Nathan Ohana - 2021 Near Scholar by The Harker School

2020-21 JOHN NEAR GRANT Recipient Expansion Derailed: The Role of Railroad Speculation, Deception, and Fraud in the Panic of 1893 Nathan Ohana

Ohana

Expansion Derailed: The Role of Railroad Speculation, Deception, and Fraud in the Panic of 1893

Nathan Ohana 2021 Near Scholar Mentors: Ms. Julie Wheeler, Ms. Amy Pelman April 14, 2021

Ohana 2 Following the end of the American Civil War, dozens of newly founded railroad companies sprung up, seeking to extend railroad networks previously concentrated east of the Mississippi River, with the eventual goal of spanning from coast to coast. 1 While “transcontinental railroad” traditionally describes the line co-built by the Central Pacific and Union Pacific companies, which was finished in Utah in 1869, the term more generally describes any one of the flurry of new western railroads completed in the 1870s. These lines connected cities in the Midwest to Rocky Mountain mining towns and western states, connecting to eastern lines that completed the cross-country journey. 2 Early on, through the Pacific Railway Act and Homestead Act, both passed in 1862, federal financial and territorial assistance primarily drove the development of the transcontinental railroads. Starting in the late 1870s, railroad companies began to transition away from lobbying for federal subsidies and using insider connections to get them. 3 Instead, private investors and banks became increasingly interested in railroads, and funding for new lines started to originate from the sale of bonds and stock, primarily northeastern and European banking houses. 4 The dangers inherent to private investment, specifically a lack of knowledge of the newly created industry and a lack of investigation into the affairs of railroads, were initially hidden from the public eye, while thousands of miles of new track led to a widespread perception of a booming industry that was conquering the West. As the fervor grew and billions of dollars poured into new lines, the industry became the backbone of the American

John F. Stover, American Railroads (Chicago, IL: University of Chicago Press, 2008), 62, https://ebookcentral.proquest.com/lib/harker-ebooks/detail.action?docID=408181. 1

Stover, 63.

Richard White Railroaded: The Transcontinentals and the Making of Modern America, (New York: W.W. Norton, 2012), 22.

White, 26.

Ohana 3 economy in the 1880s. 5 When the Philadelphia and Reading Railroad filed for bankruptcy in 1893, all the hype surrounding railroads was derailed. While not a western railroad company, its collapse prompted investors in practically every railroad to evaluate their positions and reconsider their investments, causing a withdrawal that played an instrumental role in starting the longest and largest depression in US history at the time. Douglas Steeples and David Whitten explain in their book Democracy in Desperation: The Depression of 1893 the impact the collapse of the Reading had on other investors, finding, “News of the railroad’s 125 million in liabilities shocked investors and stirred a stock exchange whose weaknesses had already excited pointed comment.” 6 Banks and others interested in the nation’s financial affairs were asking the question that has been asked in the aftermath of every financial panic in American history: How can an industry that seemed so robust and prosperous, fueling the expansion of the American frontier, be grounded on such faulty foundations? Damaging railroad development based on predatory financial tactics and speculation left investors and banks defrauded and settlers abandoned, ultimately causing a severe economic downturn delaying settlement of the American west. The Speculatory Nature of Railroad Development Typically, if a railroad company constructs a rail line, it intends to operate that line, carrying passengers or cargo and generating a profit from correctly pricing rates. As railroad tycoons and promoters in the 1880s laid down tracks west of the Mississippi, however, they had no intention of carrying passengers or freight as their primary revenue source. Instead, these railroads were built as speculative enterprises designed to generate money from their financing

White, 27.

Douglas Steeples and David O. Whitten, Democracy in Desperation: The Depression of 1893 (Westport, CT: Greenwood Press, 1998), 32.

Ohana 4 and security sales. 7 This fact changes the paradigm of how railroad development is usually considered. Understanding this fact alone places much of the western railroad development in the 1880s within a context that accurately reflects the mismatch in values between settlers, the United States government, and railroad companies. When railroad companies first developed in the 1870s, their priority was obtaining land and subsidies from the federal government. This gave the federal government tremendous control over where lines were built, and generally greater oversight of the operation of railroads. 8 With the advent of private funding, however, railroads seized the opportunity to focus less on running railroads and more on generating as much profit as possible from the sale of stocks, bonds, and other securities. This focus on financing had a tremendous impact on where corporations built railroads. Since the intention of many railroad corporations was not to profit from the operation of railroads and appropriately setting rates for freight—or at least it was not their primary concern—it makes sense that railroads were constructed with little attention paid to location. For example, Charles Francis Adams, head of the Union Pacific Railroad in the 1880s, explained that his company had done very little research into the locations that it selected to build railroads through. 9 Primarily, railroad enterprises would build ahead of demand, hoping the construction of a railroad would attract agricultural settlement. They were essentially randomly selecting plots of land, or those where the land on which to build a railroad was easily attainable and hoping the establishment of a line would incentivize settlement. Even if settlement did not happen, however, the railroad companies would not care, because their profits did not come from that source.

Carl Hovey, The Life Story of J. Pierpont Morgan (Toronto: The Cop Clark Company Limited, 1911), 125, accessed December 29, 2020, https://hdl.handle.net/2027/aeu.ark:/13960/t40s13w7g.

White, Railroaded: The Transcontinentals, 22.

White, 214.

Ohana 5 These lines, while not designed to carry any passengers, functioned as a sort of territorial claim. Charles Knickerbocker Harley, a professor emeritus of economic history at the University of Western Ontario, explains Collectively the railroads maximized their profits by not building any line until the present value of the investment reached its maximum. But individually each railroad would be best off, assuming its rivals' actions given, by building all lines in its own and its rival's territory that it perceived to have a positive present value. 10 The practice Harley describes—building railroads not at the most optimal time but at the first opportunity possible—resulted in construction of railroad lines not backed up by any immediately visible agricultural settlement. Instead, the demand came from a competing company for the land upon which to construct a line. In most cases, and especially in remote areas where premature building occurred, there would not be enough freight tonnage to sustain two railroad lines, hence placing track in a certain area and expecting settlement to follow became a more optimal strategy. 11 Harley uses a mathematical model of settlement patterns in midwestern states to predict the amount of railroad that would have been built had railroads colluded to only construct lines when there would be enough freight traffic to profit from running trains. By 1883, he calculated that in six midwestern states, the actual mileage exceeded his predictive model of building only when profitable by 8,600 miles. In 1888, the model was off by 16,000 miles. These figures provide convincing evidence that a large percentage of railroad construction happened before enough demand existed.

Charles Knickerbocker Harley, "Oligopoly Agreement and the Timing of American Railroad Construction," The Journal of Economic History 42, no. 4 (December 1982): 804, JSTOR. 10

Harley, 800.

Ohana 6 On the other hand, railroads sometimes took the exact opposite approach. Instead of building ahead of demand to stop other railroads from developing nearby, some railroads would intentionally develop near the lines of other companies. For example, White explains, “By 1889 six different companies had completed seven separate lines in western Kansas between the Great Bend of the Arkansas River in the south and the Nebraska border, an area about 120 miles wide.” 12 Even in the modern day, such concentrated lines can only be found in major metropolises, and Kansas in the 1880s was no New York City or Tokyo, so why would railroads deliberately construct lines alongside many other companies? One Union Pacific manager shared his reasoning, believing “immigration will more than offset any decrease caused by competing new lines.” 13 While this claim might be believed if it were only one or two railroads operating in the area, the claim that the construction would spur enough settlement of the area to sustain seven railroads profitably is dubious at best. This speculative construction throughout the decade resulted in the construction of 74,000 miles of track, more than any prior decade. 14 Unfortunately, most of the track that was developed fell under the umbrella of speculative construction, rendering much of the building inefficient and wasteful. Data shown in Figure 1 quantifies the inefficiency of newly constructed railroads.

White, Railroaded: The Transcontinentals, 211.

White, 211.

Harold Underwood Faulkner, Politics, Reform, and Expansion, 1890-1900 (New York, NY: Harper & Brothers, 1959), 145, Digital file. 14

Ohana 7

Figure 1. Railroad revenue per ton mile in comparison to owned railroad mileage. For railroad revenue per ton mile National Bureau of Economic Research Macrohistory III. Transportation and Public Utilities a03003d. For miles of railroad owned Census Bureau Historical Statistics of the United States Colonial Times to 1957 Chapter Q Series Page 427 Series Q 16, Page 429 Series Q 47. To better understand this graph, it is vital to comprehend the importance of revenue per ton mile, the statistic the blue line represents. Revenue per ton mile measures how much income a railroad receives from operating and carrying freight, divided by the product of the tons of cargo carried by the railroad and the mileage of their system. Declining revenue per ton mile while mileage increases, what Figure 1 displays, means that even as railroads continued to expand, their revenue was not increasing as fast as their mileage. Over the course of the 1880s, this continuous decline shows quantitatively that newly constructed railroad lines were not producing returns comparable to established networks. Despite new railroads lower profitability

Ohana 8 or unprofitability in comparison to existing track, construction continued throughout the decade, with railroads unceasingly investing more into lines proven to be excessive. Carl Hovey in his biography of J.P. Morgan, one of the largest railroad investors of the decade, indicates that only one-third of railroads had existing demand when built. 15 Even if railroads at the time were primarily profiting from financing mechanisms, there were still profits to be had from constructing lines in sensible places and working to run functional routes. Dysfunctional railroad management and more useless construction stopped that optimization from occurring. There are a few contributing factors to the inefficient and defective railroad operatives. One main cause was the lack of experience those at the helm of the corporations in the railroad industry. After all, the business of operating transcontinental railroads and routes that spanned thousands of miles across the western United States was a new one. More critically, however, railroad managers did not make a significant effort to run their railroads correctly. White explains that “patronage, favoritism, nepotism, and extortion” all played important roles in organizational hierarchies. 16 Those running the railroads were not concerned with when the next train was set to depart or what to set as rates. Instead, their focus as speculators was to plan out the next route they could build and sell bonds to finance them. 17 Financial Tactics Used by Railroads The inefficiency that this speculative railroad development brought on did not alone crash the American economy. Instead, it was the deceitful and fraudulent practices by railroad corporations that destabilized the financial system by encouraging needless and undeserved

Hovey, The Life, 97.

White, Railroaded: The Transcontinentals, 236.

Hovey, The Life, 125.

Ohana 9 investment in failing systems. One of the primary manners with which railroads could essentially steal money from their investors was through the creation of construction companies, through which money could be funneled from banks and investors straight into the pockets of speculators with little to no oversight. Many railroad companies were fronts that would be used as a mechanism to sell bonds to investors, primarily bankers and investment houses in the northeastern United States and Europe. Those investors, eager to invest in an industry they saw as key to the future of American transportation and believing in the solid foundations of the system, gave large sums of money to railroad companies to construct new lines. 18 Very rarely would the actual cost of constructing a railroad line be known. 19 There are likely two reasons for this phenomenon. The first is an actual mystery that surrounded railroad development, where the price tag of construction on such a large project could never be accurately estimated because of the immense logistical challenges and costs that came along with building. In addition, it would be in the best interest of a railroad company to try to obscure even estimated costs to the greatest extent possible. Even if railroads knew these expenses, they could issue bonds, mortgages, and stocks totaling any amount they wanted, and that amount would be perceived as the actual cost, even if the true cost was many times lower than their bonds’ issuances. In the creation and writing of financial statements, railroads could manipulate these documents in a manner that would exaggerate true costs, allowing railroads to profit from the difference between the amount of securities sold and the true cost of construction. 20 Adams explains that there was a general rule that profits on capital doled out for construction should 18

Hovey, 99.

Charles Francis Adams, Jr, "The Railroad System," 1868, in Chapters of Erie and Other Essays, comp. James T. Osgood (n.p.: Franklin Classics Trade Press, 2018), 399. 19

Adams, 400.

Ohana 10 range from 10 to 20 percent. 21 While most of the time this rule was not followed as will be discussed later, even if a railroad company tried to limit its profits, the rule allowed railroad companies to increase their profits tremendously through misleading investors on the cost of construction, thus making the same percent of a larger number. Since railroad companies were generally able to access large amounts of capital easily through the sale of securities, using a construction company, essentially a shell through which to funnel money, gave executives the tools they needed to pocket money intended for construction. The most well-known example of a railroad construction company is the Crédit Mobilier of America company, which was infamously exposed in the late 1870s for its financial fraud. The company, which the Union Pacific “contracted” with to construct new lines, charged exorbitant prices, often double the independently estimated cost of construction, to the Union Pacific. Contracted appears in quotation marks because, while Thomas Clark Durant worked to make the Crédit Mobilier appear like an independent construction contractor, he served as the president of both companies, and used the entity to rake in profits. This overcharging lost both the federal government and stockholders in the Union Pacific massive sums of capital, all the while Durant and his business partners profited massively. 22 Even after the collapse and subsequent investigation of the scheme, many railroad companies throughout the 1880s used similarly devised construction companies with the exact function as the Crédit Mobilier to profit off of investments while leading investors to believe they were simply contracting out building to a third party company, a hallmark of railroad deception throughout the late 1880s.

Adams, 401. "Crédit Mobilier Scandal," in Gale Encyclopedia of U.S. Economic History, 2nd ed., ed. Thomas Riggs (Farmington Hills, MI: Gale, 2015), 1:313, https://link.gale.com/apps/doc/CX3611000222/UHIC?u=harker&sid=UHIC&xid=9eca12f6. 21 22

Ohana 11 In the Southern Pacific and Central Pacific railroads, for example, both managed by Collis P. Huntington, construction companies were frequently used as a means of transferring wealth to him and his associates, including Leland Stanford. Their scheme functioned with a remarkable simplicity and similarity to the Crédit Mobilier, a fact that calls into question how such an operation would not be discovered and abolished. Nevertheless, the construction company, called the Pacific Improvement Company, would be paid for the construction of new track by the Central Pacific or Southern Pacific with bonds and stocks in those companies. Those securities would then either be sold by the Pacific Improvement Company to raise the necessary funds for construction, or the Pacific Improvement Company would simply take out loans for construction, and the owners of the Pacific Improvement Company would pocket the stocks and bonds, essentially paying themselves to construct a railroad. 23 Through this system, much of the liability would be held by the construction company, not by the Central Pacific and Southern Pacific, which gave them greater flexibility to sell further bonds and stocks, with investors believing the company to be less in debt than it actually was. 24 White summarizes, “The Associates did not make money from the Central Pacific or the Southern Pacific, although these were the basis of their fortunes; they made money from the Contract and Finance Company, the Western Development Company, and the Pacific Improvement Company.” 25 His findings regarding these construction companies illuminates two critical facets of the Southern Pacific’s financial machinations. The first is the presence of multiple construction companies. All three of the companies White names were all at different times operated by the Southern Pacific with the Richard J. Orsi, Sunset Limited: The Southern Pacific Railroad and the Development of the American West, 18501930 (Berkeley, Calif.: University of California Press, 2007), 30, ProQuest Ebook Central. 23

24 25

Orsi, 30. White, Railroaded: The Transcontinentals, 198.

Ohana 12 same function. These construction companies could find themselves in large amounts of debt with very few assets. As a result, using multiple different companies allowed the associates to spread out the liability and create the perception that a wide variety of contractors were used in the construction process. Secondly, it was this mechanism that allowed Huntington, Stanford, and the other associates to profit so much off seemingly unprofitable routes. Huntington himself admitted, “It is a great country west of the Rocky Mountains in acreage and very few people on this side know how little business there is there.” 26 The speculative construction described earlier characterized much of the construction undertaken by the Southern Pacific and Central Pacific railroads during that period. However, Huntington would never admit such a statement about the nature of his business during the period, as the belief that the lines would be profiting off the development of the West was primarily what investors, both domestically and internationally, believed to be the case. That made it crucial for his businesses to be assumed to be profitable, functioning entities, placing an even greater emphasis on making the primary corporations, the Southern Pacific and Central Pacific, clean from unnecessary debt and liability, all the while racking up major tallies in the construction companies. William Mahl, a vice president within the Southern Pacific network, found in 1893 that the Pacific Improvement Company, just one of the construction companies utilized by Huntington, had debt of upwards of $36 million while holding primarily illiquid assets. 27 This imbalance made these companies very leveraged and at risk if the debts were to be called, but that was exactly the situation they wanted to occur. If unpayable debts

White, 204.

White, 268.

Ohana 13 piled up in the accounts of the construction companies while they made the profits, it was their shell companies that would be placed at risk, not their personal fortunes or main companies Other major railway companies also used construction companies as the primary method to enrich executives through speculative actions. In fact, many companies were solely run or founded as entities through which bonds could be sold and capital could be raised, with little intention of properly running as transportation entities. 28 One example of such a company was the Northern Pacific Railway under the direction of Henry Villard from 1881-1884. Villard, a German immigrant with extensive connections to the financial industry in both the United States and Germany, sought to massively expand his rail network throughout the 1880s. The Northern Pacific initially sought assistance from the federal government to construct a transcontinental alternative to the Central Pacific and Union Pacific line. After completing that line, Villard began the construction of lines stretching throughout the Northwest. At the beginning of the 1890s, however, Villard was constructing new lines at a rapid clip, despite an increasing body of financial evidence that suggested his current lines were not profitable. 29 Instead of selling securities and taking out loans as a means of constructing new lines, Villard primarily used funds to purchase existing lines created by smaller companies, thus consolidating the market. Villard, however, went deep into debt to purchase these lines, and frequently plundered the company of the funds supposed to be used for expansion. In addition, the executive’s overly aggressive expansion practices put the company at a very severe financial risk. 30 In the 1880s, Villard, just years after the company had first entered bankruptcy during the Panic of 1873, aggressively 28

Hovey, The Life, 99.

White, Railroaded: The Transcontinentals, 392.

Edward Gross Campbell, The Reorganization of the American Railroad System 1893-1900 (New York, NY: Columbia University Press, 1938), 41, PDF. 30

Ohana 14 expanded his railroad, even on shaky financial foundations. He issued millions in new bonds, even as his company's finances teetered on the edge of bankruptcy. 31 Looking back on Villard’s expansion program, one can see that as soon as Villard acquired one company or completed a line, he was moving on to his next venture. This took a massive toll on how his properties were managed and maintained. 32 The mismanagement and state of disrepair of lines owned by the Northern Pacific or its subsidiaries reflects the differing incentives of those who would utilize a railroad as opposed to those who were constructing railroads at the time. Agricultural settlers wanted functioning equipment at stations and trains that ran on time, but railroad companies, especially those managed by Villard, were not focused on maintaining existing railroads. If there was enough money available to stave off bankruptcy while constructing and raising money for new lines, that avenue would be pursued. In his obituary, the New York Times describes how Villard’s financial wrongdoings eventually led to his railroads’ downfall, saying, “In 1884 the companies in which he was interested became so involved that there was a collapse.” 33 Even after his overly aggressive expansion program failed and pushed the railroad toward financial destitution, he returned to the company years later, only to see it fail again after renewed expansion leading up to the Panic. In addition to the utilization of construction companies and acquisitions to aggressively expand railroad empires and give healthy profits to executives, companies frequently

Julius Grodinsky, Transcontinental Railway Strategy, 1869-1893; A Study of Businessmen. (Philadelphia, PA: University of Pennsylvania Press, 1962), 205-206. 31

White, Railroaded: The Transcontinentals, 392.

"Henry Villard Is Dead," New York Times (New York, NY), November 13, 1900, Obituary, accessed February 28, 2021, https://timesmachine.nytimes.com/timesmachine/1900/11/13/317370162.pdf. 33

Ohana 15 manipulated and watered securities in a bid to garner tremendous amounts of capital for their companies without actually increasing the valuation of the assets the companies held. Walter Williams from the University of Memphis explains this concept: “If the total value of the carrier’s assets did not equal the stock valuation at par when issued along with its annual dividend and bond interest debt, then there was overcapitalization.” 34 Railroads frequently experienced the problem of overcapitalization during the 1880s. For those profiting off the overcapitalization, however, it was not a problem. In fact, stock watering and issuing of new stocks and bonds were the tools that allowed some to reap millions in personal fortunes. Traditionally, when issuing new stock, unless the company’s actual monetary valuation and asset holdings had increased, issuing more stock would only lower the price of each share, since the value of the stock supposedly reflected a portion of that total value. Executives and promoters, however, used deceitful financial tactics to raise the stock price artificially while not corresponding those increases with an increase in asset-tied value. 35 One such strategy was borrowing to pay dividends on existing stocks, thus artificially raising the price of the stock, since larger dividends at the time contributed to higher prices of the stock. Collis P. Huntington used this tactic with the Central Pacific Railroad, raising the stock by 16 percent in the early 1880s as a direct result of using $5 million to finance his borrowing scheme. 36 In relation to the enterprise’s use of construction companies, the Southern Pacific and Central Pacific would often transfer stocks and bonds to the construction companies, which assumed, or at least gave the outward perception that those securities had substantial monetary value, a fact that also allowed Walter Franklin Williams, "Monetary Policy and Railroad Overcapitalization: Their Roles in the Depression, 1893-1897" (PhD diss., The University of Memphis, 2016), 275, ProQuest Dissertations and Theses (10587634). 34

Adams, "The Railroad," in Chapters of Erie, 398.

White, Railroaded: The Transcontinentals, 200.

Ohana 16 the associates to control when those securities would be sold, which meant they gained an immense amount of control over the stock price and could essentially give themselves stocks in exchange for construction. 37 For every single railroad company operating at the time, the measure of a railroad’s financial liquidity and success was its ability to pay out dividends. For an industry that was so dependent on bonds, mortgages, and loans to finance construction, a dividend reflected the railroad company’s ability to pay back to investors. Even in times of crisis, maintaining at least the perception of growing stock value and ability to pay out dividends was crucial to stop the outflow of capital. Villard, for example, purchased Northern Pacific stock using his own personal fortune simply to maintain the price of the stock and stop a freefall in the price. 38 His actions reflect on the tenuous financial situations of many railroads, which as White points out “could be terrifying in times of financial crisis.” 39 The railroad industry was massively overextended financially, with no sensible path to step down from the brink of insolvency. Practically every major system was faced with millions in floating debt. In a high fixed cost industry, however, that debt could be reasonably expected since the transcontinental system was in its infancy. The major players and their executives, however, seemingly refused to cease new construction and focus on running existing railroads correctly. When the Panic of 1893 hit, over $3.9 billion in capitalization had been invested into the western railroads. 40 With the US nominal GDP that year just over $13 billion, the amount of money poured into the industry for little return, and eventually lost during the Panic, was

Orsi, Sunset Limited, 30.

Grodinsky, Transcontinental Railway, 205.

White, Railroaded: The Transcontinentals, 268.

Alfred D. Chandler, Jr., The Visible Hand: The Managerial Revolution in American Business (Cambridge, USA: Belknap, 1977), 171.

Ohana 17 unprecedented in scale. 41 To put that number into perspective and to fully understand the overcapitalization of the system, it is critical to know the revenue of railroads at the time and their asset holdings at the time. The Northern Pacific, for example, held $10 million in outstanding liabilities and debt, had $5 million in assets, and $1 million in net earnings, suggesting the railroad had taken on a substantial load of debt with not enough earnings to pay back those debts in any reasonable amount of time, especially considering the preference of its management to primarily construct new lines. 42 In addition, on $8 million out of the $10 million the company had outstanding, it was paying interest rates multiple percentage points higher than the national interest rates, reflecting the difficult situation the company would face as high interest payments mounted. 43 In the South and Midwest, the Atchison, Topeka, and Santa Fe Railway, one of the largest railroad networks west of the Mississippi at the time, also struggled from an increasing debt burden. Between 1883 and 1886, its outstanding debt doubled from roughly $1.5 million to $3 million. In the same period, however, their earnings per mile were slashed by one-quarter. These disturbing trends reflect a phenomenon shared by mainly railroads expanding aggressively at the time: decreasing profits and increasing interest payments, costs, and debts. 44 The situation at the Union Pacific in relation to its outstanding debts was even more dire. Leading up to the Panic, the railroad had over $100 million in outstanding bonds, and

Thayer Watkins, "The Depression of 1893-1898," San José State University Department of Economics, accessed February 24, 2021, https://www.sjsu.edu/faculty/watkins/dep1893.htm. 41

"The Northern Pacific Report," The Commercial and Financial Chronicle, October 22, 1892, 658, accessed February 24, 2021, https://fraser.stlouisfed.org/title/commercial-financial-chronicle-1339/october-22-1892529692/fulltext. 42

Campbell, The Reorganization, 43.

Campbell, 68.

Ohana 18 government debt exceeding $50 million.45 That occurred amid a massive construction boom. That boom, however, was described by Charles Francis Adams, head of the Union Pacific, as “insanity” and full of “lunatics.” 46 His reaction to the nature of railroad development exposed one of the horrific dichotomies that defined the decade. While railroad development would only lead to further debt and lower earnings, the alternative was to stop. Stopping, however, carried risks of bankruptcy, stock collapse, and irrelevancy. While other railroads were “growing,” a railroad that was satisfied with its current holdings and unwilling to expand would be considered a worse investment than an ever-growing railroad, despite the metrics that in hindsight point out the risks of collapse and ruin. 47 Over this time period, despite the expansion, almost all railroads experienced a decline in revenue. Multiple factors caused the precipitous decline in earnings that trended with an expansion of railroad mileage. The earning per mile statistic will obviously decrease if rail lines are being built without proper traffic to support them. In addition, bad luck relating to commodity prices sharply decreased earnings per mile. Prices of wheat, corn, beef, and oats all fell by around 36 percent between 1885 and 1890 due to a variety of factors including drought, overproduction, and federal monetary policy. 48 Along with railroad inefficiency and a lack of desire to fix it, sharply decreasing prices made it even more difficult for railroads to make interest payments and pay back lenders. The foundations of so many railroads were so faulty and

Williams, "Monetary Policy," 250.

White, Railroaded: The Transcontinentals, 208.

White, 210.

Thorstein Veblen, "The Price of Wheat since 1867," Journal of Political Economy 1, no. 1 (December 1892): 70, JSTOR. 48

Ohana 19 ill-conceived that only a transformational shift in the operating model of those companies would provide any meaningful relief, a sign of the impending doom. Failures of Regulation Amid so much chaos, speculation, and reckless expansion spurred on by investors and railroad executives, the federal government undoubtedly could have taken action to regulate speculation and prevent the seemingly inevitable debt crisis. It is first important to establish that the federal government had immense jurisdiction to act on the financial misconduct of railroads. For one, what was considered overcapitalization by many at the time was the result of fraud and deception on many levels. 49 The actions they were taking could almost certainly be punished by federal courts and legislators. In addition, numerous court cases had established decades prior that the federal government had every right to regulate interstate commerce, and states had the rights to regulate how those entities operated within their jurisdictions. At both levels, however, regulation failed in part because of the immense corruption, lobbying, and bribery efforts that took place to hamper the efforts of regulators. During the railroad boom of the 1870s, much of the lobbying that occurred, primarily at the federal level, related to government subsidies for railroads. Companies were interested in securing as much funding and as much land as possible to construct new lines. During the 1880s, however, political efforts made by railroad companies primarily concerned stopping an onslaught of regulation against railroads from occurring, a sign of the changing nature of railroad funding and the business actions they took. 50

Richard White, "Information, Markets, and Corruption: Transcontinental Railroads in the Gilded Age," Journal of American History 90, no. 1 (June 1, 2003): 191, https://doi.org/10.2307/3659790. 49

Campbell, The Reorganization, 19.

Ohana 20 One of the primary methods railroads used to inhibit the passage of legislation was filibustering. Large quantities of new bills would be introduced by representatives with close ties to the railroads, creating a legislative backlog that prevented actual pieces of legislation from moving through the legislative process in a timely manner, delaying the passage of reform. 51 The same practice was used with amendments, which would frequently be introduced in excess to delay the passage of legislation. These legislative actions, however, required pre-existing ties to be established between railroad companies and members of Congress. Those ties were easily established through unrestricted lobbying and bribery efforts. In some cases, this bribery was as simple as buying votes. Huntington, for example, paid 85 members $125 each to vote for the passage of land grants to the Southern Pacific Railroad on a route it was building to compete against the Texas and Pacific Railroad on, a tactical move to hurt another railroad’s position and further its own route development. An 1887 report found that the Central Pacific had spent over $4.5 million on these efforts over the preceding decade. 52 The continuation of these efforts in such large quantities and over an extended period reflects the effectiveness of their political machinations to secure land, funding, and freedom from regulation. While the Central Pacific and Southern Pacific maintained lobbying efforts more extensive than most railroads, the bribery efforts he and his associates maintained was commonplace in Congresses in the 1880s. At the Union Pacific, vouchers for rides on Union Pacific trains were commonly doled out to members, even at one point constituting one-tenth of all passengers on their trains. 53 To secure the passage of a funding

Campbell, 15.

White, Railroaded: The Transcontinentals, 129.

Campbell, The Reorganization, 15.

Ohana 21 bill that would have delayed and restructured the repayment of decades old government debt, Charles Francis Adams paid Senator Preston Plumb of Kansas $50,000 for his vote and his efforts to convince other senators to vote in favor of the legislation. With no regulation or watchdog to investigate railroad exploits and their financial tactics, the profitable position based on deception and at times fraud, the primary goal of railroads, was secured. Railroads further secured their position by stopping investigations and commissions from forming within the executive branch. In the election of 1884, both presidential candidates had established ties with various railroads. James Blaine, the Republican candidate, had previously accepted bribes from railroad companies in the tens of thousands. 54 The Democratic candidate, Grover Cleveland, during his time as an attorney, had represented railroad companies numerous times. Gabriel Kolko, historian and author of Railroads and Regulation, 1877-1916 points out, “His interest in the problem of railroad regulation while President was minimal.” 55 In the 1888 election, however, the railroad lobby abandoned Cleveland in his bid for reelection, instead backing Benjamin Harrison, to whom Huntington gave over $300,000 in exchange for strong input in appointments to the Interior Department. 56 Huntington’s donations, for example, would shield his railroads from investigations by the department, and give him an advantage over other railroads in securing land from grant programs, both functions of the Interior Department. Both Congressional and Executive lobbying efforts ensured the railroads would be relatively safe from any investigations or legislative barrages against their fraudulent business practices.

Stephen Winick, "Election Week Special: 'The Dodger' and the Election of 1884," American Folklife Center, last modified November 3, 2106, accessed February 28, 2021, https://blogs.loc.gov/folklife/2016/11/election-week-special-the-dodger-and-the-election-of-1884/. 54

Gabriel Kolko, Railroads and Regulation: 1877-1916 (New York: Norton, 1970), 47, accessed February 28, 2021, https://archive.org/details/railroadsregulat0000unse/page/n289/mode/2up. 55

White, Railroaded: The Transcontinentals, 129.

Ohana 22 Eventually, amid a public upheaval for regulation, the Interstate Commerce Act and Interstate Commerce Commission were formed to investigate and propose regulations for the industry. This initiative, however, was emblematic of the immense power railroad lobbyists still had at the federal level. Out of the original idea for a commission that was initially proposed by Representative John H. Reagan, friends of the railroads in Congress made sure the final version of the legislation would be as friendly to railroads as a piece of regulation could be. Railroads were also able to influence who controlled the commission and what actions it could take. 57 On the commission, for example, sat Thomas Cooley, who Kolko describes as “more the practical railroad administrator than the legal theorist.” 58 The vagueness and arbitrary nature of the written law, a product of railroad political maneuvering, ensured the act would do little to curtail railroad abuses. Overall, executives from the major railroads used their immense financial power and control over the transportation industry to prevent the passage of any meaningful legislation that would regulate the railroads, allowing their fraud and deception of investors and settlers to continue. These costs comprised a small fraction of the profits they made and allowed them to continue making even more. Effects of Railroad Mismanagement and Fraud As a result of gross negligence, mismanagement, corruption, and fraud by railroad companies and executives, the 1890s began with the United States on a collision course for a massive economic depression. The Panic would be fueled by investments that would never be repaid and a speculative bubble that had grown far too large to be sustained. Banks and financial houses had poured billions of dollars into railroad construction. While many of these banks were

White, 358.

Kolko, Railroads and Regulation, 48.

Ohana 23 located in the eastern United States, a significant portion of the money funneled into American railroads originated from European organizations. Of the $5 billion in securities held in 1890, British, German and Dutch investors held a portion of that debt. 59 Of the backers of the railroads, however, these companies had the least knowledge of the practices and norms of the industry they were investing in. Carl Hovey explains of English investors, for example, that “If they could have seen with their own eyes how the railroads of the period were pouring their money into a sluiceway they would never have survived the shock.” 60 Reasons for foreign investors’ lack of knowledge of the systems include misinformation by railroad companies and an unjustified belief about the guaranteed success of the projects in which they invested. Railroads controlled almost all the information that foreign investors received about the status of the lines and companies they bought into. For one, it was the managers who controlled the financial accounts and records, and there were no set standards for what was to be included in such documents. 61 Many investors simply did not probe into the affairs of the railroads to a sufficient degree, assuming their money was being put to good use. 62 Newspapers were the other potentially useful source of information about the affairs of the systems. These, however, were often owned or bought out by railroad owners, stemming the flow of information. Villard owned the New York Evening Post. Huntington invested heavily in the New York Star. Holding major newspapers allowed railroad titans to control the information overseas bankers received regarding their holdings, deceiving them and potentially making them appear more promising investments than they were. This practice was crucial in maintaining high levels of foreign 59

White, "Information, Markets," 22.

Hovey, The Life, 123.

Adams, "The Railroad," in Chapters of Erie, 412.

Hovey, The Life, 127.

Ohana 24 investment that exacerbated the growing speculative problem that faced the economy leading up to the Panic. The very reason foreign banks continued to invest in North America also led to their downfall and a destabilization of the financial system in 1890-91. European depressions in the 1870s had dropped interest rates and investment opportunities dramatically on the continent, pushing those investors to higher return, yet riskier investments overseas in things like American railroads. For example, one-third of the London and Westminster Bank’s investments in 1890 were in American railroads. 63As a result, the financial security of many financial institutions in Europe were tied to the success or failure of American railroads. It was not, however, an event in the United States, North America, or even Europe that began the collapse. That honor instead goes to the Argentinian wheat market. European investment banks, which had established a preference for riskier but higher return investments outside of Europe, also invested heavily in Argentina’s developing economy, specifically infrastructure. In the 1880s in the South American nation, massive inflows of credit like those given to US railroads, flowed into Argentina, making it the fifth largest receiver of foreign investment in the world. This influx allowed Argentina to rapidly develop its infrastructure. At the end of the decade, however, the country’s economy experienced a sharp decline as a result of rising interest payments, political instability, and deflated commodity prices. Rampant inflation in the country led to a decline in Argentinian bond prices and a collapse in foreign investment, the result of which was Argentina defaulting on $48 million in debt.64 The Baring Brothers

William Ripley, Railroads: Finance and Organization (New York, NY: Longmans, Green, 1923), 5, PDF.

Kris James Mitchener and Marc Weidenmeir, "The Baring Crisis and the Great Latin American Meltdown of the 1890s," The Journal of Economic History 68, no. 2 (June 2008): 464-65, https://www.jstor.org/stable/40056382. 64

Ohana 25 investment house in London held tens of millions in this Argentinian debt. In the aftermath of the crisis, the bank became insolvent and had to be bailed out by the Bank of England. 65 The near collapse of one of England’s largest banks sent signals of economic downturn through European markets. Having invested in regions like North America and South America because of the potential higher returns than investments within Europe, those banks now feared that strategy would lead to loss and began to withdraw or cease further payments of funds to those regions. Hundreds of millions were divested between 1890 and 1893, and European investors offloaded bonds and stocks in massive quantities, lowering their prices and investors’ confidence in the railroads. 66 Similarities between Argentina’s over-ambitious infrastructure program and that of the United States were widely seen by investors as a worrisome sign. 67 The collapse of the Argentinian economy amid a speculative craze embedded the thought that the same financial collapse could occur in the United States. In addition to the Baring Crisis, the passage of the Sherman Silver Purchase Act in 1890 also worried investors, both foreign and domestic, about how their investments would fare. Calling for the government to purchase more silver, the bill’s goal was to support miners and farmers in paying off their debts easier through inflation. This bill could have benefitted the railroads, which also had large outstanding debts. The inflation and currency devaluation, however, decreased investor confidence in the strength of their outlays. 68

Williams, "Monetary Policy," 240-41.

Williams, 243.

White, Railroaded: The Transcontinentals, 388.

White, 388.

Ohana 26 Between 1890, when the Baring Crisis and the passage of the Sherman Silver Purchase Act occurred, and 1893, stock prices in nearly every major transcontinental railroad dropped dramatically. The Atchison dropped from $23.5 to $17. The Union Pacific dropped from $40 to $17.5. The Missouri Pacific dropped from $53 to $25. As stock prices continued to drop, railroads began having to place more collateral on their loans as a result of margin calls, only forcing them to borrow further or use fraudulent stock manipulation to maintain prices. 69 When the Panic finally hit, however, it was not a western railroad that prompted the mass selloff. Instead, it was the collapse of J.P. Morgan’s Philadelphia and Reading Railroad, which entered into receivership, essentially bankruptcy proceedings, on February 20, 1893. 70 E.G. Campbell explains of the company that “The management…had been marked by the rashest sort of speculation; …The bubble of inflated credit having been thus punctured, a general movement of liquidation started.” 71 Investors began to question the choices they had made over the past decade and the securities they had invested in. The speculative activity that marred the Reading had been practiced to the same extent, if not more profoundly, on western rail lines. This fear triggered a selloff in securities that prompted a significant portion of the companies involved in railroad operation to be declared insolvent, their stock prices having plummeted substantially. By 1894, a fourth of all railroad mileage in the United States was in the hands of receivers, a mileage that represented a capitalization of $2.5 billion. 72

White, 389.

"Collapse of the Reading," New York Times, February 21, 1893, 3, accessed February 28, 2021, https://timesmachine.nytimes.com/timesmachine/1893/02/21/109693576.html?pageNumber=3. 70

Campbell, The Reorganization, 25.

Campbell, 27.

Ohana 27 That capitalization represented a significant portion of the American economy at the time. The implications of the misconduct on the part of the railroad, and the long-term impact this had on the American economy, but also those who believed they had a friend in the railroads and choose to settle on the frontier as a result, cannot be understated. It is first important to accurately categorize and describe the actions the railroads took. Leland Jenks takes the position in his article “Railroads as an Economic Force in American Development” that railroad development was on a constant upward trajectory throughout the late nineteenth century, and that downturns were simply the result of risks not paying off. 73 Framing the Panic of 1893 as a normal event in a business cycle and asserting railroads operated in the same manner as most enterprises in the era misidentifies causes for the Panic and the prominent role railroad executives played. Richard White points out, “Overcapitalization was more the result of fraud, deception, and insider dealing than of entrepreneurial risk taking.” 74 Consider the mismatch in perspectives first between those who were interested in investing in railroads and those companies. Primarily, an investor assumes that once built, a line will be used as a means of generating profit. So, when thousands of miles of track are constructed by a railroad company, an investor assumes that those are profitable lines constructed in profitable locations. Railroad expansion in the 1880s, however, defied this assumption. In addition, before investors could realize their money would never be returned, it was too late. To keep investors coming, fraud and stock manipulation would be used to ensure the railroad looked profitable, even if behind the scenes, the only ones profiting were the railroad

Leland H. Jenks, "Railroads as an Economic Force in American Development," Journal of Economic History 4, no. 1 (May 1944): 9, https://www.jstor.org/stable/2113700. 73

White, "Information, Markets," 191.

Ohana 28 executives plundering the company. The result was the second and more dire mismatch between railroads and settlers. Some scholars argue that the railroad construction, even if they were not managed properly and were not the primary focus of companies, still contributed to the opening of the continent and spurred agricultural development west of the Mississippi River. 75 This argument can be answered in multiple ways. Primarily, railroads were a financial mechanism for executives, not a service to be offered to farmers on the Great Plains or miners in the Rocky Mountains. For those profiting off the selling of securities, there were no stations, ties, or lines, just the money to be earned betting on those constructs. 76 However, one distinction must be made. Obviously, it would be advantageous for railroads to make money from rate setting and operation of their lines. The issues with that goal, however, were that not only did railroad executives not have any knowledge of how to do so, but ultimately the money they could bring in would pale in comparison to money generated through speculation. One of the ways speculative railroad construction hurt settlers was through encouraging farmers to develop areas not suited for farmland. Railroads frequently constructed lines in places where demand was virtually nonexistent because of unsuitable conditions and lack of transportation to those areas. However, when railroads built lines through these places, they encouraged settlers to develop there, since settlers believed that transportation was now secure, and that if a railroad constructed a line to a given area, it must have at least some farming value. Neither of these assumptions were true. This falsehood, however, led to settlement in areas that should never have been

Williams, "Monetary Policy," 247.

Campbell, The Reorganization, 15.

Ohana 29 settled, as a result of deception and lies made by the very railroads that were supposed to be an aid to the expansion of the frontier. 77

George L. Henderson, California and the Fictions of Capital (New York: Oxford University Press, 1999), 155, ProQuest Ebook Central. 77

Ohana 30 Bibliography Adams, Charles Francis. "The Railroad System." In Chapters of Erie and Other Essays, 333-429. Sheridan, WY: Franklin Classics Trade Press, 2018. Previously published in Chapters of Erie and Other Essays. Compiled by James T. Osgood. N.p., 1886. Campbell, Edward Gross. The Reorganization of the American Railroad System 1893-1900. New York, NY: Columbia University Press, 1938. Digital file. Chandler, Jr., Alfred D. The Visible Hand: The Managerial Revolution in American Business by Alfred D. Chandler, Jr. Cambridge, USA: Belknap, 1977. "Crédit Mobilier Scandal." In Gale Encyclopedia of U.S. Economic History, 2nd ed., edited by Thomas Riggs, 312-14. Vol. 1. Farmington Hills, MI: Gale, 2015. https://link.gale.com/apps/doc/CX3611000222/UHIC?u=harker&sid=UHIC&xid=9eca12 f6. Faulkner, Harold Underwood. Politics, Reform, and Expansion, 1890-1900. New York, NY: Harper & Brothers, 1959. Digital file Grodinsky, Julius. Transcontinental Railway Strategy, 1869-1893; A Study of Businessmen. Philadelphia, PA: University of Pennsylvania Press, 1962. Harley, Charles Knickerbocker. "Oligopoly Agreement and the Timing of American Railroad Construction." The Journal of Economic History 42, no. 4 (December 1982): 797-823. JSTOR. Hovey, Carl. The Life Story of J. Pierpont Morgan. Toronto: The Copp Clark Company Limited, 1911. Accessed December 29, 2020. https://hdl.handle.net/2027/aeu.ark:/13960/t40s13w7g. Jenks, Leland H. "Railroads as an Economic Force in American Development." Journal of Economic History 4, no. 1 (May 1944): 1-20. https://www.jstor.org/stable/2113700. Kolko, Gabriel. Railroads and Regulation: 1877-1916. New York: Norton, 1970. Accessed February 28, 2021. https://archive.org/details/railroadsregulat0000unse/page/n289/mode/2up. Mitchener, Kris James, and Marc Weidenmeir. "The Baring Crisis and the Great Latin American Meltdown of the 1890s." The Journal of Economic History 68, no. 2 (June 2008): 462500. https://www.jstor.org/stable/40056382. National Bureau of Economic Research. "U.S. Revenue per Freight Ton-Mile, All Railroads 1882-1911." NBER Macrohistory: III. Transportation and Public Utilities, dat. a03003d. Accessed March 31, 2021. https://data.nber.org/databases/macrohistory/rectdata/03/a03003d.dat.

Ohana 31 New York Times (New York, NY). "Henry Villard Is Dead." November 13, 1900, Obituary. Accessed February 28, 2021. https://timesmachine.nytimes.com/timesmachine/1900/11/13/317370162.pdf. "The Northern Pacific Report." The Commercial and Financial Chronicle, October 22, 1892, 658-60. Accessed February 24, 2021. https://fraser.stlouisfed.org/title/commercialfinancial-chronicle-1339/october-22-1892-529692/fulltext. Orsi, Richard J. Sunset Limited: The Southern Pacific Railroad and the Development of the American West, 1850-1930. Berkeley, Calif.: University of California Press, 2007. ProQuest Ebook Central. Ripley, William. Railroads: Finance and Organization. New York, NY: Longmans, Green, 1923. PDF. Steeples, Douglas, and David O. Whitten. Democracy in Desperation: The Depression of 1893. Westport, CT: Greenwood Press, 1998. Stover, John F. American Railroads. Chicago, IL: University of Chicago Press, 2008. https://ebookcentral.proquest.com/lib/harker-ebooks/detail.action?docID=408181. United States Census Bureau. "Chapter Q. Transportation." Historical Statistics of the United States, Colonial Times to 1970. Last modified September 1957. Series Q16 and Q47. Accessed March 31, 2021. https://www2.census.gov/library/publications/1960/compendia/hist_stats_colonial1957/hist_stats_colonial-1957-chQ.pdf. Veblen, Thorstein. "The Price of Wheat since 1867." Journal of Political Economy 1, no. 1 (December 1892): 68-103. https://www.jstor.org/stable/1824500. Watkins, Thayer. "The Depression of 1893-1898." San José State University Department of Economics. Accessed February 24, 2021. https://www.sjsu.edu/faculty/watkins/dep1893.htm. White, Richard. "Information, Markets, and Corruption: Transcontinental Railroads in the Gilded Age." Journal of American History 90, no. 1 (June 1, 2003): 19. https://doi.org/10.2307/3659790. ———. Railroaded: The Transcontinentals and the Making of Modern America. New York: W.W. Norton, 2012. Williams, Walter Franklin. "Monetary Policy and Railroad Overcapitalization: Their Roles in the Depression, 1893-1897." PhD diss., The University of Memphis, 2016. ProQuest Dissertations and Theses (10587634). Winick, Stephen. "Election Week Special: 'The Dodger' and the Election of 1884." American Folklife Center. Last modified November 3, 2106. Accessed February 28, 2021.

Ohana 32 https://blogs.loc.gov/folklife/2016/11/election-week-special-the-dodger-and-the-electionof-1884/.

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