CHAPTER III

PHILADELPHIA & READING Early history—Purchase of coal lands—Funding of floating debt— Failure—Struggles between Gowen and his opponents—Reorganization —Second failure and reorganization. The Philadelphia & Reading Railroad has been peculiarly unfortunate. Although serving a region of abundant traffic, it failed three times between 1880 and 1895, and was in the hands of receivers ten years. It was reorganized after each failure, and each reorganization was marked by bitter struggles between contending parties, due in part to divergence in financial interests, and in part to personal rivalries. In 1833 the Philadelphia & Reading Railroad was chartered by the Legislature of Pennsylvania to build a road from Philadelphia to Reading, a distance of 58 miles. Its early history does not concern us. In 1862 it leased, owned, and operated 437.4 miles of track, equivalent, roughly, to 119.4 miles of line; and derived $2,879,419 out of its gross earnings of $3,911,830 from the carriage of coal. Its capitalization was extremely high, roughly, $193,417 per mile of line,[155] and the necessary payments each year, not including dividends, took up $1,454,635. At this time the road owned no coal lands, but, like the Lehigh Valley Railroad and the Schuylkill Canal, remained a common carrier, and relied upon the advantages of its position in respect to the Southern coal fields to secure the tonnage which it required. From 1862 to 1865 inclusive the Reading enjoyed a period of extreme prosperity. The Navy Department, during the war, required large quantities of fuel, and in the revival of business after the conclusion of peace the Reading took its part. Merchandise earnings increased from $523,416 in 1862 to $1,165,277 in 1865; coal earnings from $2,879,419 to $8,627,292; and though expenses also increased, yet net earnings grew from $2,375,247 to $5,236,655, and the balance of earnings, after all charges had been paid, from $920,612 to $2,632,566. Dividends meanwhile ranged from 14 per cent on the preferred stock in 1862 to 10 per cent on both preferred and common in 1866, though the majority of the distributions were made in stock. On the whole, during the Civil War and for a whole year afterwards, the Reading was able to carry without difficulty the burden of an enormous capitalization. What increase in capital occurred at this time was in stock, and did not add to the load, although the desire to pay dividends on the increased stock led to the piling up of new issues. In 1869 an entirely new departure in Reading policy occurred. Whereas the road had previously owned no coal lands, with the advent of Mr. F. B. Gowen to the presidency it began to purchase on an enormous scale. “The repeated and serious interruptions of the business of the company,” said the annual report for 1871, “caused by strikers in the coal regions during the last few years, and the many fluctuations in the coal trade, produced by alternate periods of expansion and depression resulting therefrom, have attracted the attention of the managers of the company to the necessity of exercising some control over the production of coal, so as to prevent a recurrence of the difficulties heretofore experienced; and it was believed that the best way to accomplish this result, without injuriously affecting individual interests, was for the company to become the owner of coal lands situate upon the line of its several branches.”[156] Further, it was felt that some steps were necessary to retain for the Reading even the coal tonnage which it enjoyed. In 1871 every rival carrier had invested large sums in coal properties, and all the fields but the Schuylkill and Mahanoy (western middle) were occupied, while carriers had begun to enter the Mahanoy district, and it was reported to be their intention to build lines straight through to the Schuylkill fields. The anthracite coal regions of Pennsylvania lie in four main districts: the Northern or Wyoming; the Southern or Schuylkill; and two smaller intermediate fields known respectively as the Eastern Middle or Lehigh region and the Western Middle or Mahanoy and Shamokin basins. The Northern field is the more easily worked, and the Southern field is the richer.[157] Between 1869 and 1881 the Reading Railroad and its alter ego, the Coal & Iron Company, formed for the purpose, spent $73,326,668 for lands in the Schuylkill and Western Middle districts, securing 142 square miles, or 60 per cent of all the anthracite lands of these districts, and 30 per cent of all in Pennsylvania. Of the purchase money $69,816,204 were supplied either by the Railroad Company or by sale of Coal & Iron Company bonds which the Railroad Company guaranteed. The Coal & Iron Company incurred non-guaranteed liabilities for the rest.[158] This gave ample resources for the permanent supply of coal tonnage to the railroad, and was sufficient also to give a considerable measure of control over production in the Southern district. Independent operators did continue, however, and the Reading coal was subject to the competition of coal from other fields. More important still, in attaining control, “all kinds of coal properties, good, bad, and indifferent, were purchased without regard to original cost, location, or revenue producing capacity.”[159] In 1880 an engineer of reputation was appointed to evaluate the Reading coal lands, and recommended the surrender of five properties that originally cost $5,207,167, upon which there were encumbrances of $5,015,000. “But little weight,” said he, “should be given to the fear that rivals will possess the surrendered property; most of it is not a tempting investment.” Exorbitant prices were paid for the lands purchased. By 1881, as noted, there had been expended in all by the two Reading companies $73,326,668. This same report said that, “assuming the profit on the future coal product to be 30 cents per ton of coal shipped, that the company will be able to reduce the rate of interest on the money needed to hold and develop the property from 7 per cent to 6 per cent per annum, and that the development will be at the rate just stated [outlined earlier in the report], the whole estate has a value of $32,394,799: the company’s interest in the estate is worth $30,630,648, and, including colliery improvements belonging to the company, but situate on lands owned by others, the whole of the company’s property is worth $31,197,484.”[160] It is unquestionable that the Reading did acquire an enormously valuable property in the decade succeeding 1870. It seems just as clear that it paid more for this than was necessary; but what is perhaps more to the point is the fact that the Reading paid more than it could afford. Whatever the ultimate advantages to be gained by exclusive possession of any considerable section of the coal fields, the Reading was not large enough nor financially strong enough to make such vast purchases within so short a space of time. The prosperity of the Civil War had disappeared, net profits were fluctuating without marked tendency to increase, the figures for 1870 being actually less than those of 1863, while the interest on bonds had more than doubled since 1867, and the sum required for dividends had increased. To advance $54,886,647 to the Coal & Iron Company under these conditions, and to become responsible as guarantor for $14,929,557 more, would have been ill-advised even had the prices paid by the company been in strict accord with the commercial estimate of the time. Under the best of circumstances returns from much of the property acquired could not be secured for many years. The parts of the coal fields which were worked yielded an income, though it was seldom that the collieries were allowed to run to their full capacity; but those districts which were bought for the sake of controlling the coal situation, or in order to secure a future reserve, and which in many cases could not be worked at existing prices, occasioned a drain upon the company to the amount of interest on the purchase money, with no return of any kind. Moreover, the purchase of the coal lands put the Reading in the anomalous position of a railroad corporation interested in industrial lines. It could no longer be content with encouraging the transportation of its main source of revenue (coal), but had to care as well for the price at which this coal was sold. When depression in the coal trade came, the Reading lost both as producer and as carrier, for less was transported, and that amount was sold at a lower price; but when good times came, from which as a simple carrier it might have profited largely, it struggled with conditions of over-production which should rightly have been none of its concern. There was, finally, a peculiar fatality in the time which the Reading chose for its expansion. The year 1873 will always be remembered as one of the most disastrous in the history of the United States. Commencing with the failure of Messrs. Jay Cooke & Co. on the 18th of September, the panic spread with such rapidity as to lead to the closing of the New York Stock Exchange on September 30. All railroad securities were exceedingly depressed, call loans were high, and it was nearly impossible to secure new capital. Business the next five years was very dull, and the Reading actually earned less gross in 1879 than in the year before the panic, and this at the very time that its liabilities were so largely extended. The natural result was the financial difficulty which can be detected as early as 1876. In June it appears that, owing “to the continued depression in the iron and coal trades and the consequent falling off in transportation,” the road was obliged to reduce its working force. In July the usual dividend was passed; salaries were lowered in September, and still later a temporary loan was secured to tide over the floating debt, which then amounted to $8,272,359. By the next year the matter had become serious enough to necessitate a formal proposition to creditors for the postponement of interest payments and of payments on the floating debt. The company professed itself able to carry out the following: (_a_) To pay the interest on prior liens in full. (_b_) To pay one-half the interest on the general mortgage bonds and on the Perkiomen sterling mortgage bonds for three years in cash, and one-half in five-year interest-bearing scrip, with the option to the holder of receiving instead scrip for the three coupons first maturing and cash for the rest. (_c_) To pay for five years in scrip the interest on the debenture bonds of both the Railroad and Coal & Iron Companies; the convertible bonds of the Railroad Company, the bonds due in 1885, 1902, and 1918 of the Tidewater & Susquehanna Canal Company, and so much of the rent due to the Schuylkill Navigation Company as was applicable to the payment of dividends to stockholders of the Company and to the interest upon its mortgage loan of 1895. (_d_) To suspend the drawings for the payments of sinking funds and of the improvement and general mortgage bonds for a period not exceeding four years, if so long a time should be required for the payment of the floating debt.[161] “The relief to be obtained from the above,” said President Gowen, “will undoubtedly enable the managers, even with no improvement in traffic or increase of rates, to meet the fixed charges on all obligations of both companies other than those above named, and to pay off the entire floating debt within such time as will be satisfactory to the holders thereof.” Certain modifications were suggested by the London securityholders, providing for trustees with some power to protect the creditors,[162] and the plan went quietly into effect. From now on matters went from bad to worse. The year 1878 showed a falling off in almost every source of revenue, while expenses and charges remained very nearly the same. Depression in the coal trade and connection with the Coal & Iron Company, general dulness of business after 1873, troubles with employees, over-capitalization, all had their share in pushing the company still further into the mire. It became unable to keep its share of the existing business, and the percentages of the Schuylkill output carried by it steadily decreased from 83.49 in 1877 to 75.45 in 1881, while its percentage of the aggregate output from all the anthracite region diminished from 32.82 to 24.44. “It appears, therefore,” said the annual report for 1881, “that while other companies have steadily increased their capacity of production by regular and judicious expenditures for new openings, breakers, machinery, and other facilities for mining and delivering coal, the Reading Company has apparently remained stationary.... For this policy the local officers in charge are not probably responsible, as it was undoubtedly forced upon them by the management, because of the impoverished and embarrassed condition of the company’s finances.”[163] Throughout 1879 there was trouble over the payment of wages, perhaps as good a sign of financial difficulty as can be desired. Employees were paid in scrip, not cash, and even scrip wages were left overdue. President Gowen went to Europe toward the middle of the year, but not at all, as he carefully explained, in order to place a new loan, or to transact any business except a little in relation to some railroads for the company; in fact, the condition of the Reading was an open secret, and new loans were impossible to obtain. In May, 1880, the New York and Philadelphia banks began to refuse further accommodations. At the same time the period during which, according to the agreement of 1877, cash payment of general mortgage coupons was suspended, drew to a close, and on May 21 the Philadelphia & Reading announced its inability to meet its obligations. As was said at the time, the company did not fall with a crash because it had not far to fall. The failure occurred on May 21, and on May 24 Messrs. F. B. Gowen (president of the company), Edwin A. Lewis, and Stephen A. Caldwell were appointed receivers. Their resources were scanty and they had to do with them as best they could. On the one hand they applied to the court for authority to borrow $1,000,000 to pay the wages of employees and interest falling due July 1, and on the other they cut down expenses by reducing the working force in the repair shops, by putting the shops on short time, by discontinuing many of the trains on different lines, and by ceasing all dead work at the collieries. Before any plan could be proposed for the rehabilitation of the company the condition of its finances had to be known, and this again the receivers took in charge. Their report in June, 1880, showed a sufficiently serious state of affairs. The floating debt of the Railroad Company had mounted up to $10,254,766, besides $1,900,482 more for the Coal & Iron Company. This represented an increase of $3,604,000 as compared with November 30, 1879, and an English bondholders’ committee declared that only $2,930,000 of it were represented by value.[164] The rest had apparently been incurred in desperate attempts to preserve the solvency of the company. The total liabilities of the Railroad and Coal & Iron Companies, including mortgage, debenture debt, floating debt, and miscellaneous items, but excluding stock, were $152,436,890. The deduction from these figures of the Coal & Iron bonds held by the Railroad Company, which would have constituted a duplication of indebtedness, left a total of $106,215,830. The stock of the two companies amounted to $42,278,175, and the stock in the hands of the public to $39,278,175. The grand total of liabilities was thus the enormous sum of $145,494,005. The charges for interest and sinking funds were $7,542,094, and the annual payment of $5,629,764, due on $87,558,482 of railroad bonded indebtedness, shows that the rate of interest upon the bonds was high. The net revenue was $5,494,979, and there was therefore a deficit of $2,047,115. Meanwhile the Coal & Iron Company had reported a regular deficit up to 1880, which, though not significant in itself, because of close relations with the Railroad Company and the impossibility of determining how much the Coal Company’s rightful profits were reduced by exorbitant transportation rates, yet made it very clear that from this source the Railroad Company could expect no aid toward the cancellation of the railroad deficit revealed. The combined companies were unable to earn their fixed charges: the continuation of the struggle to do so was sure to mean, as it had in the past, merely a piling up of the floating debt. The coupon-funding scheme of 1877 had shown the inevitable result of temporary measures of relief; and though business in 1880 was rapidly improving, there was need for a radical reduction in the burden resting upon the company. Pending action, a bill for foreclosure was introduced under the general mortgage of 1874.[165] A valuation of the Reading coal properties, to which reference has already been made, was started. It was entrusted at first to Mr. S. B. Whitney, chief engineer of the Coal & Iron Company, and to Mr. Frank Carver, the land agent; but was later given over to Mr. Joseph S. Harris, chief engineer of the Lehigh Coal & Navigation Company, in order to have the opinion of an unprejudiced expert.[166] The first suggestion for a plan of reorganization came from England. The consolidated mortgage, prior to the general mortgage, was to be foreclosed; general mortgage bonds were to be deprived of their right to sue or to foreclose; all unsecured bonds and junior mortgages were to be exchanged for preferred stock; and a $15 assessment was to be levied upon the stock, for which collateral trust 7 per cent bonds were to be given. This assessment was relied on to pay off the floating debt, and the new company was to start free, with but $33,564,000 of mortgage indebtedness.[167] This plan was a step in the right direction. It recognized the validity of prior liens, followed a sound principle in providing for the floating debt by assessments upon the stock, and relieved the company from the likelihood of a future failure by its treatment of the general mortgage bonds; but it was weak in that it reduced the general mortgage to the anomalous position of a bond entitled to a fixed return without the power to enforce it. Stockholders, moreover, objected strenuously to the assessment, maintaining that business conditions were now such as to make milder measures sufficient. In October, 1880, Mr. J. W. Jones, formerly vice-president of the Reading Company, urged that an assessment on the stock was not necessary, and proposed the following: (1) To convert the income, debenture, and convertible bonds and scrip into second preferred stock bearing 5 per cent interest if earned; (2) To issue $15,000,000 of first preferred stock, with which to retire the floating debt; (3) To scale the Coal Company mortgage bonds $200,000 per annum, which could possibly be done by consent of holders, if not, then by foreclosure.[168] The main difference between this and the English scheme lay in the treatment of the floating debt. It is improbable, however, that the substitute which this plan offered would have been sufficient, and that the preferred stock could have brought $66, at which price alone it would have covered the floating debt. Reading common stock was selling in the middle of the month at 16⅜; general mortgage 6s were bringing only 74¼, while debentures and convertible 7s were being quoted at 28 and 37 respectively. In October a representative of the English bondholders arrived in Philadelphia for the purpose of examining into the condition of the company, and the following month agreed with the board of managers upon a reorganization committee to act in the United States. “The probabilities are,” said this gentleman (Mr. Thomas Wilde Powell), “that it will be found that the bondholders in London will be willing to do as they did in the case of the Erie, that is, fund a reasonable number of coupons ... for the purpose of setting at liberty a portion of the revenue to pay unfunded claims.”[169] The next move in the reorganization of the company came, however, not from this committee but from President Gowen, the man who had led the Reading into the purchase of coal lands, and who still remained in office in spite of the hostility shown toward him. His scheme comprised two parts: the first an issue of income bonds with which to pay off the floating debt (together with $5,000,000 mortgage bonds); the second a grand general mortgage to retire existing indebtedness. The plan in more detail was as follows: (1) The company was to create $34,300,000 deferred income bonds, on which interest was to be deferred to a dividend of 6 per cent on the common stock. After this amount had been paid the bonds were to take all revenue up to 6 per cent and were then to rank _pari passu_ with the common shares for further dividends. The debentures were to be issued at 30 per cent of their par value, or $15 per bond; and before selling or disposing of said bonds in the market the option of taking a _pro rata_ share was to be first offered to the stockholders of the company.[170] (2) A more permanent relief for the company was to be obtained from the proposal to issue a new long time or perpetual 5 per cent funding mortgage of $150,000,000, divided into two classes, A and B, of $75,000,000 each: class A having priority of lien and interest charge over class B. With this issue it was proposed, by purchase or exchange, to retire all outstanding indebtedness, and to acquire by purchase the securities of the companies owning the leased lines. It was estimated that $140,000,000 of the new issue would provide for all of this, the total interest on which would be $7,000,000, as against fixed charges for interest, sinking funds, and rentals, of $10,657,116, making an annual saving of $3,657,116.[171] Mr. Gowen did not expect to secure so large an annual reduction, owing to the impossibility of purchasing the higher securities and the probable appreciation in value of the lower ones; but he did expect to realize in all a saving of some $2,700,000. In part this plan was commendable; in part it was inadequate, and in part it relied on a mere juggling with words. The proposal to unify all classes of indebtedness by a grand consolidated 5 per cent mortgage was a good one, both in the simplification of accounts which was to be expected, and in the reduction in fixed charges so far as this reduction went; but on the one hand a reduction of $2,700,000 in charges was too little for a company which had reported for that very year a deficit of $2,000,000, and on the other hand too little allowance was made for the difficulty of forcing securityholders without a foreclosure sale to submit to a definitive scaling down of their holdings, with not even a preferred stock to show for the sacrifice. In its handling of the floating debt, the plan was a second edition of Mr. Jones’s stock-selling scheme, with all the good points left out. What justification there could have been for calling securities, such as the deferred incomes, “bonds,” which were to be issued for no definite time, ranked even after the common stock for dividends, and were of such doubtful character that Mr. Gowen himself proposed to sell them for one-third of their face value, does not appear; unless it be that the lack of voting power, itself a disadvantage, entitled them to the more respected name. The deferred income bonds were a device for saddling the holders of the unsecured debt with a worthless certificate which they might be induced to accept because of its name, and to which not even the Reading stockholders could object. Furthermore, even if the creditors had been eager for this new issue, in itself it would not have been sufficient. The issue, if taken up, would have yielded $10,200,000. It was proposed besides to sell $5,000,000 of unissued general mortgage bonds, which, after the success of the deferred income bonds, it was presumed would sell at par. Income bonds and general mortgage together promised a total of $15,200,000, or more than $1,000,000 over cash requirements after commissions had been paid.[172] However poor the prospect, there was no lack of syndicate guarantee. In November, 1880, a London syndicate agreed to deposit with an American bank, to be named by the company, the sum of $2,058,000, to be forfeited in case they failed to take at the issue price all deferred income bonds not taken by the shareholders. This syndicate further agreed that the company might retain, up to $1,000,000, out of the deposit money, whatever might be necessary to make up a second instalment of $4 on such neglected bonds.[173] Nothing was asked from the company in return except the chance to sell the bonds purchased at a premium. “As long as the bond- and shareholders find the money,” remarked the London _Times_, “there is nothing to be said. In all probability, however, these deferred bonds will become a medium for the very worst kind of gambling, and their chances for a dividend appear to us to be very small.”[174] In December Mr. Gowen’s plan received the approval of the American committee and of the board of managers of the company. Bondholders were in no way injured by the worthlessness of the deferred income bonds, and only the most far-sighted could be expected to have demanded a larger reduction in their claims. The same month a meeting of London bond- and shareholders passed unanimously a resolution expressing confidence in President Gowen, and adopting his scheme.[175] Opposition came from the influential London banking firm of McCalmont Bros., and the struggle centred about the annual election set for January 10,