We shall also
escape from that inefficiency which is attendant
upon excessive size.
escape from that inefficiency which is attendant
upon excessive size.
Louis Brandeis - 1914 - Other People's Money, and How Bankers Use It
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? A CURSE OF BIGNESS 177
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
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? 178 OTHER PEOPLE'S MONEY
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
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? A CURSE OF BIGNESS 179
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 lia-
bilities had increased to $425,935,000. Of course
the business of the railroad had grown largely
in those fourteen years; the road-bed was im-
proved, 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, steam-
ships, street railway-, electric-light-, gas- and
water-companies. It was these outside proper-
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? 180 OTHER PEOPLE'S MONEY
ties, 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 absorp-
tion 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 rail-
roads--had been financed in New York, but by
persons apparently entirely independent of the
Morgan allies. The smaller Connecticut rail-
roads, now combined in the Central New Eng-
land, 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
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? A CURSE OF BIGNESS 181
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 com-
panies 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 Lacka-
wanna, the Lehigh, the Erie, and the New York,
Susquehanna & Western railroads, which to-
gether control nearly all the unmined anthracite
as well as the actual tonnage. These roads have
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? 182 OTHER PEOPLE'S MONEY
been an important factor in the development of
the Money Trust. They are charged by the De-
partment 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 rail-
roads (except the Erie), has been in connection
with some act of combination. The combina-
tion of the anthracite railroads to suppress the
construction, through the Temple Iron Company,
of a competing coal road, has already been de-
clared 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 rail-
road history presents numerous instances of large
security issues made wholly or mainly to effect
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? A CURSE OF BIGNESS 183
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 Pdre Marquette
led to several receiverships.
There are, of course, other combinationa
which have not been disastrous to the owners of
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? 184 OTHER PEOPLE'S MONEY
the railroads. But the fact that a railroad
combination has not been disastrous does not
necessarily justify it. The evil of the concentra-
tion 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 securi-
ties to acquire control of the Louisville & Nash-
ville Railroad--a widely extended, self-sufficient
system of 5000 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 Com-
mission 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,
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? A CURSE OF BIGNESS 185
?
stocks in other railroads, including the Chesa-
peake & 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 re-
sumed 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 in-
come on these securities in 1912 averaged only
4. 30 per cent. on their valuation, while the Penn-
sylvania 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 Pen-
nsylvania of raising new money. Recently came
the welcome announcement of the management
that it will dispose of its stocks in the anthracite
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? 186 OTHER PEOPLE'S MONEY
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 & West-
ern, the Southern Pacific and the New Haven)
which are not a part of the Pennsylvania System.
RECOMMENDATIONS
Six years ago the Interstate Commerce Com-
mission, 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 man-
agers to engage in enterprises outside the legiti-
mate 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
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? A CURSE OF BIGNESS 187
has taken place; it can be easily and effectively
prohibited. In our opinion the following propo-
sitions lie at the foundation of all adequate regu-
lation of interstate railroads:
1. Every interstate railroad should be pro-
hibited from spending money or incurring liability
or acquiring property not in the operation of its
railroad or in the legitimate improvement, ex-
tension, 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 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 sanc-
tioned 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
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? 188 OTHER PEOPLE'S MONEY
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 stockholdings in railroads; and
3. Holding companies will be prohibited from
controlling, as does the Reading, both a rail-
road 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 im-
portant, we shall, by such legislation, remove a
potent factor in financial concentration. De-
centralization 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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? CHAPTER IX
THE FAILURE OF BANKER-MANAGEMENT
Theee 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 fis-
cal 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 stock-
holders' meeting of other companies in which he
was a director. But it was his habit, when in
189
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? 190 OTHER PEOPLE'S MONEY
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 un-
wisely accorded its sanction to the Boston &
Maine merger), Mr. Morgan himself moved
the large increases of stock which were unani-
mously voted. Of course, he attended the
important directors' meetings. His will was
law. President Mellen indicated this in his
statement before Interstate Commerce Com-
missioner Prouty, while discussing the New
York, Westchester & Boston--the railroad with-
out 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, West-
chester & Boston. I have never been enthusias-
tic or at all optimistic of its being a good invest-
ment 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. "
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? BANKER-MANAGEMENT 191
THE BANKEBS' BESPONSIBILITT
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 reckless-
ness--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 com-
munity where its railroad stocks have for gen-
erations been deemed absolutely safe invest-
ments, 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 out-
side 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.
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? 192 OTHER PEOPLE'S MONEY
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 ex-
travagant acquisitions made in mad pursuit of
monopoly; but the financial judgment, the finan-
ciering 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 man-
agement to which the severe criticism of the
Interstate Commerce Commission is particularly
directed.
Conmissioner 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
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? BANKER-MANAGEMENT 193
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 conservative-
ness. For the indebtedness (including guaran-
ties) 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 con-
sistent with "safe and sane management. "
But what can be said in defense of the finan-
cial judgment of the banker-management under
which these two railroads find themselves con-
fronted, 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 sub-
sidiary 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
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? 194 OTHER PEOPLE'S MONEY
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, particu-
larly, 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 Sys-
tem 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
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? BANKER-MANAGEMENT 195
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 extra-
ordinary 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 con-
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? 196 OTHER PEOPLE'S MONEY
trolling the transportation facilities of New
England. In the accomplishment of that pur-
pose 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 finan-
cial 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 short-
comings 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 busi-
ness for which he performs the banking service.
This detachment is desirable, in the first place,
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? BANKER-MANAGEMENT 197
in order to avoid conflict of interest. The re-
lation of banker-directors to corporations which
they finance has been a subject of just criti-
cism. Their conflicting interests necessarily pre-
vent 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 is-
suing 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 cor-
poration 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 com-
plete detachment of the banker from the corpo-
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? 198 OTHER PEOPLE'S MONEY
ration 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 finan-
cial 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 rail-
roads, 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 de-
tached from the concern whose credit or securi-
ties are under consideration. His decision to
grant or to withhold credit, to purchase or not
to purchase securities, involves passing judg-
ment 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
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? BANKER-MANAGEMENT 199
passing judgment on himself. Of course de-
tachment does not imply lack of knowledge.
The banker should act only with full knowledgef
just as a lawyer should act only with full knowl-
edge. 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 ca-
pacity 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 to-
ward a large part of his customers in a posi-
tion 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, as-
certain for themselves the facts on which to base
a proper judgment as to the soundness of securi-
ties offered. And even if these investors were
furnished with the facts, they lack the business
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? A CURSE OF BIGNESS 177
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
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? 178 OTHER PEOPLE'S MONEY
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
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? A CURSE OF BIGNESS 179
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 lia-
bilities had increased to $425,935,000. Of course
the business of the railroad had grown largely
in those fourteen years; the road-bed was im-
proved, 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, steam-
ships, street railway-, electric-light-, gas- and
water-companies. It was these outside proper-
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? 180 OTHER PEOPLE'S MONEY
ties, 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 absorp-
tion 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 rail-
roads--had been financed in New York, but by
persons apparently entirely independent of the
Morgan allies. The smaller Connecticut rail-
roads, now combined in the Central New Eng-
land, 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
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? A CURSE OF BIGNESS 181
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 com-
panies 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 Lacka-
wanna, the Lehigh, the Erie, and the New York,
Susquehanna & Western railroads, which to-
gether control nearly all the unmined anthracite
as well as the actual tonnage. These roads have
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? 182 OTHER PEOPLE'S MONEY
been an important factor in the development of
the Money Trust. They are charged by the De-
partment 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 rail-
roads (except the Erie), has been in connection
with some act of combination. The combina-
tion of the anthracite railroads to suppress the
construction, through the Temple Iron Company,
of a competing coal road, has already been de-
clared 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 rail-
road history presents numerous instances of large
security issues made wholly or mainly to effect
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? A CURSE OF BIGNESS 183
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 Pdre Marquette
led to several receiverships.
There are, of course, other combinationa
which have not been disastrous to the owners of
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? 184 OTHER PEOPLE'S MONEY
the railroads. But the fact that a railroad
combination has not been disastrous does not
necessarily justify it. The evil of the concentra-
tion 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 securi-
ties to acquire control of the Louisville & Nash-
ville Railroad--a widely extended, self-sufficient
system of 5000 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 Com-
mission 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,
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? A CURSE OF BIGNESS 185
?
stocks in other railroads, including the Chesa-
peake & 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 re-
sumed 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 in-
come on these securities in 1912 averaged only
4. 30 per cent. on their valuation, while the Penn-
sylvania 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 Pen-
nsylvania of raising new money. Recently came
the welcome announcement of the management
that it will dispose of its stocks in the anthracite
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? 186 OTHER PEOPLE'S MONEY
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 & West-
ern, the Southern Pacific and the New Haven)
which are not a part of the Pennsylvania System.
RECOMMENDATIONS
Six years ago the Interstate Commerce Com-
mission, 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 man-
agers to engage in enterprises outside the legiti-
mate 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
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? A CURSE OF BIGNESS 187
has taken place; it can be easily and effectively
prohibited. In our opinion the following propo-
sitions lie at the foundation of all adequate regu-
lation of interstate railroads:
1. Every interstate railroad should be pro-
hibited from spending money or incurring liability
or acquiring property not in the operation of its
railroad or in the legitimate improvement, ex-
tension, 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 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 sanc-
tioned 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
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? 188 OTHER PEOPLE'S MONEY
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 stockholdings in railroads; and
3. Holding companies will be prohibited from
controlling, as does the Reading, both a rail-
road 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 im-
portant, we shall, by such legislation, remove a
potent factor in financial concentration. De-
centralization 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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? CHAPTER IX
THE FAILURE OF BANKER-MANAGEMENT
Theee 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 fis-
cal 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 stock-
holders' meeting of other companies in which he
was a director. But it was his habit, when in
189
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? 190 OTHER PEOPLE'S MONEY
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 un-
wisely accorded its sanction to the Boston &
Maine merger), Mr. Morgan himself moved
the large increases of stock which were unani-
mously voted. Of course, he attended the
important directors' meetings. His will was
law. President Mellen indicated this in his
statement before Interstate Commerce Com-
missioner Prouty, while discussing the New
York, Westchester & Boston--the railroad with-
out 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, West-
chester & Boston. I have never been enthusias-
tic or at all optimistic of its being a good invest-
ment 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. "
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? BANKER-MANAGEMENT 191
THE BANKEBS' BESPONSIBILITT
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 reckless-
ness--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 com-
munity where its railroad stocks have for gen-
erations been deemed absolutely safe invest-
ments, 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 out-
side 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.
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? 192 OTHER PEOPLE'S MONEY
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 ex-
travagant acquisitions made in mad pursuit of
monopoly; but the financial judgment, the finan-
ciering 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 man-
agement to which the severe criticism of the
Interstate Commerce Commission is particularly
directed.
Conmissioner 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
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? BANKER-MANAGEMENT 193
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 conservative-
ness. For the indebtedness (including guaran-
ties) 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 con-
sistent with "safe and sane management. "
But what can be said in defense of the finan-
cial judgment of the banker-management under
which these two railroads find themselves con-
fronted, 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 sub-
sidiary 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
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? 194 OTHER PEOPLE'S MONEY
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, particu-
larly, 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 Sys-
tem 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
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? BANKER-MANAGEMENT 195
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 extra-
ordinary 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 con-
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? 196 OTHER PEOPLE'S MONEY
trolling the transportation facilities of New
England. In the accomplishment of that pur-
pose 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 finan-
cial 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 short-
comings 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 busi-
ness for which he performs the banking service.
This detachment is desirable, in the first place,
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? BANKER-MANAGEMENT 197
in order to avoid conflict of interest. The re-
lation of banker-directors to corporations which
they finance has been a subject of just criti-
cism. Their conflicting interests necessarily pre-
vent 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 is-
suing 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 cor-
poration 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 com-
plete detachment of the banker from the corpo-
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? 198 OTHER PEOPLE'S MONEY
ration 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 finan-
cial 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 rail-
roads, 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 de-
tached from the concern whose credit or securi-
ties are under consideration. His decision to
grant or to withhold credit, to purchase or not
to purchase securities, involves passing judg-
ment 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
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? BANKER-MANAGEMENT 199
passing judgment on himself. Of course de-
tachment does not imply lack of knowledge.
The banker should act only with full knowledgef
just as a lawyer should act only with full knowl-
edge. 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 ca-
pacity 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 to-
ward a large part of his customers in a posi-
tion 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, as-
certain for themselves the facts on which to base
a proper judgment as to the soundness of securi-
ties offered. And even if these investors were
furnished with the facts, they lack the business
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