BANKER-MANAGEMENT 195
these companies could not afford to buy, or to
pay dividends which had not been earned.
these companies could not afford to buy, or to
pay dividends which had not been earned.
Louis Brandeis - 1914 - Other People's Money, and How Bankers Use It
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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? 200 OTHER PEOPLE'S MONEY
experience essential to forming a proper judg-
ment. Such investors need and are entitled to
have the bankers' advice, and obviously their
unbiased advice; and the advice cannot be un-
biased where the banker, as part of the corpora-
tion's management, has participated in the crea-
tion of the securities which are the subject of
sale to the investor.
Is it conceivable that the great house of Mor-
gan would have aided in providing the New
Haven with the hundreds of millions so un-
wisely expended, if its judgment had not been
clouded by participation in the New Haven's
management?
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? CHAPTER X
THE INEFFICIENCY OF THE OLIGARCHS
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 construc-
tion, operation, and consolidation of great sys-
tems 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
201
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? 202 OTHER PEOPLE'S MONEY
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 advantages privilege
can give, and may "charge all the traffic will
bear. " And even in competitive business the
success of a long-established, well-organized busi-
ness with a widely extended good-will, must con-
tinue for a considerable time; especially if but-
tressed 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.
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? THE OLIGARCH INEFFICIENT 203
"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 occu-
pation (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 com-
pany'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 sus-
ceptible to such influences are led to unwise
decisions in the effort to prevent misinterpreta-
tions. Thus, expenditures necessary for main-
tenance, or for the ultimate good of a property
are often deferred by banker-directors, because
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? 204 OTHER PEOPLE'S MONEY
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 excerise 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 OP 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 judg-
ment. The Century Dictionary tells us that a
Director is "one who directs; one who guides,
superintends, governs and manages. " Real ef-
ficiency in any business in which conditions are
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? THE OLIGARCH INEFFICIENT 205
ever changing must ultimately depend, in large
measure, upon the correctness of the judgment
exercised, almost from day to day, on the im-
portant problems as they arise. And how can
the leading bankers, necessarily engrossed in the
problems of their own vast private businesses,
get time to know and to correlate the facts con-
cerning 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 signa-
ture 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 OP 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 2000 miles of line. In
administering the railroad and each of the prop-
erties formerly managed through these 122 sep-
arate companies, there must arise from time to
time difficult questions on which the directors
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? 206 OTHER PEOPLE'S MONEY
should pass judgment. The real managing di-
rectors 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, Presi-
dent and then Chairman of the Board of Di-
rectors of one of America's leading banks (the
First National of New York), and Mr. Rocke-
feller 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. Mor-
gan, 48 corporations, including 40 railroad cor-
porations, with at least 100 subsidiary com-
panies, and 16,000 miles of line; 3 banks and
trust or insurance companies; 5 industrial and
public-service companies. Mr. Baker, 48 cor-
porations, including 15 railroad corporations,
with at least 158 subsidiaries, and 37,400 miles
of track; 18 banks, and trust or insurance com-
panies; 15 public-service corporations and in-
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? THE OLIGARCH INEFFICIENT 207
dustrial concerns. Mr. Rockefeller, 37 corpora-
tions, including 23 railroad corporations with
at least 117 subsidiary companies, and 26,400
miles of line; 5 banks, trust or insurance com-
panies; 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 lead-
ers be deterred from continuing to perform this
public service. A very respectable Boston daily
said a few days after Commissioner McChord'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 com-
pensate 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
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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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? 200 OTHER PEOPLE'S MONEY
experience essential to forming a proper judg-
ment. Such investors need and are entitled to
have the bankers' advice, and obviously their
unbiased advice; and the advice cannot be un-
biased where the banker, as part of the corpora-
tion's management, has participated in the crea-
tion of the securities which are the subject of
sale to the investor.
Is it conceivable that the great house of Mor-
gan would have aided in providing the New
Haven with the hundreds of millions so un-
wisely expended, if its judgment had not been
clouded by participation in the New Haven's
management?
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? CHAPTER X
THE INEFFICIENCY OF THE OLIGARCHS
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 construc-
tion, operation, and consolidation of great sys-
tems 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
201
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? 202 OTHER PEOPLE'S MONEY
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 advantages privilege
can give, and may "charge all the traffic will
bear. " And even in competitive business the
success of a long-established, well-organized busi-
ness with a widely extended good-will, must con-
tinue for a considerable time; especially if but-
tressed 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.
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? THE OLIGARCH INEFFICIENT 203
"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 occu-
pation (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 com-
pany'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 sus-
ceptible to such influences are led to unwise
decisions in the effort to prevent misinterpreta-
tions. Thus, expenditures necessary for main-
tenance, or for the ultimate good of a property
are often deferred by banker-directors, because
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? 204 OTHER PEOPLE'S MONEY
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 excerise 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 OP 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 judg-
ment. The Century Dictionary tells us that a
Director is "one who directs; one who guides,
superintends, governs and manages. " Real ef-
ficiency in any business in which conditions are
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? THE OLIGARCH INEFFICIENT 205
ever changing must ultimately depend, in large
measure, upon the correctness of the judgment
exercised, almost from day to day, on the im-
portant problems as they arise. And how can
the leading bankers, necessarily engrossed in the
problems of their own vast private businesses,
get time to know and to correlate the facts con-
cerning 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 signa-
ture 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 OP 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 2000 miles of line. In
administering the railroad and each of the prop-
erties formerly managed through these 122 sep-
arate companies, there must arise from time to
time difficult questions on which the directors
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? 206 OTHER PEOPLE'S MONEY
should pass judgment. The real managing di-
rectors 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, Presi-
dent and then Chairman of the Board of Di-
rectors of one of America's leading banks (the
First National of New York), and Mr. Rocke-
feller 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. Mor-
gan, 48 corporations, including 40 railroad cor-
porations, with at least 100 subsidiary com-
panies, and 16,000 miles of line; 3 banks and
trust or insurance companies; 5 industrial and
public-service companies. Mr. Baker, 48 cor-
porations, including 15 railroad corporations,
with at least 158 subsidiaries, and 37,400 miles
of track; 18 banks, and trust or insurance com-
panies; 15 public-service corporations and in-
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? THE OLIGARCH INEFFICIENT 207
dustrial concerns. Mr. Rockefeller, 37 corpora-
tions, including 23 railroad corporations with
at least 117 subsidiary companies, and 26,400
miles of line; 5 banks, trust or insurance com-
panies; 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 lead-
ers be deterred from continuing to perform this
public service. A very respectable Boston daily
said a few days after Commissioner McChord'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 com-
pensate 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
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