CHAPTER X

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FINANCIAL DIFFICULTIES FROM 1870 TO 1879

Excessive Construction

We may now return to the more general considerations affecting Central Pacific finance which characterized the years from 1870 to 1879. There is a good deal of evidence that the years during which Mr. Colton was connected with the Central Pacific enterprise were years of financial difficulty for the associates, due in part to general depression, in part to a disproportionate amount of new construction, and in part to the continued inability of the Huntington-Stanford group for many years to interest eastern capital in western railroads.

During the years from 1869, when the Central Pacific was first opened to Ogden, to 1874, the earnings of the Central Pacific main line, both gross and net, steadily increased. The following table sets forth the facts relating to this progress, as well as figures for the succeeding years from 1875 to 1881.

Earnings and Expenses of the Central Pacific Railroad, 1874-81(*)

January 8, 1863 Gross Earnings Operating Expenses Net Earnings
(Calendar years)
November 6 to
December 31, 1869 $ 1,024,680 $ 777,348 $ 247,332
1870 7,519,983 6,009,426 1,510,557
1871 8,862,054 5,937,890 2,924,164
1872 11,963,641 8,645,276 3,318,265
1873 12,867,600 7,822,638 5,044,962
1874 13,726,561 6,468,145 7,258,416
1875 15,665,082 9,937,465 5,727,617
1876 16,994,216 10,970,599 6,023,617
1877 16,471,144 12,761,639 3,709,505
1878 17,530,859 12,005,535 5,525,324
1879 17,153,163 11,126,298 6,026,865
1880 20,508,113 12,814,121 7,693,992
1881 24,094,001 14,546,899 9,547,102
————— ————— —————
$184,381,097 $119,823,379 $64,557,718
-------- -------- -------

(*)Report compiled by the Commissioner of Railroads, 47th Congress, 1st Session House, Executive Documents No. 123, 1882, Serial No. 2030.

The greatest continuous drain upon Mr. Huntington and his friends during the decade from 1870 to 1880 came from the necessity of raising funds to provide for construction in southern California as described in earlier chapters. Had business considerations alone controlled, there is little doubt that this construction would have ceased. It did not pay for itself, and could not be expected to be profitable until the country served had been developed. Indeed, Charles Crocker once declared that when the Southern Pacific was built through the southern San Joaquin Valley, the company could have started with a railroad train at Sumner at the south of the valley and come to Stockton, and with one engine and one train of cars, hauled every living soul that lived in the valley out at one haul. The settlers between Yuma and San Bernardino could have been carried in one carload. This was as late as 1876.[240]

Inability to Get Eastern Capital

It was largely owing to this construction, as well as to the general hard times, that the gross earnings per mile of the Central Pacific and leased lines fell from $12,068.63 in 1875, to $7,677.84 in 1879. The Central Pacific did not dare stop work for fear that the federal government might be persuaded to subsidize another transcontinental road, and so deprive it of the monopoly which it was so anxious to retain; but it built as slowly as it could, and endeavored to make up by retrenching in other directions. Had the associates been able to sell securities in New York, the slowness with which the earning power of their system developed would not have been so serious a handicap. The territory was after all a rich one, and given time was sure to yield substantial profits. But a market for their stock and bonds was impossible to secure for many years. We have seen the opinion expressed by the associates in the Colton settlement, with respect to the salability of Southern Pacific-Central Pacific securities. There is no reason to doubt that this judgment was correct. Before 1880 it does not appear that there was a market for any of the Huntington-Stanford issues except the Central Pacific first mortgage bonds, and the sale of these was very slow.[241]

There is evidence that the associates not only recognized this situation, but that they took what steps they could to meet it. Central Pacific stock was listed on the New York Stock Exchange in 1874, and on the San Francisco Stock Exchange in 1878, not so much with the idea of selling any large number of shares, as in order to make a beginning which might ultimately lead to an established market. Arrangements were made to have the stock called at San Francisco every day, and the associates stood always ready to buy it back at a slight decline. The payment of dividends was begun in 1873 and continued until by the end of 1877 the sum of $18,453,670 had been distributed. Yet all this had little result for many reasons, among which doubtless should be again mentioned the personal liability attaching under California law to holders of stock in California corporations.

Naturally Southern Pacific securities of any type were still more difficult to sell than Central Pacific stock. Mr. Huntington found that the Southern Pacific Railroad was not known in the East, even by parties who had spent some considerable time in California.[242] To overcome this he advertised Southern Pacific stock and bonds in a great variety of ways, sometimes by personal conference with eastern bankers, sometimes by the issue of pamphlets or by the insertion of items in the newspapers, sometimes by the manipulation of bond sales upon the Stock Exchange. Occasionally he bought a few outstanding Southern Pacific bonds in order to support the credit of the company.[243] But here again, in spite of his efforts practically no bonds were sold, and Southern Pacific stock could not be disposed of at any price.

Market for Securities

A good deal of specific testimony by New York brokers is available to show the estimation in which Central Pacific and Southern Pacific securities were held late as 1879. It is all cumulative, and to the effect that no market existed at that time for any of these issues except Central Pacific first mortgage bonds. Thus S. H. Thayer said of Central Pacific stock: “I don’t think it would have found any market; I do not think it would have been possible to have sold it at any price; the stock had no friends, nobody knew of it, nobody traded in it; that is, in a general market; I do not know what might have been done by private negotiation; but in the public market nothing could have been done with 20,000 shares towards selling it.”[244] Similar testimony was given by D. O. Mills, of San Francisco. Mr. Mills was asked what price could have been obtained in the San Francisco market in 1879 for $13,000,000 in Southern Pacific bonds, and replied that he did not think these bonds were salable then, that it would have been a matter of bargain and sale, and would not have depended upon any market value.[245] Mr. Thayer also testified that the Southern Pacific bonds were on the stock exchange list in New York, but were bonds no one dealt in, and about which few were informed.[246]

It would probably be a mistake, in spite of this testimony, to attribute the reluctance of eastern investors to buy Southern Pacific bonds solely to unfamiliarity with the security. Not only was the economic development of southern California slight and the probable earnings of the Southern Pacific for some years small, but the state as a whole was not in the seventies an attractive field for investment. During the decade from 1860 to 1870, California had grown rapidly in wealth and prosperity. Population had increased and manufactures had begun to develop. In agriculture, fruits, berries, and grapes had been added to the important quantities of grain and vegetables already produced. But the immediate effects of the completion of the transcontinental railroad had been harmful to California, rather than beneficial.

For this there were several reasons: (1) speculation in real estate around San Francisco Bay had so discounted the completion of the line that the actual opening of communication caused a reaction rather than an advance; (2) the combination of a stimulated immigration due to greater facilities for travel, with the sudden release of a considerable part of the labor used in railroad construction, had forced down wages, while, on their part, California merchants had become exposed to competition from eastern distributing houses; (3) droughts in the South, the decline in the production of the mines, and the collapse of speculation in Nevada silver properties, all had given rise to acute suffering and discontent. These things in turn had reacted on political conditions, and had produced, first, the so-called sand-lot excitement, and then the agitation that led in 1879 to a revision of the state constitution. Meanwhile the passage of the Thurman Act, and the various disputes between the Pacific railroads and the federal government had provided special reasons for distrusting the securities of the Southern Pacific and Central Pacific companies, quite apart from conditions peculiar to the section in which their mileage lay.

Short-Term Borrowing

To repeat, it was this failure to dispose of the railroad stock and bonds which they had to sell that threw the associates back upon the necessity of raising money by short-time loans at extravagant rates of interest, and which, in the late seventies, peculiarly exposed them to the dangers of stringency in the New York money market. The partners at times paid as high as 12 per cent for loans.[247] Every element affecting their credit had to be closely watched, lest lenders refuse to discount their paper, and interest on the company’s bonds go by default; for it was a customary practice for the associates to take care of interest, at least over short periods, by loans.

In December, 1876, Huntington wrote that the January interest would this time have to come out of earnings, as he had been away from New York so much that he had not been able to secure loans there.[248] The same month Huntington complained of certain pamphlets which one A. A. Cohen had been sending East. “If the parties that inaugurate such fights as we now have with Cohen,” he wrote, “and have with the Sacramento Union and Senator Booth ... had to raise money outside of California, where our property cannot be seen, I am disposed to think such fights would be few.”[249] In May, 1877, Huntington let his partners know that reports from California to the effect that the railroad magnates there were spending their money for personal expenses with unexampled recklessness had hurt the Central Pacific credit.[250] At another time he reported that the rumor was abroad that the Central Pacific had no power under its charter to give notes for money, and that this had been denied.[251]

All through 1877 the letters exchanged between Huntington and his partners in the West show the strain which the Central Pacific was under. Huntington was continually wiring for money in lots of $50,000 to $100,000. Colton was sending it, sometimes by telegraphic transfer, sometimes in coin. As early as in May, 1877, Colton was talking of dull business and of reducing expenses. On August 23 he said that he did not exactly like the present financial outlook. The following day he spoke of the need of keeping credit good. “We cannot afford to ever be called on for money,” he wrote, “and not be able instantly to respond. Our affairs are too extended and extensive for us to take any chances of suspicion. It would hurt us in many ways, and take a long time to restore confidence.... I will now commence to renew our loans for six or twelve months, and take in sail everywhere.”[252] In September he repeated, “I am going to send you, for the next three months, every dollar I can, and, for God’s sake, keep all you can for the January interest. That must be paid. We will not pay out a dollar here, I am not obliged to. I read every department a lecture on economy about once a week.”[253] Earlier in the year the accounts of the Huntington group with the London and San Francisco Bank and with the Bank of California had been overdrawn from $150,000 to $350,000 each, and Colton was picking up every dollar outside which he could secure without showing his hand.[254]

Indorsement of Notes

As a general practice the associates seem to have refused to put their personal indorsement on the notes which they discounted. Huntington was very insistent that no indorsements be given; yet in January, 1878, conditions had grown so bad that Huntington asked the associates to indorse 100 blank notes and send them to him, to be used as a last resort, and this was done in spite of the violent protest of Mark Hopkins. Colton wrote Huntington:

I told him [Hopkins] I felt the wise thing for us all to do, was to stand in and protect all interests against the debts now owing, but to all agree not to incur any more, not to build any more road, or to buy any steamship, or property, either jointly or individually, until we got out of debt, and had the money in bank to pay for what we bought. That proposition just met his views, and he said that if I would agree that we would all live up to that, he would sign 20 of the blank notes, which he did, 10 of each.[255]

i202

Conditions in California grew worse rather than better after the notes were sent, but those in the East improved, and the indorsed notes do not seem to have been used. Yet, of course, the large accumulation of floating indebtedness of the Central Pacific could not be hidden altogether, and the credit of the company was correspondingly impaired.[256]

Sale of Securities

The first successful negotiations for the sale of Central Pacific and Southern Pacific securities were initiated in 1878 with the firm of Speyer and Company, of New York, and resulted in two agreements, dated the 27th and 28th of January, 1880, respectively. On the former date Huntington agreed to deliver, on or before January 31, 1880, as might be demanded, 50,000 shares of the capital stock of the Central Pacific Railroad at 72, ex-dividend, to Roswell P. Flower, John D. Prince, and Daniel Probst, representing a syndicate formed for the purpose. In case the parties took the stock just referred to, Huntington agreed further to deliver 50,000 more shares within six months from the date of the agreement, at 77. In any event, and provided that the syndicate took the first 50,000 shares mentioned in the agreement, Huntington undertook that no other Central Pacific stock beyond a stipulated amount of 40,000 shares should be sold to any other parties for a period of seven months from the date of the agreement.[257]

The syndicate which took Central Pacific stock at this time seems to have considered the enterprise a speculation justified by the resumption of dividends by the company, and by the improving stock market conditions of the time. Mr. Probst said that the general market had become so strong in the latter part of 1879 that it was a good time to sell anything.[258] On conclusion of the agreement a regular stock market campaign was opened with the usual accompaniment of matched sales to give an appearance of activity.[259] The stock nevertheless steadily declined, and the option held by the syndicate to take a second block of shares was not exercised.

The day after the arrangement for the purchase of the Central Pacific stock was concluded, and partly because of its conclusion, Speyer and Company entered into a written contract with the Western Development Company, containing a variety of provisions which together show the factors upon which the value of Southern Pacific securities then depended in the eyes of eastern bankers. Under an agreement dated January 28, the Western Development Company agreed to sell to Speyer and Company $1,000,000 in Southern Pacific bonds, within ten days, at 86. Within the year it undertook, in addition, to sell, if Speyer and Company should wish to buy, an additional $4,000,000 in bonds, at 87.51, and a still further amount of $5,000,000 at 90. On their part, the Western Development and Southern Pacific companies agreed not to sell any of the said bonds within a year to others than Speyer and Company, and the Central Pacific agreed not to issue bonds under the mortgage in question, to exceed $40,000 per mile.

Terms of Contract with Bankers

The more important features of the agreement with Speyer and Company in 1878 were, however, the following, relating to the lease arrangements between the Central Pacific and the Southern Pacific. Under these provisions the Southern Pacific agreed to secure a new lease from the Central Pacific within three months, containing (1) a provision that the lease should continue five years from the 1st of May, 1879; (2) a provision that the lease should be extended if the Southern Pacific was not connected with the eastern system of railroads, on the 32d parallel, within five years, until such connection should be made, provided that the extension of time should not exceed five years; and (3) a provision that the Central Pacific should pay a rental under the lease, sufficient to cover interest.

The Southern Pacific also agreed with Speyer and Company that if at any time before the expiration of nine years from the date of the lease contemplated, a railroad should be extended so as to connect the railroad of the party of the first part with the eastern system of roads, and the Central Pacific Railroad Company should refuse to prorate with the party of the first part, then the party of the first part would, before the expiration of one year from the date of such refusal, fill up or cause to be filled up one of the two gaps then unfinished between Tres Pinos and Huron, and between Soledad and near Lerdo, whichever it might choose to build.

The Southern Pacific finally undertook to furnish to the parties of the third part, within ninety days from the execution of the agreement, the written opinion and certificate of the chief engineer of the Southern Pacific, that the line of road either between Tres Pinos and Huron or between Soledad and near Lerdo could be completed and put in running order within twelve months of the commencement of work thereon, and could be constructed for the bonds reserved per mile.

The stipulation in the agreements relating to the lease of the Southern Pacific to the Central Pacific, and those anticipating further construction along the coast route, are of special interest. It is evident that the credit of the Central Pacific and not that of the Southern Pacific was the basis of the whole transaction. At the time the contract was signed, the option to take Southern Pacific bonds at 86 and 90, respectively, was considered valuable, but in fact this option was not exercised.

Later Improvement

After 1880 financial conditions generally improved. The earnings of the Central Pacific-Southern Pacific roads were still subject to fluctuations, but for several years substantial dividends were declared, and the sale of large quantities of Central Pacific stock in Europe enabled the associates to reduce their commitments. Moreover, by 1883 the long delayed extension to The Needles was completed and the necessary outlay for new construction was greatly lessened. The year 1883 may be taken as the close of the construction period of the Huntington system. Henceforth, in the absence of special disaster, and subject to successful settlement of its indebtedness to the government, the solvency of the Central Pacific and Southern Pacific railroads may be said to have been assured. We may therefore at this point turn away from the more personal and financial aspects of the enterprise, to the consideration of certain important political matters with which the associates were long concerned.


                                                                                                                                                                                                                                                                                                           

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