
 this stock from them at a handsome profit. The practice of 
 padding or starving income statements has in the past been 
 one of the most prolific sources of profit to insiders in the 
 case of speculatively managed railroads, but under the 
 supervision of the Interstate Commerce Commission such 
 manipulation is now practically impossible. 
 
 Stock Watermg 
 
 Another practice which has at various times in the past 
 been prevalent, has been that of stock watering or the 
 issuance of stock for purely speculative purposes. For ex- 
 ample, the Erie between 1868 and 1872 had its capital stock 
 increased from $17,000,CX)0 to $78,000,000 primarily for 
 manipulation in the market. It has been said that convert- 
 ible bonds were put out by this road during these years to 
 such an extent that they were limited only by the capacity 
 of the printing presses. 
 
 We have already reviewed the situation of the Chicago, 
 Rock Island & Pacific Railway Company and its two hold- 
 ing companies, showing the tremendous inflation of the 
 capital account. The total capitalization of these three 
 
 13 
 
Railroads From the Investor’s Viewpoint 
 
 companies amounted to $1,500,000,000 which was controlled 
 by a little more than $5,000,000 of Preferred Stock. 
 
 Unscrupulous or designing managers of properties have 
 been able so to manipulate the affairs of their roads in 
 the past that the burden on the property in the way of 
 interest charges became absolutely impossible. The New 
 Haven, which we have mentioned before, is a case in 
 point. Within nine years to 1912, the outstanding securi- 
 ties of this property were increased from $93,000,000 to 
 $417,000,000, although only fifty miles of line were added 
 during that time. New issues of stock and bonds during 
 this period brought in in cash $340,000,000, most of which 
 was invested in properties outside the sphere of the rail- 
 road’s own activities — namely, in trolley companies, steam- 
 ship lines, electric light and power plants, docks and water 
 frontage. This situation was brought about by an absolute 
 disregard of the interests of the public or of the share- 
 holders of the road, and was largely planned for the benefit 
 of certain insiders. So bad did this situation finally become 
 that the Federal authorities were in 1914 forced to inter- 
 vene and order the dissolution of these various properties. 
 
 The most famous instance of all, which illustrates prob- 
 ably every abuse possible, is the manipulation by E. H. 
 Harriman of the Chicago & Alton Railroad. For years this 
 property had been considered one of the finest and best 
 managed in the country. Over a space of about seven years 
 beginning in 1898, the capitalization of this road was ex- 
 panded from about $34,000,000 to about $115,000,000, 
 although according to the accounts of the road only about 
 $18,000,000 had been expended in improvements and addi- 
 tions to the property. It seems, therefore, that securities 
 totaling over $62,000,000 were sold to the public during 
 that time without one dollar of consideration. This amount 
 added practically $66,000 a mile to the capitalization of the 
 road and burdened it with a debt from which it has never 
 recovered. The road was passed from syndicate to syndi- 
 cate, in the course of each step of which insiders made a 
 profit, and it was finally sold to the Rock Island, who could 
 ill afford to handle a property so tremendously burdened. 
 
 14 
 
Federal Securities Corporation 
 
 In the past, methods which were permitted in keeping* 
 accounts afforded very favorable opportunities for increases 
 in capitalization and for other manipulations by insiders. 
 Happily not all of the railroads in the country have fol- 
 lowed these practices. Many have liberally utilized their 
 surplus earnings to build up their properties. The Pennsyl- 
 vania for example for years followed the “dollar for dollar” 
 policy of spending literally one-half of its income for 
 maintenance, upkeep and betterments. During the period 
 between 1887 and 1911, the Pennsylvania put back into its 
 lines east of Pittsburg, $262,000,000 out of earnings. 
 
 The Chicago & Northwestern during twenty years up 
 to 1913 set aside $77,000,000 out of its net income of about 
 $200,000,000 and put it either into improvements or carried 
 it over to surplus. In the South, the Louisville & Nashville 
 took $18,000,000 out of its earnings in eight years prior to 
 1907 to put back into its property. This amount was equal 
 to over 30% on its capital stock while the total surplus 
 built up to 1912 was equal to 90% of the capital stock. 
 
 The roads which have followed this character of policy, 
 keeping themselves clear of the evils of over-capitalization 
 and manipulation, have continued to thrive and to grow, 
 and, fortunately, as time has gone along fewer and fewer 
 roads have practiced these evils. Those that have, have 
 learned through bitter experience that no road can live 
 and grow under such practices and that only with conserva- 
 tive capitalization and sound, sane operating methods may 
 a road build for itself a strong place among the carriers of 
 the country. 
 
 Roads, seemingly, have had to learn these things by 
 experience, just like individuals, but when the lesson has 
 once been learned, its good effects have usually been lasting. 
 Some of the strongest properties in the country today are 
 those that in the past have been guilty of the worst prac- 
 tices and even become involved in the most serious diffi- 
 culties. We must not take these records too seriously in 
 considering the railroads of today, because such practices 
 are next to impossible under the jurisdiction of the Inter- 
 state Commerce Commission. However, since we are re- 
 
 15 
 
Railroads From the Investor’s Viewpoint 
 
 viewing the past history of the railroads of the United 
 States, we must face the facts as they are, even while we 
 realize that in most cases the lurid spots of the past are the 
 very foundation of the strength of the present. Many a 
 road is prosperous and thriving today only because diffi- 
 culty in the past (and even receivership and foreclosure) 
 has forced the managers to a basis of sound financing and 
 efficient operation. It is only when roads have practiced 
 bad methods that they have become involved in trouble ; 
 but since so many of them have had to learn their lesson, 
 a brief survey of the financial difficulties that they have 
 gone through must be considered if we are to get a correct 
 idea of the situation. 
 
 At one time or another practically one-half of the rail- 
 roads of the country have been in receivership. That is a 
 startling statement. Receiverships and re-organizations in 
 the railroads of the United States have been brought on 
 usually by one or more of the evils which have been dis- 
 cussed above. 
 
 The aggregate number of receiverships and the aggre- 
 gate mileage involved reach astounding totals. Certain 
 figures that we have seen show that since 1875 over 
 $8,000,000,000 of stocks and bonds of the railroad companies 
 of the United States have gone through receivership 
 manipulation, while over $7,000,000,000 have actually come 
 under foreclosure sale. This is a total of over $15,000,000,000 
 which is almost equal to the total aggregate valuation of all 
 the railroads allowed by the Interstate Commerce Com- 
 mission in their recent decision. (This allowed value was 
 about $18,000,000,000.) As the present total capitalization 
 in stocks and bonds of all the railroads in the United States 
 is something over $16,000,000,000, it will be seen that there 
 has been in receivership during the past 40 years an amount 
 of securities practically equal to the present capitalization 
 of the railroads and almost equal to their present physical 
 value. Moreover the mileage which has been aflected by 
 foreclosure and receivership since 1875 is, roughly speaking. 
 
 16 
 
Federal Securities Corporation 
 
 about equal to the present total mileage of the United 
 States. 
 
 Overexpansion — In the early days of railroad con- 
 struction, both before and after the Civil War, vv^hen Con- 
 gress and the State legislatures 'were recklessly voting 
 land and money appropriations for railroad aid and con- 
 struction, expansion was quite a natural result. In many 
 cases where land grants were given and subsidies voted, 
 the promoters were unscrupulous men who did not stop to 
 consider whether the population of a district made a rail- 
 road a necessity ; their only idea was to get the line con- 
 structed that they might gain the benefit of the appropria- 
 tions and of the land grants. This was true in the case of 
 the Northern Pacific, which under Jay Cook, expanded too 
 rapidly in a sparsely settled territory and in 1873 came to 
 grief. This was the trouble also with the Atchison, Topeka 
 & Santa Fe, which was forced into receivership in 1887 and 
 again went to pieces in 1893. In 1893 also, the Northern 
 Pacific was forced into its second receivership largely be- 
 cause of over-expansion in branch lines which were un- 
 profitable because they ran into unsettled territory and 
 ended nowhere. The Atchison, in 1871 had only 471 miles 
 of line, but by 1888 had expanded to 7,000 miles, 2,700 of 
 which had been constructed or acquired in two years in an 
 ambitious attempt to reach Chicago, the Pacific Coast, and 
 the Gulf of Mexico at one and the same time to make a 
 trans-continental railroad out of a local line. 
 
 Overcapitalization — Over-expansion, however, was not 
 the only factor that brought grief to the roads that we 
 have mentioned. In all of these cases, and in practically 
 each one where over-expansion has had its efifect, a sec- 
 ond influence has operated to cause receivership and re- 
 organization. This is overcapitalization. We have seen 
 how this evil brought ruin to the Rock Island system and 
 we have briefly reviewed the tremendous overcapitaliza- 
 tion of the Chicago & Alton within the space of a very 
 few years, which brought this splendid property to a condi- 
 tion of weakness from which it has never recovered. We 
 all are familiar with the receivership of the Cincinnati, 
 
 17 
 
Railroads From the Investor’s Viewpoint 
 
 Hamilton & Dayton in recent years, but we may not all 
 know that the difficulties of this road were brought on 
 l^ecause in two years the bonded indebtedness of the com- 
 pany was piled up from $12,000,000 to $48,000,000, while its 
 floating debt, which at the beginning of that two year 
 period was almost nothing, grew in the end to about 
 $ 10 , 000 , 000 . 
 
 In overcapitalization, of course, it is not so much the 
 excessive amount of Preferred or Common stock which 
 brings on trouble, as it is an overloading of bonds, which 
 means an overloading of fixed charges. Weak roads like 
 the Wabash, for example, have had almost no chance to 
 get into a position of strength because of the fact that they 
 were so loaded with fixed charges that no margin of surplus 
 was left for development or upkeep of the property. The 
 Erie, which is one of the classics in the history of receiver- 
 ships of railroads in the United States, has come in and 
 gone out of receivership and foreclosure sale more times 
 than any other road in the country, largely because the 
 men who were in power were robbing the road by piling 
 up indebtedness, usually in the form of collateral trust 
 bonds, with little or no security back of them. This road 
 again and again Avas guilty of the practice of issuing new 
 oblig'ations in order to provide funds to take care of the 
 interest on the old ones; so that in 1857, in 1873, in 1884, 
 and a fourth time in 1893, the road went into receivers’ 
 hands, and in 1908 escaped a fifth time only by the slightest 
 possible kind of margin. Other instances in more recent 
 times are the Missouri Pacific and the Frisco, which were 
 forced into receivership because of overcapitalization and 
 of increasing fixed obligations until they were more than 
 the earnings of the roads could possibly bear. 
 
 Fraud and Deception — The third cause for receiver- 
 ship, a cause which goes hand in hand with the other 
 two which we have just mentioned, is fraud and deception, 
 coupled usually with speculation. In the case of the 
 Atchison receivership, for example, income had been over- 
 stated for years. The Baltimore & Ohio, too, was forced 
 to suffer through the practice of its owners in falsifying 
 
 18 
 
Federal Securities Corporation 
 
 income statements; while the real situation in connection 
 with the Chicago & Alton during the time of the Harriman 
 control was not given out to the public and it would seem 
 was not even known to the Rock Island at the time that 
 the latter purchased control. 
 
 It is said that deception had its part in almost every rail- 
 road that was ever owned or controlled by Jay Gould. The 
 troubles of the Gould roads, of course, have been many. 
 Practically every one of them except the Denver & Rio 
 Grande, has gone into receivership, and even this road is at 
 present in a very precarious position. Starting from the 
 West, these Gould roads include the Western Pacific, the 
 Missouri Pacific, the WMbash, the Wabash Pittsburg Term- 
 inal, and the Wheeling and Lake Erie, all of which have 
 known receivership. We all know of the ambitious attempt 
 which he made to combine these parts into a trans-conti- 
 nental system running from ocean to ocean, but which went 
 to pieces in 1893. 
 
 P(Birn©(dli ©{p D©pir©§in©im 
 
 There are certain outstanding periods in the history of 
 the railroads. First, there is the panic of 1873 to 1877, 
 before the modern railroad was evolved, when over ten per 
 cent of the mileage of the country went into receivership, 
 and one-fourth of the total bonded indebtedness defaulted 
 on its interest. Second, in the panic year of 1883, and 
 over a period lasting until 1887, another large group of 
 roads went into receivership. At this time eleven thousand 
 miles of line were taken over by the receivers. Third, the 
 panic years of 1893 to 1895, when the number and extent 
 of receiverships broke all records. Statistics show that on 
 June 30, 1894, 192 companies were in the hands of receivers, 
 while the total mileage involved by the companies was in 
 excess of 40,000 miles. The total amount of capitalization — 
 namely, of stocks and bonds — of these roads aggregated 
 about $2,500,000,000, or about one-quarter of the total rail- 
 road capitalization at that time. Fourth, in 1907, a period 
 of financial distress, 18,000 miles of road went into receiver- 
 Gii]). Fifth, we all remember the time of apprehension of 
 
 19 
 
Railroads From the Investor’s Viewpoint 
 
 1913 and 1914, when about $600,000,000 of notes and bonds 
 were involved in financial difficulties. 
 
 Of course, in practically every one of these cases the 
 weakness in the road was there before the financial strin- 
 gency came on. A period of financial distress merely 
 crystallized the situation and hastened a result which in 
 many cases undoubtedly would have followed in regular 
 course. In all of these situations, the primary cause of 
 failure was inability of the railroads to pay their fixed 
 charges out of earnings. 
 
 Similarly, in reorganization, the problem has been to 
 reduce the funded indebtedness either in par value amount 
 or in interest rate, so that the total obligations of the com- 
 pany would be within its earning power. This has not 
 always been done in receivership. In the first Atchison 
 receivership, for example, and also in the first Northern 
 Pacific receivership, the amount of funded indebtedness was 
 not cut down nor were the interest charges reduced. As a 
 matter of fact, in the Northern Pacific case, the amount 
 was increased instead. The result was that both of these 
 roads again went into receivership, when the financial de- 
 pression of 1893-1895 came upon the country. 
 
 Most of the reorganizations, however, have followed the 
 basic principle of reducing the fixed charges. Some have 
 accomplished the purpose by drastically reducing the 
 amount of funded indebtedness outstanding per mile. 
 Others have not reduced the par value amount of funded 
 indebtedness but have reduced the interest rate, as in the 
 case of the second Northern Pacific receivership, which cut 
 the interest charges in two without any decrease in the 
 funded indebtedness. Others again have brought about the 
 same result not by reducing the interest charges, but by 
 making a part of the interest charges payable only if earned. 
 In the second Atchison reorganization this was done and 
 part of the bonds which were re-issued to the holders of 
 the old obligation were made Adjustment Income 4s, the 
 interest on which was payable only if earned. 
 
 20 
 
Federal Securities Corporation 
 
 Sftiroinig M©a(dl§ 
 
 We have laid a good deal of stress on the various diffi- 
 culties which railroad operation has encountered in the 
 past, but we wish also to emphasize the fact that these 
 weaknesses have not been prevalent among the roads as a 
 class. It is said that the annals of a peaceful nation are 
 short. Similarly we can sum up in a few words the story of 
 those roads which were started under sane principles of 
 finance and operation, have continued under the same prin- 
 ciples and today remain secure properties. The weak roads, 
 poorly financed, overexpanded and subject to manipulation, 
 have been up and down and much must be said to cover 
 their varied history. The strong roads on the other hand 
 do not figure in this history, but their story is one of gradual 
 growth in mileage and prosperity. They have expanded 
 slowly and at the right times. As the territory has grown 
 and the industries within it have thrived, the roads have 
 been expanded and have prospered. They have put money 
 back into the property at the right times, so that their road 
 bed and equipment has been properly maintained. Again 
 they have not been guilty of overexpansion. 
 
 We all are familiar with the names of these roads. 
 There are outstanding systems of this character in the 
 East, in the West and in the South. In the East we have 
 the New York Central, which is merely an end to end 
 consolidation of a great number of roads which were built 
 by various parties. This property always has and does 
 today enjoy a splendid reputation. Dividends have been 
 paid constantly since 1870. The Lake Shore which is part 
 of this system is considered one of the finest pieces of rail- 
 road in the country. The Michigan Central is also a 
 splendid property and has paid continuous dividends over 
 a long period of years. The Pennsylvania is an example 
 of a road which has grown and expanded under conservative 
 principles of capitalization as the territory and as industries 
 within the territory have grown. We all know that this 
 property has paid dividends continually since 1856, and 
 that the management, decade after decade, has stood out 
 for their principle of maintaining the efficiency of the prop- 
 
 21 
 
Railroads From the Investor’s Viewpoint 
 
 erty regardless of stock market or other influences. The 
 Norfolk & Western, which is practically a Pennsylvania 
 property, as the latter owns over $38,000,000 of its common 
 stock, is also a road of this same class, which enjoys a 
 splendid reputation. 
 
 In the Middle West and the West, one of the outstanding 
 properties is the Chicago, Burlington and Quincy. This 
 road begun as a branch line between Chicago and Aurora in 
 1849, has grown gradually and has built feeders in its terri- 
 tory as the population has grown. Today this road is called 
 the “mother of railroad presidents” because it has produced 
 so many, and enjoys the reputation of being one of the flnest 
 pieces of property in the country. Its principle of expansion 
 was to build new lines in the territory only as the popula- 
 tion warranted. The Great Northern on the other hand, 
 which with the Northern Paciflc jointly controls the C. B. 
 & O., under Mr. Hill adopted a little different method of 
 expansion. Mr. Hill’s policy was to build a road in a 
 territory which he was sure would be productive, and then 
 pull the population in after him. We all know what a 
 tremendous success Mr. Hill made of a defunct railroad 
 company which he and his associates purchased in 1878 
 and which he with his foresight and judgment expanded 
 carefully and conservatively into one of the splendid 
 systems of the country. In point of capitalization per mile, 
 the Great Northern and C. B. & O. are among the most 
 conservative in the country. The Chicago & North- 
 western is another road whose affairs have been conducted 
 under a sane conservative policy, which has never since 
 very early times been in difficulties. Dividends have been 
 paid by this company almost continually since 1864; to date 
 over $70,000,000 have been paid in preferred dividends to 
 stockholders and over $120,000,000 in common dividends. 
 The Chicago, Milwaukee & St. Paul also enjoyed a similar 
 reputation for a great many years, but more recently this 
 property has suffered from one reason or another. Its 
 principles of capitalization are not as conservative as the 
 other roads which we have mentioned, and it has been said 
 that the building of its Puget Sound extension was an ex- 
 
 22 
 
Federal Securities Corporation 
 
 pansion which was not warranted at the time. In any case 
 this road which for years has been a strong one, is today 
 struggling to keep its place. 
 
 In the South also there are two splendid properties. 
 The Illinois Central, the outstanding one of these, has un- 
 interruptedly paid dividends since 1863 and the Louisville 
 & Nashville with the exception of eight years in its early 
 history and five years in the 90’s, has also paid dividends 
 since 1864. We have previously mentioned in this pamphlet 
 how these two roads have maintained the efficiency of. their 
 properties by reinvesting earnings in road bed and equip- 
 ment. 
 
 There are other roads which today occupy a very strong 
 position into which they have grown only after they have 
 encountered difficulties in the past. The Norfolk & Western 
 is really a road of this character, as it experienced receiver- 
 ship early in its history. We have previously mentioned 
 the Northern Pacific, Atchison, Union Pacific and South- 
 ern Pacific, all four of which are without question among 
 the outstanding roads of the country. Under Mr. Harri- 
 man, the Union and Southern Pacific systems, which 
 were practically bankrupt at the time he took them over, 
 were developed into wonderful properties physically by the 
 investment of millions in road bed and equipment. Today 
 the Union Pacific is so prosperous that it has been said it 
 could stop running its trains entirely and still continue to 
 pay the interest on its funded debt out of the earnings from 
 outside investments. We can multiply details of this char- 
 acter, but in a treatise of this kind it is possible only to draw 
 outlines of strength and weakness. The past history of any 
 of these properties must be studied in detail really to 
 understand the situation in regard to each company. 
 
 23 
 
Railroads From the Investor’s Viewpoint 
 
 JAMES J. HILL 
 
 24 
 
Federal Securities Corporation 
 
 II 
 
 EECEMT HISTORY 
 Siftuaaftnomi Dimifmg ftEe W@irM War 
 
 This brings our story down to the time that the United 
 States entered the War. We are all more or less familiar 
 with the problems which the railroads were asked to face at 
 that time. We know of the labor situation and the increas- 
 ing scale of prices which confronted railroads in 1917 as a 
 result of the world war in Europe. Traffic, of course, had 
 been tremendous during 1916, which was one of the most 
 prosperous years in the annals of railroad history of the 
 United States. This prosperity continued during the early 
 part of 1917, but the situation changed at the time of our 
 entr}^ into the war. 
 
 Notwithstanding the large volume of traffic which the 
 roads were carrying, the railroad situation (due to the rising 
 costs of labor, of material and of money) in the Spring of 
 1917 became acute. There was a large shortage of equip- 
 ment of all kinds due to the heavy traffic, as well as an 
 insufficient and inefficient labor supply at high costs. As 
 a result, the margin of net earnings showed a declining 
 tendency, and there appeared to be an impending demoral- 
 ization of railroad credit. In addition, the political attitude 
 toward the railroads was most uncertain, a condition that 
 added further perplexities to the situation. The net result 
 was that during the nine months of war preceding Govern- 
 ment operation of the railroads, the situation was uncertain 
 and critical. 
 
 It was recognized by the Government, the railroad com- 
 panies, and the public at large that, upon our entrance into 
 the war, the interests of the railroad companies should be 
 made subservient to the general welfare of the country and 
 to the plan of moving all things toward a favorable termin- 
 ation of the war as early as possible. The companies volun- 
 tarily surrendered their individual initiative and independ- 
 ence because it seemed necessary as a war measure, but in 
 
 25 
 
Railroads From the Investor’s Viewpoint 
 
 so doing floundered about in a sea of irresponsible and 
 inexperienced centralized direction and were given little or 
 no assurance of financial or corporate independence. We all 
 know that under this system the difficulties of operation 
 multiplied to an extent that made government operation not 
 only a military necessity for the country, but a financial 
 necessity for the roads. It is said that private operation 
 under military necessity could hardly have been continued 
 without at least financial demoralization of the roads and 
 perhaps general bankruptcy. True, it was recognized that 
 the taking over of the railroads of the country by the Gov- 
 ernment would be attended with certain serious evils. It 
 was recognized that it might result in laxity of executive 
 direction, in inefficiency of operation on the part of labor, 
 in increased costs of operation with decreasing earnings, as 
 well as in deterioration of equipment and road bed. All of 
 these things we know actually did result from government 
 control, and yet it was probably the only course which could 
 have been pursued from the standpoint of the good of the 
 country and the good of the roads as a whole. 
 
 Fadairal ©p©ira{Ln©im 
 
 The roads were taken over by the government on Jan- 
 uary 1, 1918. They were rented by the government at a 
 rental which amounted to the average net operating earnings 
 of each road for the three years preceding government con- 
 trol. The year 1915 was not a very good year for the roads ; 
 1916, on the other hand, was one of the best years they had 
 ever had; 1917 was an average year. An average of the net 
 earnings of all three years was considered to be a very fair 
 allowance for the roads during the period of Government 
 control. A contract to this effect was made by the Govern- 
 ment with each railroad separately and individually. There 
 were some cases where this general arrangement seemed to 
 be unfair to the roads, as in the case of the Western Pacific, 
 which had just gone through receivership and had had prac- 
 tically no net earnings during the three years previous to 
 government control. In situations like this, where the 
 railroad objected to the plan of Government rental, the cases 
 were taken up by a referee and decided individually. 
 
 26 
 
Federal Securities Corporation 
 
 The period during government control can probably be 
 passed over very quickly because the results of such opera- 
 tion are more or less fresh in our minds. It was necessary 
 for the government, of course, to have absolute control of 
 traffic, to give preference to shipment of troops and of war 
 materials, and to make the interest of shippers secondary. 
 Traffic was diverted from customary channels — certain 
 roads were asked to take care of an unusually heavy density 
 of traffic ; on others the traffic was lighter than under 
 ordinary conditions. This could not but result in ineffi- 
 ciencies of operation by reason of congestion of traffic in 
 certain spots and thinness in certain others. One unfor- 
 tunate result was that because a road had no responsibility, 
 it was not as particular as formerly in getting foreign cars 
 out of its hands and back to the owning railroad. 
 
 The roads were under-equipped, and the equipment 
 under-maintained. When the railroads were taken over, the 
 the freight cars and other equipment generally were in poor 
 condition, because of the universal labor shortage. Because 
 of the car-pooling arrangement under government control, 
 there was little incentive for operating officials to keep their 
 cars in repair since only a small percentage of each com- 
 pany’s cars would remain on its own line. This situation 
 could not but contribute to a general freight-car and 
 passenger-car deterioration, especially since, under pres- 
 sure, cars and locomotives were often kept on the rails 
 when they should have been in the repair shops. More- 
 over, during the twenty-six months of government control 
 only 100,000 new freight cars and 1900 new locomotives 
 were ordered and put into use. Prior to Federal control 
 the average production of freight cars each twelve months 
 had been 100,000 so that there was a greater shortage of 
 car equipment at the end of Federal control than at the 
 ])eginning. 
 
 Moreover, all costs, as everyone no doubt remembers, 
 including labor and materials, were increased tremendously 
 during the period of the war, whereas freight rates were 
 increased almost not at all until the war was practically 
 over. The total rental which it was necessary for the 
 
 27 
 
Railroads From the Investor’s Viewpoint 
 
 government to pay in each year amounted to about $950,- 
 000,000. In 1919, when the net operating income of the 
 railroads was less than $550,000,000, the loss to the govern- 
 ment in operating the roads was over $400,000,000. The 
 final result according to the report of Director General 
 Hines made to President Wilson on February 28th, 1920, 
 was that this was an excess of operating expenses and 
 rentals over operating revenue for 26 months amounting 
 to $715,500,000. We mention this merely to show the 
 tremendous increases in labor and operating costs to the 
 railroad companies without corresponding increases in 
 rates. 
 
 The roads were in government hands for twenty-six 
 months. On March 1, 1920, at the time they were turned 
 back to private ownership. Director General Hines of the 
 Railroad Administration issued a statement in which he 
 briefly analyzed the operation under government control. 
 He said he knew the government had been severely criticized 
 because of the deficit which had been incurred, but he 
 pointed out that the cost of transportation had to be paid 
 in one way or another, and that it was exactly the same 
 whether the money was taken out of the people in the form 
 of taxes or in the form of increased freight rates. As it was, 
 the medium of taxation was chosen because of the unsettling 
 effect large increases in freight rates would have had on bus- 
 iness generally. It was necessary that all business should 
 go forward as smoothly as possible because of the great 
 need for manufactured articles of all kinds during and 
 because of the war. It did not seem politic to increase 
 freight rates ; but since the increased costs of labor and of 
 materials increased costs of operation to the point of a 
 deficit, it became necessary to make up the deficit in the 
 form of taxes. 
 
 In justification of his position. Director Hines drew an 
 analogy between the history of the operation of the railroads 
 during the war and the history of the operation of the 
 United States Steel Corporation. The Steel Company’s 
 operating costs from 1914 to 1918 increased 150%, whereas 
 the operating costs of the railroads increased 102%. The 
 
 28 
 
Federal Securities Corporation 
 
 cost per unit, moreover, of the Steel Company’s product 
 increased 61%, whereas the railroads’ cost per unit of traffic 
 increased 60%. 
 
 Mr. Hines further pointed out that certain situations, 
 over which he had no control, greatly increased the cost of 
 transportation for the government. For example, the 
 increase in rates granted in June of 1918 should have been 
 granted long before that time. If it had been granted in 
 January instead, the net advantage to the roads would have 
 been about $494,000,000. Again, we all remember the coal 
 strike, which took place in the fall of 1919, the results of 
 which were not chargeable to the Government, but which 
 cost the Government $114,000,000 net in operating the car- 
 riers. Further than this, the deficit of about $400,000,000, 
 which occurred in operating the railroads in 1919, was in 
 very large part occasioned by the extraordinary slump in 
 freight business in the first six months of that year. Mr. 
 Hines estimated the deficit in these six months at $292,500,- 
 000 as against a total deficit for the year of about $400,000,- 
 000. The deficit during the first six months is not properly 
 chargeable to government operation, because the war was 
 over and the slump in traffic would have been there just the 
 same, whether the roads themselves or the government were 
 operating the carriers. 
 
 All told, while the operation of the roads by the govern- 
 ment was a costly procedure, it would seem that under the 
 circumstances results were as good as could have been 
 expected. Under war time conditions, it was necessary 
 that the public generally should pay for the cost of forced 
 transportation under trying conditions, and the method 
 chosen to make this payment was probably just as good 
 as, if not ])etter than, any other that was possible. 
 
 It is very interesting to study the results of the various 
 railroad companies during the twenty-six months of govern- 
 ment control, because it is a pertinent indication of the 
 
 29 
 
Railroads From the Investor’s Viewpoint 
 
 strength and earning capacity of the various properties. A 
 road must not be judged, of course, on this shovcing alone, 
 because, in the case of many, influences over which the 
 managers of the property had no control tended toward a 
 poor showing. However, those roads which in spite of 
 generally increased costs and in spite of inadequate in- 
 creases in freight rates were able to earn amounts equal to 
 or even exceeding the amounts of the government rental, 
 are clearly shown to be strong properties, at least during 
 the period of government control. 
 
 The fact that during 1918 and 1919 both the Atchison 
 and Union Pacific earned amounts greater than the govern- 
 ment rental is a most interesting commentary on the finan- 
 cial strength of these two systems. The Michigan Central 
 also is in this class, as well as the Nickel Plate, the Pere 
 Marquette, and the Big Four. The Oregon Short Line, 
 which is really part of the Union Pacific, also in both years 
 earned more than its guarantee. The Western Pacific, too, 
 falls into this class, probably only because it had just passed 
 through a receivership period of small earnings. 
 
 The Delaware, Lackawanna & Western, the Chesapeake 
 & Ohio, the Atlantic Coast Line, the Louisville & Nashville, 
 the Southern, the St. Louis & San Francisco, and the St. 
 Louis Southwestern, were among the roads which earned 
 more than their guarantee in one of the two years. The 
 Southern roads, generally, made a very good showing, be- 
 cause of the fact that the army camps were located in the 
 South occasioning large increase in traffic during those 
 years. The New York Central earned almost its guarantee 
 during both years but made a better showing in 1919 than 
 in 1918. The Norfolk & Western also made a good show- 
 ing in both years. The Chicago, Burlington & Quincy, the 
 Southern Pacific, the Northern Pacific, the Rock Island, 
 the Denver & Rio Grande, as well as the Kansas City 
 Southern and Texas & Pacific, fall into this same group of 
 roads which made a very good showing but fell short of 
 earning their guarantee during two years. 
 
 On the other hand, certain roads which one would ordin- 
 arily expect to make a better showing, did rather poorly. 
 
 30 
 
Federal Securities Corporation 
 
 The Illinois Central earned $12,900,000 in 1918, and only 
 $4,000,000 in 1919, as compared with the government guar- 
 antee of $16,000,000. The Great Northern earned about 
 $12,000,000 in both years, as compared with the government 
 guarantee of over $28,000,000. The Chicago & Northwestern 
 similarly earned about $12,000,000 each year as compared 
 with the rental of over $23,000,000. The Philadelphia & 
 Reading, which also is a strong road and should be classed 
 with the others just mentioned, earned $11,000,000 in 1918, 
 and only $5,000,000 in 1919, as compared with a guarantee 
 of over $17,000,000. It is not surprising, of course, that the 
 New England Roads did not do very well. The New Haven 
 with a standard return of about $17,000,000 earned $7,700,000 
 in 1918 and $6,900,000 in 1919. The Boston & Maine earned 
 $1,895,000 in 1918 and $3,577,000 in 1919 compared with a 
 rental of $9,832,000. The Boston and Albany earned about 
 half its guarantee, and the Maine Central showed a deficit 
 in both years. 
 
 The Delaware & Hudson and the Lehigh Valley, both 
 of which are anthracite roads and which might be expected 
 to make a good showing, did relatively quite poorly. The 
 Central of New Jersey, also an anthracite road made a fair 
 showing in 1918 with net earnings of $6,000,000 but in 1919 
 fell off with earnings of only $1,400,000 as compared with a 
 guarantee of over $9,000,000. The Pennsylvania Lines, both 
 East and West, did not show very well during the war. 
 The eastern lines were guaranteed $51,000,000 net, whereas 
 in 1918, the earnings were only about $19,900,000 and in 
 1919 a little over $8,000,000. The lines west of Pittsburg 
 showed $4,400,000 net in 1918, and $5,700,000 in 1919 com- 
 pared with a $14,000,000 guarantee. It is not surprising, of 
 course, that roads like the Wabash, the Chicago Great 
 Western, the Seaboard Air Line and the Missouri Pacific 
 should not do as well as some of the other roads, but the 
 poor showing of the Chicago, Milwaukee & St. Paul is 
 probably the greatest surprise of all. This road earned only 
 $3,900,000 in 1918, and $3,200,000 in 1919, as compared with 
 a gox'ernment guarantee of almost $27,900,000. 
 
 31 
 
Railroads From the Investor’s Viewpoint 
 
 Tla© Train!§p®rftafta®im Acit 
 
 On March 1, 1920, as we have previously mentioned, the 
 roads were turned back to their original owners. Mr. Wilson 
 in 1919 had promised that he would turn the roads over to 
 their owners on January 1, 1920. He frankly said that he 
 did not know how this was to be done, but he hoped that 
 certain legislation would be put through by Congress so 
 that this might be effected. A railroad bill had been in 
 preparation in the House, as a matter of fact, by Mr. John J. 
 Esch of Wisconsin and in the Senate by Mr. Cummins of 
 Iowa. 
 
 The problem resolved itself into effecting a compromise 
 between the two bills, and during the first week in February 
 the conferees came to an agreement. On February 18, the 
 bill was completed in conference and the legislation pro- 
 posed by the conferees was reported to the Senate and to 
 the House, passed and finally signed on February 28, 1920. 
 
 The bill as it is now in operation contains the following 
 provisions : 
 
 1. Freight and passenger rates so to be adjusted by the 
 Interstate Commerce Commission as to yield the carriers 
 for the two-year period beginning March 1, 1920, a return 
 of 5^4% on the aggregate value of railroad property, with 
 permission on the part of the Interstate Commerce Com- 
 mission to make this allowed return 6%, the additional ^ of 
 1% to be used for non-productive maintenance, betterments 
 and equipment. 
 
 2. One half of a railroad’s net operating income in 
 excess of 6% of its property value to be distributed equally 
 between the road’s reserve fund and the Federal Railroad 
 Contingent Fund, the latter to be administered by the Com- 
 mission for the assistance of weaker roads. 
 
 3. The government to continue its guarantee of stand- 
 ard return to all the roads for six months after the date of 
 resumption of private operation up to September 1, 1920 — 
 rates and fares as well as wages not to be reduced prior to 
 that date without the consent of the Interstate Commerce 
 Commission. 
 
 32 
 
Federal Securities Corporation 
 
 . 4. Permission to be granted to consolidate the railroads 
 of the country in accordance with a general consolidation 
 plan to be prepared by the Interstate Commerce Com- 
 mission. , 
 
 5. All labor disputes to be submitted to a permanent 
 Federal Board appointed by the President, to be composed 
 of nine members, three'-^representing the employees, three 
 representing the railroads, and three representing the public. 
 
 6. $300,000,000 to be appropriated as a revolving fund for 
 the purpose of making loans to the railroads and of paying 
 claims to them on account of disputes arising out of Federal 
 control, the railroads to pay interest on the money so loaned 
 at the rate of 6%. (The bill originally provided that this 
 was to be paid back in five years, but on June 5, 1920, by 
 amiendment the time was extended to fifteen years.) 
 
 It will be seen that by the provisions of this bill each 
 road was guaranteed for six months a return equal to that 
 which it received under government control. After Septem- 
 ber 1, 1920, the bill did not guarantee any return whatso- 
 ever. It merely authorized the Interstate Commerce Com- 
 mission to regulate rates and fares by geographical districts 
 in such a way as to yield 5)4% on the aggregate fair value 
 of all the railroad property investment in each district. 
 
 The Interstate Commerce Commission has divided the 
 country into four districts — the Eastern, the Southern, the 
 Mountain Pacific, and the Western districts. In a general 
 way the Eastern district includes the railroads north of the 
 Ohio River and east of the Mississippi River; the Southern 
 district includes those roads south of the Ohio River and 
 east of the ^lississippi ; the ATstern district is the area west 
 of the Mississip])i and east of an irregular line drawn through 
 what is called the “Denverpoints” ; while the Mountain 
 Pacific district includes those roads west of the Western 
 district to the Pacific C(;ast. Each of these districts con- 
 tains weak as well as strong roads, but the bill does 
 not mean that each road, strong or weak, is guaranteed 
 5)4% on its value, as determined by the Commission. It 
 means that rates should be S(j adjusted that the return will 
 
 33 
 
Railroads From the Investor’s Viewpoint 
 
 be 5^% on the aggregate property value of all the railroads 
 in each district. This would probably mean more than 
 5^% for the strong roads and less than that for the weak. 
 
 After 6% has been earned by a railroad upon its fair 
 value, without regard for other income, the excess over this 
 amount shall be divided between the railroad which earned 
 the excess and the Railroad Contingent Fund. This fund 
 is to be used either for making loans to the carriers or for 
 the purchase of equipment to be leased to the carriers. In 
 either case, the government is to receive from the railroad 
 6 % on the amount so invested. The railroads’ share of the 
 surplus above 6 % of the property value, is to be placed in a 
 Trust Fund for the purpose of building up a surplus for the 
 road until this fund equals 5% of the property value of any 
 particular carrier, after which the road is privileged to use 
 it for any purpose it desires. This fund may be used for 
 making up interest or dividends during those years when 
 the carriers’ earnings are less than the required amount. 
 
 Such was the situation when on March 1 the railroads 
 were turned over to their private owners. Under govern- 
 ment ownership, it is said that the railroad expenses in- 
 creased over $1,500,000,000 a year. Whatever the amount 
 was, the roads were left with a real legacy of enormously 
 increased expenses, with properties that were in poorer 
 shape than when they were turned over, and with less, and 
 in many cases much poorer, equipment. The railroads were 
 faced with the serious problem of meeting this situation of 
 poor condition of road l)ed and equipment with expenses 
 and labor costs constantly increasing. 
 
 The employees during the first six months of private 
 operation were negotiating for higher wages. On April 
 16, the first meeting of the Labor Board under the Trans- 
 portation Act was called and on July 20 this Board an- 
 nounced at Chicago that wage increases had been awarded, 
 which it was estimated at the time would add $600,000,000 
 to the operating expenses of the roads. \Vhile these nego- 
 tiations were going on, the roads themselves were nego- 
 
 34 
 
Federal Securities Corporation 
 
 tiating for increased rates and on May 24 hearings were 
 opened by the Interstate Commerce Commission. On July 
 29, the Interstate Commerce Commission granted the rail- 
 roads increases in freight and passenger rates, which it was 
 then estimated would yield about $1,500,000,000 additional 
 revenue per year to the carriers, the new rates to become 
 effective on August 26. Under the decision of the Commis- 
 sion the roads in the Eastern District were authorized to 
 increase their freight rates 40%, those in the Southern and 
 Mountain Pacific Districts 25%, and those in the Western 
 District 35%. The Commission also authorized the carriers 
 to advance passenger rates 20%, Pullman rates 50%, and 
 excess baggage and milk rates 20%. 
 
 The report of the Commission at the time these rate 
 increases were authorized is a very interesting document. 
 The problem which was presented to them was to fix rates 
 for the railroads in the different groups at such a figure that 
 for the two year period ending March 1, 1922, they would 
 yield at least 5^4% on the fair value of the aggregate 
 physical property of the roads in a given district. The first 
 thing to ascertain and establish, therefore, was the aggre- 
 gate value of the railway property of the carriers held for 
 and used in the service of transportation. The valuation 
 work of the railroads under the Interstate Commerce Com- 
 mission Act was still incomplete, but the work had pro- 
 gressed so far that the results were of great value in reach- 
 ing the determination which the Commission needed as a 
 basis. From the valuations which had been made and other 
 evidence which was submitted, as well as information 
 which the Commission had obtained, the Commission deter- 
 mined that the total value of the steam railway property 
 for their purpose was approximately $18,900,000,000, 
 divided as follows: 
 
 Eastern Group $ 8,800,000,000 
 
 Southern Group 2,000,000,000 
 
 Western and Mountain Pacific Group.. 8,100,000,000 
 
 $18,900,000,000 
 
 35 
 
Railroads From the Investor’s Viewpoint 
 
 The carriers themselves asked for rates which, capital- 
 ized on the basis of a 6% return, would make the value of 
 the properties in excess of $20,500,000,000 and they actually 
 carried the cost of road and equipment on their books at a 
 figure in excess of $20,000,000,000. 
 
 The Eastern carriers asked that they be permitted to 
 earn an annual net railway operating income of $559,409,933 
 which would represent 6% on the book cost of $9,323,498,- 
 898. The figures for 1919 showed that the rates in effect at 
 the time the investigation was going on would fall short 
 $500,000,000 annually of earning the net railway operating 
 income to which they claimed they were entitled. The 
 Commission recognized that not only had there been a 
 sharp decline in railway operating income during the 
 previous three or four years, but also that the operating 
 ratio had increased at “a rate that causes serious concern.” 
 For the five years prior to 1916 the operating ratio of the 
 Eastern carriers was 71%. This had increased to 75% in 
 1917, to almost 86% in 1918, to 88^% in 1919 and 97.68% 
 in the first four months of 1920. This means that during 
 the first four months of 1920, after paying operating 
 expenses there was left only 2.32 cents out of each dollar 
 for the payment of interest on funded debt, taxes and other 
 items such as rents, hire of equipment, leases, etc. ; in short 
 for the payment of fixed charges. During the six year 
 period beginning with 1912, it took approximately 28.79 
 cents out of every dollar of operating revenue to pay these 
 fixed charges, so that the need of the Eastern carriers for 
 an increase in rates was immediately apparent. In addition 
 to the above, it will be recalled that in July, 1920, the Labor 
 Board placed in effect a general increase in wages which 
 it was estimated would add approximately $314,500,000 
 annually to the operating expenses of the carriers in the 
 Eastern group. This entire situation in the opinion of the 
 Commission could be met by a 40% increase in freight 
 rates and by the other increases previously rehearsed. 
 
 In the Southern group, as a whole, the situation was 
 much more favorable. The carriers in this group asked 
 that their rates be increased so that they might earn net 
 
 36 
 
Federal Securities Corporation 
 
 $136,049,091 which represents a return of 6% on a value of 
 $2,267,484,847. The roads in the Southern group estimated 
 that under the schedule of rates in effect at the beginning 
 of 1920, their operating income would be approximately 
 $120,000,000 less than this sum. The operating expenses 
 in this group had like those in the Eastern district in- 
 creased heavily but not to the same extent. During the 
 six years ended 1917, the operating ratio of the Southern 
 carriers varied from 65% in 1916 to 74% in 1914. In 1918 
 it was 77%%, in 1919 it had advanced to 86%, and for the 
 first four months of 1920 was 86.22%. The roads in this 
 group asked for an increase of approximately 31% in freight 
 revenue and received an advance of 25% in freight together 
 with the general advance in passenger and Pullman rates 
 previously outlined. 
 
 In the Western and Mountain Pacific groups the 
 carriers requested that their rates be fixed on a basis to 
 permit them to earn $537,833,024 which represents a 6% 
 return on $8,963,883,753. On the basis of the prediction of 
 the carriers the operating income of these districts would 
 fall short approximately $350,000,000 of the amount to 
 which they believed they were entitled. The operating 
 ratio of the roads in these groups had increased similarly 
 with those in the other two groups. This ratio, which 
 between 1912 and 1917 had ranged from 63% to 68%, had 
 advanced to 81% in 1919 and to 86.6% for the first four 
 months of 1920. In taking the various figures of the roads 
 in this group and adjusting them to the standard set by 
 the Interstate Commerce Commission, it was determined 
 that the return stipulated under the Esch-Cummings Bill 
 could be earned through an increase for the Western group 
 of 35% in freight rates and for the Mountain Pacific group 
 of 25%, together with the general increases in passenger 
 and other rates. 
 
 In the opinion of the Interstate Commerce Commission 
 these increases in rates, both freight and passenger, would 
 yield at least 5%% on the total valuation of the railroads 
 of the country as determined by them. In this connection 
 it is very interesting to note that the aggregate valuation 
 
 37 
 
Railroads From the Investor’s Viewpoint 
 
 the Commission placed on the properties not only covers 
 all of the funded debt of the railroads at par, but also covers 
 all the capital stock of the railroads at par and leaves a 
 margin of about $2,000,000,000 besides. In other words, 
 in the opinion of the Commission, the roads are today con- 
 servatively worth $2,000,000,000 more than their entire 
 capitalization. 
 
 IResMlits Uimdleir Private ©peratiem 
 
 The law says the roads are entitled to earn 5^% to 6% 
 on this valuation or between $1,039,500,000 and $1,134,000,- 
 000. There seems to be a misconception, not so much on 
 the part of the investing public, but rather on the part of 
 the general public, about the Transportation Act. It seems 
 popularly to be supposed that under the terms of the Act 
 the government guarantees 5^2% to 6% on the railroad 
 investment. The Transportation Act says that rates shall 
 be so arranged as to allow the roads to earn a net profit 
 of between 5^% and 6% on the aggregate property value 
 but the government does not guarantee this profit. The 
 Interstate Commerce Commission itself can only guess as 
 to whether the rates it fixes will produce the adequate 
 profit. It can only control rates; it cannot control volume 
 of traffic, nor price of material, of money or of labor. As 
 a matter of fact it has no assurances as to labor costs as 
 wages are fixed by the Federal Labor Board without con- 
 sultation with the Interstate Commerce Commission. 
 
 Much, of course, depends on the efficiency of the rail- 
 roads themselves and we all know that the efficiency of the 
 railroads was greatly increased during the first year of 
 private operation. When the roads were turned back to 
 their original owners, most of the operators began im- 
 mediately to improve and rehabilitate their properties, as 
 well as to increase efficiency all along the line. The 
 carriers during the first year of operation for their own 
 account, spent millions of dollars on road-beds and 
 terminals. 
 
 We have previously mentioned how equipment was 
 neglected during the period of the war and how new equip- 
 
 38 
 
Federal Securities Corporation 
 
 ment necessary to the efficient operation of the roads was 
 not added when needed. The fact that $125,000,000 of the 
 $300,000,000 revolving fund authorized by the Transporta- 
 tion Act was allotted for the purchase of equipment shows 
 the need of the roads in this respect. Many of the carriers 
 in 1921 purchased new equipment financed through equip- 
 ment trust obligations sold to the public and most of them 
 showed increased efficiency in the use of the old equipment 
 available. 
 
 As a matter of fact, the first six months of private opera- 
 tion, during which the government guarantee was in force, 
 were dedicated to increasing the efficiency of the roads. 
 To show what was accomplished : the tonnage per freight 
 car was increased from 28.3 tons on March 1, 1920, to 29.8 
 tons on September 1. This does not seem a large gain but 
 put in terms of freight cars it means the equivalent of 
 adding 100,000 freight cars to the equipment of the systems. 
 The average mileage per day was also increased from 22.3 
 on March 1, 1920, to 27.4 on September 1, 1920, a gain 
 which is equivalent to 400,000 freight cars. The number 
 of cars loaded also showed a great increase and the number 
 of tons moved one mile during the first six months of 1920, 
 were 3,000,000,000 tons more than during the first ten 
 months of 1918, which was a record year in the midst of 
 the war. During the year after the termination of Federal 
 control the roads moved 9,000,000,000 ton miles more than 
 in 1918 employing the same facilities. These latter figures 
 did not continue in force during 1921 when traffic slumped 
 but they are illustrative of the genuine effort the roads 
 made toward efficiency and the splendid results accom- 
 plished. 
 
 Tn spite of these efficiencies and economies the rail- 
 roads did not earn anywhere near their 5j/% to 6% return 
 for 1920 nor did they do so in 1921. Tn 1920 the net income 
 of the railroads was only $62,000,000; had the government 
 not guaranteed the standard return up to September 1 
 there would have been a deficit in railroad operation of 
 roundly $2,000,000,000. As it was the $62,000,000 net was 
 asked to pay interest charges of about $450,000,000. Hy 
 
 39 
 
‘Railroads From the Investor's Viewpoint 
 
 comparison we may mention that in 1916 the roads earned 
 net $1,040,000,000 which was $240,000,000 more than div- 
 idend requirements. During the first five months of opera- 
 tion under the new rates, that is, September, 1920, to 
 January, 1921, inclusive, with a volume of business that 
 was considered large enough to produce the standard 
 5)4%, the roads as a whole earned only 3%. 
 
 For the first six months of 1921 the net revenue 
 amounted to $142,000,000. This was about one quarter of 
 what the law entitled the roads to earn and was $95,000,000 
 short of enough to pay six months’ interest on the bonds 
 of the companies. From September 1, 1920, when the 
 guaranty period ended to June 30, 1921, the roads earned 
 net, $368,445,000 or at the rate of about 2.5%. For eight 
 months of 1921, ended xVugust 31, the roads failed to earn 
 the authorized 6% by over $692,000,000 and again earned 
 only 2.6% on the aggregate valuation. The figures show 
 that during the first twelve months of operation under 
 private ownership, that is up to September 1, 1921, the 
 roads earned a smaller return on the book cost of their 
 road and equipment than in any year since railway statis- 
 tics were kept. The amount earned in this twelve months 
 was less than 3% of the aggregate value. The smallest 
 return in any previous year of which there is a record is 
 1894 when 3.2% was earned. How^ever, earnings improved 
 from month to month and during August, 1921 the roads 
 for the first time earned at the rate of 5)4% on the aggre- 
 gate value, the net earnings in this month being over 
 $90,000,000. 
 
 Resiioiriis for Cunrfiaikd EarnEinigs 
 
 \\ by, then, if the roads increased their efficiencies so 
 greatly did they failed to earn their stipulated return in 
 the face of the very generous increases in rates granted 
 in xAugust, 1920? The reasons were three: (1) There was 
 a great slump in business in 1921 and consequently in the 
 volume of traffic handled by the roads. (2) The rates of 
 increase, while generous, were still not large enough to 
 
 40 
 
Federal Securities Corporation 
 
 produce the required revenue. (3) The operating costs of 
 the roads had been tremendously increased. 
 
 The slump in business we have all felt and remember. 
 In the early part of 1921 the slump was at its height, but 
 as the year went along traffic seemed to pick up and earn- 
 ings grew better. Earnings are an indication of this : in 
 February there was an actual deficit of $7,000,000 in opera- 
 tion while in September the roads reported net earnings of 
 over $90,000,000. To illustrate; in July traffic had already 
 begun to quicken materially as indicated in the results in 
 terms of net earnings but even so the number of cars 
 loaded in four weeks in July was 2,981,106 as compared 
 with 3,559,081 during the same weeks of 1920 and 3,365,049 
 for the same weeks of 1919. 
 
 An analysis of the car loadings is interesting as indicat- 
 ing which particular kinds of traffic showed the greatest 
 falling off. It is a peculiar fact that the shipments of 
 agricultural products, of grain, and of merchandise, espe- 
 cially the higher grades of manufactured products were 
 very large and in some instances greater in 1921 than in 
 1920 or 1919. On the other hand, shipments of bulkier 
 materials were unprecedentedly small ; namely, coal, iron 
 ore, forest products, lime, cement, etc. When we consider 
 what a large part of the traffic of the roads is always made 
 up of the bulky products of mines and forests, it is easy to 
 understand the great falling off of traffic in the first half 
 of 1921. Coal, itself, ordinarily constitutes 35% of the 
 total tonnage of the roads. 
 
 The coal situation was unprecedented. From Decem- 
 ber, 1920, when the coal shipment situation was about 
 normal, to May 1921, in the short space of five months, the 
 tonnage of coal shipped per day was almost cut in tvvo. In 
 fact never have the coal shipments been relatively as small 
 as they were in the first ])art of 1921. The years 1914 and 
 1915 like 1921, were years of business depression. Since 
 then the population of the country has increased and the 
 needs of manufacture have greatly increased. And yet in 
 tlie first seven months of 1921 the shipments of bituminous 
 coal were 12,000,000 tons less than in 1914 and 2,000,000 
 
 41 
 
Railroads From the Investor's Viewpoint 
 
 less than in 1915. In a comparison with 1919, we hnd a 
 falling off of 29,000,000 tons and with 1918, of 110,000,000 
 tons for the seven month period from January to July. 
 
 We have said that one reason for the failure of the 
 roads to earn their 5j4% was that the increases in rates, 
 while generous, were not large enough ; nor were they 
 properly timed. Since 1915, there have been four general 
 increases in rates: 3.7% in January, 1917; 2% in March, 
 1918; 25% in June, 1919; and an average of 34% in August, 
 1920. The total increase was 78%. Operating expenses 
 in the same period increased from $2,055,181,884 for the 
 fiscal year ended June 30, 1915 to $5,830,696,007 for the 
 calendar year 1920. Even considering the expenses for the 
 calendar year 1915 as $2,250,000,000 which would be very 
 generous, the increase in operating expenses was over 
 150% in the six year period as compared with a 78% in- 
 crease in freight rates. The increase, of course, was all 
 that business would stand but the point is that it was not 
 enough to permit the roads to earn 534% on their book 
 values. The railroads also point out that if the rates had 
 been gradually advanced from time to time since 1915, the 
 shock to business would not have been so great and the 
 returns to the roads larger and steadier. 
 
 Iinicireas© m ©poiraftninig 
 
 lAw people seem to realize how tremendously the 
 operating costs of the railroads have increased in recent 
 years. A few general statements will emphasize the 
 startling truth. We have said that the operating costs 
 increased over 150% from 1915 to 1920. In 1918, the 
 operating expenses were greater than the total operating 
 revenue for 1917, with about the same volume of traffic. 
 The labor cost in 1920 was greater than the entire gross 
 operating revenue in 1916, again with about the same 
 volume of traffic. The labor cost itself had advanced from 
 $1,190,000,000 in 1915 to $3,698,000,000 in 1920, or much 
 more than trebled. Material costs advanced from $447,- 
 000,000 in 1915 to $1,064,000,000 in 1920. Material costs 
 have been usually from 34 to 34 as great as labor costs, yet 
 
 42 
 
Federal Securities Corporation 
 
 the material costs of 1920 were almost identical with the 
 labor costs of 1915. It is rather startling that in 1920 the 
 net earnings left after operating expenses were only 1% 
 out of total operating revenues of $6,171,000,000 as 
 against 28.9% in 1916 from gross operating revenues of 
 $3,596,000,000. 
 
 The labor cost is the one over which the most dis- 
 cussion and conflict has occurred. There has been in the 
 past and probably will continue to be, a wide divergence 
 of opinion as to how the labor question should be adjusted. 
 The transportation act provides that Boards of Labor Ad- 
 justment might be local to a railroad, might be regional, or 
 might be national in jurisdiction. Managers of the roads 
 have always felt that they themselves should deal with 
 their own employees by means of local boards. The rail- 
 road men on their part insist that the boards be national, 
 and that the power be centralized. The roads naturally 
 have fought wage increases in view of mounting costs 
 while the employees have resented decreases. 
 
 The labor problem of the roads can best be illustrated 
 by showing what percentage of each dollar earned during 
 various years was paid out for the most important items of 
 expense and what percentage was left the roads as return 
 on the investment, thus : 
 
 1916 1917 1918 1919 1920 
 
 % % % % % 
 
 Labor 40.8 43.3 53.6 55.3 59.9 
 
 Fuel 7.0 9.8 10.2 9.2 10.9 
 
 Materials 12.5 12.2 13.1 15.6 17.3 
 
 Return on Investment... 28.9 23.3 13.1 8.8 1.0 
 
 The minor items are omitted in the above table which 
 shows that in 1920 about 60% of the total gross revenue 
 of the roads was paid in wages as against 41% in 1916. 
 The following figures show the yearly average wage of rail- 
 road employees : 
 
 1916 1917 1918 1919 1920 
 
 $892 $1,004 $1,419 $1,482 $1,908 
 
 43 
 
Railroads From the Investor’s Viewpoint 
 
 The wage per man has more than doubled. Moreover, 
 in 1917 the last year the roads were operated privately dur- 
 ing the war the average number of employees was 1,732,- 
 876. In 1920 wdien the roads were turned back the average 
 number of employees was 1,993,524, a gain of 260,000 em- 
 ployees during the period of government control. The 
 roads contend that this increase in the number of men was 
 occasioned by the national agreements with their very 
 costly labor arrangements. These special arrangements 
 which the managers were forced to accept when the roads 
 were turned back to private operation are said to have 
 added $300,000,000 to the annual operating costs of the 
 properties. 
 
 The best way to visualize the gradual decrease in net 
 income and the increase in labor costs is to show the figures : 
 
 Gross Revenue Labor Cost Net Income Return 
 
 1916 $ 3 , 597 , 000,000 $ 1 , 468 , 000,000 $ 1 , 040 , 000,000 6 . 16 % 
 
 1917 4 , 014 , 000,000 1 , 739 , 000,000 934 , 000,000 5 . 26 % 
 
 1918 4 , 881 , 000,000 2 , 613 , 000,000 639 , 000,000 3 . 51 % 
 
 1919 5 , 145 , 000,000 2 , 843 , 000,000 455 , 000,000 2 . 46 % 
 
 1920 6 , 171 , 000,000 3 , 698 , 000,000 62 , 000,000 . 32 % 
 
 This shows that the labor cost for 1920 was greater than 
 the total gross revenue for 1916. The 1919 labor cost was 
 just about equal to the 1917 total operating expense. Again 
 the 1918 total operating expense was less than $400,000,000 
 more than the 1920 labor cost. 
 
 The wage increase put in effect in July, 1920, was an 
 average increase of 22% in wages. It was estimated it 
 would add $600,000,000 to the expenses of the roads. The 
 wage decrease put into effect on July 1, 1921, was an 
 average decrease of 12%. It was estimated to reduce 
 operating expenses $400,000,000 while the abrogation of 
 the national agreements was estimated to reduce the 
 amount another $300,000,000 when effective. The em- 
 ployees resented the cut in wages and when further reduc- 
 tions were asked for by the roads with a disposition on 
 the part of the Federal Labor Board to grant them the 
 employees in October, 1921, threatened a nation-wide strike 
 Avhich was averted only by Federal interference. 
 
 44 
 
Federal Securities Corporation 
 
 The employees, however, recognize that a cut in wages 
 was not only inevitable but imperative. The managers on 
 their part recognize that a reduction in freight rates was 
 also essential. In fact, at the time of the threatened strike a 
 bulletin of the Association of Railway Executives stated, 
 ‘Tt is evident that existing transportation charges bear in 
 many cases a disproportionate relationship to the prices at 
 Avhich commodities can be sold in the market, and that 
 existing labor and other costs of transportation thus impose 
 upon industry and agriculture generally a burden greater 
 than they should bear. This is especially true of agriculture. 
 The railroad managements are sensitive to and sympathetic 
 with the distressing situation and desire to do everything 
 to assist in relieving it that is compatible with their duty to 
 furnish the transportation which the public must have.” 
 
 In November, 1921, the Interstate Commerce Commis- 
 sion proposed and the roads accepted a ten per cent de- 
 crease in the rates on agricultural products, efiective about 
 January 1, 1922. Other decreases must follow as decreases 
 in Avages, materials and money occur. It should be borne 
 in mind that a fifteen per cent reduction in operating 
 expenses based on 1920 figures means $875,000,000 annually 
 to the roads; a twenty per cent reduction means $1,160,- 
 000,000 or the equivalent of six per cent in the total aggre- 
 gate value of the properties. This does not seem so hope- 
 less as some were pleased to think during the early part 
 of 1921. In fact, it is not hopeless at all ; it is A^ery probable 
 indeed. 
 
 m C©inidEftn®inis 
 
 The situation grew stronger month by month almost 
 continuously during 1921. The government on its part 
 strengthened and clarified its position greatly during the 
 year by the sale of a considerable portion of the equipment 
 trust obligations it owned as well as by settling a large 
 number of the claims of the carriers against the govern- 
 ment as a result of Federal operation. Up to October 
 ])ractical]y v$100, 000,000 of the 6% equipment trust obliga- 
 tions OAvned by the government had been sold to financial 
 
 45 
 
Railroads From the Investor’s Viewpoint 
 
 houses who had in turn resold them to the public. The 
 government originally had about $380,000,000 of these 
 equipment trust obligations and it is only a question of 
 time when the balance will be marketed. With respect to 
 settlement of carrier’s claims, as much progress had been 
 made. Up to October 1st sundry claims aggregating $856,- 
 000,000, growing out of Federal operation, had been filed 
 for final settlement. These claims represented about 78% 
 of the total mileage under government control and, there- 
 fore, the total amount of claims was expected to reach some- 
 thing over $1,000,000,000. Up to October 1st, 1921, claims 
 aggregating $387,000,000, or almost half of the amount filed 
 up to that time, had been finally adjusted and paid. The 
 amount of the government allowances on these claims was 
 $117,715,000, or about 30% of the amount claimed. 
 
 The progress of the roads themselves has been very 
 evident in the reports of the net earnings from month to 
 month. It will be recalled that during January and 
 February of 1921, the roads earned a deficit in each month. 
 From March to August, inclusive, the operating results 
 have been as follows : 
 
 Operating Operating 
 
 Revenue Expenses Net Income 
 
 March $459,262,510 $400,429,308 $30,695,192 
 
 April 433,357,199 375,698,986 29,248,874 
 
 May 444,875,089 380,041,234 37,080,654 
 
 June 461,562,317 380,927,429 51,641,014 
 
 July 462,849,446 362,841,183 69,298,521 
 
 August 505,508,274 382,279,070 90,241,103 
 
 Three tendencies are at once apparent from an examina- 
 tion of these figures: (1) the tendency of the gross 
 revenues to increase from month to month showing a slight 
 increase in volume of traffic, (2) the tendency of the 
 operating expenses to decrease (at least in percentage of 
 gross) indicating either increased efficiency or decreased 
 maintenance, or both, and (3) the tendency of the net in- 
 come to increase showing a tendency to approach the level 
 where 5j4% to 6% of the property values will be earned. 
 In August, 1921, the $90,000,000 of net earnings was at the 
 annual rate of a little over 5l4% on the property value of 
 
 46 
 
Federal Securities Corporation 
 
 $18,900,000,000 allowed by the Commission. In September, 
 the net had fallen off slightly to about $87,000,000, but still 
 at the rate of 5^%. 
 
 As indicated in the above figures, the increase in net 
 earnings from month to month has been due to two causes : 
 (1) increased efficiency in operation and decreased main- 
 tenance, and (2) increased business from month to month. 
 The decline in material prices has also had its influence, 
 and the wage reduction has been a big factor in the months 
 since July. 
 
 In the matter of maintenance, the roads report that they 
 spent $373,000,000 less for maintenance for the first eight 
 months of 1921 than they did in the same period of 1920. 
 Had the maintenance been the same for 1921 as for 1920, 
 instead of realizing a net operating income of over $303,- 
 000,000 for eight months there would have been an actual 
 deficit of over $70,000,000. During September of 1921, the 
 gross operating revenues were 19.6% less than during 
 September, 1920, while operating expenses were 26% 
 smaller. Expenditures on maintenance for September, 
 1921, showed a decrease of 23.3%, but slightly larger than 
 in August. This reduction represents a postponement of 
 outlay until conditions improve rather than an actual 
 saving. 
 
 It has been only by the most rigid economies that the 
 roads were able to make the showings registered. That 
 the roads had a better hold on their expenditures, is in- 
 dicated in the fact that in June, 1921, 82.34 cents out of 
 every dollar of revenue went for expenses compared with 
 85.43 cents in May. In June, 1920, the figure was 96.84 
 cents and in May, 1920, 95.69 cents. In July, 1921, the 
 operating ratio had fallen to 78% and in August, 1921 to 
 about 75%. We have already detailed earlier how during 
 1920 the roads had increased the average movement per 
 car per day, as well as the average tonnage per car, and 
 the average number of cars ])er train, lly buying on a 
 hand to mouth basis, es])ecially coal, and by intensive 
 
 47 
 
Railroads From the Investor’s Viewpoint 
 
 efforts to reduce coal and material consumption, as well as 
 by cutting the number of employees down to the very 
 minimum, considerable additional savings in operation were 
 effected. In reaching the low ratios of operation for 
 August and September, 1921, not only were the economies 
 of operation and the retrenchment in maintenance opera- 
 tive, but the reduction in wages and the increase in traffic 
 had their contributing influence. 
 
 Traffic was on the upturn from month to month during 
 1921, as reflected in the figures of gross revenues and in 
 the car loading reports. The tendency during the entire 
 year 1921 has been toward an increase in the volume of 
 traffic in grain and general merchandise, but against an 
 increase in the movement of the heavier products of mines, 
 such as coal and ore, the backbone of freight traffic. From 
 month to month the freight car loadings have shown in- 
 creases and the idle car figures decreases. A few figures 
 chosen at random will be of interest. For the week ending 
 July 30th, 1921, the freight loadings totaled 796,570 cars, 
 an increase of 6,222 cars over the previous week. Again 
 the week of August 30th, 1921, showed a gain of 7,471 cars 
 over the previous week. The total for the week of August 
 30th was 816,436 cars, a gain of about 20,000 cars in a 
 month. In one week of September, 1921, the loadings were 
 830,603 cars while in the corresponding week of October, 
 the number of car loadings had increased to 901,078, or an 
 approach to 1920 levels. In one month from August, 1921 
 to September, 1921, the idle cars decreased from 513,040 to 
 237,972, a reduction of over 50%. 
 
 Pireseinift SiftimsiftEOini mmd Funftiuiira Pir©M®imis 
 
 The situation is improving and will gradually straigliten 
 itself out. Problems of moment are still ahead of the 
 roads, the administration, the Labor Board and the Inter- 
 state Commerce Commission, but every day progress is 
 being made toward settlement of a situation that in tlm 
 early part of 1921 seemed exceedingly difficult of solution. 
 The future must solve other problems. In IMarch, 1922, 
 for example, the first two year period of operation under 
 
 48 
 
Federal Securities Corporation 
 
 private control will have ended, and it will be up to Con- 
 gress and the Interstate Commerce Commission to make 
 new regulations or to continue in effect the ones now opera- 
 tive. But this should not concern us. The solution of the 
 railroad difficulty always has been and always will be 
 found. The roads are too vital a part of our life and 
 prosperity for any other result ever to come about. Posi- 
 tive influences are daily working in this direction. Before 
 Congress at this time, for example, is the Funding Plan 
 which is strongly being urged by President Harding as a 
 contributing force to the solution of the railroad problems. 
 The Interstate Commerce Commission in accordance with 
 the provision of the Transportation Act is studying the. 
 possibility of consolidations among the roads and has in- 
 vited reports of experts on this very important question. 
 Consolidation of the weaker systems with the stronger can- 
 not help but fortify the whole fabric. 
 
 However complex the situation may be at this time, it 
 would seem to us that the railroad companies are today in 
 a much stronger position than they have been probably 
 at any time in their history. They are operating under a 
 law which should in time assure the average road annually 
 5^% net on its property valuation. The general situation 
 in the industry is strengthened because the basic principles 
 on which the roads are working are more firmly estab- 
 lished. The trying conditions of today and tomorrow are 
 transient and will pass, but the basic principles of operation 
 of the roads will remain to control continued prosperity 
 over a long period of time. 
 
 However, while this is true and while the railroads as 
 a whole are in a stronger situation fundamentally than 
 they have been in the past, the comparative relationships 
 between the different properties will probably continue as 
 before. What we mean to say is that just as in the past 
 there have been strong roads, average roads and weak 
 roads, so in the future the various systems will fall in much 
 the same classifications. The earning power and prosperity 
 of any individual road will in the future depend on mucli 
 the same factors as heretofore, namely conservatism in 
 
 49 
 
-Railroads From the Investor’s Viewpoint 
 
 capitalization, degree of up-keep of property, and efficiency 
 of operation. The past history of railroading will have its 
 influence on the future of the entire industry. It is for this 
 reason that the past history of the railroads of the country 
 should be of value to the investor in his consideration of 
 railroad bonds. 
 
 50 
 
Federal Securities Corporation 
 
 lEI 
 
 IRAILROAD SECURITIES 
 
 The average investor is probably much better acquainted 
 with the factors to be considered in judging railroad securi- 
 ties than he ‘is with the past or even more recent history 
 of the railroads of the United States. It is for this reason 
 that we have outlined as fully as the booklet would permit, 
 the history of the railroads and will condense as much as 
 clearness and accuracy will permit, the detail of those 
 factors essential of consideration in the purchase of rail- 
 road bonds. 
 
 Tike Tw® Impoffftamft Factors 
 
 Whether the investment be railroad, municipal, utility 
 or industrial bond, there are two fundamentals which 
 govern its worth: (1) The lien position of the bond itself 
 and (2) the credit position of the issuing corporation. 
 There is a third consideration which often influences inves- 
 tors’ minds as to the worth of a bond, namely, market- 
 ability — but it is obvious that marketability has no bearing 
 on security and it is security that we wish solely to take 
 into account. 
 
 So far in this booklet in Parts I and II we have dealt 
 only with the second of these two large considerations, the 
 credit position of the roads. We have outlined the credit 
 position of the railroads of the country as a whole especially 
 during the past few chaotic years and we have indicated 
 here and there the credit positions of various individual 
 roads. We have given sufficient outline of the various ups 
 and downs of the railroad systems of the country to need 
 no further emphasis on the point that the credit of a road 
 is of great importance. We have seen sound roads like 
 the New England systems gradually grow into a situation 
 of great financial weakness. We have also seen other 
 roads, like the Atchison and the Northern Pacific change 
 from a position of financial weakness to one of consider- 
 able financial strength. Again we know that certain prop- 
 
 51 
 
Railroads From the Investor’s Viewpoint 
 
 erties like the Pennsylvania, the New York Central, the 
 Louisville and Nashville and Illinois Central started with 
 the ideal of conservative capitalization and strong financial 
 position, continue through the decades to maintain this 
 strong financial structure and credit. 
 
 Although a record of the past is generally conceded to 
 be a fair guarantee of the future, we must remember that 
 there are notable instances when a record of the past 
 proved a sad guarantee of the future. This point must be 
 kept in mind in considering the records which we have just 
 reviewed. 
 
 So far we have emphasized the importance of the 
 credit position of the railroads in judging their investments. 
 But the factor of credit position should not be over em- 
 phasized at the expense of the other consideration, namely, 
 the lien position of the bond. Both should be considered 
 jointly in order to determine what is a sound investment. 
 Sometimes investors are prone to emphasize one of these 
 factors at the expense of the other. The lien position of one 
 of the railroads now in a weak credit position may in itself 
 be exceedingly strong but it is not a very comfortable feel- 
 ing to realize that the credit of the system may jeopardize 
 the payment of principal and interest, in spite of the 
 inherent strength of the investment. 
 
 On the other hand, too much emphasis should not be 
 placed on the mortgage position of a certain bond. This 
 fact was most convincingly brought out in the reorganiza- 
 tion a few years ago of the Missouri Pacific system. Hold- 
 ers of first mortgage bonds issued at a low rate per mile on 
 branch lines which were not very valuable in earning power 
 to the system were in the reorganization given less 
 desirable securities in exchange for their holdings than the 
 holders of junior securities on main line mileage. It did 
 them little good to complain because it mattered very little 
 to the general good of the system whether these lines were 
 included or divorced in reorganization ; they contributed 
 practically nothing to the credit position of the road. 
 
 Then, too, the credit position of a road may be so empha- 
 sized that the lien position of a security is forgotten, as, for 
 
 52 
 
Federal Securities Corporation^ 
 
 example, in the case of the Southern Pacific Company Con- 
 vertible 4’s which are merely unsecured obligations of a 
 holding company. When, however, good security as deter- 
 mined by lien position, is coupled with good credit, the 
 investor has a very high type of investment security. 
 
 The two factors which we are now considering are in 
 many ways bound to one another. It follows that the 
 bonds of a road conservatively capitalized enjoy a better 
 lien position than those of a road which is over capitalized. 
 It also follows that a road which has a low bonded debt 
 per mile is in a better earning power position than one 
 which has a large bonded indebtedness, traffic possibili- 
 ties in the two territories being equal. Investors who 
 study railroad investments carefully and especially those 
 who may be acquainted with Mr. Moody's Analysis of 
 Railroad Investments instinctively combine these two con- 
 siderations in analyzing a railroad investment that may be 
 offered. There are many considerations which may be 
 taken into account in analyzing a railroad security but the 
 bondman and the well posted investor simmer these down 
 to one : namely, a comparison of the bonded debt of the 
 road per mile with the earning power of the road per mile. 
 This one consideration combines the two factors of lien 
 position and credit position, as will at once be evident. The 
 lien position is indicated by the bonded debt per mile. The 
 credit position is indicated by the net earnings per mile. 
 
 To illustrate what we mean we will use certain figures 
 taken from the last current volume of Moody’s Analysis 
 of Railroad Investments. To take a very extreme case we 
 will compare the indebtedness and the earning power of 
 the Atchison with the indebtedness and earning power of 
 the Erie. In 1919 the per mile bonded debt of the Atchison 
 was slightly less than $25,000 and in 1917 (the last figures 
 given by Mr. Moody), the net earnings per mile were 
 $5,342. The Erie, on the other hand, showed bonded in- 
 debtedness per mile in excess of $126,000 and net earnings 
 per mile for 1917 of v$5,439. Even though the Erie may 
 have more second and third track mileage than the Atchison 
 it is at once apparent that most of the securities of a road 
 
 53 
 
Railroads From the Investor’s Viewpoint 
 
 with a bonded indebtedness of $126,000 per mile have a less 
 desirable lien position than the securities of a road with a 
 bonded indebtedness of $25,000 per mile. It is also 
 apparent that a road faced with the necessity of paying 
 interest on securities outstanding at the rate of $126,000 
 per mile enjoys a less desirable credit position than one 
 which must pay interest on securities at the rate of $25,000 
 per mile, the net earnings per mile of each system being 
 about the same. 
 
 These are extreme cases chosen deliberately to illustrate 
 our point. Most of the roads will fall somewhere between 
 these two extremes as the Atchison is one of the most con- 
 servatively capitalized of roads enjoying the highest 
 measure of credit, whereas the Erie has earned much the 
 opposite reputation. All the other roads in the country 
 fall in their own respective niches in a comparison of this 
 kind and the investor who wishes to determine these facts 
 can obtain them from the good investment houses. It 
 would be interesting to compare all of the important roads 
 of the country in a test of this character but the scope of 
 this booklet will not permit. We believe we can say, how- 
 ever, that it should not be difficult for the investor to con- 
 clude for himself from the information which has been 
 given in this booklet which are the roads whose lien posi- 
 tion and credit position rank high and those whose positions 
 are less desirable. 
 
 Classes ©IF IRanlif©a(dl Boiadls 
 
 A brief discussion of the different types of railroad 
 bonds and the general esteem in which each type is held 
 should be of interest to the investor. We feel that the 
 investor is more or less familiar with these classes of rail- 
 road bonds and, therefore, our discussion will be brief. 
 First we will consider those bonds which are secured by 
 mortgage on the mileage of the railroad system. These 
 naturally fall into four groups : 
 
 1. Divisional Liens. 
 
 2. First Mortgage General System Liens. 
 
 3. General or Refunding ^Mortgages. 
 
 4. Collateral Mortgages. 
 
 54 
 
Federal Securities Corporation' 
 
 Divisional Liens — The Divisional Liens came into being 
 through the growth of great systems and by consolida- 
 tion of small properties. A line of several hundred 
 miles originally operated as a separate unit and having 
 outstanding against it first mortgage bonds would in con- 
 solidation become a part of a larger system. The first 
 mortgage bonds of this original line thereby become 
 divisional liens of the larger system. The Chicago & North- 
 western, for example, is made up of many small roads which 
 have gradually been absorbed into the parent system. The 
 New York Central is an end to end consolidation of a great 
 many small properties. Practically every large system in 
 the country has its divisional liens. 
 
 As a general rule such issues are of high character, espe- 
 cially in roads of good credit and the bonds sell at the top 
 prices. However, it must be borne in mind that just be- 
 cause a bond is a divisional lien it is not necessarily strong 
 because first mortgage divisional issues may fare badly with 
 a road of weak credit as in the instance of the Missouri 
 Pacific reorganization. However, when a divisional lien 
 covers an important part of the mileage the investment is 
 usually conservative. An example of a very strong divi- 
 sional lien is the C. B. & Q., Illinois Division 4% bonds 
 which cover practically the entire mileage of the Burlington 
 system in Illinois and the line running from Chicago to the 
 Twin Cities. The Great Northern has a number of issues 
 of divisional bonds issued at various times as Mr. Hill 
 expanded the Great Northern system, all of which are very 
 high-grade but which are very rarely seen in the market 
 because they have been put away in places from which they 
 do not come out. These are only a few of a great number 
 of very fine divisional issues. 
 
 First Mortgage General System Liens — The second 
 class of mortgage bonds are those which are secured by a 
 first mortgage on much of the main line mileage of the 
 large systems and are generally considered very high grade 
 investments. The Northern Pacific Prior Lien 4s, the Union 
 Pacific First and the Land Grant 4s, the C. B. & Q. General 
 4s and the Atchison General 4s are outstanding examples 
 
 55 
 
Railroads From the Investor’s Viewpoint 
 
 of this type of investment. The last two issues mentioned 
 are called general mortgage bonds and while they are not 
 secured by first mortgage on all of the property which they 
 cover they are, nevertheless, a first mortgage on a consider- 
 able portion of the main line mileage. Such issues are 
 usually better known and enjoy a wider general market 
 than the divisional liens because the amounts outstanding 
 are larger and give a greater trading opportunity. 
 
 General Mortgages — As the roads grew and new need 
 for money arose, it became necessary for the systems 
 to do financing by means of junior bond issues since 
 most of the mileage was already covered by first mort- 
 gages. It is in this manner that refunding mortgages or 
 the first and refunding mortgages of the railroads came 
 into being. In the 80s and 90s when this type of financing 
 was first brought out on a scale, the mortgages were called 
 general mortgages rather than refunding mortgages. In 
 most cases these general mortgages cover at least a part 
 of the mileage by first mortgage and sufficient bonds are 
 reserved to retire the underlying liens as they become due. 
 Usually such issues were made to run over a period of 100 
 years and covered the entire property of the road as con- 
 stituted at the time of issue, including the terminals and 
 equipment. Sometimes when such issues were brought out 
 a considerable portion of the mileage was not mortgaged 
 as in the case of the C. B. & Q. and the Atchison mentioned 
 above, so that these general mortgage bonds covered sev- 
 eral thousand miles of road as a first mortgage. The inves- 
 tor is acquainted with the general mortgage bonds of the 
 Northwestern, the Northern Pacific, the Pennsylvania and 
 other roads which have outstanding this class of security. 
 
 Refunding Mortgages — In recent years these general 
 mortgage bonds have not been used largely because 
 they were limited under the terms of the indentures to 
 interest not to exceed 4% and only to refund underlying 
 liens. Instead the systems have used the refunding mort- 
 gage bonds to finance their requirements. These refunding 
 mortgages were so drawn as to carry a higher coupon rate 
 than 4% and were authorized in amounts in excess of the 
 
 56 
 
Federal Securities Corporation 
 
 underlying lien requirements, thus affording the roads the 
 opportunity of obtaining additional working capital. In 
 cases where a road has outstanding both a general mortgage 
 and a refunding mortgage, the general mortgage has usually 
 been closed and the refunding mortgage covers the same 
 property and anything additional which the road may have 
 acquired since the general mortgage was issued. There- 
 fore, most of the refunding mortgages are secured by first 
 mortgage on a small amount of mileage and by a second 
 and third and in some cases by a fourth mortgage on the 
 main portion of the road. There are some systems in which 
 this character of lien has been given the name of refunding 
 and improvement mortgage as in the case of the New York 
 Central. 
 
 Most of the large systems have outstanding refunding 
 liens of one character or another. In the case of roads 
 of high credit these bonds are well regarded. For example, 
 the refunding 4^s of the Northern Pacific which is a road 
 of high credit, have always sold at higher prices than the 
 refunding bonds of the B. & O. which has not at all times 
 in its history enjoyed the highest standard of credit. 
 
 Collateral Mortgages — The collateral mortgages can be 
 dealt with rather briefly. In the true sense of the word 
 collateral mortgages secured by the deposit of other 
 securities are not a direct mortgage on line, although 
 l)onds may be deposited under them which are secured 
 by direct mortgage. In other cases collateral issues may 
 be secured by deposit of stocks and other junior securities. 
 The Southern Pacific Company Collateral Trust 4s of 
 1949, for example, are secured by the deposit of certain 
 amounts of the stock of the Central Pacific Railway Com- 
 pany. The Illinois Central has outstanding two issues 
 of collateral trust 4% bonds due in 1952 and in 1953, each 
 of which is secured by a first lien on important mileage 
 through the deposit of all of the liens outstanding on this 
 mileage. These bonds were made collateral trust issues of 
 the Illinois Central because the credit of the Illinois Central 
 was higher than that of the unknown individual lines whose 
 bonds were outstanding. This is usually the reason for the 
 
Railroads From the Investor’s Viewpoint 
 
 issuance of collateral trust bonds. This issuance of 
 collateral trust issues can be carried to excess, as was done 
 in the case of the Erie, and for this reason collateral issues 
 should be carefully scrutinized, especially since the tend- 
 ency of the investor in considering issues of this kind is to 
 emphasize the credit position of the road at the expense of 
 the lien position of the bonds. 
 
 Many roads have outstanding several other classes of 
 securities, namely, debenture, convertible, income, terminal, 
 and equipment bonds. 
 
 Debenture Bonds — Debenture issues may or may not be 
 secured by mortgage. Usually at the time the debenture 
 bond is issued it is not secured by mortgage but merely is 
 the obligation of the company to pay. Debenture inden- 
 tures, however, often carry the provision that if any further 
 securities are put out on the property the debentures in 
 their turn are equally to be secured with the new bonds. 
 The New York Central Debenture 4s of 1934, which are a 
 well known bond and the debenture 4s of 1932 are both 
 equally secured with the New York Central Consolidated 4s 
 of 1998 which are a second, third, fourth and fifth lien on 
 parts of the New York Central property. The Lake Shore 
 and Michigan Southern Debenture 4s of 1928 and 1931 simi- 
 larly are equally secured with the Lake Shore & Michigan 
 Southern 3^s. On the other hand, the Convertible Deben- 
 ture 6s due in 1935, are not secured by mortgage. Again in 
 the case of issues of this character the investor would do 
 well to scrutinize carefully the lien position of the bond 
 as well as to consider the credit position of the road. 
 
 Convertible Bonds — In recent years convertible bonds 
 have flourished. In some instances convertible issues 
 have been put out without any mortgage security, as in the 
 case of the Southern Pacific Company Convertible 4s of 
 1929 and the Union Pacific Convertible 4s of 1927 which, 
 however, are no longer convertible. In more recent years 
 the convertible bonds have been equally secured with the 
 refunding or with the refunding and improvement bonds 
 which immediately antidated the issuance of the convertible 
 bonds. Lor example, the B. & O. Convertible 4l4s are 
 
 58 
 
Federal Securities Corporation 
 
 equally secured with the refunding and general 5s and 6s 
 due in 1995 and the Chicago, Milwaukee & St. Paul Con- 
 vertible 5s of 2014 are equally secured with the general and 
 refunding 4^s of the same date. This road also has out- 
 standing some convertible 4^s due in 1932 which are 
 equally secured with both the convertible 5s and the gen- 
 eral and refunding bonds. It may be of interest that the 
 Debenture 4s of 1934 and the Gold 4s of 1925 are equally 
 secured with both the General and Refunding 4}^s and the 
 two convertible issues which we have mentioned. This is a 
 field which is very complicated and where the most care- 
 ful character of scrutiny should be paid to issues in con- 
 sidering them as investments. They should be judged, as 
 in previous cases, by the lien position of the bond and the 
 credit position of the road in conjunction, without the over 
 emphasizing of either one of the two factors. 
 
 Income Bonds — We have previously mentioned that 
 in receivership and reorganization, the important thing 
 has always been to reduce the fixed charges of the road 
 within the limit of the road’s net earnings. One of the ways 
 of accomplishing this purpose is to permit the outstanding- 
 par value amount of securities to remain unchanged, but to 
 make the interest on part of the bonds payable only if 
 earned. It is in this manner that Income Bonds, or Adjust- 
 ment Income Bonds, as they are sometimes called, came 
 into being. 
 
 In the Atchison reorganization of 1895 this procedure 
 was followed, with the result that we have outstanding 
 today the Atchison Adjustment 4’s, which while secured 
 by mortgage on the property, are payable as to interest 
 only if that interest is earned. Up to July 1st, 1900, this 
 interest was not even cumulative, but since that time it has 
 been cumulative and is paid out of surplus. The Seaboard 
 Air Line, too, as a result of its recent reorganization has 
 had outstanding since 1909 an issue of $25,000,000 Adjust- 
 ment 5’s, the interest on which is payable only if earned. 
 The interest on these bonds has ])een cumulative from the 
 beginning. The St. Louis & San Francisco Railway Com- 
 
 59 
 
Railroads From the Investor’s Viewpoint 
 
 pany has outstanding two issues of this character as a result 
 of its reorganization: the Cumulative Adjustment 6’s, 
 which are payable as to interest from available net income, 
 but which are cumulative ; and the Income Mortgage 6’s, 
 due in 1960, which are payable out of the available net in- 
 come of the company for each fiscal year ending June 30th, 
 after payment of interest on the Cumulative Adjustment 
 6’s. The interest on these latter bonds is not cumulative. 
 In each of these cases, the bonds are a mortgage on prop- 
 erty securing the payment of the principal, but as the inter- 
 est is payable only if earned, the worth of such issues is 
 largely dependent upon the credit position of the road. As 
 a general case. Income Bonds are not highly regarded, 
 although the Adjustment 4’s of the Atchison rank almost on 
 the same plane with other high-grade 4% railroad bonds of 
 roads of the best credit. The reason for this, of course, is 
 the excellent credit which the Atchison has enjoyed almost 
 continuously since its reorganization in 1895. 
 
 Terminal Bonds — From the standpoint of security po- 
 sition and credit position it is difficult to find a higher 
 grade investment than a Terminal Bond issued against 
 properties located in the larger cities. These bonds are 
 safeguarded in several ways. First, they are usually a 
 mortgage on terminal properties, either passenger or freight 
 or both, which are very valuable because they are usually 
 located in the business center of the city. Second, the 
 interest on these bonds is usually made an operating- charge 
 against the roads which use the terminal. Third, the bonds 
 are very often guaranteed in addition as to both principal 
 and interest by the user railroads. There have been a 
 number of instances where roads which have been in re- 
 ceivership and have been in default on even first mortgage 
 bonds on their systems have continued to pay interest on 
 the Terminal Bonds. The reason for this is that in order 
 to continue to operate, the roads must continue to use the 
 terminals, and in order to get into the terminals it is neces- 
 sary to pay the terminal charges which cover the interest 
 on the bonds. The terminal charge is generally regarded 
 
 60 
 
Federal Securities Corporation 
 
 as an operating charge and is considered to come ahead of 
 all bond interest on the other securities of the railroad. 
 
 The Chicago Union Station 6^’s, which are guaranteed 
 by the Chicago, Burlington & Quincy, the Pennsylvania, 
 and the Chicago, Milwaukee & St. Paul, and are an operat- 
 ing charge against these three roads and the Chicago & 
 Alton, are possibly one of the best chosen investments of 
 this group. The terminal companies operating in Kansas 
 City, St. Louis, and St. Paul have also outstanding Terminal 
 Bonds which are very highly regarded ; and in a general 
 way, the Terminal Bonds of companies in the larger centers 
 of population offer opportunity for conservative investment 
 which it is impossible to excel. 
 
 Equipment Bonds — Equipment Bonds generally enjoy 
 a reputation much like that of Terminal issues. A road 
 cannot operate without its equipment, and when issued 
 by good roads. Equipment Bonds in the past have always 
 been considered one of the very highest forms of railroad 
 investment. Again, as in the case of Terminal issues, roads 
 which have been in receivership and in default on mortgage 
 bonds have continued to pay interest and principal on their 
 Equipment issues when due. 
 
 It is the usual procedure at the present time to issue 
 these Equipment Bonds under the Philadelphia Plan. 
 Under this Plan, the title to the equipment does not remain 
 in the railroad company itself, but a trust is created and 
 the title to the equipment remains with the trustee until 
 the final installment of the notes is paid. In this case, 
 instead of being a direct obligation, the notes or certificates 
 are guaranteed by the railroad which rents the equipment 
 from the trustee, the rentals being sufficient to take care 
 of interest and maturities when due. The investor on his 
 part does not receive the note of the railroad company itself, 
 1)Ut the certificate of the trustee, secured by the equipment 
 whose title rests in the trustee. The general record of 
 lUjuipment Bonds has been unusually good, and when 
 issued by roads of good credit, such certificates must be 
 considered as being extremely high grade investments. 
 
 61 
 
Railroads From the Investor’s Viewpoint 
 
 INVESTMENT SAFETY 
 
 62 
 
Federal Securities Corporation 
 
 C0MCLUSI0M 
 
 This booklet makes no attempt to treat with justice any 
 phase of the railroad situation. The history of operation of 
 the railroads from the time of our entry into the war up 
 to the present time has been treated with most detail, but 
 by no means exhaustively. The primary idea of this book- 
 let is to give the investor a bird’s eye view of the past 
 history of the roads, the problems which they have faced 
 in the past few years and are facing today, and the factors 
 to be considered in judging railroad investments. 
 
 Many questions which the investor will ask are answered 
 in these pages. It is our hope that the most important ones 
 have been covered. Many questions unanswered will occur 
 to the investor who reads this booklet thoughtfully and 
 with care. To such the Federal Securities Corporation 
 extends its fullest service. If there are analyses of partic- 
 ular bonds or of individual railroad systems which the 
 investor would like, we will be glad to supply the informa- 
 tion on request. Our desire in publishing this booklet is 
 the same as that in every department of our business, to 
 serve the investor to the utmost of our ability. 
 
 63 
 

 
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