Iron Empires

by Michael Hiltzik

  Industrialists and economists would debate whether these innovations stabilized American industry or sapped its energy. What was clear, however, was that they would revolutionize the structure of American business and, eventually, draw to Morgan the unwelcome attention of a new breed of Washington reformer.

  10

  A Community of Interests

  TWO MONTHS AFTER Morgan’s defeat in the battle of Dubuque, a congressional commission began examining the same problems he had detected in the railroad industry’s structure and behavior.

  On the surface, the United States Pacific Railway Commission had a narrow charge—to determine the financial condition of the railroads built with government loans and their ability to repay that money. More precisely, the commission’s target was the Union Pacific. That road was not only the best known and most expensive of the land-grant railroads, but the one in the most parlous economic straits. In the course of its inquiry, however, the commission would lay bare everything that had gone wrong with the industry in the years since the meeting at Promontory.

  The UP’s chief problems were excessive competition and plunder by insiders, which left the road physically decrepit, financially crippled, and under the control of a hostile Congress disinclined to give it a break. Had the railroad’s senior bonds been held by private individuals, the commission reported, they would have been “almost valueless.” The government had powers of foreclosure not available to individuals, the commission observed, but this step would merely give the taxpayers ownership of a wasting asset, “a result which can not be desired by any intelligent legislator.” As was observed in 1885 by the railroad’s government directors (put in place ostensibly to safeguard the federal investment in the road), the Union Pacific had been endowed with a “perfect and absolute monopoly” and “princely” profits, yet its finances were a shambles. The fact that the company had collected enough revenue to float $40 million in securities and pay out more than $26.6 million in dividends on its shares, yet still had not the means to redeem its government debt, pointed inescapably to the conclusion that “the past history of the company appears now like a travesty upon corporation management.”

  The government directors and the commission together expressed the hope that conditions henceforth would be different under Charles Francis Adams Jr., who had been appointed president of the Union Pacific three years earlier, in 1884.

  Seen through one lens, Adams seemed miscast to take over the railroad’s management. The UP was a huge enterprise in a complicated industry, but Adams had no operational experience as a business manager at any level (though he had served on the UP board since 1882.) The co-author of the muckraking classic Chapters of Erie (parts of which were written by his brother Henry), it was Adams who years earlier had predicted that the UP would end up as “two rusty streaks of iron on an old road-bed” if speculators continued to manipulate the road’s finances under the nose of Congress. (This description was commonly paraphrased as “two streaks of rust.”)

  Critical challenges faced the Union Pacific in 1884. The speculative piracy of which Adams warned had come to pass, and worse was in store. Jay Gould was gone, which was a good thing; but he had left the road desperately ill-equipped to meet the looming maturity of the government loans that had financed construction through to the driving of the golden spike. The initial installment of debt, calculated at more than $50 million in principal and interest, was scheduled to come due on November 1, 1895. Whatever sentiment might have existed in Congress to forgive the loans or take repayment at a discount had evaporated with the Crédit Mobilier disclosures, for a failure by the government to demand payment of principal and interest in full would look like an endorsement of flagrant criminality. In 1878 Congress had attempted to anticipate the maturity deadline by passing the Thurman Act, which created a fund to sequester all payments the government made for official use of the railroad, along with a portion of the UP’s annual profits. The expectation was that the fund would grow enough by 1895 to cover the debt repayment, but it was a forlorn hope. By that point, it now seemed clear, the fund would hold only about $17.6 million.

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  Grandson of one president and great-grandson of another, Charles Francis Adams, second from right in this photo taken with fellow officers during the Civil War, was the railroad industry’s first muckraker. But he failed miserably when he tried to apply what he had learned about railroad management as president of the Union Pacific in the 1880s.

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  Unless the government debt could be renegotiated and the resulting freed-up capital applied to refurbish its physical condition, the Union Pacific would be unable to meet the competitive challenges of the coming decades.

  Seen through that lens, Adams could be considered almost the perfect man for the job. He was Gould’s polar opposite, unsullied by a record of speculation and looting. Not only was his personal character unassailable, but he had devoted much of his career to exposing the very piracy that had brought the railroad industry to bankruptcy and disrepute. He seemed to be the new broom the UP needed at that moment.

  No one felt more strongly about his suitability than Adams himself. “With a good deal of natural confidence in myself, I looked upon assuming the management of a great railway system . . . as the legitimate outcome of what had, in my case, gone before,” he would recall years later. “I was simply playing my game to a finish. I was not yet fifty, and I did not want to break off and go into retirement in mid-career.”

  He was not unaware of the pitfalls ahead. The Union Pacific “was in bad repute, heavily loaded with obligations, odious in the territory it served; . . . A day of general reckoning was at hand.” Shortly before taking office as president, Adams made a reconnaissance trip along the line with his fellow director Fred Ames, the son of Oliver Ames. They found conditions to be “in a shocking bad way,” he would recall. The line’s “service was demoralized, it had just backed down before its employees in face of a threatened strike, and it was on the verge of bankruptcy.”

  Despite these challenges, Adams remained convinced to the end of his days that his scheme for renewal via renegotiating the government debt had been “well-conceived [and] entirely practicable.” The only real flaw, he acknowledged, was his own weakness of character. “Unfortunately for myself, I lacked the clean-cut firmness to adhere to it. Had I only done so, I should have achieved a great success, and been reputed among the ablest men of my time.” Adams had overestimated himself, but also underestimated the challenges he faced. He accepted the presidency of the Union Pacific filled with good intentions and ambition; but the six and a half years he spent in that post would be the most miserable of his life.

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  CALLING THE UP’S reputation with its prairie customers “odious” was a charitable way of looking at things. Railroads across the nation were anything but popular among their customers, but the Union Pacific was especially detested, for not only was it a monopoly along much of its length, but an especially pitiless monopoly. According to the government directors’ 1885 report, its rates were set “upon the principle that corporate extortion is a performance in which a railroad management may indefinitely indulge with impunity.” Compounding the evil of extortionate rates were the freight rebates and free passenger passes the UP bestowed upon politically well-connected shippers and their cronies, which invested the whole enterprise with the acrid stink of corruption. Rank dishonesty seemed to be baked into its bones.

  As for the Gould legacy, the looming economic downturn would expose the folly of his management style just as a receding tide exposes derelict vessels to the open air. One appalling example uncovered by Adams involved the Denver & South Park Railroad, a branch line Gould purchased in 1882 from John Evans, the governor of Colorado Territory. “Everything in Colorado was in that very inflated condition which usually precedes a great collapse,” Adams testified to the Pacific Railway Commission. “The chief source of revenue was in carrying men and material into Colorad
o to dig holes in the ground called mines, and until it was discovered that there was nothing in those mines the business was immense. . . . Everyone was crazy. When [the craze] broke down and these mines and villages were deserted—and they stand there deserted to-day—of course the business left the road.” But the branch line stayed in the UP portfolio, draining resources at a rate of $60,000 a year.

  Adams took office armed with the best wishes of the Union Pacific’s customers and government patrons. At the outset he seemed to fulfill their hopes. Adams and his managers “have done away with a great deal of obnoxious abuses” and done much “to smooth down the differences of difficulties between the people of this state and their road,” an Omaha newspaper editor told Congress in 1886. The Pacific Railway Commission praised the Adams administration for having “devoted itself honestly and intelligently to the herculean task of rescuing the Union Pacific Railway from the insolvency which seriously threatened it at the inception of its work.”

  Yet Adams’s efforts were doomed to founder on hidden shoals. Raised in a family devoted to government service and as experienced in the ways of Washington as any clan in the country, he was deeply shocked at the moral climate of the capital in the 1880s. He wrote that his initial visit to Capitol Hill, where he hoped to fend off legislation consigning the Union Pacific to receivership, became “my first experience in the most hopeless and repulsive work in which I ever was engaged—transacting business with the United States government, and trying to accomplish something through Congressional action.”

  On Capitol Hill he had run smack into “the most covertly and dangerously corrupt man I ever had opportunity and occasion carefully to observe in public life.” Adams had the patrician grace not to identify his adversary by name in retailing this history in his autobiography, but he was undoubtedly referring to Senator George F. Edmunds of Vermont. Adams wrote that his experience with Edmunds contradicted the Vermonter’s reputation for “ability and . . . rugged honesty” in every respect: “I can only say that I found him an ill-mannered bully.” Assessing Edmunds’s integrity, Adams judged that the senator’s antipathy toward the UP derived entirely from his pique over the railroad’s refusal to put him on its payroll.

  Edmunds blocked Adams’s every effort to reach a financial agreement with the government. In the end, Adams slinked away in defeat: “I was—there is no use denying it, or attempting to explain it away—wholly demoralized,” he wrote of his final eighteen months as UP president. “I hated my position and my duties, and yearned to be free. . . . Railroads, and the railroad connection, occupied over twenty years of my life; and when at last, in December 1890, I got rid of them, it was with a consciousness of failure, but a deep breath of relief.” He would never engage with the railroad industry again.

  But Edmunds’s corruption had been only one obstacle Adams faced. There was also the behavior of his fellow railroad bosses. The building of new competitive lines had fallen off after the Panic of 1873, but resumed with the return of prosperity. Every surviving railroad faced new rivals; staggered by the crushing fixed costs bequeathed them by the watered financing of the post–Civil War era, they had no choice but to attract freight contracts by any means at hand—most often by cutting rates to the level of fixed costs or, in the most desperate situations, even lower, just to have some revenue flowing in.

  Through the 1880s the railroad bosses tried to fight against rate cutting with every form of collusion they could contrive, chiefly through pools. These were agreements in which competing railroads apportioned traffic among themselves or shared the income from secretly fixed rates. Instead of undercutting one another, in other words, the railroads strived to keep rates high, jointly pocketing the excess profits.

  The pools all failed, for two main reasons. First, customers’ perception that the roads were colluding against them gave rise to official investigations and legislative action to outlaw the arrangements. Second, the railroad bosses simply were unable to work in concert, even for mutual gain. As the Commercial and Financial Chronicle observed, every railroad leader “has been wholly selfish, bristling all over with hostile purpose towards every other. No right of territory, no settlement of rates, no adjustment of business, stood for a moment as a hindrance to the insatiable craving of getting business.”

  As president of the Union Pacific, Adams had joined in a pool to end a rate war among eastern railroads; the pool’s collapse in 1884 taught him the inevitability of failure. The final meeting of the presidents “struck me as a somewhat funereal gathering,” he recounted. “Those composing it were manifestly at their wits’ ends. They evidently felt, one and all, that something had got to be done; yet no one knew what to do. Everything had been tried and everything had failed. . . . They reminded me of men in a boat in the swift water above the rapids of Niagara. They were looking one at another in blank dismay, and asking ‘What next?’ and no one could tell what next.”

  Initiatives by several states to outlaw pools were overruled in 1886 by the US Supreme Court on grounds that they had no authority under the Constitution to regulate interstate commerce. That dumped the matter into the lap of Congress, which responded in 1887 with the Interstate Commerce Act, the first major effort at industrial regulation in American history. At first the railroads fought the act as ferociously as they had been fighting each other. Eventually, they settled for keeping the Interstate Commerce Commission, which was to administer the act, securely under their thumbs.

  By the time of the act’s passage, the railroad industry was in a state of anarchy, desperate for someone to impose order—a Bismarck. The hour produced the man, in the person of Pierpont Morgan. The challenge confronting Morgan was daunting indeed, but he was fully aware of its magnitude. “For forty years,” observed John Moody, “American railroad promoters, reckless optimists, gigantic thieves, huge confidence men—magnified a hundred times by the size of their transactions—had juggled and manipulated and exploited this great business for their own profit and the general loss of every one else concerned. Morgan had been watching.”

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  PIERPONT MORGAN HAD exploited the knowledge he gained during his 1869 grand tour to dabble in railroad securities throughout the 1870s. Then, near the end of the decade, came the deal that brought him into railroading in a major way. It involved the vast holdings in the New York Central of William H. “Billy” Vanderbilt, who had inherited the stake in 1877 upon the death of his father, the Commodore. Billy decided in 1879 to shed a large portion of the unwieldy investment, in part because he had wearied of the constant warfare it provoked with his family’s old adversary, Jay Gould. Moreover, the investment was threatened by a movement in the New York legislature to ban single-family ownership of major railroads. Vanderbilt hired Morgan to unload the shares through an international syndicate, converting the New York Central from a private family holding into a public company. The sheer scale of the transaction was breathtaking: The sale of Vanderbilt’s 250,000 shares was “the largest ever made by a single owner of railroad stock,” reported the New York Tribune, which added that the result would affect “the entire railroad interests of this country.” That was because the deal effectively united the interests of Vanderbilt and Gould, whose “Wabash syndicate” became the largest holder of the New York Central by acquiring 60,000 shares.

  What was perhaps most significant was that in consummating the deal, Pierpont took a seat on the New York Central board as well as the authority to fill two other seats, which he gave to Gould associates Cyrus Field and Solon Humphreys. Although Vanderbilt remained the president of the New York Central—and would continue in that role until his death in 1885—Pierpont Morgan had gained a perch at the heart of the industry from which to start exercising power over “the entire railroad interests” of the United States.

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  Over the next decade Morgan would continue to build his influence. Starting in 1880 he managed financings for the Northern Pacific, whose mercurial new c
ontrolling shareholder, the German-born Henry Villard, was trying to complete the construction plans halted by the collapse of Jay Cooke & Co. Morgan took a seat on the Northern Pacific board in 1883, the same year Harriman had joined the IC board, and subsequently helped to oust Villard in order to clear the way for a more complete reorganization. In 1885 he took on the rescue of the Philadelphia & Reading, a declining road serving the coal mines of western Pennsylvania, again taking a seat on the board along with the chairmanship of the voting trust that controlled the road. By the end of the 1880s, the news that Pierpont Morgan had interested himself in the financing or management of an otherwise hobbled railroad was often enough to restore that line’s access to investors in the United States and across the Atlantic.

  Pierpont’s hands-on work, however, also made him intimately familiar with the behavior that was destroying the industry from the inside, including the building of superfluous lines for no reason but to harry competitors into buying them out. The prime example in his experience involved the New York, West Shore & Buffalo. This was a road partially financed by Gould, George Pullman, and Villard, built along the west bank of the Hudson as a nuisance to the Vanderbilts’ New York Central line across the river (an example of the conflicts with Gould that so wearied Billy Vanderbilt). When the West Shore went bankrupt it was promptly acquired by the Pennsylvania Railroad, which under the leadership of the imperious Thomas A. Scott and his successor George B. Roberts continued to harry the New York Central with rate cutting. By 1885 the Central was forced to set rates so low it was operating its passenger service at a loss and its shares were being crushed. “I look on the West Shore road just as I would on a man whose hand I had found in my money drawer—a common, miserable thief,” Vanderbilt fumed to the New York Tribune. In truth, the Pennsylvania was merely returning to Vanderbilt the same treatment it had received at his hands, for he earlier had built the South Pennsylvania Railroad, an unnecessary line from Harrisburg to Pittsburgh, to compete directly with the Pennsylvania’s own route to the coal fields. The two camps could have settled their conflicts in a draw, but Vanderbilt’s refusal to take the West Shore off the Pennsylvania’s hands at anything above pennies on the dollar prolonged the conflict.