Part 31

═══════════════════════════╤══════════╤══════════╤══════════╤══════════ Track. │ 1908. │ 1890. │Increase. │Percentage │ │ │ │ of │ │ │ │increase. ───────────────────────────┼──────────┼──────────┼──────────┼────────── Single track │213,888.36│142,665.89│ 71,222.47│ 49.9 Second track │ 20,209.05│ 8,437.65│ 11,771.40│ 139.5 Third track │ 2,081.16│ 760.88│ 1,320.28│ 173.5 Fourth track │ 1,408.99│ 561.81│ 847.18│ 150.8 ───────────────────────────┼──────────┼──────────┼──────────┼────────── Total, all main tracks │237,587.56│152,426.23│ 85,161.33│ 55.9 Yard track and sidings │ 73,728.57│ 30,750.17│ 42,978.40│ 139.8 ───────────────────────────┼──────────┼──────────┼──────────┼────────── Total mileage operated │311,316.13│183,176.40│128,139.73│ 69.9 (all tracks) │ │ │ │ ═══════════════════════════╧══════════╧══════════╧══════════╧══════════

"The Interstate Commerce Commission in 1908 report that their Balance Sheet covers 'miles of road' aggregating 213,888.36 miles, whereas their statement of mileage represents all roads reporting to the Commission whether or not they furnished a Balance Sheet.

"To analyze the Consolidated Balance Sheet, we have revised the statement of mileage to cover same roads as are included in the General Balance Sheet. The 'miles of road,' _i. e._, miles of first main track, are actual. The Commission's report not showing separately for each line the miles of other main tracks or yard tracks and sidings, the figures shown in the statement of mileage are _approximate_. It includes mileage of all second, third and fourth tracks. Undoubtedly, practically all of the second tracks, third tracks and fourth tracks are owned, or operated by, roads furnishing the Commission with a Balance Sheet. Mileage of Yard Tracks and Sidings is based on the proportion which the single-track mileage of roads represented in the Balance Sheet bears to the total single-track mileage of roads reporting to the Commission."

Mr. Riggs considers _seriatim_ nine objections to the ordinary methods of estimating cost of replacement which were mentioned specifically by the writer, as among the most important commonly omitted items, in an address before the New York Traffic Club, delivered during January, 1909. He concedes that the writer is correct in urging that allowances for "working capital with which to carry on the business" and for "impact and adaptation" ought to be included, and were omitted in Michigan and have been usually omitted. These are two of the nine objections specifically raised. As to five others, Mr. Riggs seems to be in considerable doubt. Concerning the objection that an allowance of 3% for interest during construction is too low, he contends that it was justified in Michigan by the "assumption," that the whole work of replacement would be accomplished in one year, and also "that on long roads partial operation would commence as various sections of the line were completed." He admits that these assumptions "clearly would not be proper" under different conditions, but appears to hold that they were warranted as to the Michigan work.

Another of the writer's objections was the absence of an allowance for "wear and tear of materials during the period of construction." As to this, Mr. Riggs says:

"This deterioration is a necessary incident to any construction work. It has not been customary or usual to take account of it. To add to the amount capitalized on account of this item would be manifestly improper. The only way in which this could be cared for would be in an adjustment of the depreciation reserve when raised to cover that which takes place during the construction period."

Of course, the depreciation account, when there is one, is a charge to operation. Therefore, Mr. Riggs' anxiety to disagree with the writer has led him into a frame of mind in which he is prepared to find that it is "manifestly improper" to charge to capital the real cost of construction, but is quite proper to charge to operation a part of the cost of construction, even though this results in carrying into the operating account items of expense incurred long before operation began or could have begun.

Mr. Riggs thinks that the writer was incorrect in objecting that "a uniform price for earthwork was used, thus ignoring the varying character of soil and length of haul," but he admits that there was "practically no classification in the Southern Peninsula of Michigan, or, in fact, on 90% of the mileage of the State," and his defense goes no further than to assert that "the price * * * was not much out of the way when considered as a fair average for the territory."

His criticism of the objection to the use of a uniform price list for materials, and ignoring the source of supply and the cost of delivery at the point of use, is equally forced, for it admits that "no effort was made to use different unit prices as between counties," and only contends that "in a number of cases" differences in prices were made.

The absence of an allowance for interference by labor troubles, weather conditions (which he admits are "a frequent source of annoyance, delay, and sometimes of expense"), Mr. Riggs defends on the ground that it is "an expense difficult to separate and set up," and therefore ought to be covered by an allowance for contingencies. On the same ground, he could easily carry every item of cost of replacement into the contingent account.

The two remaining objections specifically raised by the writer are squarely attacked by Mr. Riggs. As to one of them, the propriety of an allowance for carrying charges up to the time of attaining a revenue basis, has been admitted by the Railroad Commission of Wisconsin, but it is a broader question than ought here to be discussed. The writer will only suggest, at present, that in some form or other, these charges must be on the whole and in the long run met out of net operating income, and that the cheapest way, for the user of the services supplied, is to carry them into the capital account—otherwise there must be an early amortization of this item, which cannot do otherwise than to throw a heavy burden on the early schedules of charges. The language of the Wisconsin Railroad Commission on this subject merits quotation, and is as follows:[40]

"But new plants are seldom paying at the start. Several years are usually required before they obtain a sufficient amount of business or earnings to cover operating expenses, including depreciation and a reasonable rate of interest upon the investment. The amount by which the earnings fail to meet these requirements may thus be regarded as deficits from the operation. These deficits constitute the cost of building up the business of the plant. They are as much a part of the cost of building up the business as loss of interest during the construction of the plant is a part of the cost of its construction. They are taken into account by those who enter upon such undertakings, and if they cannot be recovered in some way, the plant fails by that much to yield reasonable returns upon the amount that has been expended upon it and its business. Such deficits may be covered either by being regarded as a part of the investment and included in the capital upon which interest is allowed, or they may be carried until they can be written off when the earnings have so grown as to leave a surplus above a reasonable return on the investment that is large enough to permit it. When capitalized, they become a permanent charge on the consumers. When charged off from the surplus, they are gradually extinguished. (These facts alone, however, do not always furnish the best or most equitable basis for the disposal of such deficits.) Whether they should go into the capital account, or whether they should be written off, as indicated, are questions that largely depend on the circumstances in each particular case."

The other objection that is squarely opposed by Mr. Riggs is the refusal to allow for unavoidable discounts on the securities sold. Here he quotes with complete approval an unnamed writer, who contends that the impropriety of such an allowance is proven because, as between an issue of $10,000,000 in bonds (par value) at 4% and at 4½%, the 4% bonds bringing 90 and the 4½% selling at par, there is an annual saving, in issuing the 4% of $50,000 in interest, and that, if the issue is to be for fifty years, this saving is $2,500,000, or $1,500,000 in excess of the discount. Of course, these figures are correct, but both Mr. Riggs and his unnamed authority seem strangely to have overlooked the fact that if a railway construction requires $10,000,000, it cannot be obtained by issuing $10,000,000 in par value at 90. The comparison, of course, ought to be based on the issue of enough bonds at each rate to obtain equal sums of money. As $10,000,000 in par value of bonds sold at 90 would produce $9,000,000, the following comparison is based on the issue of enough bonds at each rate payable in fifty years to secure that sum.

Fifty-Year Bonds, 4½% sold at par. 4% sold at 90.

Amount of capital required $9,000,000 $9,000,000 Par value of bonds necessary 9,000,000 10,000,000 Annual interest charge 405,000 400,000

If 4% bonds are used: Annual saving in interest $5,000 Fifty years saving in interest 250,000 Loss, original discount 1,000,000 _________ Net loss $750,000

Of course, the foregoing figures are not absolutely accurate, for the real net loss in the issue of the 4% rather than the 4½% bonds at these prices would be the difference between the $5,000 annual saving in interest and the amounts which would have to be set aside annually for fifty years to produce $1,000,000, the amount of the discount, at the end of that period. But the table is sufficiently accurate to expose the curious error into which Mr. Riggs has fallen. Perhaps it will convince him that it would be better, hereafter, not to stray so far outside the field of civil engineering.

Mr. Riggs has little sympathy with those railway men who venture to express the opinion that regulation ought not to extend so far as to render it impossible to conduct the railway business in a business-like way. His animadversions on railway men in general have already been illustrated herein. He finds nothing worse with which to characterize a previous utterance of the writer's than to say of it:

"The manifest impatience with all forms of governmental interference with corporations, which so often characterizes the utterances of prominent railway officials, appears in this paper to a marked degree."

At the risk of incurring further displeasure, the writer will not omit now to observe that, in his judgment, the whole question whether railways shall be generally and officially valued, and how and by whom the task shall be performed, is primarily conditioned by the country's need of managing its legislative control of railway methods so as not to restrict unduly the flow of capital into that industry. The steady pressure for legislation during the last five years has so extended legislative regulation that, for the first time, the sturdy, frugal, conservative, "small investor" stands in the forefront of the problem. His views of the stability and future prosperity of the American railway industry now dominate the situation. What they are may be read in the facts attending recent efforts to finance necessary improvements of old and prosperous railways. It developed before the Interstate Commerce Commission during the recent hearings in connection with the proposed partial adjustment of rates to the diminished purchasing power of the money in which they are paid, that one of the greatest of Eastern railway systems, paying 8% annual dividends on its stock, which is very widely distributed, had offered new shares to its stockholders at a premium of 25%, and had found them unsalable at that figure, so that it was obliged to recall the offer and put them out at par. Other testimony disclosed the failure of one great company to obtain an offer of more than 85 for its 4% bonds, while another had been forced to go to France to raise $10,000,000, and many others have been forced to the expedient of issuing short-term notes at relatively high rates of interest. It also appeared that extensive proposals for new branch lines had been abandoned or postponed, in view of the impossibility of obtaining funds on reasonable terms.

Other testimony shows that locomotive shops and car builders are putting out not more than half of their capacity; that the supply trade is receiving no new orders. Never, since the beginnings of the American railway industry, has the American and foreign investor been so reluctant to supply necessary capital, or so doubtful of the future of railway enterprises. This fact is not due to absence of confidence in the industrial future of the American people, but is directly attributable to the unanswered inquiry as to how far the policy of legislative control is to extend. Either this question must be answered in a manner satisfactory to the investor, or the credit of the Government must be made available for the extension and improvement of railway facilities, either through Governmental guaranties of adequate returns to capital, or through Government ownership; for adequate and properly constructed and equipped railways the public must and will have. Thus far, the American public is ready neither for Federal guaranties nor for Federal ownership; it is to be hoped that it will never be ready for either. In this situation, if a Federal valuation is to be undertaken, it is primarily important that it should be under such auspices and by such methods that the investor will not be alarmed as to its consequences. This is not a suitable occasion to attempt to lay down all the considerations applicable to such a valuation, but it ought to be perfectly clear that it must relate to value in use, not to some concept of value limited to replacement cost which excludes some of the most important elements of value (which are also those most worthy of a return, because they represent the highest and most difficult social and industrial services), in order to obtain a means of excluding these same elements from possibilities of adequate reward.

One of the most important items to be considered is the "cost of progress," which is sometimes referred to as "abandoned property," or as "obsolescence." For illustration, in the revision of the grade and line of a road, whereby the capacity of existing track is doubled, the present instructions of the Interstate Commerce Commission require the charge to operating expenses of the cost of that portion of the old line no longer continued in use. If, however, the doubling of the capacity of the line be secured by the construction of a second main track, the entire cost of the new work can be charged to capital account and paid for from the proceeds of the sale of capital securities. The latter method becomes the easier to finance, but what of the comparative results? Say, for example, the original cost of material of existing property, including equipment, stations, yards, etc., was $10,000,000, that the first main track cost $1,000,000, and that to double the capacity of the main track would require a present expenditure of $1,000,000, either for (1) a reduction of the grades and curves of the first main track, or (2) for the construction of a second main track. The increase in capacity is identical, but in the first case the cost of train service to handle the tonnage is decreased 50%, and some reduction in maintenance is secured, while in the second case no economies of operation are effected, but the expenses may be increased. Undoubtedly, Road (1) would be much more favorable than Road (2), yet the Commission says a portion of the cost of perfecting Road (1) must be charged to operating expenses, and cannot be capitalized. What general manager will dare recommend such extensive improvements when the charging of a portion of the cost to operating expenses will show the dividend as unearned, and thus render the securities of the company no longer legal investments for savings banks, trustees of trust funds, etc.? As an alternative, he might permit the old line to remain, and by placing thereon a few cars occasionally, could consider it as still in use, and carry it in his capital account, thus avoiding the charge to operating expenses. Thus, again, is it the method and not the result that is controlled by these instructions. What should be done is to permit the cost to be charged against the surplus accumulated during the years in which the property to be abandoned was used. This would not affect adversely the operating income of the year, and would not impair the credit of the Company.

Plainly, the instructions of the Commission tend to compel a method that is contrary to the economic law.

Obviously, any requirement as to valuation which would impose on the carrier such a result as that shown would compel the continuance of the less efficient service and prevent the progress which such replacements express. The railway business is a continuing one, and an improvement ought to be made whenever it can earn income, not only on its own cost, but on that of the property abandoned, even though it cannot afford income sufficient to wipe out the whole capital charge for the latter in a single year. There is no reason for requiring each item of capital to earn its cost in addition to its interest during its individual life. Such a requirement would cry halt to progress. It is reasonable and proper that such charges to operation should be made as far as the rapid development of the art of transportation permits, and such is the practice of every well-managed railway; but, to make the practice uniform and compulsory, permitting no exceptions and allowing no scope for individual judgment, is quite another thing. When the conditions warrant such a course, the railway ought to be permitted to adjust its accounts in a manner of which the following is typical:

Replacing. Not replacing.

Capital account $19,750 $5,000

Additional net operating income attributable to 1,000 250 this item

Charge to operation for abandoned property 250

______ _____

Operating gain $750 $250

A valuation adjusted in recognition of this developmental need would include, in addition to the item of $15,000 for the replacement cost of the new locomotive, an item representing "cost of progress" of $4,750 for the former locomotive. It is not to be overlooked that in actual practice it would be easy to obtain this allowance by cumbering the yards and round-houses with obsolete and superfluous equipment. The plan of Professor Adams places a premium on such a course, and there are many conditions under which it could and would be followed where it would be less obvious and more detrimental. For example, it might be that an additional track over a steep grade and a new alignment which would avoid it would cost the same. The new alignment would give greater operating efficiency, but it would require the charging off of the old line; the new track over the grade would be more costly to operate, but would leave the apparent capital unimpaired. It is such possibilities as this that are giving pause to the investors who would otherwise supply funds for the needed development of the American railway system. How far this development has so far required the abandonment of property capable of further use and having genuine capital value is indicated by available records. The aggregate capacity of all equipment has increased much faster than the increase in number of locomotives and cars. The reports of the Interstate Commerce Commission only show this information for the years 1902 to 1908, both inclusive. The average tractive power of locomotives in 1908 was 26,356 lb., as compared with 20,485 lb. in 1902, being an increase of 5,871 lb., or 28.7% per locomotive. The average capacity of freight cars in 1908 was 35 tons, as compared with 28 tons in 1902, an increase of 7 tons, or 25 per cent. Undoubtedly, the average capacity of locomotives and the average capacity of freight cars in 1908 was not less than 60% above the average capacity of 1890.

L. F. Loree, M. Am. Soc. C. E., President of The Delaware and Hudson Company, as Reporter (For United States) to the International Railway Congress, held in Paris in 1900, communicated with all roads in the United States then operating 500 miles of line, or more, relative to the capacity of cars actually in service. The result is shown in Table 12.

As a result of these improvements in roadway and equipment, the average number of tons of freight handled per freight train in 1908 was 351.80 tons, as compared with 296.47 tons in 1902, an increase of 55.33 tons, or 18.6 per cent. The average tons per freight train in 1908 was 351.80, as compared with 175.12 in 1890, an increase of 176.68 tons, or 100.8 per cent.

These improvements have not been solely or mainly for the benefit of the carriers, though there is no question that they have been prompted by railway self-interest. The new car of 40 tons capacity is but 20% longer than the old car of 13 tons, which means a great augmentation of the efficiency of the private sidings and tracks of the manufacturers, as well as the side tracks and terminals of the railway. Who would retrace the steps of progress of the last decade or of the last two decades? Yet the project to tie railway earnings to replacement cost, which makes no allowance for the costly steps in such progress, is in reality a project to tie them to their present state of development and to prohibit future progress. Nor can it be forgotten that it is an inviolable law of Nature that that which does not go forward must go backward—nothing can remain stationary.

The story of the crude millionaire who wanted to know the value of the "plant" of Oxford University, in order that he might duplicate it, is not inappropriate, and ought to have some significance to those who imagine that replacement cost would tell the story of railway values. Do they imagine, because they are ignorant of them, that a great railway organization carries no traditions of loyalty, of persistence in the face of overwhelming difficulty, of generous recognition of public needs and rights, of courageous adherence to the real interests of its shareholders that inspire its personnel and provide a genuine _esprit du corps_? Do they find no superiority in one organization over another, no systematic economies of method, no especial adaptation to economic needs that has value more genuine than any replaceable element, and is at least equally worthy of compensatory return?

TABLE 12.—CLASSIFICATION OF FREIGHT EQUIPMENT ACCORDING TO THE CAPACITY.