Chapter II: Erie (2)

The year 1885 was taken up with suits brought against the Erie by certain of its branch lines. In February the directors of the Buffalo & Southwestern Company brought suit to recover $345,000 interest defaulted during the previous January. The complaint alleged that the Erie was insolvent, and asked that it be restrained from using the gross receipts of the road until the default should have been made good. The Erie paid the back interest, but in July, after another default, an injunction was obtained forbidding it to divert any part of the earnings received or to be received from this property. It was recited that on May 24, 1881, the Buffalo & Southwestern had been leased to the Erie for 35 per cent of the gross earnings, subject to certain deductions; that the Erie had delayed payment of the rental due in January, 1885, and had refused to pay that due in July, 1885, but that it was still receiving the gross earnings of the plaintiffs’ road, and had applied these to the payment of its debts other than the rentals of this road.[123] In November, after the Erie’s other troubles were settled, the litigation was terminated by an agreement to reduce the Buffalo & Southwestern rental from 35 per cent to 27½ per cent. Other suits arose, directly or indirectly, because of the control which Mr. Jewett maintained as trustee of the stock of the Chicago & Atlantic and the Cincinnati, Hamilton & Dayton railways even after his resignation from the Erie Company. On the one hand President King was anxious to repossess himself of these important branches for the Erie, and on the other Mr. Jewett was not disinclined to do what damage he could to the managers who had succeeded in supplanting him. In the matter of the Chicago & Atlantic Mr. Jewett gained the first victory in a temporary injunction forbidding the Erie to divert traffic from this line contrary to contract. This injunction was soon, however, substantially vacated, and President King in his turn obtained a decision that Jewett had been made trustee of the Chicago & Atlantic simply because he had been at the time vice-president of the New York, Lake Erie & Western Railroad Company and could be relied upon to control the road as the western outlet of the Erie. A receiver was subsequently appointed and the road reorganized as the Chicago & Erie Railroad Company, the Erie agreeing to guarantee payment of its first mortgage bonds, and receiving in return the $100,000 of capital stock and $5,000,000 in income bonds, besides $2,000,000 first mortgage bonds which were in part payment of old advances.[124] In his action concerning the Cincinnati, Hamilton & Dayton President King was less successful; and Mr. Jewett was sustained in his refusal to deliver proxies for the stock held to the larger company. The result was to turn the Erie to the Big Four, upon which, instead of upon the Dayton road, the management was for some time to rely for an entrance into Cincinnati.

During these various contests the suggestions of the English committee were not lost to view, and in the latter part of 1885 they crystallized into definite propositions. The floating debt then consisted of two parts: first, the defaulted coupons on the second consolidated bonds; and second, the current liabilities accumulated for the purposes before described. The relief proposed was likewise in two parts, and involved the issue of a 5 per cent mortgage, secured by deposit of the second consolidated coupons maturing and to mature in June and December, 1884, June, 1885, and June, 1886, and a 6 per cent mortgage upon the property of the Long Dock Company, comprising the valuable terminals of the Erie at Jersey City.[125] The funding of the coupon issue proved simplicity itself; the funded coupons were exchanged for bonds of the new gold mortgage, which were to be redeemable at 105 at the pleasure of the company.[126] By the end of 1886 these bonds had been accepted by the holders of $32,982,500 of the outstanding $33,597,400 of the second consols, and $3,957,900 of them had been issued. Dealing with the Long Dock Company was slightly complicated by the fact that 8000 shares of that company were pledged as part security for the issue of Erie collateral bonds. To free them $800,000 in cash were deposited with the trustee of the mortgage, which were in turn employed by him to pay off $727,000 of the 6 per cent collateral bonds, thus reducing the interest charge on that issue $43,620 per annum. This done, the Long Dock Company extended the lease of its property and franchises to the Erie to 1935 at a rental of $480,000 per annum, and contemporaneously therewith placed a consolidated mortgage upon its property to secure $7,500,000 of 50-year 6 per cent gold bonds; of which $3,000,000 were reserved to retire existing indebtedness, and the proceeds of $4,500,000 were paid to the Erie for the cancellation of its floating debt. The total result was to increase fixed charges by $270,000 of interest at 6 per cent on the Long Dock bonds, and by $197,895 on $3,957,900 of the new funded 5s, less the reduction of $43,620 on cancelled collateral bonds; leaving a net increase of $424,275.[127] For its ingenuity the scheme was to be admired; from any other point of view it was to be condemned as another example of that borrowing to pay interest which had brought the Erie to its existing straits. The incapacity of the creditors of the company to realize that continued borrowing of money to pay current obligations was only to ensure repeated bankruptcy seemed complete.

After this new “salvation,” the Erie started once more on its laborious attempt to pay interest on its outstanding bonds. From 1887 to 1892 the business increased somewhat, and despite a decrease in the average receipts per ton mile[128] a gain of about $4,700,000 in gross earnings was secured; from which is to be deducted an increase of $310,996 in fixed charges, and of $4,076,111 in operating expenses.

The prohibition of pooling in 1887 affected the company unfavorably. Previous to the passage of the Interstate Commerce Act the other lines had been paying it an annual average of $42,500 on west-bound business from New York for shortages under the operation of the trunk-line pool, besides about $88,000 annually on east-bound dead freight and $19,770 on live stock. These payments ceased when the Act was passed, although a differential on west-bound traffic was subsequently allowed.[129] But the leakage which was most apparent lay in the large rental and heavy operating cost of the New York, Pennsylvania & Ohio. It will be remembered that the Erie had leased that road for 32 per cent of the gross earnings when earnings were $6,000,000 or under, and 50 per cent when they should be above that figure. In 1887 this was amended so as to provide that for every increase of $100,000 over $6,000,000 in the gross earnings the Erie should pay to the lessor an additional one-tenth of one per cent of such gross earnings until the gross earnings should be $7,250,000, and the rental 33½ per cent, after which the percentage was not to increase.[130] Under the old lease the Erie had guaranteed to carry over the line 50 per cent of all its east-bound and 65 per cent of all its west-bound through traffic—under the new lease, these maxima were increased to 55 per cent and 70 per cent; but even this failed to make the branch road pay. Its grades were high, its equipment and sidings were limited, its cost of operation was well above 68 per cent; and the increase in tonnage provided for emphasized each and every disadvantage. Up to 1893 the results of operations were as follows:

_Loss_ _Profit_

First 5 months to Sept. 30, 1883 $199,540
Twelve months ending Sept. 30, 1884 $270,281
1885 239,820
1886 51,322
1887 91,965
1888 343,911
1889 331,134
1890 77,376
1891 19,586
1892 425,888
1893 197,106
---------- --------
$1,827,726 $420,203
Net loss, 1,407,523

It thus appears that the terms of the amended lease were in reality more onerous than the contract which they succeeded, and that whatever the value of the branch as a feeder, its operation involved large and fairly regular deductions from the net income of the parent line. Emphasis on these facts was laid in the annual reports, and frequent demands were made that the New York, Pennsylvania & Ohio bring its road up to the standard of like connections of through trunk lines. Meanwhile improvements were imperative on the Erie’s own lines: new equipment was needed, new rails and new motive power, and at the same time surplus earnings were somewhat less. The directors adopted the expedient of allowing current liabilities to accumulate, and put $8,496,572 into the road from October 1, 1884, to September 30, 1892, of which $3,351,977 represented surplus earnings, $2,375,400 increase in bonded indebtedness, and the balance floating debt. In the matter of traffic policy they paid particular attention to the coal business, which, however, lost ground as compared with other freight, and to the local business, which it was the policy of the management to encourage. In 1890 the board declared that “the time had arrived when extraordinary expenditure for improvements and the necessities of the property were no longer necessary.”[131] In 1891 3 per cent on the preferred stock was paid, the first dividend since 1884.[132]

From 1887 to 1893, with all its struggles, the Erie was continually on the verge of failure. The capitalization in 1892 was at the enormous total of $163,607,485 on an operated mileage of 1698 miles, while fixed charges were $4993 per mile, and the available net revenue but $4830.[133] Given, with this condition, a gross floating debt which amounted in 1892 to $9,163,166, and represented in a large measure the inability of the company to make necessary repairs, no further explanation is needed for the bankruptcy which soon took place.

Early in 1893 rumors were current that the Erie might be thrown into the hands of a receiver. The reports were vigorously denied, but on July 25, nevertheless, on application of the company itself, Judge Lacombe appointed President John King and Mr. J. G. McCullough as receivers of the property. The measure was taken to avoid the sacrifice of collaterals deposited. “Within the last few weeks,” said President King, “during the severe money stringency the floating debt of the Erie ... became impossible of renewal, and in order not to sacrifice the best interests of the company it was decided to place the road in receivers’ hands, and preserve the system intact, and preserve and develop the transportation business for the company.”[134] The action occasioned no surprise, and there was even a disposition to praise the management for having preserved the solvency of the company. “The company was bankrupt _de facto_ when it passed to its new control,” says Mott, and “that the time when it must become bankrupt _de jure_ was held off so long was a striking demonstration of the tact and resourcefulness which the new _régime_ had been able to bring to bear in the management of the company’s unpromising affairs, and in judicious shifting and manipulating of the heavy burdens Erie bore upon its chafed and weary shoulders.”[135] What a receivership meant was a new opportunity to put the company upon a genuinely sound foundation, by providing new capital to pay off the floating debt and to allow for future additions and improvements, and by getting fixed charges to a point well within the road’s capacity to earn. We shall see what use was made of the chance.

The matter of reorganization was set about at once. On January 1 a plan appeared, prepared, at least nominally, by a special committee chosen by the directors,[136] and backed by the well-known firms of Drexel, Morgan & Co. of New York and J. S. Morgan & Co. of London.[137] By its terms no mortgage senior to the second consolidated mortgage was to be disturbed save the first mortgage, which matured in 1897. The bonds to be dealt with were thus reduced to $41,481,048, besides which provision had to be made for the floating debt and for future capital requirements. The plan proposed to authorize a blanket mortgage of $70,000,000 at 5 per cent, of which $33,597,000 were to exchange at par for the 6 per cent second consolidated bonds and funded coupons thereof, $4,031,400 to exchange for the funded coupon bonds of 1885, and $508,008 for the income bonds. Of the balance, $6,512,800 were to be reserved to settle with the old first lien and collateral trust bonds, $15,915,208 to supply capital requirements in the future, and $9,915,208 to be offered for subscription in order to pay the floating debt. The new management did not conceive that these last bonds could be sold to advantage in the general market, but imposed as a condition of the exchanges as above that second consols, funded coupon, and income bonds should subscribe at 90 to the extent of 25 per cent of their holdings; hoping that the grant of the right of immediate foreclosure upon default would induce the second consols to come in. Both these consols and the funded coupon bonds of 1885, it may be remarked, were to be kept alive and deposited with the trustee for the protection of the new bonds. Stated in tabular form the distribution of securities was to be as follows:

To acquire the existing second consols, $33,597,400
To acquire the funded coupons of 1885, 4,031,400
To acquire the income bonds, 508,008
For subscription as above, 9,915,208
To acquire the old reorganization first lien and
collateral trust bonds, 6,512,800
To be expended for construction, equipment, etc., not
to exceed $100,000 in any year, except that $500,000
might be used to acquire existing car trusts, 15,435,184
-----------
Total, $70,000,000

The new mortgage was to cover the property of the New York, Lake Erie & Western, including its leasehold of the New York, Pennsylvania & Ohio, and the capital stock of the Chicago & Erie Railroad.[138] There was to be no assessment, no syndicate to raise money, and no voting trust.

This plan was advanced as adequate to restore the prosperity of the company. Examination will show its weakness. It comprised two measures of relief: first, reduction of interest by one per cent on the second consolidated bonds; second, the settlement of the floating debt. The first might be thought to have been the kernel of the plan, and the reduction in fixed charges the principal thing aimed at. That it was not is shown by the fact that so liberal were the new bond issues that the total fixed charges after reorganization were to be greater than those before. The floating debt which remained had arisen from lack of funds with which to make current and necessary improvements and repairs. This debt was the immediate cause of the failure of the company, and its cancellation was the real purpose of the plan. The method proposed was a forced levy upon bondholders, but the levy took, not the form of an assessment, but that of a subscription to new bonds on which payment of interest was to be as obligatory as any other charge. The operation differed, therefore, from an ordinary sale of securities in the more favorable selling price which it assured. It did little, however, to lighten the burden which had crushed the company. The only bright spot in the plan was the provision for future construction and improvement, which, though involving a still further increase in indebtedness, was justified because these improvements would serve not only to maintain but to make greater the earning powers of the company. Finally, it was the peculiar effect of this plan that it put the pressure imposed upon the wrong parties: the second consolidated and other junior bondholders were to be forced to subscribe to the new issue, when in fact it was the stockholders who should have been turned to, and whom it was consonant with no sound principle of finance to spare. Other matters come out in the objections raised by bondholders.

Opposition to the plan was vigorously headed by men like Kuhn, Loeb & Co., E. H. Harriman, August Belmont, Hallgarten, Peabody, Vermilye, and others.[139] In England a meeting of dissentients was held and a committee was elected;[140] in America the first formal action was the dispatch of a letter to the Erie managers by opposing bankers which is important enough to be quoted in full.

“Consultations and comparisons of views have recently taken place,” said these gentlemen, “between the owners and representatives of the second consolidated mortgage bonds and other bonds of your company, to whom the proposition as detailed in your circular of January 2 is not satisfactory.... Your plan seems unjust, inasmuch as it demands a permanent reduction of interest on the bonded indebtedness for which no adequate equivalent is offered, and it levies a forced contribution upon the bondholders through the demand for a subscription to new bonds at a price considerably over and above the market value these new bonds are likely to command, while the fixed charges proposed to be created appear to be considerably larger than, in the light of past earnings and experience, the property of the company can carry with safety.

“Instead of 5 per cent bonds, as provided in the published plan, 4 per cent bonds, in our opinion, should be issued, while for the interest to be surrendered the bondholders should receive an equivalent in interminable non-cumulative 4 per cent debentures, interest payable if earned; the holders of the debentures to have sufficient representation in the management to protect them.

“The floating debt should be liquidated from the proceeds of an adequate amount of new 4 per cent bonds (and debentures if desirable), which shall be offered to the shareholders and bondholders at a price rather below than above the probable market value of the new securities, and under the guarantee of an underwriting syndicate.

“Provision should also be made to obtain the conversion on fair terms of the reorganization prior lien bonds into the new bonds, so that it shall become practicable to secure the new 4 per cent bonds at once by a lien second only to the ‘Erie first consolidated 7 per cent bonds’; the new 4 per cent bonds to be issued under a general mortgage to an amount sufficient to provide for future additions and improvements, and with adequate provision for the taking up of the underlying bonds, and the issue of 4 per cent bonds in their stead.... Any plan now adopted for the readjustment of the finances of your company should seek, as its first object, to reduce the permanent charges so well within the earning capacity of the property as to make another default in the future an improbability.... We trust this communication will be received in the spirit in which it is submitted.”[141]

The directors refused to modify their plan, and the bankers, therefore, notified them of the election of a protective committee.[142] On March 6 a meeting of stockholders approved the plan, and the same week Messrs. Drexel, Morgan & Co. gave notice that, having received deposits of a majority of each class of bonds, they had declared the plan operative as announced.[143]

Defeated in their appeal to the securityholders, the opposition turned to the courts. As a preliminary, they obtained an opinion from the well-known firm of Messrs. Evarts, Choate & Beaman, which held, first, that the Erie could not legally pay interest on the new bonds proposed until it had paid the interest on every one of the old second mortgage bonds, regardless of whether the latter was deposited with the reorganization committee; second, that if the old second mortgage bonds which were deposited as security for the new issue should be kept alive as proposed, the company would be increasing its obligations beyond the legal limit;[144] and third, that much of the stock voted at the special meeting at which the new mortgage had been authorized was not really owned by the persons who had issued the proxies thereon as the law provided.[145] Following the opinion, suit was commenced by Mr. Harriman in April for an injunction against the recording of the new mortgage, on the ground that the Drexel & Morgan proxies did not represent the actual stockholders, and in June by one John J. Emery to prevent the execution of the mortgage. Judge Ingraham in the Supreme Court Chambers denied an injunction, using in his opinion the following language: “While it is clear,” said he, “that there are certain obligations resting upon the majority to refrain from infringing the legal right of the minority, and that a court of equity will enforce and protect the rights of the minority, still, when the holder of a very small number of bonds or shares of stock seeks to enjoin a very large majority from carrying out a plan such majority deem to be for their benefit, I think the court should not interfere unless it plainly appears that some legal right of the minority is endangered.”[146]

What could not be accomplished by the hostile bankers was nevertheless to happen from the inherent weakness of the plan itself. It has been said that the new scheme involved an increase instead of a decrease in fixed charges. How this was to be met was not demonstrated; and already in June, 1894, it was necessary to announce that the coupons then due would not be paid for the present. In December matters were even worse, and a circular from Drexel, Morgan & Co. confessed the company’s inability to meet the coupons maturing. “Nevertheless,” the firm continued, “it seems to us inexpedient to treat the inability of the company to pay interest as an occasion for present foreclosure without giving a further chance to the company, especially as payment of bondholders’ subscriptions to the new bonds has not yet been called to provide the company with money necessary to pay the floating debt. It is, therefore, now proposed that the new bonds be issued with the coupons of June 1, 1894, and December, 1894, attached, but stamped as subject to a contract with the company which shall provide that they shall be paid as soon as practical out of the first net earnings over and above the railroad company’s requirements to meet interest and rentals accruing after December 1, 1894, except in case a default on later coupons shall give power of foreclosure, in which event the stamped coupons shall retain all their original rights.” The modification was assented to,[147] but could not save the plan. Reluctantly the managers were forced to abandon it, and to consent to more radical propositions.

August 26, 1895, the new and final reorganization plan appeared. There were to be issued:

$175,000,000 first consolidated mortgage 100-year gold bonds;
30,000,000 first preferred 4 per cent non-cumulative stock;
16,000,000 second preferred 4 per cent non-cumulative stock;
100,000,000 common stock.

The first consolidated mortgage bonds were to be divided into prior lien bonds to the amount of $35,000,000, and general lien bonds to the amount of $140,000,000; the former to have priority of lien over the latter for both principal and interest. Both classes of bonds were to be secured by mortgage and pledge of all railroads and properties of every kind embraced in the reorganization as carried out and vested in the new company, and also all other properties which should be acquired thereafter by issue of any of the new bonds. Both issues were to bear interest at 4 per cent, except $29,435,000 of the general lien bonds, which were to bear 3 per cent for two years from July 1, 1896, and 4 per cent thereafter. The stock was to rank for dividends in the order given. Provision was made that no additional mortgage could be put upon the property to be acquired, and that no additional issue of first preferred stock could be made except with the consent in each instance of the holders of a majority of the whole amount of each class of preferred stock, given at a meeting of the stockholders called for that purpose; and with the consent of the stockholders of a majority of such part of the common stock as should be represented at such meeting, the holders of each class of stock voting separately; also that the amount of second preferred stock could not be increased except with like consent of the holders of a majority thereof, and a majority of such part of the common stock as should be represented at the meeting. All classes of stock were to be deposited in a voting trust until December 1, 1900, and until the expiration of such further period, if any, as should elapse before the Erie should in one year have paid 4 per cent cash dividends on the first preferred stock; though the voting trustees might terminate the trust earlier at their discretion.

Generally speaking, the prior lien bonds were relied on to pay the floating debt, to buy in the New York, Pennsylvania & Ohio, and to retire certain prior liens of the old company. The general lien bonds were reserved for undisturbed bonds, and, with the first preferred stock, exchanged for junior New York, Lake Erie & Western securities. The second preferred stock went for old preferred stock and income bonds, and the new common stock exchanged for old common.

The distribution was as follows: The old New York, Lake Erie & Western reorganization first lien and collateral bonds were paid off from the proceeds of the new prior lien bonds; the second consols received 75 per cent in new general lien bonds and 55 per cent in preferred stock; the funded coupon bonds of 1885 received 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred stock; the income bonds 40 per cent in general liens and 60 per cent in first preferred stock; the New York, Lake Erie & Western preferred stock, on payment of assessment, 100 per cent in new common. For all other bonds included in the plan there were reserved general lien bonds in amounts usually equal to the par of the securities to be retired.

The cash requirements and the floating debt were as follows:

Floating debt, receivers’ certificates, etc., $11,500,000
Collateral trust bonds (Erie), at 110, 3,678,400
Reorganization first lien bonds (Erie), 2,500,000
Early construction and expenditures, 5,337,288
Car trusts for three years, 2,000,000
-----------
$25,015,688

The necessity for retirement of the first lien and collateral bonds arose from the early maturity of the former, and from the fact that stocks and bonds of various Erie properties which it was desirous to consolidate with the new company were pledged for the latter. The wisdom of allowing for early construction and expenditure could not be denied; car trust payments were required to preserve the rolling stock, and the floating debt and receivers’ certificates called obviously for cash. Provision was made, first, by an assessment on the stock of $8 on preferred and $12 on common, with higher payments in case of delay, and estimated to yield $10,023,368; second, by a contribution from the New York, Pennsylvania & Ohio of $742,320; and third, by the sale of $15,000,000 prior lien bonds as indicated above. A syndicate of $25,000,000 was formed to subscribe to the prior liens, and to take the place of and succeed to all the rights of stockholders who should not deposit their stock and pay the assessment thereon.

With the settlement of cash requirements, unification of the Erie system was assured; “subject only to the undisturbed bonds and stock until retired by use of the bonds reserved for that purpose or the rentals corresponding thereto.” “The new bonds and stock will,” said the plan, “represent the ownership (either in fee or in possession of securities) approximately of:

N. Y., L. E. & W. proper, 538 miles
N. Y., P. & O., 600
Chicago & Erie, 250
N. Y., L. E. & W. Auxiliary Companies, 550
----
Total, 1938 miles[148]

—with valuable terminal facilities at Jersey City, Weehawken, Buffalo, etc., and also one-fifth ownership in the stock of the Chicago & Western Indiana Railroad Company. Also all the Erie coal properties, ... representing an aggregate of 10,000 acres of anthracite, of which about 9000 acres are held in fee, and 14,000 acres of bituminous, held under mining rights ... also the Union Steamboat Company, with its terminals and other properties in Buffalo, and its fleet of five lake steamers on which the Erie mainly depends for the lake and railway traffic,” etc.

Fixed charges under the plan were estimated at $7,850,000. Fixed charges in 1894 had been $9,400,000. For the first two years after reorganization, moreover, the charges were to be further reduced by $300,000 per annum, as the new general lien bonds were to bear only 3 per cent interest during that period; and an additional saving of $1,000,000 was looked for when the exchange of old bonds for new on the maturity of its existing prior issues should have been eventually completed. This sum of $7,850,000 the company was expected to have no difficulty in earning in view of the immediate expenditure of $5,337,208 for new construction, additions, and betterments, and the gradual distribution of the proceeds of $17,000,000 of general lien bonds to the same end. The compensation to Messrs. J. P. Morgan & Co. and Messrs. J. S. Morgan & Co. for their services as depositaries, and in carrying out the plan was put at $500,000 and expenses. Foreclosure was finally to take place and a new company was to be organized.

This plan differed from its abandoned predecessors in four important particulars, each of which was in its favor:

(1) It employed bonds and stock instead of bonds alone;

(2) It lowered instead of increased fixed charges;

(3) It procured cash from stockholders instead of from second consolidated mortgage bondholders; and

(4) It absorbed the New York, Pennsylvania & Ohio into the Erie system instead of continuing the lease thereof.

In the employment of bonds and stock instead of a simple issue of bonds, the Erie managers adopted what experience has shown to be the best method of dealing with the complicated situation arising from a great railroad default. The use of securities on which return was optional side by side with those on which return was obligatory tended both to protect the railroad company when earnings were low, and to benefit the recipients of the new securities when earnings were high. As worked out, it gave to the second consols and funded coupons a less return in the one case, and an equal or greater return in the other, than did the plan of 1894, and to the income bonds, though it offered no chance of equal gain, it at least promised a minimum below which payments should not fall. It further made a far nicer recognition of the relative priorities of different classes of old bonds possible, and whereas the previous plan had made the same demands on, and had given the same return to the second consols, the funded coupon bonds of 1885, and the income bonds, the new plan gave, as has been pointed out, to the first 75 percent in general lien bonds and 55 per cent in first preferred stock; to the second, 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred; and to the third, 40 per cent in general liens and 60 per cent in first preferred stock. Income, coupon, and consolidated bonds benefited alike from the assessment upon the stock, which laid the burden of raising cash upon the owners of the road, where it most properly fell. No species of security was given for the assessment, not even common stock, with which the managers might well have been generous; although it must be remembered that the sale of $15,000,000 prior lien bonds for cash was part of the reorganization plan. It may be remarked that since, on July 2, 1895, the common stock was being offered at 10⅝, with no sales, and the preferred at 22½, and since the chance for dividends which the new stock was to enjoy was most remote, it was perhaps well that the syndicate guarantee of the payment of assessments had been obtained. Fixed charges by the new plan were lower, as a result of the liberal use of stock in the exchanges and the cancellation of floating debt as above; while the terms under which the outstanding New York, Pennsylvania & Ohio bonds were retired were the most drastic part of the scheme. In all, the total mortgage indebtedness of the Erie Company and its leased or controlled lines of $234,680,180 for January, 1896, was reduced to $137,704,100 by June 30 of that year.[149]

A weak point in the plan was, nevertheless, the small reduction in bonded indebtedness which it occasioned. Although, to repeat, the bonded indebtedness of the system was reduced from $234,680,180 to $137,704,100, the shrinkage was more apparent than real, since it consisted chiefly in the exchange of stock for New York, Pennsylvania & Ohio mortgage bonds, on which interest had not been paid by the Erie, and but seldom by the New York, Pennsylvania, & Ohio itself. These securities were slashed in most drastic fashion, particularly such of them as were inferior to the first mortgage. The amount of the reduction in the volume outstanding is indicated by the fact that for $5000 first mortgage New York, Pennsylvania & Ohio bonds were given $1000 Erie prior lien bonds, $500 Erie first preferred, $100 Erie second preferred, and $750 Erie common stock; and for $500 second mortgage, or for $1000 third mortgage, were given $100 Erie common stock. If, now, we exclude the New York, Pennsylvania & Ohio bonds from our consideration of the funded debt, we find the indebtedness of the Erie system on January 1, 1896, excluding the non-assumed New York, Pennsylvania & Ohio bonds to have been $121,399,431; and on June 30, excluding the new prior lien bonds used to exchange for these securities, to have been $123,304,100; or an increase through the reorganization of $1,904,669.[150] Further, there was an accompanying increase in the capital stock of the combined companies, which did not, of course, involve an increase in fixed charges, but which increased the volume of securities outstanding.[151] What the reduction in the capital of the New York, Pennsylvania & Ohio, joined with its amalgamation with the Erie system, did do was to lessen the burdens of that line to the parent company. For many years the Erie had engaged to operate the branch for 68 per cent and had paid 32 per cent of its gross earnings to the New York, Pennsylvania & Ohio, to be applied to payment or partial payment of interest on the excessive issues which were now retired. It was probably to be long before an operating ratio of 68 per cent could be successfully maintained; but the Erie after reorganization was obliged to turn over, not 32 per cent of gross earnings, but 4 per cent on the $14,400,000 prior lien bonds which had been given for New York, Pennsylvania & Ohio securities, or an amount of $576,000; which amounted to a reduction of the minimum rental of more than one-half, and of the sums actually paid of almost three-quarters.[152]

Turning again to fixed charges, we find them estimated, after the first two years, at $7,850,000. The average net earnings for the period 1887–94 had been $9,331,250. These earnings will not serve strictly as a basis for calculation, for from 1887 to 1892 they include an average of perhaps $750,000 derived from Lehigh Valley trackage payments and other sums now discontinued. With the deduction, therefore, of this amount from the net earnings of the period named, the average is reduced to $8,768,750; or $918,750 more than it was thought fixed charges would be. When it is considered that this $918,750 represented the sum available for dividends on $146,000,000 of outstanding Erie stock, it is plain that the over-capitalization of the company in 1895 was still very great.

With these comments it is necessary to leave the plan. It was far the best that had ever been applied to the rehabilitation of Erie’s affairs; it was discriminating in its nature, and, thanks to the increasing prosperity of the last eleven years, it has been fortunate in its results. In August, 1895, a decree of foreclosure was signed in the city of New York, and the following November the property was sold under the second consolidated mortgage, and purchased by the reorganization committee for $20,000,000.[153]

Since 1895 the Erie has shared in the prosperity of the country. Its ton mileage has increased from 3,939,679,175 in 1897 to 6,275,629,877 in 1907; its gross earnings have grown from $31,497,031 to $53,914,827; and its net earnings, which had hovered for so many years near or below the level of fixed charges, have now soared away above. Under these circumstances it is but natural that large sums should have been applied to improvements. Between December 1, 1895, and June 30, 1907, $12,732,486 were spent in the purchase of land, in yards, stations, and buildings, in reducing grades, relocating tracks, and in other ways, and charged to capital; $36,511,046 were spent for new equipment, and charged to capital; and $8,625,307 were taken from income for equipment and improvements of various sorts. These expenditures have had a most gratifying result. The average train load has grown from 224.74 tons in 1895 to 471.67 in 1907, although coal now constitutes a smaller proportion of the freight; and the average revenue per train mile has more than doubled, in face of a revenue per ton mile which has only slightly increased. In 1907 the Erie’s ton mileage was 59 per cent greater than in 1897, and its passenger mileage was 73 per cent greater, but the expense of conducting transportation had increased but 27 per cent. Instead of freight cars with an average capacity of 22½ tons the company now uses cars which average 34 tons. Instead of locomotives which on the average could exert a tractive force of only 24,500 pounds as late as 1901, it has now engines which average 31,000. Freight train mileage is 2,600,000 less than it was in 1896, and passenger train mileage has only slightly increased.

And yet, with all this prosperity, it cannot be said that the Erie enjoys an assured position. In 1907 it had to pay out 89 per cent of the largest income which it had ever received for operating expenses, fixed charges, and taxes. Of its net income of about $6,000,000 the modest dividends of 4 per cent on its first and second preferred stock absorb some $2,500,000, and the widespread financial difficulties of 1907 have led its management to declare the dividends for that year payable in scrip and not in cash. And although the present period of reaction dates back but a little way the company has been already obliged to the issue of short term notes.

In matters of railroad policy the Erie has accordingly been conservative. In 1898 it acquired control of the New York, Susquehanna & Western, from New York City to Wilkesbarre in northeast Pennsylvania. Three years later it bought the entire stock of the Pennsylvania Coal Company in order to protect its tonnage, and, as the directors expressed it, for other reasons which seemed good; and in 1901 also it bought an interest in the Lehigh Valley. The most sensational episode which has occurred has been the purchase and subsequent release of the Cincinnati, Hamilton & Dayton. It seems that in 1905 Mr. J. P. Morgan bought a majority of a syndicate’s holdings in Cincinnati, Hamilton & Dayton stock, amounting to a majority of the total issue; a purchase which carried control of the Pere Marquette and of the Chicago, Cincinnati & Louisville, or of a total system of 3675 miles. This stock Mr. Morgan turned over to the Erie at a price reported to be $160 a share. From a traffic point of view the deal seemed likely to strengthen the Erie’s position in Ohio, Indiana, and Michigan, while more than doubling the mileage of its system. Because of the financial condition of the new companies, however, the purchase was decidedly unwise; and, after an investigation, Mr. Morgan’s offer to take the road off the Erie’s hands was gladly accepted. On December 4, 1905, Mr. Judson Harmon was appointed receiver of the Cincinnati, Hamilton & Dayton and of the Pere Marquette, and the reorganization of these properties is just being completed.

At present the Erie is operating 2169 miles of road as against 2166 in 1896. Its earnings have greatly increased, its capitalization has grown in less proportion,[154] but it has not yet a sufficient margin of surplus earnings to meet a decline in prosperity without serious misgivings. Dividends on its first preferred stock have been paid since 1901, and on its second preferred since 1905. The common stock cannot expect a dividend in any period which can be foreseen.