by James Grant
Seven
Striking It Rich Reluctantly
In the spring of 1911, a dull time in the stock market, Baruch accepted one proposition and refused another. The one he took was a block of bonds of an insolvent short-line railroad. That, in turn, led him to another investment in the bonds of a second indigent road. The opportunity he turned down was control of a majority of stock in an undeveloped sulphur mine. In retrospect (in the clarity of which he is second-guessed) it was just the time to have done the opposite. His railroads went from bad to worse. The sulphur mine struck it rich on a plateau forty feet above sea level in Matagorda County, Texas. Eventually Baruch extricated himself from his railroads and bought heavily in sulphur, but the false start cost him millions.
The story of why and how he erred begins with the fact that he was a railroad buff. As a boy in South Carolina he was delighted by the passing trains of the Charlotte, Columbia & Augusta line. As a grown speculator in 1902, he had bought stock in the Louisville & Nashville Railroad with an eye to acquiring control of the company, but was obliged to settle for a $l million trading profit instead. In 1911 or 1912 he committed a large sum to the Wabash Railroad to the end of securing a voice in its management. In his single-mindedness, he overestimated both the Wabash and the prospects for railroads in general, which were slipping.[24]
The news, on March 30, 1911, of his purchase of $3,128,000 of the 4 percent, first mortgage, fifty-year bonds of the Wabash Pittsburgh Terminal Railway Company was met with expressions of hope and bafflement. The Terminal Company, to shorten its name, was insolvent, money-losing, and lawyer-bound. It was not entirely clear that the company would be around when its bonds fell due in 1954, much less have the money to redeem them, or even, in the meantime, to resume the annual payment of 4 percent interest which it had suspended in 1908. Bonds that would ostensibly mature at 100 cents on the dollar changed hands about the time when Baruch bought at about 46 cents.[25] The difference between the two figures was roughly the measure of the market’s doubts about the Terminal Company. It was also a measure of the potential profit to Baruch if the road were restored to financial health. As prospects for payments improved, so would the price of the bonds. The fact that a trader as shrewd as he had seen something of value in the company was a hopeful sign. The question was, what had he seen?
What anybody could see was that the road was in trouble. In 1908 the bondholders went to court to complain that they hadn’t been paid and to ask the judge to install a management that would try to pay them. He did so. This is the legal state known as receivership, in which management is vested in people whom a court appoints rather than in directors whom the stockholders elect. Since the Terminal Company earned too little and owed too much, the goal of the receivers was to enhance earnings and to reduce the fixed charges that had to be met year in and year out. The most important of these was interest on its bonds. The company’s trains ran and its mines yielded coal, but its bondholders went unpaid, which was the symptom of the trouble.
The impetus for building the Terminal Company was the fact that the Pennsylvania Railroad had the great Pittsburgh market almost to itself. The plan of the entrepreneurs was to contract a line sixty-three miles to the west of Pittsburgh to connect with Toledo. In advance the backers booked business with the Carnegie Steel Company and formed an alliance with two Midwestern lines. The first of these allied roads was the Wheeling & Lake Erie, which ran to Toledo from the Terminal Company’s westernmost point at Pittsburgh Junction, Ohio. At Toledo, the Wheeling & Lake Erie connected with the second friendly road, the Wabash, which described short loops around the Midwest. The entente gave the Wabash and the Wheeling & Lake Erie the right to run trains into Pittsburgh. In return the Terminal Company gained access to Toledo and from there to the dozens of points served by the Wabash, including St. Louis and Chicago. The Terminal Company got the better of the deal because the Wheeling & Lake Erie and the Wabash pledged to turn over a portion of their earnings to the Terminal Company’s bondholders. The alliance was sealed in common ownership and by a shared strategic design. The Terminal Company was to own a majority of shares in the Wheeling & Lake Erie, and the Wabash was to own all of the stock of the Terminal Company. When Jay Gould, the unregulated capitalist, died in 1892, he left an estate well furnished in the stock of the Wabash and Missouri Pacific railroads. George Gould, his son, had an ambition to build a transcontinental line, pushing east and west from St. Louis, in which both the Terminal Company and Wheeling & Lake Erie would be vital spurs. Although the Gould dream dissolved in the Panic of 1907, the bonds of the Terminal Company had earlier seemed a safe investment. Savings banks and life insurance companies bought them confidently.
As much as any other single cause, topography was the bane of the Terminal Company. So rugged was its right-of-way that ninety-five bridges, three trestles and seventeen tunnels had to be built or acquired, representing a distance of 6.9 miles spanned or bored through, fully 10 percent of the 67 miles under ownership. Earnings fell short of the sums that were needed to pay interest on the capital that was borrowed to build it all. The company had 15,000 acres of first-class coal land but only 1,500 freight cars. It lost $936,972 in its first year of operation and continued to lose money in 1906, 1907, and 1908. On May 28, 1908, on complaint of the holders of its bonds and notes, it was declared insolvent, making the elapsed time between organization and failure four years and twenty-three days, flat. The Wheeling & Lake Erie failed eleven days later.
The striking feature of the Terminal Company’s career in the courts is how long it lasted and how little came of it. The point of receivership is to bring about a reorganization. A bondholders’ protective committee was appointed to draw up a plan, but the committee slumbered. In 1910, a rival committee was organized, but it too was ineffectual, and beseeching letters from investors began to reach President Taft. To anticipate slightly, the committees were merged under the leadership of the lawyer Samuel Untermyer, who dunned the bondholders for a large assessment. When he was asked what the money was for, he replied that the joint committee’s expenses had run to $3 million. By that time, the market value of the company’s bonds had been slashed to less than $5 million, compared to some $30 million at the start in 1904, and letters from aggrieved bondholders began to reach President Wilson. Meantime, upon its fall into receivership in 1908, the Wheeling & Lake Erie had gone to court to ask that its contracts with the Terminal Company be set aside. The harmonious exchange of traffic ceased, and the price of Terminal Company bonds sank. In 1910, they were quoted at 54 cents on the dollar, down from 95½ cents in 1905. The Kennebunk Savings Bank of Kennebunk, Maine, which had bought some bonds at a high price, was asked what it thought of them at a low price. “Thoroughly disgusted with the whole situation,” wrote an officer in 1910. “Sold out some time ago.” By March 1911, when Baruch, paying a price of 46 or so, became the largest individual holder of that issue, gloom was thick.
The best speculators seem to buy when everybody else wants to sell. Sizing up the situation in 1911, Baruch perhaps decided that the bad news was out, that a reorganization plan would emerge sooner rather than later, and that the Terminal Company would one day become a vital link in a refurbished Wabash system. E. H. Harriman, his idol, had invested in the Wheeling & Lake Erie in 1908, when the bad news was only starting to come out.
It was the system in which Baruch believed and he began to accumulate the 4 percent bonds of the Wabash proper. To the casual observer the Wabash Railroad had as much or as little to commend it as the Terminal Company did. In the fiscal year ended June 30, 1911, it lost $403,421. The loss was significant because it occurred despite a $1 million rise in gross receipts. The company was short of boxcars and was incidentally burdened by its investments in the Terminal Company and in the Wheeling & Lake Erie. In September 1911, the president of the Wabash, Frederic A. Delano, wrote the stockholders frankly:
Speaking in general terms of the Company’s present condition and future prospects, it is grat
ifying to point out that it has reached an earning capacity of practically thirty million dollars gross [i.e., $30 million of revenues], or approximately $12,000 per mile—being about double the figures of twelve years ago—and this has been accomplished with only a moderate increase in facilities. At the same time this very lack of facilities, such, for example, as insufficient double track and car and locomotive equipment, in large measure accounts for the higher ratio of operating expenses. Every investigation of Wabash conditions, and there have been many by both interested and disinterested parties, confirms the statement that the property as it stands has been well maintained but that it might, if cash were available for needed betterments and improvements, greatly increase its earning capacity and decrease its operating ratio. The Wabash, with its short lines between St. Louis and Kansas City, St. Louis and Omaha, St. Louis and Chicago, St. Louis and Detroit, Chicago and Detroit, Chicago and Toledo, Kansas City and Toledo, Kansas City and Detroit, lags behind its competitors both in volume of business and in the cost of doing it, because it has not the adequate facilities. The difficulty is a financial one and has been beyond the power of the management to remedy.
Shortly thereafter, the Wabash found that it too was unable to meet the payments due to its creditors. At Christmastime 1911, it was haled into court, found insolvent, and consigned to receivers. Although insolvency connotes ruin and upheaval, the Wabash proceedings began in a forgiving way. Two of the three men whom a judge in the US Circuit Court in St. Louis appointed to help the company catch its breath were drawn from incumbent management. One of them was Mr. Delano, the president, who had just confessed that the financial problems were out of management’s control. As in the Terminal Company receivership, rival bondholders’ protective committees were formed, the insurgents charging that the proceedings were a little too friendly. The irony there was that the chief of the Wabash insurgents was James N. Wallace, who had headed up a determinedly inert committee of the Terminal Company. The personnel of the established Wabash committee included Edwin Hawley, the railroad man with whom Arthur Housman had almost come to grief in the stock market. It was Hawley’s death in February 1912 that drew Baruch into the thicket of the Wabash.
Baruch’s first step in that direction was the purchase of a large block of the railroad’s 4 percent, fifty-year first refunding and extension bonds. The size of his investment was not reported, but it was described (as the Terminal Company block had been) as the largest held by any one man. Next, on April 4, he was named to fill the place on the bondholders’ committee left vacant by Hawley’s death. News of his appointment raised hopes for an expeditious reorganization, caused a rally in the company’s low-priced stock, and prompted good press. The Hearst papers predicted that Baruch’s railroad career would rival Harriman’s. There was talk that he meant to retire from Wall Street to devote himself to railroad matters, which the New York Herald doubted: “Those who know him best declare that he has no intention of retiring, and, so far as wishing to become another Harriman, he is perfectly willing to remain B. M. Baruch, the only and original.” (However, citing the press of business, he did step down as a governor of the Stock Exchange, in November 1913.) The Wall Street Journal, ordinarily not given to personality pieces, let itself go:
The announcement by Dow Jones & Co. that B. M. Baruch would be elected to the Wabash bondholders’ committee was received with mingled feelings. Most people seem to regard Mr. Baruch as a speculator, or stock market operator, and nothing more. They can hardly be blamed for this, as it is only in such capacity that the newspapers have mentioned his name. Yet that view does him an injustice. He is a man who has shown remarkable ability in selecting investments, and sizing up the business situation. He would be an addition to any board of directors, and the prospects of the Wabash will be brightened when his voice is heard in the councils of its management.
Besides Baruch the committee included Thomas H. Hubbard, who had helped to reorganize the Wabash when it got into trouble back in 1889; Winslow S. Pierce, a lawyer who specialized in railroad bankruptcies and who had once been chairman of the Union Pacific; Robert Goelet, a New York City real estate investor; Alvin W. Krech, president of the Equitable Trust Company; and a Mr. Robert Flemming. Their job was to serve as a kind of board of directors in extremis. The work was difficult technically because of the complexity of an enterprise spanning 2,514 miles, and also morally, because the committeemen represented different interests but were charged with serving the good of all.
The question was by how much fixed charges, in particular interest payments, would have to be reduced, and which class of securities would bear the brunt of the reduction. To the annoyance of the people who thought they were running things, Baruch threw himself into the job. That May, Jacob Schiff, whose firm was banker to the reorganization proceedings, dashed off a stiff note to Baruch to remind him who was who:
Though we have among ourselves discussed the lines of a reorganization plan very frequently, we have sought to avoid getting our ideas fixed too firmly, preferring to keep an open mind until we shall very thoroughly understand the full possibilities of the property, when properly reorganized. . . . We are large bondholders ourselves, and we want to see full justice done to the holders of the 4 percent, bonds but at the same time we feel responsibility for the reorganization will attach vastly more to ourselves than to the individual members of the committee, except perhaps its chairman, and because of this, I am sure, you will cooperate with us in the framing of a plan which shall do credit alike to ourselves and the committee.
The committee kept an open mind for what struck Baruch as an unconscionably long time. In 1912, consultants’ reports were received, inspection tours were embarked upon, and improvements were effected, but no plan of reorganization was produced. Although the Pierce and Wallace committees agreed to join forces, they produced no plan in 1913. In 1914, a federal judge in Cleveland held that the traffic exchange agreements among the Terminal Company, Wheeling & Lake Erie, and Wabash were in fact null and void. The Terminal Company bonds for which Baruch had paid 46, and which he may or may not still have owned, changed hands around 12. Moreover, the Wabash continued to founder. Its annual deficit, which had been cut to $376,332 in 1913, in 1914 opened to $2.7 million. The inability of the bondholders’ committees to produce a reorganization plan became a small Wall Street joke, of which The New York Times took note in April 1914:
The reorganization plan for the Wabash Railroad, originally ready for the underwriters a year ago, and subsequently ready every few weeks, has not been materially changed now since April 1, which leads security holders to think perhaps it is in its final form.
On May 21, two years after Schiff had admonished Baruch to be patient, a plan was floated. It proposed various reductions in the railroad’s capital and in the annual burden of its fixed charges. Holders of the 4 percent bonds were invited to exchange those securities for a more junior (but, it was thought, safer) type in a new Wabash; stockholders were asked to pay $20 a share in cash in exchange for new stock and a small bond. But just then the earnings of the road took a turn for the worse. On July 31, 1914, the New York Stock Exchange was indefinitely closed on account of the imminence of war in Europe. On October 15, the Wabash plan was withdrawn. The failure, Baruch and his associates hastened to note, was owing not to the war but instead to onerous taxes and to the unwise regulation of railroad rates. The Commercial & Financial Chronicle quoted them:
Passenger rates have been broken down and freight rates have been held stationary or reduced in an era of rapid advance in the cost of everything entering into the requirements of a railway operation. During the last few years, one-third of the space between revenue and cost has been closed. Briefly, passengers are now carried on the Wabash RR at the rate of one-tenth of a cent per mile less than it costs the railroad to run its passenger service; freight is carried at a revenue of only a little over one-tenth of a cent per ton mile over the cost of carrying it. Under these conditions, no increase in th
e volume of either class of business will offset the proportions of cost. Economies have been carried to a limit where they have become more than doubtful, and costs cannot be materially or permanently reduced. Improvement and equipment programs have been necessarily discontinued: Credit has been definitely terminated. The situation of the Wabash is not unique. Its position is in the path which all the railways of this country are following in varying stages of progress.
The committee’s bleak appraisal was confirmed by the market. On January 19, 1915, the Wabash 4 percent bonds slipped to 19, their lowest price ever. Baruch, who had paid something on the order of 50 or 60 for his bonds (which he probably still owned), was sick at heart and rumored to be impaired in finances. One day at lunch, Thomas F. Ryan, who was his usual solvent self, approached him and said in a stage whisper: “You know I am with you half on that Wabash deal.” In other words, if necessary, he would take half of Baruch’s bonds at the price he had paid for them. It wasn’t necessary, but the gesture was welcome.
Late in January, thanks to a regulatory and financial thaw, the committee got back to work again, and a final plan was presented in April 1915. In keeping with the railroad’s decline, it was more austere than the first. Instead of $20 a share, stockholders were asked to pay $30. The railroad’s capital was reduced by $17 million as compared to the $10 million proposed in 1914. The bondholders were assessed for cash to the extent that the stockholders refused to pay. It turned out that the toll per $1,000 bond was $654.82. The bondholders could pay, in which case they received securities in the new Wabash, or not. If not, they received the munificent sum of $33.15 per bond.
For Baruch, the plan, the talk, and the years of delay constituted a personal defeat. There had been speculative huzzahs when he was elected to the bondholders’ committee: the price of Wabash common had jumped by ⅝ of a point, to 7⅞. Three years later, it changed hands at 1¼. The bonds, which traded at 61 in the spring of 1912, were quoted at 29. Baruch blamed management for its “gross misrepresentation of earnings” and his fellow committeemen for their selfishness and all around bullheadedness. But the truth was that the Wabash was only one railroad wreck among scores and that the Midwest was more prolific of failure than any other part of the country. In 1907–1917 the crisis of the 1890s was replayed: 59,846 miles of railroad fell into receivership, representing invested capital of $3.7 billion, or an amount three times greater than the national debt prior to the First World War. Baruch had chosen the wrong industry, the wrong region, and the wrong company. (As a generous contributor to progressive political candidates, he had helped, in a roundabout way, to foster the regulatory climate that pushed the railroads down.) It was announced in the spring of 1915 that the members of the reorganization committee would be paid for their work. Baruch, on principle, would accept nothing. Six months later, he stood at the head of a syndicate that wanted to buy a large interest in the Southern Pacific Railroad. For better or worse, he failed in this too.