Other people's money, and how the bankers use it, 1914
CHAPTER 10 - THE INEFFICIENCY OF THE OLIGARCHS

Illustration from Harper's Weekly January 3, 1914 by Walter J. Enright

- By Justice Louis Brandeis -

We must break the Money Trust or the Money Trust will break us. The Interstate Commerce Commission said in its report on the most disastrous of the recent wrecks on the New Haven Railroad: "On this directorate were and are men whom the confiding public recognize as magicians in the art of finance, and wizards in the construction, operation, and consolidation of great systems of railroads. The public therefore rested secure that with the knowledge of the railroad art possessed by such men investments and travel should both be safe. Experience has shown that this reliance of the public was not justified as to either finance or safety." This failure of banker-management is not surprising. The surprise is that men should have supposed it would succeed. For banker-management contravenes the fundamental laws of human limitations: First, that no man can serve two masters; second, that a man cannot at the same time do many things well.

SEEMING SUCCESSES

There are numerous seeming exceptions to these rules; and a relatively few real ones. Of course, many banker-managed properties have been prosperous; some for a long time, at the expense of the public; some for a shorter time, because of the impetus attained before they were banker-managed. It is not difficult to have a large net income, where one has the field to oneself, has all the advantage privilege can give, and may "charge all the traffic will bear." And even in competitive business the success of a long-established, well-organized business with a widely extended good-will, must continue for a considerable time; especially if buttressed by intertwined relations constantly giving it the preference over competitors. The real test of efficiency comes when success has to be struggled for; when natural or legal conditions limit the charges which may be made for the goods sold or service rendered. Our banker-managed railroads have recently been subjected to such a test, and they have failed to pass it. "It is only,"' says Goethe, "when working within limitations, that the master is disclosed."

WHY OLIGARCHY FAILS

Banker-management fails, partly because the private interest destroys soundness of judgment and undermines loyalty. It fails partly, also, because banker directors are led by their occupation (and often even by the mere fact of their location remote from the operated properties) to apply a false test in making their decisions. Prominent in the banker-director mind is always this thought: "What will be the probable effect of our action upon the market value of the company's stock and bonds, or, indeed, generally upon stock exchange values?" The stock market is so much a part of the investment-banker's life, that he cannot help being affected by this consideration, however disinterested he may be. The stock market is sensitive. Facts are often misinterpreted "by the street'" or by investors. And with the best of intentions, directors susceptible to such influences are led to unwise decisions in the effort to prevent misinterpretations. Thus, expenditures necessary for maintenance, or for the ultimate good of a property are often deferred by banker-directors, because of the belief that the making of them now, would (by showing smaller net earnings), create a bad, and even false, impression on the market. Dividends are paid which should not be, because of the effect which it is believed reduction or suspension would have upon the market value of the company's securities. To exercise a sound judgment in the difficult affairs of business is, at best, a delicate operation. And no man can successfully perform that function whose mind is diverted, however innocently, from the study of, "what is best in the long run for the company of which I am director?" The banker-director is peculiarly liable to such distortion of judgment by reason of his occupation and his environment. But there is a further reason why, ordinarily, banker-management must fail.

THE ELEMENT OF TIME

The banker, with his multiplicity of interests, cannot ordinarily give the time essential to proper supervision and to acquiring that knowledge of the facts necessary to the exercise of sound judgment. The Century Dictionary tells us that a Director is "one who directs; one who guides, superintends, governs and manages." Real efficiency in any business in which conditions are ever changing must ultimately depend, in large measure, upon the correctness of the judgment exercised, almost from day to day, on the important problems as they arise. And how can the leading bankers, necessarily engrossed in the problems of their own vast private business, get time to know and to correlate the facts concerning so many other complex businesses? Besides, they start usually with ignorance of the particular business which they are supposed to direct. When the last paper was signed which created the Steel Trust, one of the lawyers (as Mr. Perkins frankly tells us) said: "That signature is the last one necessary to put the Steel industry, on a large scale, into the hands of men who do not know anything about it."

AVOCATIONS OF THE OLIGARCHS

The New Haven System is not a railroad, but an agglomeration of a railroad plus 121 separate corporations, control of which was acquired by the New Haven after that railroad attained its full growth of about 2,000 miles of line. In administering the railroad and each of the properties formerly managed through these 122 separate companies, there must arise from time to time difficult questions on which the directors should pass judgment. The real managing directors of the New Haven system during the decade of its decline were: J. Pierpont Morgan, George F. Baker, and William Rockefeller. Mr. Morgan was, until his death in 1913, the head of perhaps the largest banking house in the world. Mr. Baker was, until 1909, President and then Chairman of the Board of Directors of one of America's leading banks (the First National of New York), and Mr. Rockefeller was, until 1911, President of the Standard Oil Company. Each was well advanced in years. Yet each of these men, besides the duties of his own vast business, and important private interests, undertook to "guide, superintend, govern and manage," not only the New Haven but also the following other corporations, some of which were similarly complex: Mr. Morgan, 48 corporations, including 40 railroad corporations, with at least 100 subsidiary companies, and 16,000 miles of line; 3 banks and trust or insurance companies; 5 industrial and public service companies. Mr. Baker, 48 corporations, including 15 railroad corporations, with at least 158 subsidiaries; and 37,400 miles of track; 18 banks, and trust or insurance companies; 15 public-service corporations and industrial concerns. Mr. Rockefeller, 37 corporations, including 23 railroad corporations with at least 117 subsidiary companies, and 26,400 miles of line; 5 banks, trust or insurance companies; 9 public service companies and industrial concerns.

SUBSTITUTES

It has been urged that in view of the heavy burdens which the leaders of finance assume in directing Business-America, we should be patient of error and refrain from criticism, lest the leaders be deterred from continuing to perform this public service. A very respectable Boston daily said a few days after Commissioner McCord's report on the North Haven wreck: "It is believed that the New Haven pillory repeated with some frequency will make the part of railroad director quite undesirable and hard to fill, and more and more avoided by responsible men. Indeed it may even become so that men will have to be paid a substantial salary to compensate them in some degree for the risk involved in being on the board of directors." But there is no occasion for alarm. The American people have as little need of oligarchy in business as in politics. There are thousands of men in America who could have performed for the New Haven stockholders the task of one "who guides, superintends, governs and manages," better than did Mr. Morgan, Mr. Baker and Mr. Rockefeller. For though possessing less native ability, even the average business man would have done better than they, because working under proper conditions. There is great strength in serving with singleness of purpose one master only. There is great strength in having time to give to a business the attention which its difficult problems demand. And tens of thousands more Americans could be rendered competent to guide our important businesses. Liberty is the greatest developer. Herodotus tells us that while the tyrants ruled, the Athenians were no better fighters than their neighbors; but when freed, they immediately surpassed all others. If industrial democracy—true coöperation—should be substituted for industrial absolutism, there would be no lack of industrial leaders.

ENGLAND'S BIG BUSINESS

England, too, has big business. But her big business is the Coöperative Wholesale Society, with a wonderful story of 50 years of beneficent growth. Its annual turnover is now about $150,000,000—an amount exceeded by the sales of only a few American industrials; an amount larger than the gross receipts of any American railroad, except the Pennsylvania and the New York Central systems. Its business is very diversified, for its purpose is to supply the needs of its members. It includes that of wholesale dealer, of manufacturer, of grower, of miner, of banker, of insurer and of carrier. It operates the biggest flour mills and the biggest shoe factory in all Great Britain. It manufactures woolen cloths, all kinds of men's, women's and children's clothing, a dozen kinds of prepared foods, and as many household articles. It operates creameries. It carries on every branch of the printing business. It is now buying coal lands. It has a bacon factory in Denmark, and a tallow and oil factory in Australia. It grows tea in Ceylon. And through all the purchasing done by the Society runs this general principle: Go direct to the source of production, whether at home or abroad, so as to save commissions of middlemen and agents. Accordingly, it has buyers and warehouses in the United States, Canada, Australia, Spain, Denmark and Sweden. It owns steamers plying between Continental and English ports. It has an important banking department; it insures the property and person of its members. Every one of these departments is conducted in competition with the most efficient concerns in their respective lines in Great Britain. The Coöperative Wholesale Society makes its purchases, and manufactures its products, in order to supply the 1399 local distributive, coöperative societies scattered over all England; but each local society is at liberty to buy from the wholesale society, or not, as it chooses; and they buy only if the Coöperative Wholesale sells at market prices. This the Coöperative actually does; and it is able besides to return to the local a fair dividend on its purchases.

INDUSTRIAL DEMOCRACY

Now, how are the directors of this great business chosen? Not by England's leading bankers, or other notabilities, supposed to possess unusual wisdom; but democratically, by all of the people interested in the operations of the Society. And the number of such persons who have directly or indirectly a voice in the selection of the directors of the English Coöperative Wholesale Society is 2,750,000. For the directors of the Wholesale Society are elected by vote of the delegates of the 1399 retail societies. And the delegates of the retail societies are, in turn, selected by the members of the local societies;—that is, by the consumers, on the principle of one man, one vote, regardless of the amount of capital contributed. Note what kind of men these industrial democrats select to exercise executive control of their vast organization. Not all-wise bankers or their dummies, but men who have risen from the ranks of coöperation; men who, by conspicuous service in the local societies have won the respect and confidence of their fellows. The directors are elected for one year only; but a director is rarely un-seated. J. T. W. Mitchell was president of the Society continuously for 21 years. Thirty-two directors are selected in this manner. Each gives to the business of the Society his whole time and attention; and the aggregate salaries of the thirty-two is less than that of many a single executive in American corporations; for these directors of England's big business serve each for a salary of about $1500 a year. The Coöperative Wholesale Society of England is the oldest and largest of these institutions. But similar wholesale societies exist in 15 other countries. The Scotch Society (which William Maxwell has served most efficiently as President for thirty years at a salary never exceeding $38 a week) has a turn-over of more than $50,000,000 a year.

A REMEDY FOR TRUSTS

Albert Sonnichsen, General Secretary of the Cooperative League, tells in the American Review of Reviews for April, 1913, how the Swedish Wholesale Society curbed the Sugar Trust; how it crushed the Margerine Combine (compelling it to dissolve after having lost 2,300,000 crowns in the struggle); and how in Switzerland the Wholesale Society forced the dissolution of the Shoe Manufacturers Association. He tells also this memorable incident: "Six years ago, at an international congress in Cremona, Dr. Hans Müller, a Swiss delegate, presented a resolution by which an international wholesale society should be created. Luigi Luzzatti, Italian Minister of State and an ardent member of the movement, was in the chair. Those who were present say Luzzatti paused, his eyes lighted up, then, dramatically raising his hand, he said: ‘Dr. Muller proposes to the assembly a great idea—that of opposing to the great trusts, the Rockefellers of the world, a world-wide cooperative alliance which shall become so powerful as to crush the trusts.’ "

COOPERATION IN AMERICA

America has no Wholesale Cooperative Society able to grapple with the trusts. But it has some very strong retail societies, like the Tamarack of Michigan, which has distributed in dividends to its members $1,144,000 in 23 years. The recent high cost of living has greatly stimulated interest in the cooperative movement; and John Graham Brooks reports that we have already about 350 local distributive societies. The movement toward federation is progressing. There are over 100 cooperative stores in Minnesota, Wisconsin and other Northwestern states, many of which were organized by or through the zealous work of Mr. Tousley and his associates of the Right Relationship League and are in some ways affiliated. In New York City 83 organizations are affiliated with the Cooperative League. In New Jersey the societies have federated into the American Cooperative Alliance of Northern New Jersey. In California, long the seat of effective cooperative work, a central management committee is developing. And progressive Wisconsin has recently legislated wisely to develop cooperation throughout the state. Among our farmers the interest in cooperation is especially keen. The federal government has just established a separate bureau of the Department of Agriculture to aid in the study, development and introduction of the best methods of cooperation in the working of farms, in buying, and in distribution; and special attention is now being given to farm credits—a field of cooperation in which Continental Europe has achieved complete success, and to which David Lubin, America's delegate to the International Institute of Agriculture at Rome, has, among others, done much to direct our attention.

PEOPLE'S SAVINGS BANKS

The German farmer has achieved democratic banking. The 13,000 little cooperative credit associations, with an average membership of about 90 persons, are truly banks of the people, by the people and for the people. First: The banks' resources are of the people. These aggregate about $500,000,000. Of this amount $375,000,000 represents the farmers' savings deposits; $50,000,000, the farmers' current deposits; $6,000,000, the farmers' share capital; and $13,000,000, amounts earned and placed in the reserve. Thus, nearly nine-tenths of these large resources belong to the farmers—that is, to the members of the banks. Second: The banks are managed by the people—that is, the members. And membership is easily attained; for the average amount of paid-up share capital was, in 1909, less than $5 per member. Each member has one vote regardless of the number of his shares or the amount of his deposits. These members elect the officers. The committees and trustees (and often even, the treasurer) serve without pay: so that the expenses of the banks are, on the average, about $150 a year. Third: The banks are for the people. The farmers' money is loaned by the farmer to the farmer at a low rate of interest (usually 4 per cent. to 6 per cent.); the shareholders receiving, on their shares, the same rate of interest that the borrowers pay on their loans. Thus the resources of all farmers are made available to each farmer, for productive purposes. This democratic rural banking is not confined to Germany. As Henry W. Wolff says in his book on cooperative banks: "Propagating themselves by their own merits, little people's cooperative banks have overspread Germany, Italy, Austria, Hungary, Switzerland, Belgium. Russia is following up those countries; France is striving strenuously for the possession of cooperative credit. Servia, Roumania, and Bulgaria have made such credit their own. Canada has scored its first success on the road to its acquisition. Cyprus, and even Jamaica, have made their first start. Ireland has substantial first-fruits to show of her economic sowings. "South Africa is groping its way to the same goal. Egypt has discovered the necessity of cooperative banks, even by the side of Lord Cromer's pet creation, the richly endowed `agricultural bank.' India has made a beginning full of promise. And even in far Japan, and in China, people are trying to acclimatize the more perfected organizations of Schulze-Delitzsch and Raffeisen. The entire world seems girdled with a ring of cooperative credit. Only the United States and Great Britain still lag lamentably behind."

BANKERS' SAVINGS BANKS

The savings banks of America present a striking contrast to these democratic banks. Our savings banks also have performed a great service. They have provided for the people's funds safe depositories with some income return. Thereby they have encouraged thrift and have created, among other things, reserves for the proverbial "rainy day." They have also discouraged "old stocking" hoarding, which diverts the money of the country from the channels of trade. American savings banks are also, in a sense, banks of the people; for it is the people's money which is administered by them. The $4,500,000,000 deposits in 2,000 American savings banks belong to about ten million people, who have an average deposit of about $450. But our savings banks are not banks by the people, nor, in the full sense, for the people. First: American savings banks are not managed by the people. The stock-savings banks, most prevalent in the Middle West and the South, are purely commercial enterprises, managed, of course, by the stockholders’ representatives. The mutual savings banks, most prevalent in the Eastern states, have no stockholders; but the depositors have no voice in the management. The banks are managed by trustees for the people, practically a self-constituted and self-perpetuating body, composed of "leading" and, to a large extent, public-spirited citizens. Among them (at least in the larger cities) there is apt to be a predominance of investment bankers, and bank directors. Thus the three largest savings banks of Boston (whose aggregate deposits exceed those of the other 18 banks) have together 81 trustees. Of these, 52 are investment bankers or directors in other Massachusetts banks or trust companies. Second: The funds of our savings banks (whether stock or purely mutual) are not used mainly for the people. The depositors are allowed interest (usually from 3 to 4 per cent.). In the mutual savings banks they receive ultimately all the net earnings. But the money gathered in these reservoirs is not used to aid productively persons of the classes who make the deposits.

The depositors are largely wage earners, salaried people, or members of small tradesmen's families. Statically the money is used for them. Dynamically it is used for the capitalist. For rare, indeed, are the instances when savings banks' moneys are loaned to advance productively one of the depositor class. Such persons would seldom be able to provide the required security; and it is doubtful whether their small needs would, in any event, receive consideration. In 1912 the largest of Boston's mutual savings banks—the Provident Institution for Savings, which is the pioneer mutual savings bank of America—managed $53,000,000 of people’s money. Nearly one-half of the resources ($24,262,072) was invested in bonds—state, municipal, railroad, railway and telephone and in bank stock; or was deposited in national banks or trust companies. Two-fifths of the resources ($20,764,770) were loaned on real estate mortgages; and the average amount of a loan was $52,569. One-seventh of the resources ($7,566,612) was loaned on personal security; and the average of each of these loans was $54,830. Obviously, the "small man" is not conspicuous among the borrowers; and these large-scale investments do not even serve the individual depositor especially well; for this bank pays its depositors a rate of interest lower than the average. Even our admirable Postal Savings Bank system serves productively mainly the capitalist. These postal saving stations are in effect catch-basins merely, which collect the people's money for distribution among the national banks.

PROGRESS

Alphonse Desjardins of Levis, Province of Quebec, has demonstrated that cooperative credit associations are applicable, also, to at least some urban communities. Levis, situated on the St. Lawrence opposite the City of Quebec, is a city of 8,000 inhabitants. Desjardins himself is a man of the people. Many years ago he became impressed with the fact that the people's savings were not utilized primarily to aid the people productively. There were then located in Levis branches of three ordinary banks of deposit—a mutual savings bank, the postal savings bank, and three incorporated "loaners"; but the people were not served. After much thinking, he chanced to read of the European rural banks. He proceeded to work out the idea for use in Levis; and in 1900 established there the first "credit-union." For seven years he watched carefully the operations of this little bank. The pioneer union had accumulated in that period $80,000 in resources. It had made 2,900 loans to its members, aggregating $350,000; the loans averaging $120 in amount, and the interest rate 6 1/2 per cent. In all this time the bank had not met with a single loss. Then Desjardins concluded that democratic banking was applicable to Canada; and he proceeded to establish other credit-unions. In the last 5 years the number of credit-unions in the Province of Quebec has grown to 121; and 19 have been established in the Province of Ontario. Desjardins was not merely the pioneer. All the later credit-unions also have been established through his aid; and 24 applications are now in hand requesting like assistance from him. Year after year that aid has been given without pay by this public-spirited man of large family and small means, who lives as simply as the ordinary mechanic. And it is noteworthy that this rapidly extending system of cooperative credit-banks has been established in Canada wholely without government aid, Desjardins having given his services free, and his travelling expenses having been paid by those seeking his assistance.

In 1909, Massachusetts, under Desjardins' guidance, enacted a law for the incorporation of credit-unions. The first union established in Springfield, in 1910, was named after Herbert Myrick—a strong advocate of cooperative finance. Since then 25 other unions have been formed; and the names of the unions and of their officers disclose that 11 are Jewish, 8 French-Canadian, and 2 Italian—a strong indication that the immigrant is not unprepared for financial democracy. There is reason to believe that these people's banks will spread rapidly in the United States and that they will succeed. For the cooperative building and loan associations, managed by wage-earners and salary-earners, who joined together for systematic saving and ownership of houses—have prospered in many states. In Massachusetts, where they have existed for 35 years, their success has been notable—the number, in 1912, being 162, and their aggregate assets nearly $75,000,000.

Thus farmers, workingmen, and clerks are learning to use their little capital and their savings to help one another instead of turning over their money to the great bankers for safe keeping, and to be themselves exploited. And may we not expect that when the cooperative movement develops in America, merchants and manufacturers will learn from farmers and workingmen how to help themselves by helping one another, and thus join in attaining the New Freedom for all? When merchants and manufacturers learn this lesson, money kings will lose subjects, and swollen fortunes may shrink; but industries will flourish, because the faculties of men will be liberated and developed.

President Wilson has said wisely:

"No country can afford to have its prosperity originated by a small controlling class. The treasury of America does not lie in the brains of the small body of men now in control of the great enterprises… It depends upon the inventions of unknown men, upon the originations of unknown men, upon the ambitions of unknown men. Every country is renewed out of the ranks of the unknown, not out of the ranks of the already famous and powerful in control."

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Other people's money, and how the bankers use it, 1914
CHAPTER 9 - THE FAILURE OF BANKER-MANAGEMENT

Illustration from Harper's Weekly December 27, 1913 by Walter J. Enright

- By Justice Louis Brandeis -

There is not one moral, but many, to be drawn from the Decline of the New Haven and the Fall of Mellen. That history offers texts for many sermons. It illustrates the Evils of Monopoly, the Curse of Bigness, the Futility of Lying, and the Pitfalls of Law-Breaking. But perhaps the most impressive lesson that it should teach to investors is the failure of banker-management.

BANKER CONTROL

For years J. P. Morgan & Co. were the fiscal agents of the New Haven. For years Mr. Morgan was the director of the Company. He gave to that property probably closer personal attention than to any other of his many interests. Stockholders' meetings are rarely interesting or important; and few indeed must have been the occasions when Mr. Morgan attended any stockholders' meeting of other companies in which he was a director. But it was his habit, when in America, to be present at meetings of the New Haven. In 1907, when the policy of monopolistic expansion was first challenged, and again at the meeting in 1909 (after Massachusetts had unwisely accorded its sanction to the Boston & Maine merger), Mr. Morgan himself moved the large increases of stock which were unanimously voted. Of course, he attended the important directors' meeting. His will was law. President Mellen indicated this in his statement before Interstate Commerce Commissioner Prouty, while discussing the New York, Westchester & Boston—the railroad without a terminal in New York, which cost the New Haven $1,500,000 a mile to acquire, and was then costing it, in operating deficits and interest charges, $100,000 a month to run:

"I am in a very embarrassing position, Mr. Commissioner, regarding the New York, Westchester & Boston. I have never been enthusiastic or at all optimistic of its being a good investment for our company in the present, or in the immediate future; but people in whom I had greater confidence than I have in myself thought it was wise and desirable; I yielded my judgment; indeed, I don't know that it would have made much difference whether I yielded or not."

THE BANKER'S RESPONSIBILITY

Bankers are credited with being a conservative force in the community. The tradition lingers that they are preeminently "safe and sane." And yet, the most grievous fault of this banker-managed railroad has been its financial recklessness—a fault that has already brought heavy losses to many thousands of small investors throughout New England for whom bankers are supposed to be natural guardians. In a community where its railroad stocks have for generations been deemed absolutely safe investments, the passing of the New Haven and of the Boston & Maine dividends after an unbroken dividend record of generations comes as a disaster.

This disaster is due mainly to enterprises outside the legitimate operation of these railroads; for no railroad company has equaled the New Haven in the quantity and extravagance of its outside enterprises. But it must be remembered, that neither the president of the New Haven nor any other railroad manager could engage in such transactions without the sanction of the Board of Directors. It is the directors, not Mr. Mellen, who should bear the responsibility.

Close scrutiny of the transactions discloses no justification. On the contrary, scrutiny serves only to make more clear the gravity of the errors committed. Not merely were recklessly extravagant acquisitions made in mad pursuit of monopoly; but the financial judgment, the financiering itself, was conspicuously bad. To pay for property several times what it is worth, to engage in grossly unwise enterprises, are errors of which no conservative directors should be found guilty; for perhaps the most important function of directors is to test the conclusions and curb by calm counsel the excessive zeal of too ambitious managers. But while we have no right to expect from bankers exceptionally good judgment in ordinary business matters; we do have a right to expect from them prudence, reasonably good financiering, and insistence upon straightforward accounting. And it is just the lack of these qualities in the New Haven management to which the severe criticism of the Interstate Commerce Commission is particularly directed.

Commissioner Prouty calls attention to the vast increase of capitalization. During the nine years beginning July 1, 1903, the capital of the New York, New Haven & Hartford Railroad Company itself increased from $93,000,000 to about $417,000,000 (excluding premiums). That fact alone would not convict the management of reckless financiering ; but the fact that so little of the new capital was represented by stock might well raise a question as to its conservativeness. For the indebtedness (including guaranties) was increased over twenty times (from about $14,000,000 to $300,000,000), while the stock outstanding in the hands of the public was not doubled ($80,000,000 to $158,000,000). Still, in these days of large things, even such growth of corporate liabilities might be consistent with "safe and sane management."

But what can be said in defense of the financial judgment of the banker-management under which these two railroads find themselves confronted, in the fateful year 1913, with a most disquieting floating indebtedness? On March 31, the New Haven had outstanding $43,000,000 in short-time notes; the Boston & Maine had then outstanding $24,500,000, which have been increased since to $27,000,000; and additional notes have been issued by several of its subsidiary lines. Mainly to meet its share of these loans, the New Haven, which before its great expansion could sell at par 3 1/2 per cent. bonds convertible into stock at $150 a share, was so eager to issue at par $67,500,000 of its 6 per cent. 20-year bonds convertible into stock as to agree to pay J. P. Morgan & Co. a 2 1/2 per cent. underwriting commission. True, money was "tight" then. But is it not very bad financiering to be so unprepared for the "tight" money market which had been long expected? Indeed, the New Haven's management, particularly, ought to have avoided such an error; for it committed a similar one in the "tight" money market of 1907-1908, when it had to sell at par $39,000,000 of its 6 per cent. 40-year bonds.

These huge short-time borrowings of the System were not due to unexpected emergencies or to their monetary conditions. They were of gradual growth. On June 30, 1910, the two companies owed in short-term notes only $10,180,364; by June 30, 1911, the amount had grown to $30,759,959; by June 30, 1912, to $45,395,000; and in 1913 to over $70,000,000. Of course the rate of interest on the loans increased also very largely. And these loans were incurred unnecessarily. They represent, in the main, not improvements on the New Haven or on the Boston & Maine Railroads, but money borrowed either to pay for stocks in other companies which these companies could not afford to buy, or to pay dividends which had not been earned.

In five years out of the last six the New Haven Railroad has, on its own showing, paid dividends in excess of the year's earnings; and the annual deficits disclosed would have been much larger if proper charges for depreciation of equipment and of steamships had been made. In each of the last three years, during which the New Haven had absolute control of the Boston & Maine, the latter paid out in dividends so much in excess of earnings that before April, 1913, the surplus accumulated in earlier years had been converted into a deficit.

Surely these facts show, at least, an extraordinary lack of financial prudence.

WHY BANKER-MANAGEMENT FAILED

Now, how can the failure of the banker-management of the New Haven be explained?

A few have questioned the ability; a few the integrity of the bankers. Commissioner Prouty attributed the mistakes made to the Company's pursuit of a transportation monopoly.

"The reason," says he, "is as apparent as the fact itself. The present management of that Company started out with the purpose of controlling the transportation facilities of New England. In the accomplishment of that purpose it bought what must be had and paid what must be paid. To this purpose and its attempted execution can be traced every one of these financial misfortunes and derelictions."

But it still remains to find the cause of the bad judgment exercised by the eminent banker-management in entering upon and in carrying out the policy of monopoly. For there were as grave errors in the execution of the policy of monopoly as in its adoption. Indeed, it was the aggregation of important errors of detail which compelled first the reduction, then the passing of dividends and which ultimately impaired the Company's credit.

The failure of the banker-management of the New Haven cannot be explained as the shortcomings of individuals. The failure was not accidental. It was not exceptional. It was the natural result of confusing the functions of banker and business man.

UNDIVIDED LOYALTY

The banker should be detached from the business for which he performs the banking service. This detachment is desirable, in the first place, in order to avoid conflict of interest. The relation of banker-directors to corporations which they finance has been a subject of just criticism. Their conflicting interests necessarily prevent single-minded devotion to the corporation. When a banker-director of a railroad decides as railroad man that it shall issue securities, and then sells them to himself as banker, fixing the price at which they are to be taken, there is necessarily grave danger that the interests of the railroad may suffer—suffer both through issuing of securities which ought not to be issued, and from selling them at a price less favorable to the company than should have been obtained. For it is ordinarily impossible for a banker-director to judge impartially between the corporation and himself. Even if he succeeded in being impartial, the relation would not conduce to the best interests of the company. The best bargains are made when buyer and seller are represented by different persons.

DETACHMENT AN ESSENTIAL

But the objection to banker-management does not rest wholly, or perhaps mainly, upon the importance of avoiding divided loyalty. A complete detachment of the banker from the corporation is necessary in order to secure for the railroad the benefit of the clearest financial judgment; for the banker's judgment will be necessarily clouded by participation in the management or by ultimate responsibility for the policy actually pursued. It is outside financial advice which the railroad needs.

Long ago it was recognized that "a man who is his own lawyer has a fool for a client." The essential reason for this is that soundness of judgment is easily obscured by self-interest. Similarly, it is not the proper function of the banker to construct, purchase, or operate railroads, or to engage in industrial enterprises. The proper function of the banker is to give to or to withhold credit from other concerns; to purchase or to refuse to purchase securities from other concerns; and to sell securities to other customers. The proper exercise of this function demands that the banker should be wholly detached from the concern whose credit or securities are under consideration. His decision to grant or to withhold credit, to purchase or not to purchase securities, involves passing judgment on the efficiency of the management or the soundness of the enterprise; and he ought not to occupy a position where in so doing he is passing judgment on himself. Of course detachment does not imply lack of knowledge. The banker should act only with full knowledge, just as a lawyer should act only with full knowledge. The banker who undertakes to make loans to or purchase securities from a railroad for sale to his other customers ought to have as full knowledge of its affairs as does its legal adviser. But the banker should not be, in any sense, his own client. He should not, in the capacity of banker, pass judgment upon the wisdom of his own plans or acts as railroad man.

Such a detached attitude on the part of the banker is demanded also in the interest of his other customers—the purchasers of corporate securities. The investment banker stands toward a large part of his customers in a position of trust, which should be fully recognized. The small investors, particularly the women, who are holding an ever-increasing proportion of our corporate securities, commonly buy on the recommendation of their bankers. The small investors do not, and in most cases cannot, ascertain for themselves the facts on which to base a proper judgment as to the soundness of securities offered. And even if these investors were furnished with the facts, they lack the business experience essential to forming a proper judgment. Such investors need and are entitled to have the bankers' advice, and obviously their unbiased advice; and the advice cannot be unbiased where the banker, as part of the corporation's management, has participated in the creation of the securities which are the subject of sale to the investor.

Is it conceivable that the great house of Morgan would have aided in providing the New Haven with the hundreds of millions so unwisely expended, if its judgment had not been clouded by participation in the New Haven's management?

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Other people's money, and how the bankers use it 1914
CHAPTER 8 - A CURSE OF BIGNESS

Illustration from Harper's Weekly December 20, 1913 by Walter J. Enright

- By Justice Louis Brandeis -

Bigness has been an important factor in the rise of the Money Trust: Big railroad systems, Big industrial trusts, big public service companies; and as instruments of these Big banks and Big trust companies. J. P. Morgan & Co. (in their letter of defence to the Pujo Committee) urge the needs of Big Business as the justification for financial concentration. They declare that what they euphemistically call "cooperation" is "simply a further result of the necessity for handling great transactions"; that "the country obviously requires not only the larger individual banks, but demands also that those banks shall cooperate to perform efficiently the country's business"; and that "a step backward along this line would mean a halt in industrial progress that would affect every wage-earner from the Atlantic to the Pacific." The phrase "great transactions" is used by the bankers apparently as meaning large corporate security issues. Leading bankers have undoubtedly cooperated during the last 15 years in floating some very large security issues, as well as many small ones. But relatively few large issues were made necessary by great improvements undertaken or by industrial development. Improvements and development ordinarily proceed slowly. For them, even where the enterprise involves large expenditures, a series of smaller issues is usually more appropriate than single large ones. This is particularly true in the East where the building of new railroads has practically ceased. The "great" security issues in which bankers have cooperated were, with relatively few exceptions, made either for the purpose of effecting combinations or, as a consequence of such combinations. Furthermore, the combinations which made necessary these large security issues or underwritings were, in most cases, either contrary to existing statute law, or contrary to laws recommended by the Interstate Commerce Commission, or contrary to the laws of business efficiency. So both the financial concentration and the combinations which they have served were, in the main, against the public interest. Size, we are told, is not a crime. But size may, at least, become noxious by reason of the means through which it was attained or the uses to which it is put. And it is size attained by combination, instead of natural growth, which has contributed so largely to our financial concentration. Let us examine a few cases.

THE HARRIMAN PACIFICS

J. P. Morgan & Co., in urging the "need of large banks and the cooperation of bankers," said: "The Attorney-General's recent approval of the Union Pacific settlement calls for a single commitment on the part of bankers of $126,000,000." This $126,000,000 "commitment" was not made to enable the Union Pacific to secure capital. On the contrary it was a guaranty that it would succeed in disposing of its Southern Pacific stock to that amount. And when it had disposed of that stock, it was confronted with the serious problem—what to do with the proceeds? This huge underwriting became necessary solely because the Union Pacific had violated the Sherman Law. It had acquired that amount of Southern Pacific stock illegally; and the Supreme Court of the United States finally decreed that the illegality cease. This same illegal purchase had been the occasion, twelve years earlier, of another "great transaction,"—the issue, of a $100,000,000 of Union Pacific bonds, which were sold to provide funds for acquiring this Southern Pacific and other stocks in violation of law. Bankers "cooperated" also to accomplish that.

UNION PACIFIC IMPROVEMENTS

The Union Pacific and its auxiliary lines (the Oregon Short Line, the Oregon Railway and Navigation and the Oregon-Washington Railroad) made, in the fourteen years, ending June 30, 1912, issues of securities aggregating $375,158,183 (of which $46,500,000 were refunded or redeemed) ; but the large security issues served mainly to supply funds for engaging in illegal combinations or stock speculation. The extraordinary improvements and additions that raised the Union Pacific Railroad to a high state of efficiency were provided mainly by the net earnings from the operation of its railroads. And note how great the improvements and additions were: Tracks were straightened, grades were lowered, bridges were rebuilt, heavy rails were laid, old equipment was replaced by new; and the cost of these was charged largely as operating expense. Additional equipment was added, new lines were built or acquired, increasing the system by 3524 miles of line, and still other improvements and betterments were made and charged to capital account. These expenditures aggregated $191,512,328. But it needed no "large security issues" to provide the capital thus wisely expended. The net earnings from the operations of these railroads were so large that nearly all these improvements and additions could have been made without issuing on the average more than $1,000,000 a year of additional securities for "new money," and the company still could have paid six per cent. dividends after 1906 (when that rate was adopted). For while $13,679,452 a year, on the average, was charged to Cost of Road and Equipment, the surplus net earnings and other funds would have yielded, on the average, $12,750,982 a year available for improvements and additions, without raising money on new security issues.

HOW THE SECURITY PROCEEDS WERE SPENT

The $375,000,000 securities (except to the extent of about $13,000,000 required for improvements, and the amounts applied for refunding and redemptions) were available to buy stocks and bonds of other companies. And some of the stocks so acquired were sold at large profits, providing further sums to be employed in stock purchases.

The $375,000,000 Union Pacific Lines security issues, therefore, were not needed to supply funds for Union Pacific improvements; nor did these issues supply funds for the improvement of any of the companies in which the Union Pacific invested (except that certain amounts were advanced later to aid in financing the Southern Pacific). They served, substantially, no purpose save to transfer the ownership of railroad stocks from one set of persons to another.

Here are some of the principal investments:

1. $91,657,500, in acquiring and financing the Southern Pacific.

2. $89,391,401, in acquiring the Northern Pacific stock and stock of the Northern Securities Co.

3. $45,466,960, in acquiring Baltimore & Ohio. stock.

4. $37,692,256, in acquiring Illinois Central stock.

5. $23,205,679, in acquiring New York Central stock.

6. $10,395,000, in acquiring Atchison, Topeka & Santa Fe stock.

7. $8,946,781, in acquiring Chicago & Alton stock.

8. $11,610,187, in acquiring Chicago, Milwaukee & St. Paul stock.

9. $6,750,423, in acquiring Chicago & Northwestern stock.

10. $6,936,696, in acquiring Railroad Securities Co. stock (Illinois Central stock).

The immediate effect of these stock acquisitions, as stated by the Interstate Commerce Commission in 1907, was merely this: "Mr. Harriman may journey by steamship from New York to New Orleans, thence by rail to San Francisco, across the Pacific Ocean to China, and, returning by another route to the United States, may go to Ogden by any one of three rail lines, and thence to Kansas City or Omaha, without leaving the deck or platform of a carrier which he controls, and without duplicating any part of his journey. "He has further what appears to be a dominant control in the Illinois Central Railroad running directly north from the Gulf of Mexico to the Great Lakes, parallel to the Mississippi River; and two thousand miles west of the Mississippi River he controls the only line of railroad parallel to the Pacific Coast, and running from the Colorado River to the Mexican border…. "The testimony taken at this hearing shows that about fifty thousand square miles of territory in the State of Oregon, surrounded by the lines of the Oregon Short Line Railroad Company, the Oregon Railroad and Navigation Company, and the Southern Pacific Company, is not developed. While the funds of those companies which could be used for that purpose are being invested in stocks like the New York Central and other lines having only a remote relation to the territory in which the Union Pacific System is located." Mr. Harriman succeeded in becoming director in 27 railroads with 39,354 miles of line; and they extended from the Atlantic to the Pacific; from the Great Lakes to the Gulf of Mexico.

THE AFTERMATH

On September 9, 1909, less than twelve years after Mr. Harriman first became a director in the Union Pacific, he died from overwork at the age of 61. But it was not death only that had set a limit to his achievements. The multiplicity of his interests prevented him from performing for his other railroads the great services that had won him a world-wide reputation as manager and rehabilitator of the Union Pacific and the Southern Pacific. Within a few months after Mr. Harriman's death the serious equipment scandal on the Illinois Central became public, culminating in the probable suicide of one of the vice-presidents of that company. The Chicago & Alton (in the management of which Mr. Harriman was prominent from 1899 to 1907, as President, Chairman of the Board, or Executive Committeeman), has never regained the prosperity it enjoyed before he and his associates acquired control. The Père Marquette has passed again into receiver's hands. Long before Mr. Harriman’s death the Union Pacific had disposed of its Northern Pacific stock, because the Supreme Court of the United States declared the Northern Securities Company illegal, and dissolved the Northern Pacific-Great Northern merger. Three years after his death, the Supreme Court of the United States ordered the Union Pacific-Southern Pacific merger dissolved. By a strange irony, the law has permitted the Union Pacific to reap large profits from its illegal transactions in Northern Pacific and Southern Pacific stocks. But many other stocks held "as investments" have entailed large losses. Stocks in the Illinois Central and other companies which cost the Union Pacific $129,894,991.72, had on November 15, 1913, a market value of only $87,851,500; showing a shrinkage of $42,043,491.72 and the average income from them, while held, was only about 4.30 per cent. on their cost.

A BANKER'S PARADISE

Kuhn, Loeb & Co. were the Union Pacific bankers. It was in pursuance of a promise which Mr. Jacob H. Schiff—the senior partner—had given, pending the reorganization, that Mr. Harriman first became a member of the Executive Committee in 1897. Thereafter combinations grew and crumbled, and there were vicissitudes in stock speculations. But the investment bankers prospered amazingly; and financial concentration proceeded without abatement. The bankers and their associates received the commissions paid for purchasing the stocks which the Supreme Court holds to have been acquired illegally—and have retained them. The bankers received commissions for underwriting the securities issued to raise the money with which to buy the stocks which the Supreme Court holds to have been illegally acquired, and have retained them. The bankers received commissions paid for floating securities of the controlled companies—while they were thus controlled in violation of law—and have, of course, retained them. Finally when, after years, a decree is entered to end the illegal combination, these same bankers are on hand to perform the services of undertaker—and receive further commissions for their banker-aid in enabling the law-breaking corporation to end its wrong doing and to comply with the decree of the Supreme Court. And yet, throughout nearly all this long period, both before and after Mr. Harriman's death, two partners in Kuhn, Loeb & Co. were directors or members of the executive committee of the Union Pacific; and as such must be deemed responsible with others for the illegal acts. Indeed, these bankers have not only received commissions for the underwritings of transactions accomplished, though illegal; they have received commissions also for merely agreeing to underwrite a "great transaction" which the authorities would not permit to be accomplished. The $126,000,000 underwriting (that "single commitment on the part of the bankers" to which J. P. Morgan & Co. refer as being called for by "the Attorney General's approval of the Union Pacific settlement") never became effective; because the Public Service Commission of California refused to approve the terms of settlement. But the Union Pacific, nevertheless, paid the Kuhn Loeb Syndicate a large underwriting fee for having been ready and willing "to serve" should the opportunity arise: and another underwriting commission was paid when the Southern Pacific stock was finally distributed, with the approval of Attorney General McReynolds, under the Court's decree. Thus the illegal purchase of Southern Pacific stock yielded directly four crops of commissions; two when it was acquired, and two when it was disposed of. And during the intervening period the illegally controlled Southern Pacific yielded many more commissions to the bankers. For the schedules filed with the Pujo Committee show that Kuhn, Loeb & Co. marketed, in addition to the Union Pacific securities above referred to, $334,000,000 of Southern Pacific and Central Pacific securities between 1903 and 1911. The aggregate amount of the commissions paid to these bankers in connection with Union Pacific-Southern Pacific transactions is not disclosed. It must have been very large; for not only were the transactions "great"; but the commissions were liberal. The Interstate Commerce Commission finds that bankers received about 5 per cent. on the purchase price for buying the first 750,000 shares of Southern Pacific stock; and the underwriting commission on the first $100,000,000 Union Pacific bonds issued to make that and other purchases was $5,000,000. How large the two underwriting commissions were which the Union Pacific paid in effecting the severance of this illegal merger, both the company and the bankers have declined to disclose. Furthermore the Interstate Commerce Commission showed, clearly, while investigating the Union Pacific's purchase of the Chicago & Alton stock, that the bankers' profits were by no means confined to commissions.

THE BURLINGTON

Such railroad combinations produce injury to the public far more serious than the heavy tax of bankers' commissions and profits. For in nearly every case the absorption into a great system of a theretofore independent railroad has involved the loss of financial independence to some community, property or men, who thereby become subjects or satellites of the Money Trust. The passing of the Chicago, Burlington & Quincy, in 1901, to the Morgan associates, presents a striking example of this process. After the Union Pacific acquired the Southern Pacific stock in 1901, it sought control, also, of the Chicago, Burlington & Quincy,—a most prosperous railroad, having then 7912 miles of line. The Great Northern and Northern Pacific recognized that Union Pacific control of the Burlington would exclude them from much of Illinois, Missouri, Wisconsin, Kansas, Nebraska, Iowa, and South Dakota. The two northern roads, which were already closely allied with each other and with J. P. Morgan & Co., thereupon purchased for $215,227,000, of their joint 4 per cent. bonds, nearly all of the $109,324,000 (par value) outstanding Burlington stock. A struggle with the Union Pacific ensued which yielded soon to "harmonious coöperation." The Northern Securities Company was formed with $400,000,000 capital, thereby merging the Great Northern, the Northern Pacific and the Burlington, and joining the Harriman, Kuhn-Loeb, with the Morgan-Hill interests. Obviously neither the issue of $215,000,000 joint 4's, nor the issue of the $400,000,000 Northern Securities stock supplied one dollar of funds for improvements of, or additions to, any of the four great railroad systems concerned in these "large transactions." The sole effect of issuing $615,000,000 of securities was to transfer stock from one set of persons to another. And the resulting "harmonious cooperation" was soon interrupted by the government proceedings, which ended with the dissolution of the Northern Securities Company. But the evil done outlived the combination. The Burlington had passed forever from its independent Boston owners to the Morgan allies, who remain in control.

The Burlington—one of Boston's finest achievements—was the creation of John M. Forbes. He was a builder; not a combiner, or banker, or wizard of finance. He was a simple, hard-working business man. He had been a merchant in China at a time when China's trade was among America's big business. He had been connected with shipping and with manufacturers. He had the imagination of the great merchant; the patience and perseverance of the great manufacturer; the courage of the sea-farer; and the broad view of the statesman. Bold, but never reckless; scrupulously careful of other people's money, he was ready, after due weighing of chances, to risk his own in enterprises promising success. He was in the best sense of the term, a great adventurer. Thus equipped, Mr. Forbes entered, in 1852, upon those railroad enterprises which later developed into the Chicago, Burlington & Quincy. Largely with his own money and that of friends who confided in him, he built these railroads and carried them through the panic of '57, when the "great banking houses" of those days lacked courage to assume the burdens of a struggling ill-constructed line, staggering under financial difficulties. Under his wise management, and that of the men whom he trained, the little Burlington became a great system. It was "built on honor," and managed honorably. It weathered every other great financial crisis, as it did that of 1857. It reached maturity without a reorganization or the sacrifice of a single stockholder or bondholder.

Investment bankers had no place on the Burlington Board of Directors; nor had the banker-practice, of being on both sides of a bargain. "I am unwilling," said Mr. Forbes, early in his career, "to run the risk of having the imputation of buying from a company in which I am interested." About twenty years later he made his greatest fight to rescue the Burlington from the control of certain contractor-directors, whom his biographer, Mr. Pearson, describes as "persons of integrity, who had conceived that in their twofold capacity as contractors and directors they were fully able to deal with themselves justly." Mr. Forbes thought otherwise. The stockholders, whom he had aroused, sided with him and he won. Mr. Forbes was the pioneer among Boston railroad-builders. His example and his success inspired many others, for Boston was not lacking then in men who were builders, though some lacked his wisdom, and some his character. Her enterprise and capital constructed, in large part, the Union Pacific, the Atchison, the Mexican Central, the Wisconsin Central, and 24 other railroads in the West and South. One by one these western and southern railroads passed out of Boston control; the greater part of them into the control of the Morgan allies. Before the Burlington was surrendered, Boston had begun to lose her dominion, even, over the railroads of New England. In 1900 the Boston & Albany was leased to the New York Central,—a Morgan property; and a few years later, another Morgan railroad—the New Haven—acquired control of nearly every other transportation line in New England. Now nothing is left of Boston's railroad dominion in the West and South, except the Eastern Kentucky Railroad—a line 36 miles long; and her control of the railroads of Massachusetts is limited to the Grafton & Upton with 19 miles of line and the Boston, Revere Beach &Lynn,—a passenger road 13 miles long.

THE NEW HAVEN MONOPOLY

The rise of the New Haven Monopoly presents another striking example of combination as a developer of financial concentration; and it illustrates also the use to which "large security issues" are put. In 1892, when Mr. Morgan entered the New Haven directorate, it was a very prosperous little railroad with capital liabilities of $25,000,000 paying 10 per cent. dividends, and operating 508 miles of line. By 1899 the capitalization had grown to $80,477,600, but the aggregate mileage had also grown (mainly through merger or leases of other lines) to 2017. Fourteen years later, in 1913, when Mr. Morgan died and Mr. Mellen resigned, the mileage was 1997, just 20 miles less than in 1899; but the capital liabilities had increased to $425,935,000. Of course the business of the railroad had grown largely in those fourteen years; the road-bed was improved, bridges built, additional tracks added, and much equipment purchased; and for all this, new capital was needed; and additional issues were needed, also, because the company paid out in dividends more than it earned. But of the capital increase, over $200,000,000 was expended in the acquisition of the stock or other securities of some 121 other railroads, steamships, street railway-, electric-light-, gas- and water-companies. It was these outside properties, which made necessary the much discussed $67,000,000, 6 per cent. bond issue, as well as other large and expensive security issues. For in these fourteen years the improvements on the railroad including new equipment have cost, on the average, only $10,000,000 a year.

THE NEW HAVEN BANKERS

Few, if any, of those 121 companies which the New Haven acquired had, prior to their absorption by it, been financed by J. P. Morgan & Co. The needs of the Boston & Maine and Maine Central—the largest group—had, for generations, been met mainly through their own stockholders or through Boston banking houses. No investment banker had been a member of the Board of Directors of either of those companies. The New York, Ontario & Western—the next largest of the acquired railroads—had been financed in New York, but by persons apparently entirely independent of the Morgan allies. The smaller Connecticut railroads, now combined in the Central New England, had been financed mainly in Connecticut, or by independent New York bankers. The financing of the street railway companies had been done largely by individual financiers, or by small and independent bankers in the states or cities where the companies operate. Some of the steamship companies had been financed by their owners, some through independent bankers. As the result of the absorption of these 121 companies into the New Haven system, the financing of all these railroads, steamship companies, street railways, and other corporations, was made tributary to J. P. Morgan & Co.; and the independent bankers were eliminated or became satellites. And this financial concentration was proceeded with, although practically every one of these 121 companies was acquired by the New Haven in violation either of the state or federal law, or of both. Enforcement of the Sherman Act will doubtless result in dissolving this unwieldy illegal combination.

THE COAL MONOPOLY

Proof of the "cooperation" of the anthracite railroads is furnished by the ubiquitous presence of George F. Baker on the Board of Directors of the Reading, the Jersey Central, the Lackawanna, the Lehigh, the Erie, and the New York, Susquehanna & Western railroads, which together control nearly all the unmined anthracite as well as the actual tonnage. These roads have been an important factor in the development of the Money Trust. They are charged by the Department of Justice with fundamental violations both of the Sherman Law and of the Commodity clause of the Hepburn Act, which prohibits a railroad from carrying, in interstate trade, any commodity in which it has an interest, direct or indirect. Nearly every large issue of securities made in the last 14 years by any of these railroads (except the Erie), has been in connection with some act of combination. The combination of the anthracite railroads to suppress the construction, through the Temple Iron Company, of a competing coal road, has already been declared illegal by the Supreme Court of the United States. And in the bituminous coal field—the Kanawha District—the United States Circuit Court of Appeals has recently decreed that a similar combination by the Lake Shore, the Chesapeake & Ohio, and the Hocking Valley, be dissolved.

OTHER RAILROAD COMBINATIONS

The cases of the Union Pacific and of the New Haven are typical—not exceptional. Our railroad history presents numerous instances of large security issues made wholly or mainly to effect combinations. Some of these combinations have been proper as a means of securing natural feeders or extensions of main lines. But far more of them have been dictated by the desire to suppress active or potential competition; or by personal ambition or greed; or by the mistaken belief that efficiency grows with size. Thus the monstrous combination of the Rock Island and the St. Louis and San Francisco with over 14,000 miles of line is recognized now to have been obviously inefficient. It was severed voluntarily; but, had it not been, must have crumbled soon from inherent defects, if not as a result of proceedings under the Sherman law. Both systems are suffering now from the effects of this unwise combination; the Frisco, itself greatly overcombined, has paid the penalty in receivership. The Rock Island—a name once expressive of railroad efficiency and stability—has, through its excessive recapitalizations and combinations, become a football of speculators, and a source of great apprehension to confiding investors. The combination of the Cincinnati, Hamilton and Dayton, and the Père Marquette led to several receiverships.

There are, of course, other combinations which have not been disastrous to the owners of the railroads. But the fact that a railroad combination has not been disastrous does not necessarily justify it. The evil of the concentration of power is obvious; and as combination necessarily involves such concentration of power, the burden of justifying a combination should be placed upon those who seek to effect it. For instance, what public good has been subserved by allowing the Atlantic Coast Line Railroad Company to issue $50,000,000 of securities to acquire control of the Louisville & Nashville Railroad—a widely extended, self-sufficient system of 5,000 miles, which, under the wise management of President Milton H. Smith had prospered continuously for many years before the acquisition; and which has gross earnings nearly twice as large as those of the Atlantic Coast Line. The legality of this combination has been recently challenged by Senator Lea; and an investigation by the Interstate Commerce Commission has been ordered.

THE PENNSYLVANIA

The reports from the Pennsylvania suggest the inquiry whether even this generally well-managed railroad is not suffering from excessive bigness. After 1898 it, too, bought, in large amounts, stocks in other railroads, including the Chesapeake & Ohio, the Baltimore & Ohio, and the Norfolk & Western. In 1906 it sold all its Chesapeake & Ohio stock, and a majority of its Baltimore & Ohio and Norfolk & Western holdings. Later it reversed its policy and resumed stock purchases, acquiring, among others, more Norfolk & Western and New York, New Haven & Hartford; and on Dec. 31, 1912, held securities valued at $331,909,154.32; of which, however, a large part represents Pennsylvania System securities. These securities (mostly stocks) constitute about one-third of the total assets of the Pennsylvania Railroad. The income on these securities in 1912 averaged only 4.30 per cent. on their valuation, while the Pennsylvania paid 6 per cent. on its stock. But the cost of carrying these foreign stocks is not limited to the difference between this income and outgo. To raise money on these stocks the Pennsylvania had to issue its own securities; and there is such a thing as an over-supply even of Pennsylvania securities. Over-supply of any stock depresses market values, and increases the cost to the Pennsylvania of raising new money. Recently came the welcome announcement of the management that it will dispose of its stocks in the anthracite coal mines; and it is intimated that it will divest itself also of other holdings in companies (like the Cambria Steel Company) extraneous to the business of railroading. This policy should be extended to include the disposition also of all stock in other railroads (like the Norfolk & Western, the Southern Pacific and the New Haven) which are not a part of the Pennsylvania System.

RECOMMENDATIONS

Six years ago the Interstate Commerce Commission, after investigating the Union Pacific transaction above referred to, recommended legislation to remedy the evils there disclosed. Upon concluding recently its investigation of the New Haven, the Commission repeated and amplified those recommendations, saying: "No student of the railroad problem can doubt that a most prolific source of financial disaster and complication to railroads in the past has been the desire and ability of railroad managers to engage in enterprises outside the legitimate operation of their railroads, especially by the acquisition of other railroads and their securities. The evil which results, first, to the investing public, and, finally, to the general public, cannot be corrected after the transaction has taken place; it can be easily and effectively prohibited. In our opinion the following propositions lie at the foundation of all adequate regulation of interstate railroads: 1. Every interstate railroad should be prohibited from spending money or incurring liability or acquiring property not in the operation of its railroad or in the legitimate improvement, extension, or development of that railroad. 2. No interstate railroad should be permitted to lease or purchase any other railroad, nor to acquire the stocks or securities of any other railroad, nor to guarantee the same, directl[y] or indirectly, without the approval of the federal government. 3. No stocks or bonds should be issued by an interstate railroad except for the purposes sanctioned in the two preceding paragraphs, and none should be issued without the approval of the federal government. It may be unwise to attempt to specify the price at which and the manner in which railroad stocks and securities shall be disposed of; but it is easy and safe to define the purpose for which they may be issued and to confine the expenditure of the money realized to that purpose." These recommendations are in substantial accord with those adopted by the National Association of Railway Commissioners. They should be enacted into law. And they should be supplemented by amendments of the Commodity Clause of the Hepburn Act, so that: 1. Railroads will be effectually prohibited from owning stock in corporations whose products they transport; 2. Such corporations will be prohibited from owning important stock holdings in railroads; and 3. Holding companies will be prohibited from controlling, as does the Reading, both a railroad and corporations whose commodities it transports. If laws such as these are enacted and duly enforced, we shall be protected from a recurrence of tragedies like the New Haven, of domestic scandals like the Chicago and Alton, and of international ones like the Frisco. We shall also escape from that inefficiency which is attendant upon excessive size. But what is far more important, we shall, by such legislation, remove a potent factor in financial concentration. Decentralization will begin. The liberated smaller units will find no difficulty in financing their needs without bowing the knee to money lords. And a long step will have been taken toward attainment of the New Freedom.

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