A laudable effort is being made by railway finan ciers to clear away the tangle of intercorporate re lationships and dispose of the original undergrowth of small mortgages so that in their place there may be issued comprehensive open-end mortgages which, in time, will become first mortgages upon entire systems as the smaller issues mature or are exchanged. Taken as a class, railway bonds have had the highest invest ment standing. However, the intricacies of railway finance exceed those of any other type of American finance. This counseled the investor to observe the general reputation of the management of the issuing and controlling companies, to consult bond houses run by capable and conservative men, and to regard scru pulously the maxim that high yield implies danger.
The quotations of some railway bonds on August 21, 1916, as furnished by Redmond and Company, of New York City, were as follows: 3. Collateral trust bonds.—A result of the process of consolidation was the collateral trust bond. When the control of small properties has been secured thru the control of stock, the stocks are often deposited as security, and bonds are issued against them. In this way the public is induced to finance the operation. In this endeavor to make bonds out of stocks the saving grace is the margin of the market value of the stocks pledged over and above the par value of the bonds issued. If such a margin is a changing factor, influenced by the fluctuations of the market, the security possesses the offsetting merit of ready mar ketability.
4. Guaranteed same process of con solidation has led to the guaranteeing of the stocks and bonds of subsidiary companies. Out of a total of some 142 issues of guaranteed stocks now on the market, 122 are the result of railway consolidations. The Western Union Telegraph Company and the New York Railways Company furnish conspicuous illustrations of this form of security. The value of a guaranteed stock depended both upon the original equity and upon the strength of the guarantor. Most of the issues are low-yield pure investments, and very closely held, and are bid up against the ordinary in vestor by trustees and corporate investors.
5. Effects of rate control and rising in vestor in railway securities had to consider the con sequences of placing railway managements between an upper millstone of state and Federal commissions and a nether millstone of labor unions and rising com modity prices. The former factor held rates static or lowered them from time to time, and the latter ele ments were rapidly forcing upward the costs of oper ation. Between the two the margin of safety, com posed of the surplus of net earnings over and above fixed charges, grew thinner and thinner.
The public remembers the scandals of the Erie, the juggling of the Cincinnati, Hamilton and Dayton, the pyramiding of the Rock Island Company and of the St. Louis and San Francisco Railroad, the bal
looning of Chicago and Alton issues, the foolish tragedy of the Wabash Pittsburgh Terminal, the crushing of the Denver and Rio Grande and the bloodsuckers attached to the Missouri, Kansas and Texas. Out of these and dozens of other memories a feeling of distrust and hostility toward the railroads was instilled gradually into many minds. This atti tude expressed itself finally in vigorous Commission control for the purpose of regulating rates, abolishing secret discriminations, making railway accounts pub lic, and regulating car and train service. This gen eration of railway managers inherits an alienated pub lic mind.
And now, within the past fifteen years, a new enemy for the railway to deal with arose in the form of a steady upward climb of commodity prices, from the low point of the middle nineties to levels which rival, and even exceed, the prices of the Civil War period. A railroad must use ties, rails, lumber, build ings, supplies, cars, locomotives, coal, oil, grease, tools, machines and almost every known variety of common labor and skilled service. All of these goods and serv ices, with few exceptions, cost more than formerly. The following tabulations will illustrate changes in prices and wages : The wages paid out by American railways amounted in 1900 to 38.8 per cent of gross earnings; in 1914 it reached 45.3 per cent.
The effect upon the income account of this increase in expenses has been generalized as follows on the basis of the statement of 19 standard railroads, the gross earning capacity being reduced to a unit of $100,000 : As a result of these changes railway stocks, as a class, became difficult to distribute to the investing public. Many stocks dropped to below par so that new issues were impossible, since the issue of shares at less than par is illegal in most jurisdictions. Financing accordingly turned to bonds. But many mortgage issues were found to be exhausted, while junior issues were unpopular. Furthermore, the steady decline in railway bonds prevented new issues except at higher interest rates than those of the bonds outstanding. In this dilemma, while the investing public was turning more and more toward municipal and public utility bonds, the railroads turned to the banks for funds, and financed themselves temporarily with short-term notes at high rates. They bought equipment thru equipment trusts. Some of them cut down expenditures for maintenance and capital ized small improvements. They appealed to the in vestor with convertible bonds and with collateral trust bonds secured by their own stocks which had failed of a direct market. A few of them have even issued long-term bonds and capital stock to pay for equip ment or to retire the principal of equipment trusts. All this involved the increase of fixed charges.