“At the rates which we find would have been reasonable, . . . the total charges should have been $301.84 . . . The complainants can have reparation only for the difference between what they actually pairl, $310.75, and what we now find should have been assessed, or for the sum of $8.91. An order in accord will be herewith issued.” — Opinion No. 1901, INTERSTATE COMMERCE COMMISSION.
WAS it indeed for such momentous results as this that the country was bombarded by presidential messages; that the utmost activities of the press, for and against legislation, were called into action for months; and that almost unlimited oratory stands spread forth upon the pages of the Congressional Record? Was all this expenditure of political energy in the enactment of the Hepburn Act of 1906 worth while, in order that a peach-canner in Martinsdale, Georgia, should receive reparation of $8.91 on about three carloads of his wares? Was a mountain in travail to bring forth such a mouse as this? Perhaps not, for this man alone; but the significant fact is that, within two years, about nine thousand of his fellows appealed to the Federal government for an adjustment of their transportation difficulties, great and small. The overwhelming majority of these complaints were settled informally out of court, and in this work of reconciliation one of the most conspicuous and beneficial functions of the new Commission appears. But an increasing number of these complaints seem to require a formal hearing and decision of record. Some indication of the public relief sought is afforded by the fact that within approximately the first two years and a half, up to August 28, 1908, 1053 cases on the formal docket were disposed of, leaving over five hundred issues still undecided. As compared with this total of over fifteen hundred formal complaints under the new law, the number filed under the old law amounted to only 878 throughout the long period of eighteen years. Moreover, the number of complaints filed seems to be steadily increasing. During the first year from September 1, 1906, only 387 cases were filed; the next year the number rose to 448; and in the last twelvemonth, to August 28, 1909, it amounted to 1083. Surely it cannot be averred that the public has failed to respond to the new law.
These activities of the government’s agents, it is almost needless to mention, afford no true measure of the benefits resulting from the law. Like every other sound piece of legislation, it was intended to be preventive, not punitive. The number of arrests by the police affords no indication of the effectiveness of a criminal statute. Not the violations of law, but the breaches forestalled, are of real significance. And similarly in this instance, one surely finds the primary benefit of legislation, not in the complaints preferred, but in the fact that, under the improved relationship between the principals concerned, many long-standing causes of irritation and misunderstanding are being removed. The real gain, not to be measured by figures, is to be found in the improved spirit of the intercourse now prevalent between railway officials and their customers. The shipper — especially if he be a small one — having business to transact may now be sure of courteous treatment and a prompt and probably just outcome. In the old days he was too often made to feel his utter economic dependence. As a high traffic official recently put it to me, “ One reason we do not like this law is because we have to stop and think twice what we are about. We must be ready to explain and show a warrant for every act. An attack of indigestion cannot any longer serve as an excuse for an arbitrary, off-hand ruling.” This improved spirit has permeated the whole staff of railway officials, from the officious baggagesmasher, who made one feel that it was a favor to have one’s chattels demolished, to the vice-president in charge of traffic, who has seen a new light on the public aspect of his calling.
For a year or more after the law first went into effect, the railroad managers on their part seemed submissive and in a chastened mood. The Commission also exercised its new powers rather timidly. But a change seems to have supervened of late on both sides. So far as the railroads are concerned, the political atmosphere has certainly cleared. Popular hostilityagainst them has considerably abated. “ The best tariff we ever had ” moves toward the middle of the stage. A change of administration has ensued, with a marked increase in the professionally legal ballast of the ship of state. A goodly number of important cases before the Federal courts, which once appeared threatening, have been decided in favor of the carriers. Thus the “ commodities clause,” forbidding railroads to operate coal-mines and similar enterprises, has been pretty effectually emasculated by the Supreme Court. For while with one hand it upheld the constitutionality of the law, with the other it pointed the broad and easy way to evade it. The late Mr. Harriman, before the same tribunal, was excused from revealing any of the details as to his frauds upon the Chicago and Alton and Union Pacific stockholders, for whom as director he was supposed to be a responsible trustee. The Standard Oil Company, by the aid of eminent counsel, seems likely to evade punishment for much of its rebating. And an unexpectedly large number of injunctions have of late issued to postpone enforcement of the Commission’s orders until they are passed upon by the Supreme Court.
Nor is it likely that the brightening financial situation is without effect. Now that the dark days of the depression of 1907 have passed into history, ambitious financial plans, temporarily abandoned, are being revived. Some of these probably would be hampered by any further extension of the principle of government regulation and publicity. Certain it is that the railroads have chirked up. They are manifestly “ feeling their oats ”; and are displaying a disposition to contest the law at every point. Upwards of thirty cases are now pending before the various Federal courts, which have been taken there on appeal from the Interstate Commerce Commission.
This opposition to the law is perhaps in part also due to the fact that the Commission itself has stopped whittling and has begun to saw wood. A number of really fundamental questions are up for settlement. Can it be that the great contest of 1905 has been so soon forgotten? Must the great political principle of public accountability of common carriers be reaffirmed by another popular upheaval? Surely railway managements cannot be so blind to their own welfare as deliberately to invite it.
The nature of the complaints before the Interstate Commerce Commission, with its amplified powers under the new law, affords the best indication of the most important feature of its work — namely, the settlement of disputes between the railroads and their clients. And it will be apparent that a large number of these only indirectly raise the issue of the actual freight rate. Oftentimes they concern rather the manner of conducting business. An attentive perusal of these decisions of the Commission offers interesting evidence of the range of a carrier’s activities. Every little station all over the country between Aaron and Zuwash, and every conceivable commodity, from “ mole-traps in crates” to “jewelers’ sweepings,” is comprehended. The fact that these disputes, often pecuniarily insignificant, could not be amicably adjusted by the good offices of the Commission informally, but necessitated formal hearing and decision, is the strongest possible proof that some competent tribunal of this sort was greatly needed in the interest of industrial peace.
One of the commonest petty complaints is of misrouting of freight. Goods are carried by a roundabout way, or by one not enjoying the lowest through rate. Thus, to be specific, in 1908 six carloads of print-paper were shipped from Little Falls, Minnesota, to Boisé, Idaho. Three routes were open, the rates being respectively $1.30, $1.36, and $2.17 per hundred pounds. The Northern Pacific road, in absence of instructions, sent the goods by the third route, — presumably the one most profitable to itself, — the result being a freight rate $1760.62 greater than it need have been. Reparation to this amount was granted within three months by order of the Commission.
Another frequent difficulty concerns the supply of suitable cars for the needs of the shipper. Carload rates are always proportionately lower than charges for package shipment. The carriers very properly prescribe a certain minimum lading as a requisite for the grant of these proportionately lower wholesale rates. The shipper at carload rates must, however, pay for the full capacity of the car, whether his shipment fills it or not. No exception can be taken to this practice, unless the carrier is unable or unwilling to supply cars of a suitable size. This sometimes happens. For instance, in 1908, a lumberman in Oregon, having a shipment of 39,500 pounds to make to a point in Pennsylvania, requested of the Southern Pacific a car of 40,000 pounds capacity. Not having one at hand, a much larger car was furnished, having a minimum capacity of 60,000 pounds. Following the standing rule as to carload rates, the shipper was compelled to pay 621/2 cents per hundred pounds on the marked capacity of the car, that is to say, on 20,000 pounds more freight than he actually shipped. This made a difference of $128.12 in the freight bill, — nearly fifty per cent in excess of the charge based upon the actual shipment. The Commission issued its order for reparation within five weeks of the filing of the complaint.
A flagrant case of the misapplication of similar rules was recently decided. A retail druggist at Douglas, North Dakota, bought a sheet of plate glass eight feet square at St. Paul for fortysix dollars. Usually such large sheets have to lie flat on the car floor; and, occupying so much space, are properly assessed at a minimum weight of five thousand pounds, regardless of the actual lading. But in this instance the glass was carried upright, screwed to the end of the car, along with a lot of miscellaneous freight. Applying the standard rule made the freight bill for a distance of 587 miles, $9.50 more than the entire cost of the glass at St. Paul. It appears strange that the carrier should have permitted so clear a case to come to a formal hearing at all. Presumably it contested it as much for the protection of its standard rules, as for the sake of the actual revenue involved. No exception can be taken to these shipping rules as a whole; but these cases make it evident that their application may be at times too harsh and rigid. The tribunal established by the new law performs a much-needed service to the community in tempering their application in exceptional instances.
Attempts at arbitrary exclusion from participation in through shipments, in order to stifle competition, not infrequently crop out in these decisions. In 1905 the Enterprise line, capitalized at four hundred thousand dollars, put three steamers into commission from Fall River to New York. This independent line was of the utmost importance to the cotton manufacturers, as it was expected that at New York connection could be made with competing rail and water lines to every part of the United States. But all these lines, presumably at the behest of the New York, New Haven and Hartford Railroad, which had hitherto enjoyed a monopoly of the business, and which, with its enormous tonnage of highgrade freight to be parceled out among connecting lines at New York, was a formidable factor, promptly declined to join in making any through rates. All their local rates from New York on were, of course, prohibitory. In one instance, while the through rate accorded to the shipper over the New Haven road was 165/8 cents per hundredweight from New York on, the patron of the Enterprise line was charged 251/2 cents for the same service.
This case recalls a similar one in 1897, when the independent Miami line of steamers from New York tried to break the monopoly held by the steamship lines owned by the railroads out of Galveston, Texas. The roads not only refused to pro-rate, but actually demanded prepayment of freights from Galveston on, as local rates. The Federal courts tinkered with the subject for a while, until the Circuit Court of Appeals, while recognizing a probable violation of law, affirmed that suit could be legally instituted only by the United States. Meantime, of course, the company was forced out of that business; and rates have steadily risen ever since. In this later instance of the Enterprise line, the Commission promptly ordered an extension of the same privileges to the independent line that were enjoyed by its powerful rival.
No railroad can be blamed for seeking to protect its own business interests. It is the function of this tribunal with its amplified powers to determine when these efforts conflict with the rights of others. In the far Northwest it was long a grievance that neither passengers nor shippers from the State of Washington could find an outlet anywhere except over the united Hill fines of road. Neither through tickets nor through bills of lading could be had by a natural route to the Middle West, or even to Colorado or Utah, through Portland, Oregon. The reason was plain. The northern transcontinental lines got more revenue from traffic which went east over their lines a thousand miles, by way of Spokane, than when it was turned over to a rival line at Portland, Oregon, after a haul by them of only one hundred and fifty miles. Even in 1907, at the time of extreme congestion of the Northern Pacific main line, when it was literally overwhelmed with business, the lumbermen complained that they could find no relief by these other routes.
Theopeningof this Portland gateway did not have to await the truce or reconciliation of the Hill-Harriman forces — the mere dictum of private individuals; it was speedily accomplished by an easy process of law. In this instance the business interests of an entire state took joint issue with the carriers. But the same remedy is open to the small shipper. Thus, in 1907, the Commission intervened in behalf of the Hope Cotton-Seed Oil Company. This little concern in the South shipped seventeen cars of one season’s product out over a certain road, on a low through rate. The railroad agent was then informed that these shipments interfered with the policy of establishing new industries of this sort on another line; and the through rate was canceled. This jumped the charges from 171/2 cents per hundredweight to 67 cents, — almost the entire worth of the cottonseed. Since the new law went into effect, the Commission has prescribed a new rate of 30 cents; and industrial peace is the result.
Thus does the work of this tribunal go on, with its daily grist of opinions on almost every conceivable phase of the transportation business. It may be to prescribe that, even though inflammable, small-lot shipments of petroleum must be accepted by a carrier at least twice every week, instead of on only one day; that structural iron may be stopped off en route at Indianapolis, as it is at Chicago and St. Louis, to be sheared, fitted, and punched, without losing the benefit of a low through rate, just as cotton is halted at the compressor, or grain is milled in transit; that a definite rate must be quoted on jewelers’ sweepings, — the dirt and waste laden with particles of gold destined to the smelter, — even though it expose the carrier to the risk of exorbitant claims for damage in case of accident. But whatever the issue, one has the satisfying conviction, after reading the pros and cons in the decisions, not only that the matter has been settled by a disinterested and supposedly impartial third party, but that the decision is endowed with the beneficent force of public authority. As one reads these decisions, there is no evidence of political log-rolling, or of legal quibbling. They go straight to the point on the economic and common-sense issues involved.
By no means are all these decisions in favor of the shipper. In fact, during the first fourteen months, only fortysix out of one hundred and seven formal cases were thus settled. The railroads enjoy no monopoly of unfair practices. Indeed, many of the rules, the exceptional application of which works hardship, were originally provided to meet some attempt at fraud by shippers. They might be underclassifying; seeking free storage on wheels pending sale of their goods; claiming exorbitant damages; or perpetrating any one of a thousand petty meannesses to which human nature is liable. One or two instances of shippers’ complaints set aside as unreasonable may not be out of place.
The Topeka banana dealers in 1908 complained that bananas en route from New Orleans were subject to an appreciable shrinkage in weight, amounting to about six hundred pounds per car. Inasmuch as about fouteeen thousand cars were being moved annually, it is clear that the aggregate loss of weight was considerable. The practice had been to weigh the bananas when transferred from the steamers at New Orleans to the cars, and to levy the freight rate upon this weight. To this the dealers objected, instancing among other things the practice, long prevalent in the cattle business, where a similar loss of weight in transit occurs, of charging according to the weight of the shipments, not at the initial point, but at the point of delivery. At first sight the complaint appears to be well founded. Surely one should not be compelled to pay freight on a greater lading than is carried. But the Commission on examination decided in favor of the roads. It was shown that the service was most exceptional as to the shipment, handling, and speed; and it was held that the charges were on the whole reasonable and just.
One of the most important issues in which the railroads have won their contention concerned the loading of lumber on flat-cars. For half a century the practice has been that the shipper should provide his own lumber-stakes and pay freight on them as on the lumber itself. In 1905 the National Lumbermen’s Association tried to change all this, and to impose upon the carriers the legal duty of securing the loads in place as they do with many other commodities. The carriers offered a compromise, agreeing to allow five hundred pounds per car free for the weight of the stakes; but refused to accept responsibility for safely stowing the goods. The Commission finally, after prolonged inquiry by experts, relieved the carriers of this care and expense.
It is undeniable also that the carriers have found solace in certain unforeseen ways under the amended law. The rigid prohibition of all favors and rebates has substantially raised the general level of charges, so general was the practice of cutting rates a few years ago. To be sure, this increase has affected principally the large shippers, thus tending to equalize opportunity between all grades of competitors. But over and above this, the prohibition of any act tainted with favoritism has enabled the carriers successfully to withstand many leakages of revenue. Claims for damages can be plausibly denied on the ground that their settlement might arouse suspicion, and possibly lead to prosecution for the grant of individual favors. Many roads have also actually augmented their revenues by this same line of argument. The custom of charging a merely nominal rental of one dollar for freight-sheds, other buildings, or land used for sidetracks or elevators, was formerly general. It would have been awkward to place these contracts on a strictly commercial basis, especially where the tenants were shippers, with the option of resorting to a rival line. But on the plea that a continuance of these nominal rentals might be considered a criminal act of favoritism, substantial increases of revenue have been obtained. On one road alone over three thousand of these nominal rentals have been raised to strictly commercial figures. The aggregate increase of revenue from this source has been by no means inconsiderable.
An odd feature of the problem of railway legislation is that it has to do with all three of the great coördinate branches of the government. The making of rates seems to be a legislative act; their supervision, as actually applied, an executive or administrative act; and their correction or review, a judicial act. Separation of these three powers is a fundamental principle of our government. To enter into a discussion of the reforms needed in the mere methods of procedure and administration of the present law — a topic with which the present administration is admirably fitted to cope — is beyond the province of this article. Suffice it to say that a logical repartition of hitherto confused and conflicting governmental functions is proposed, in order to promote celerity and certainty in the application of the law. The present Commission, with certain enlarged powers, is to hear and pass upon complaints, this being an executive act. A special commerce court is to be created, to attend finally to all matters of judicial review of orders of the Commission, short of those purely constitutional questions which must go forward to the Supreme Court. And this strengthening of the judicial arm is to be accompanied by a transfer of the service of prosecution of suits to the Department of Justice. To the non-legal expert it would appear to be an admirable division of governmental labor.
The problems put up to the Interstate Commerce Commission are not all of the relatively petty or individual character of those already described. As was confidently predicted by railroad men, this body with its enlarged powers has been brought face to face with great economic questions, whose determination is vital to entire commonwealths, and even to the whole country. One of t hese hard nuts for the Commission to crack concerns the reasonableness of the various freight-rate advances which have of late been occurring all along the line. This raises a question as to the absolute fairness of the new rates as against the interest of the general public. One conclusion is certain. The new law has not prevented the carriers from persisting in a policy, adopted nearly ten years ago after a generation of steadily declining rates, of quite generally putting up their charges. Unfortunately, the law of 1906 is defective in making no provision for dealing adequately with such cases. The Interstate Commerce Commission is limited in its scope to the consideration only of specific complaints. It cannot of its own initiative pass upon the reasonableness of an entire new schedule of rates in advance of its taking effect. It must take the matter up, if at all, bit by bit, as individual shippers chance to complain, after the rates have become operative. This abridgment of its power to pass upon the reasonableness of tariffs as a whole was effected in +he Senate. It was not contemplated either by the late administration or by the House of Representatives. The result, as was predicted, is that little protection is afforded to the public in any large way. Judging by results, the railroads are as free as they ever were to increase their tariffs, whenever they see fit so to do.
There is imperative need of amending the law, and of granting power to suspend such rate-advances, not as now in particular cases on complaint, but as to entire schedules of rates, prior to their taking effect. The experience of the last few years has amply proved the need of some such amendment; and it is gratifying to note that President Taft, judging from his public utterances, seems likely to favor the proposal.
It is matter of common knowledge that railway rates persistently rose between 1900 and 1906. The extent of the changes since the new law went into effect, is not so generally appreciated. From an arsenal of evidence, a few details may be selected as typical.
Few commodities are of greater importance to the United States than chemical fertilizers, used in enormous quantities all over the country. The basis of these is phosphate rock. The freight rate on this from Tennessee to Chicago in 1907 was $3.40 per ton. It was increased to $3.95, until the Commission ordered its reduction to the old figure. At the same time the Oregon lumbermen had their rates to the East increased about one-quarter, after a period of quiescence of six years. From the Willamette Valley to San Francisco — a test case now before the courts — lumber rates were $3.10. In 1907 they were put up to $5. The Commission held that $3.40 was an adequate rate. The last general increase occurred in January, 1909, particularly in transcontinental rates, where the fruit of the Harriman monopoly made itself felt. Not unduly great in the East, considering the increased costs of operation, — twentyfive cents per ton on pig iron and iron pipe, for instance, — the Pacific Coast rates from New York rose often as high as fifty per cent. The rate on dry goods went up by one-third. Therein lies a part of the motive power for Union Pacific speculative finance.
Occasionally one strikes an exorbitant rise in the East, however, as in one instance where on imported iron pyrites used in making sulphuric acid, the rate, which in 1903 was $1.56, became $2.72 four years later. And the hardship often obtains in the fact that these increases have been most marked in the case of the small shipper, — the very one who, in these days of large enterprises, we can least afford to spare. The rate on cotton goods from the South to the Pacific Coast rose only fifteen per cent between 1896 and 1907 by the carload; for smaller lots it rose sixty-five per cent. In 1907, 38,000,000 pounds of cheese were produced in southwestern Wisconsin. The shipper to Chicago by carload paid only about ten per cent more in 1907 than eight years earlier; but the shipper in smaller lots was compelled to pay forty per cent more. As always, the change is along the line of least resistance. Such a policy makes for larger dividends; but does it tend to the perpetuation of equality of opportunity as between great and small concerns? That is a social question of the very first importance.
This chronicle of rate-advances in a time of industrial depression is not offered as an indictment of recent railroad management. It is merely intended to show the contrast between the present conditions of combination and monopoly, and the old-fashioned days before 1900. Everybody then assumed as a matter of course that railroad rates, while they might slacken in their thirty years’ decline, would probably never be actually higher than at that time. And yet here they are greatly enhanced in a time of trade reaction; and, for aught that one can see, likely to keep on rising. And while the rises of 1900 were part and parcel of a world-wide price movement, these later advances bear some indications of greater independence. That little incident of a prompt rise of the rate on lemons from California, just as soon as the new tariff law had effectually debarred the Sicilian product and enabled higher prices to the consumer to be charged, was a case in point. Not all the benefits of a protective tariff were to go to the fruit-grower, by any means!
The allegation of the railway men is that these freight-rate advances are not peculiar to the carriers alone. They discern a warrant for them in their greatly enhanced wage-scales and pricelists since 1900. “ The decline in the purchasing power of the railroad’s dollar ” has been a favorite subject for railway writers, — generally, by the way, presaging another increase of freight rates. But it is certainly open to question whether the carriers have not already fully squared their accounts in this regard. They certainly have fared better in this respect than the general public. The record of increase of net incomes and stock dividends within the last ten years certainly appears to prove that, while their scale of expenditures may be rising, its acceleration is exceeded by the growth of income. No other conclusion is possible.
The carrier’s argument that a rise of freight rates must fully keep pace with the course of general prices and wages, also neglects consideration of the well-established economic principle, that a railroad’s profits normally increase more than in proportion to the swelling volume of its traffic. Technically speaking, a railroad affords one of the clearest known examples of an industry subject to the law of increasing returns. This was exceptionally clear before 1898, when prices and wages began to mount. Between 1880 and 1897, for example, three times as much freight and two and one-quarter times as many passengers were transported, at an increased operating cost of only about one hundred per cent. The everwidening margin would have yielded increasing net returns, had not unregulated competition constantly pared down the rates. This erosion of rates, thanks to the advent of monopoly and combination, has now entirely ceased. So that the effects of the law of increasing returns can be more readily observed.
Even during the last ten years, therefore, the evidence is indubitable that the railways make more money in proportion to the growing volume of their business than they did before. And there is no question as to the enormously rapid rate at which their business is likely to grow in future. Statistically measured, the railways of this country in 1907 carried more than double the traffic of 1898. Take the case of the Union Pacific Railroad. In 1900 its freight business amounted to about 1,572,000,000 ton miles. For 1909, the corresponding figure was5,266,000,000, an increase of over three hundred per cent — or about thirty-three per cent yearly. Surely this enormous growth of business, under the known laws of increasing railroad profits, ought to count for something in the public’s favor. And yet the large increase of transcontinental freight rates in January, 1909, bears no evidence that it did so.
Turning from the past to the future, the all-important question is as to the rights of the shipping and consuming public against further continuation of this policy of rate-advances, in the face of the bounteous rates of return upon the actual capital invested. How far are the common carriers of the country partners of the people in industrial prosperity? Are they alone to be immune from the periodic industrial reactions to which all other forms of business are exposed? Because the volume of their business declines in times of panic, are they entitled to recoup their losses by advancing the price of their commodity — transportation — because they seem to have the power to do so? That was certainly their policy during the depression of 1907-08. And if they can increase their rates in a time of depression, how much greater is the probability that they will continue to do so now that prosperity has returned.
To all these contentions it will very properly be replied, that the necessity for enormously increased transportation facilities, in order to keep pace with the growth of the country, makes it imperative that attractive returns on the new capital invested should be guaranteed. This is certainly true. Nor can it be doubted that the antirailroad political hysteria of 1906-07 threatened unduly to cut off this supply of new capital. But there is still a latent popular suspicion that in far too many cases exorbitant returns are yielded.
This suspicion has been kept alive by numerous recent events. The Northern Pacific Railroad, in addition to enormous improvements of its plant out of surplus, for some time regularly paid seven per cent dividends, and that too on $93,000,000 of new stock issued at par; then, suddenly, in December, 1908, paid an extra cash dividend of eleven per cent out of a secret fund, not known to exist except by its directors. The Great Northern Railroad in 1898 increased its capital stock by one-half, and again in 1906 doubled this total in order to keep pace with its earnings. The earnings of some of the anthracite coal roads are spectacularly large. The Lackawanna for some years has earned over fifty per cent annually on its outstanding capital stock, effecting a partial distribution of its surplus by a cash dividend of fifty per cent, and a stock dividend of fifteen per cent in 1909. Even the Reading is making a show of earnings on its huge overload of capitalization, — partly a product of early fraud and speculation, and partly representing debts incurred to buy up and carry the American anthracite coal-supply of the next hundred years. And in 1910 even the notorious Nickel Plate line, unloaded upon the Lake Shore a generation ago, as a speculative hold-up, begins to pay dividends on its common stock.
The expert may perhaps be able in some cases to show a warrant for these acts. He may prove, for instance, that long-continued reinvestment of surplus earnings in the property has legitimately enhanced its value; or, to be specific, that the extra Northern Pacific dividend of 1908 represented an accumulation of income based upon conservative management. An enthusiast might even go so far as to attempt to prove that the late Mr. Harriman’s increase of the stock and bonds of the Chicago and Alton Railroad by $62,660,000 — without a dollar’s worth of new capital paid in — was merely an effort to readjust the outstanding capitalization of a prosperous road, after years of thrifty management, to its newly discovered earning capacity. And the validity of this argument must be admitted within reasonable limits. The trouble is that the undiscerning public is unable to distinguish the fraudulent from the honest financing; and visits its suspicions alike upon the sound and the unsound.
There is one weak point in the elaborate defense by the financial expert of an unlimited enhancement of railroad earnings and dividends. It is advanced in support of the contention that railroad charges must not be held subject to review. This is the assumption that all undistributed surplus earnings of a company are as completely the property of the stockholders as are the presumably reasonable dividends declared. And at first sight, this appears plausible enough. If, as actually happened in 1907, net earnings of all the railroads of the United States, available for dividends and improvements, amounted to $479,000,000, while only $227,000,000 was actually checked out to stockholders, more than half still remained on hand. A goodly portion of this, of course, must be laid by for the lean years when earnings fall below the average. But what of the remainder? Obviously there is only one use to be made of it. Reinvest it in the plant, lay double tracks, buy new equipment; and — the optimist will add — give better service even if it costs more to do so. But immediately there arises a question in the public mind. These surplus earnings, thus reinvested, are in part the public’s investment. After liberal dividends have been currently declared and all the risks of bad years have been insured against, the stockholders’ sole right to the balance would seem to be neither absolute nor clear. Or, otherwise stated, the stockholders’ right to a maintenance of the existing level of rates is called in question. Charges once reasonable under conditions of liberal but not excessive dividends, may become exorbitant when the returns on invested capital exceed a fairly ample rate. Such is the principle of division of profits in the London and Boston sliding scale of rates for gas companies. And the analogy is clear with the popular demand expressed in the British budget for taxation of the unearned increment of land values.
The trouble, of course, is that in practice these surpluses are quietly laid away year by year, and then suddenly capitalized in the form of stock dividends or other bonuses. This custom blocks the wheels of the argument above stated. This argument, that the surplus above fair dividends was in part the public’s surplus, was predicated upon the assumption that the ownership of railroad securities is unchanging and permanent. But stocks and bonds are constantly passing from hand to hand. Suppose a road is known to be accumulating a heavy surplus from — let us say — exorbitant rates. The value of its securities rises steadily in the same proportion, if the facts be known. Innocent persons, trustees, and widows buy these securities at the new and enhanced prices. The former stockholders “ cash in ” their shares, and pocket their portion of the surplus. The new owners pay full value for the portion which they thus acquire. When this surplusis distributed as a “melon,” they are merely given possession of goods, already paid for. Shall public authority intervene, and deny the right of these eleventh-hour investors to come into their own? No court would permit it for a moment. The public’s share in the surplus earnings is gone forever. And what is worse, the private owners once possessed of these surpluses become endowed with the right to a fair dividend return thereon for all future time. Exorbitant rates create undue surpluses; such surpluses lead to new issues of stock; and this stock, once issued, compels a continuation of the high rates.
The economic phenomena of increasing and possibly unreasonable freight rates, of unwarranted surpluses, of “ melon-cutting ” and stock dividends, all impel one to the same conclusions, — conclusions embodied in the recommendations of President Taft to Congress. All these phenomena hang together as cause and effect. A vicious wheel of policy is set rolling, which cannot be arrested. Nor may any halfway plan of control be adopted. That is the trouble with the Hepburn Act. Admirable as many of its provisions are, it can never be successfully applied in any large way, until the interdependence of earnings, that is to say of rates, of capitalization, and of the value of the properties themselves, is recognized by law.
One of the most extensive rate-controversies in our economic history in the Far West perfectly illustrates this statement. All the Rocky Mountain cities, from Spokane to Albuquerque, have been up in arms for years about their high rates of transportation from the East. These rates are often as much as one hundred per cent higher than rates to the more distant Pacific Coast points. The complaints of Spokane may be taken as typical of the complaints of practically every town of any size in the Rocky Mountain area. The rate from New York to Spokane on “ tin pails and lard pails nested “is $1.90 per hundredweight; while the rate through to Seattle is only 85 cents. The result is that no dealer in these goods at Spokane can meet the competition of rivals at Seattle. What is true of nested lard pails is true of practically all goods consumed. It is obvious that there are only two possible remedies for this disparity in charges. The Seattle rates may be raised; or the Spokane rates may be reduced. The former course is precluded by ever-present water competition by way of Cape Horn and the Isthmus, To raise rail rates to Seattle would simply force traffic to come by sea. To adopt the other alternative — to reduce Spokane rates — means to cut into the earnings of the transcontinental roads. These Spokane rates could justly be reduced only if they were unreasonably high. The only possible standard by which to judge of this fact, in general, is on the basis of the rates of return on the entire investment of the Great Northern and Northern Pacific railroads. Their attorneys introduced this line of argument voluntarily, by offering proof that their properties were well worth the amount of their capitalization, and that on this basis no abnormal rates of return obtained. Spokane met this argument by recital of a long series of high dividends, and of stock-watering.
The Commission was thus forced to take up the matter of valuation; just as the Supreme Court of the United States has repeatedly been led to the same conclusion. It promptly appeared that both great transcontinental systems had regularly been earning from ten to fifteen per cent annually upon their stocks at par; and that a part at least of this capitalization was fictitious. Yet the surplus over fair dividends distributed had regularly been reinvested in the property; and, as we have seen, this surplus had been indistinguishably merged in the rest of their outstanding securities. As the Commission observed in its opinion, the harm done by unjustifiable stock-watering was irremediable. It was of no avail to close the stable door after the horse had been stolen. What should have been done, was to provide for some system of government regulation of the issue of railway securities year by year; and then to see to it that the rates charged should produce no more than a fairly liberal return on this capital after making due allowance for all contingencies.
There is nothing revolutionary in the idea of a valuation of railroad property by public authority. No less than four slates have done it most elaborately; and one of them at least has annually inventoried the possessions of its public carriers since 1893.1 Railroad enterprises have never prospered anywhere more than in these states, Michigan, Wisconsin, and Minnesota. And even in Texas, the projected new construction affords ample proof that investment is not deterred by the presence of this form of state control. One of the surprising features of some of these valuations by state authority, moreover, is their indication that many of our railroads are not in reality overcapitalized at all. In Minnesota, for instance, the total issue of stocks and bonds in 1908 was $44,200 per mile; an amount just about equal to the estimated cost of reproduction, with due allowance for depreciation. In other words, this official valuation showed that the roads represented an investment practically equal to their entire issues of stocks and bonds. State valuation should indeed have no terrors for the honestly administered property. One of its principal benefits would be the segregation of the financial railway sheep from the goats in the public and investment eye.
An interesting case of governmental valuation far exceeding in amount the issue of securities, recently occurred in Massachusetts. The question of a fair scale of rates for its services being raised, an inventory of the physical property of the New England Telephone and Telegraph Company showed a valuation of $46,500,000. This property was capitalized for only $38,900,000. Such a proceeding under the seal of public authority is of two-fold advantage. It allays public suspicion of over-capitalization. It also encourages capital by affording proof of the security behind its investments.
Advocacy of the principle of Federal valuation of railways does not necessarily mean that all the railroad possessions of the country need be inventoried at once. To do this would involve the expenditure of several million dollars. Moreover, the practice in effecting such valuation is by no means standardized as yet. It is a proceeding studded with technical difficulties of the first order. But, little by little, as state after state and corporation after corporation take account of stock, the procedure will become established. It is a branch of administrative activity requiring business and engineering talent of a high grade; but experience has already demonstrated its entire feasibility. And the need of it for the final settlement of disputed rates would seem to be beyond question.
The crowning feature of the legislation proposed by the Taft administration is governmental control of the issue of stocks and bonds by railroad companies. It is becoming increasingly clear that unless the Federal government assumes such responsibility the several states will do so independently. This latter alternative would be ineffective, and at the same time intolerable. Nor is there anything subversive of the established order in this proposal. Massachusetts has had an anti-stockwatering law since 1893. The result is that over-capitalization, whether of railroads, traction companies, or gas and electric-light companies is a nonexistent evil. States as far apart as Texas and Wisconsin have also successfully applied the same rule of publicity to the financial acts of their corporations. The most notable instance is, however, the creation of the Public Service Commissions of the State of New York. In the settlement of such knotty questions as the reorganization of the metropolitan traction companies, or the financing of the waterlogged Erie Railroad, they may occasionally have blundered; but, on the whole, no unbiased critic will hesitate a moment in attesting their work a great success. No agency could protect the people from the evil results of the barefaced frauds upon the investing public perpetrated in the financing of the New York traction companies. Yet clearer skies are ahead; and a distinct improvement in the character of rapid transit has already resulted from the activity of these public bodies.
Several positive advantages, other than the mere prevention of gross fraud, are likely to follow the adoption by the Federal government of the principle of supervision of the finances of interstate public-service companies. The first of these, of course, is the prevention of an extortionate scale of charges for service rendered. Only last November the Wells-Fargo Express Company “ cut a melon,”by the declaration overnight of a three hundred per cent cash dividend out of accumulated surplus. Having thus trebled its capitalization, and the new shares having become widely disseminated, express rates in future over a large part of the United States must be maintained high enough to pay dividends upon this enormously inflated basis. Had guardians of the public interest been suitably forearmed, the economic warrant for this act would have been at least subject to review.
Not the least of the benefits incident to Federal control of railway finance would also be the stability thereby imparted to the financial markets. One of the worst evils of our American railway finance has been stock-market manipulation by directors and their friends. The very recent rigging of Rock Island shares is a case in point. Despite the brilliancy of some of his achievements with the Union Pacific, it is indubitable that the late Mr. Harriman inextricably entangled his railroads in stock-market operations. That his speculative plunges under corporate names had a successful issue, does not in the least lessen the force of the criticism. Such operations depend in the main upon secrecy in financial affairs. The publicity incident to governmental control of capitalization would go far to abate what has long been a nuisance and a menace in American corporate finance.
Still another positive benefit which would accrue from the adoption of the President’s policy of financial regulation, would be the extension of the market for railroad securities. Two great stores of capital for investment, one old and one very new, might be largely drawn upon for the development of transportation in future, were the light of publicity and governmental approval to be thrown upon new issues of securities. European capital has too often fared badly at the hands of American railroad managers. Our Eries and our Chicago Great Westerns have too far outweighed our Illinois Centrals and our Pennsylvanias among foreign investors. They have come to regard America as a field for speculation, rather than as one for investment. And the same thing is true in some degree of our Western farmer. Our agricultural population “ out West ” is no longer up to the ears in debt. The aggregate of its invested capital is now becoming large. This will be a great financial reservoir as years go by. These people, like the European investors, hold state activity in high esteem. Could their savings be led into the channel of railroad investment, especially in the lines serving their own localities, the carriers would profit, not only directly, but by the creation of an atmosphere of political conservatism as well. It makes a great difference in the temper of a village whether the deacons of the church and the selectmen of the township are merely shippers of farm produce, or are shareholders in the railroad at the same time. A prime factor in winning the confidence of this class, and in offsetting the appeals of the political demagogue, would be the acquiescence of the railroads in a reasonable policy of financial supervision.
Eminent railway counsel avers that this is no time to reopen the issue of Federal railroad legislation; that, in fact, we are only just recovering from an era of political hysteria on the subject; and that legislative tinkering should be postponed until the Hepburn Act has at least had a fair trial. The answer is that the present administration is pledged to this policy, — to the perfecting of the programme of President Roosevelt in this regard. In a time of widespread prosperity, the American people are in a not unfriendly state of mind toward the carriers of the country. The experience of years proves that adequate public control is the only alternative for a socialistic programme of public ownership. The American people are happily not interested in this latter plan. But the bills now pending in Congress, and the state of public opinion on the subject, show the insistent demand for adequate supervision in future of these most powerful and indispensable public servants. In time of peace prepare for war. The surest protection against the shafts of the demagogue will be found under the ægis of publicity and ample Federal supervision.
- These state valuations have been more technically described by the author in the Political Science Quarterly, 1907, pp. 577-610. The latest valuation in Minnesota is described in the Quarterly Journal of Economics for May, 1909.↩