Rail Bonds

The total national wealth of the country is estimated to be in the neighborhood of $360,000,000,000 (1928 figure), of which some $21,691,000,000 is the staggering sum represented by the people's investment in railroads, more than any other classification except real estate. In times past, panics have been caused by overenthusiasm for the carriers and their stocks, but now as in 1921 no such reason for Depression exists. Rail stocks have long since passed their lurid youth.

Into the bonds of the railroad companies has poured a torrent of funds seeking, above all else, security of principal. Capitalists, wage-earners, fiduciary trustees and savings banks alike have found in rail bonds a safe haven for their money and a fair return thereon. But the Depression of today by its length and severity has shattered the standards of other times, undermined the confidence of generations. Quick cause for this undermining came when the railroads appealed en masse last winter to the Interstate Commerce Commission for a 15% increase in freight rates, on the ground that unless this was granted their revenue would fall so low the maintenance of their properties would be jeopardized.

The Commission, sympathetic, said it would consider the plea. A long series of hearings began. Testimony was taken in all parts of the country. Final arguments will begin in Washington Sept. 19. There have been many protests from farmers, from mine owners, from all producers of raw materials which must be transported. But informed opinion was that the carriers must have relief and that the Commission would grant at least a 12% increase.

Exempt from this may be some commodities (perhaps wheat and corn), some manufactured goods and a variety of miscellaneous products (flour, cement) which have foreign competition. The actual increase to the roads might be nearer 6% as measured by gross freight revenues. And the Commission moves slowly; Depression continues; many months must pass before any increase can be translated to earnings. Hence a nervous psychology has developed in the minds of investors toward rail bonds. Part of this psychology has been due to misunderstanding of newspaper headlines saying that many rail bonds may soon be "illegal."

Trust funds and savings banks in New York State are the largest rail bond holders whose purchases are governed by law. The importance of these is great: over 50% of the total mutual savings bank deposits of the country are in New York. But life insurance companies are also enormous purchasers of rail bonds and, like commercial banks, are under more lenient laws qualifying their purchases.* In order for a rail bond to be legal for savings banks and trust funds the company must have earned its fixed charges one and one-half times in the fiscal year immediately preceding the purchase and in five out of the six preceding years. If the bonds are removed from the legal list, trust fund managers have no choice but to dispose of the bonds within six months. Savings banks, however, need not sell the bonds until instructed to do so by the State bank superintendent.

Last week rail bonds sank perilously close to their lows for the year in the wake of a liquidation which carried railroad common stock averages below their 1931 lows. On all sides the whisper was heard that savings banks were selling their holdings rather than await an avalanche of selling after the first of the year. This whisper was highly unlikely since many months will elapse before even the weakest of issues will be outlawed by bank examiners. Selling by managers of trust funds was certainly an important factor in the decline, but the deduction from this that savings banks were also liquidating rail bonds on a large scale was scoffed at by bank executives.

With their case on trial before the Interstate Commerce Commission, the railroads themselves were not unwilling to have things look as black as receivership. Fairman R. Dick, partner of Roosevelt & Son. secretary of a bondholders committee on the railroad emergency, added to the dismal tale last week when he testified before the Commission that: Railroads could no longer dispose of their bonds; their securities were no longer regarded as secondary reserve by the banks; only the bonds of three railroads in the country could be regarded as high grade (Atchison, Topeka & Santa Fe; Union Pacific; Norfolk & Western).

Railroads and savings banks are almost equally involved in the New York legality phase of the problem. Since Jan. 1, 57 separate issues of rail bonds have been dropped from the legal list. There remain 624 issues, but an estimate was recently made that well over 50% of these would have to be removed by next year. If there should be no recovery in 1932 sufficient to reinstate these bonds they would lose all possibility of legality until 1937. on account of the five-out-of-six-year rule. This would mean that during the latter half of 1932 as the situation became apparent to the bank superintendent there would be a forced liquidation of tremendous volume. Savings banks in New York have already discussed this openly in an effort to show that they must have an outlet for their funds. Rail bonds now absorb about $732,000,000, the third largest investment on their lists. Railroads point out that if the banks are forced to sell rail bonds it will depress the market so much that the carriers will not be able either to raise working capital or to refund some $800,000,000 of obligations maturing between 1931 and

1935-Suggestions have been made that a law be rushed through the New York State Legislature early next year, granting the savings banks a moratorium on the bonds. That would only postpone the day of reckoning. True, in 1921 (when the legal requirement was that a road must have paid at least 4% for the past five years) such a step was successful. But 1921 conditions were different. In 1921 the Government had been operating the roads as a War measure and the moratorium was only to cover bonds of that period. Experts could see no valid excuse now for tampering with a law made after careful thought as recently as 1929.

* In the U. S., life insurance company purchases are limited to bonds and preferred and guaranteed stocks. In Canada these companies may purchase common stocks. Sun Life Assurance Co. of Canada held $304,559,000 of common stocks on Dec. 31, 1930, the largest portfolio of common stocks of any company in the world. Last week Sun paid its regular $6.25 quarterly dividend but omitted a $25 semi-annual extra which it had paid since 1929.

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