UC-NRLF GIFT OF What Every Investor Should Know An inquiry into the economic and political tendencies of the times and their ef- fect on hivesf- ment securities By Walker M. Van Riper Second Edition Published by American Trust Company , Saint Louis FOREWORD IT is significant that during the last few years two of our foremost college presidents, Nicholas Murray Butler of Columbia, and James Roscoe Day of Syracuse, have seen fit to voice themselves in no uncertain terms regarding the changes that they fear are taking place in the fundamental principles of government in the United States. Both of these men are thorough stu- dents and keen observers of American history and government. They believe that the proposed changes will prove dis- astrous. President Butler in the preface to his book, "Why Should We Change Our Form of Government?" says that what he has written is based on the conviction that "the representative republic erected on the FOREWORD American continent under the Constitu- tion of the United States is a more ad- vanced, a more just and a wiser form of government than the socialistic and direct democracy which it is now proposed to substitute for it." And this is exactly the attitude also of President Day in his book "The Raid On Prosperity." It is not our purpose in the following chapters to deal with political speculations of that nature. The significance of the books mentioned lies in the fact that they are very strong evidence that the changes in political and economic conditions which we are now undergoing are so funda- mental and important as to demand uni- versal attention. That certain changes are taking place is apparent to even the most casual ob- server. What these changes will mean for humanity as a whole only time and the college professors can tell. But that certain of these tendencies will affect in a permanent way the value and FOREWORD security of certain types of investments is something which requires no more than a simple survey of the facts to establish. It is the purpose of the following pages to examine and analyze these tendencies and, without attempting to pass judgment as to their worth or expediency or justice, simply to indicate their relations to the types of investments affected by them. These are things which every investor should know and understand thoroughly. Deep seated and far reaching, they affect fundamental values and are the elements in the safe investment of funds over which the individual has no control. Every investor should know these ten- dencies that he may work with and profit by them. For to blindly ignore them means certain loss. CHAPTER I. Our Problem Plow the Study of Tenden- cies May be Utilized. IN reading the historian's analysis of some great movement which has changed the course of human events one often feels how simple it all was and how blind the people of those days must have been not to have seen what was tak- ing place. Why was the fading of the "glory that was Greece and the grandeur that was Rome" not foreseen and prevented by the Aristotles and Platos, the Ciceros and Caesars, the noblemen of ancient history? They were trained in the philosophy and art of government above all men before or since. Why did they fail? The reasons for the rise and fall of the Spanish Empire seem perfectly plain to- WHAT EVERY INVESTOR SHOULD KNOW day. Yet why have the Spaniards never seen them ? And why don't they see them now? It is because the historian looks back- ward through the ages with an impartial and a just eye. He condenses, classifies and interprets the tendencies of a period. He eliminates the inconsequential. Like a visitor from another planet he sees things as they are. The contemporary, on the other hand, sees things as he wishes them to be. He is part and parcel of the changes that are taking place. In the midst of the trees he cannot know the forest. The tendencies of a period form a com- posite picture of all the tendencies of all the individuals of the period. But they are so numerous, so complex, so contra- dictory, so personal, that for one who is himself a child of such tendencies to at- tempt to analyze and sort and value them is more than futile. Today the observer may note such con- CONFLICT OF TENDENCIES tradictory and apparently unrelated ten- dencies as the waning influence of the church and the decrease in drunkenness and immorality, a growing- divorce rate and a decreasing birth rate, the awaken- ing of a new business conscience and an astonishing interest in the adventures of \Ynllingford and Blackie Daw, a quicken- ing of the spirit of democracy and the wor- ship of the almighty dollar, the movement for international disarmament and whis- pers of another great European war, the passage of corrupt practices acts and the growth of the pension roll. An attempt to say that these tendencies and the many others not mentioned taken all together will mean thus and so for humanity, that they indicate that our country is on the road to the demnition bow-wows, or that they point the way to a new era of Utopian happiness would be an act of sheer madness. It is altogether beyond the power of any human being to do this. WHAT EVERY INVESTOR SHOULD KNOW It is not, however, either impossible or foolhardy or difficult to analyze a partic- ular tendency. Not for predicting what its effect on the course of human events will be. But simply to learn its probable effect on particular conditions closely associated with it. Thus one has only to show that there is such a tendency in order to prove that the decrease in illiteracy, for instance, will stimulate the book business or that the lessening of drunkenness will injure the saloon-keeper. Our problem here is such a one. It is simply to select the important present-day political and economic tendencies which may affect the value or stability of differ- ent kinds of investment securities and to point out how these tendencies have af- fected securities in the recent past and what their effect in the near future is likely to be. We are not going to attempt to foist on you another "investment system/' nor to 10 THEORIES NOT ALWAYS PRACTICAL prove by a mass of charts and statistics that "prosperity runs in cycles," and that by simply following our advice you can invariably buy at the low point and sell at the high. Too much of that sort of thing is being done already. For ten or fifteen dollars you can purchase the "services" of any number of statistical organizations which will enable you to get rich quick by play- ing the stock market in accordance with their advice. Just so one learns from the advertise- ments that there are any number of phil- anthropic gentlemen who, for a few paltry dollars, will teach anyone how to make a fortune out of a mail-order business or poultry raising or squabs or bees or mush- rooms. For our part we often wonder why these benevolent altruists do not take their own medicine and get rich themselves instead of spending so much money in clever ad- 11 WHAT EVERY INVESTOR SHOULD KNOW vertisements to persuade the rest of us to try their experiments. We have yet to find any outside specu- lator who has beaten the stock market game. And we are inclined to think that a "system" has about as much value there as with horse-racing or poker or in the "Green Room" at Monte Carlo. Fluctuations in the market value of a bond listed on the New York Stock Ex- change may have no inherent relation whatever to the actual security on which the bond is based. They may be and gen- erally are the result of manipulation, the law of supply and demand, gossip, rumor or whim. No one can predict intelligently concerning these causes. Our observations, however, have led us to believe that there are a variety of eco- nomic tendencies operating during any period which affect permanently the in- trinsic value of one class of investments or another. Either favorably or unfavorably. Thus the growth of the protectionist 12 TENDENCY OF INVESTMENT VALUES idea undoubtedly stimulated and strength- ened a great number of industries, while this same tendency, combined with another contained in our early navigation laws, played havoc with our merchant marine. And we believe that a careful analysis of present-day tendencies will indicate how investments based on certain industries are being depreciated in value in a perma- nent and lasting way and how other in- vestments, on the other hand, are being strengthened and are increasing in value. CHAPTER II. Political Doctrines Indicate Tendencies Radicalism Government Regulation Its Effect on the Railroads How Rail- road Bonds Have Depreciated. IN countries like England and the United States, which are under popu- lar forms of government, the political parties form one of the best indices of what changes are taking place. And in discussing these changes it will be neces- sary for us to consider in some degree the various doctrines promulgated by our political parties. But the reader will please bear in mind that this is not a political tract, and that it is not our intention to go into the merits of any of the questions considered. It is our purpose simply to point out in 15 WHAT EVERY INVESTOR SHOULD KNOW so far as it is possible the tendencies of the times as evidenced by the trend of our political doctrines and to show what these tendencies mean for the average investor. Under a democratic government the voters naturally divide themselves into two great parties which, in the last analysis, are conservative and radical. In the United States this tendency has been modified and retarded by the Civil War, but of late years the growth of pro- gressive or insurgent wings in both the Democratic and Republican parties and finally the split of the latter into Progres- sives and Republicans indicate strongly that we are witnessing a new party align- ment of conservatives and radicals along natural lines. Now, change is inevitable and eternal. It goes on all the time. Everywhere. For nothing in this world stands still. And this applies to politics as well as to industry, to human society as well as to plants and animals. 16 RADICAL LEGISLATION ON INCREASE In a complicated social system such as ours, however, the rate of change is either retarded or accelerated according as the conservative or radical element is in the ascendency. But the trend of change, the tendencies of the times, are always directed or col- ored by the radical element, whether it is in control or not. The conservatives stand for the old order of things. They are against change. But even when in power they must com- promise with the radicals and to some ex- tent comply with the changes desired by them. Thus during the past few years we have seen a great deal of radical legislation un- der a wholly conservative government. And during the recent campaign each of the three great parties claimed to be the only true progressive party. Hence it follows that we can best ana- lyze the changes that are now taking place and predict those soon to follow by study- 17 WHAT EVERY INVESTOR SHOULD KNOW ing the doctrines of the radicals or pro- gressives in our politics. Now the keynote of the radicalism of this period and mind you, we do not use the term "radicalism," in a derogatory sense, for it is clear that all the true progress in history has come through rad- icalism the keynote of this movement, whether it calls itself Progressive, Repub- lican, Democratic or Socialist, is contained in the expression, "human rights versus property rights." And this simply means that the eco- nomic forces and freedom of contract under which our industrial system would naturally grow up are to be modified by government interference in such a way that humanity in general and the laboring classes in particular will be benefited and improved. And this is to be done by regulating the competition of our industries with those of foreign countries and by fixing transpor- 18 STEPS IN GOVERNMENT REGULATION tation rates, hours of work, wages and prices. Without regard for its effect on human- ity in general our purpose here is simply to ascertain what will be the effect of this policy on investment securities. The first step in this policy of govern- ment regulation was taken in the early days of our history in the passage of the navigation acts and the initial protective tariff laws. The purpose of this legisla- tion was to stimulate and to direct along certain lines the industrial activities of the country. Next came the interstate commerce laws and the establishment of the Interstate Commerce Commission with power to regulate freight rates. And this was followed by a mass of leg- islation in the States regulating, or rather reducing, passenger rates and regulating the railroad business in many other ways. It is not necessary for us to trace the 19 WHAT EVERY INVESTOR SHOULD KNOW history of this restrictive legislation, for it is so recent as to be familiar to everyone. Much of it has doubtless been remedial and salutary. And in these days to ques- tion the efficacy of the Interstate Com- merce Commission would be the rankest heresy, for it is reported from time to time that even the railroad men themselves consider it a godsend to the business. On the other hand, a great deal of this legislation has been purely mischievous and meddlesome, if not absolutely vicious. The Texas Legislature, for example, passed a law making it a criminal offense for a train to be late. And the Arizona Legislature, at its first sitting, practically without inquiry or in- vestigation of any kind, passed a series of railroad bills which, considering the needs of the State, probably reach the limit of folly and stupidity. These Acts provided for a reduction of passenger rates on all roads in the State to three cents a mile. A cut of forty per 20 ACTS OF ARIZONA LEGISLATURE cent for branch lines and twenty-five per cent for main lines. Required an extra man on light engines, that is, engines that are not pulling cars. To find a plausible reason for this bill is a problem for the ages. Required electric headlights on all loco- motives. This is the strongest headlight made and is probably the best for a single- track road. But on double-track it is a positive danger. Four other States have forbidden the railroads to use this kind of headlight on double-track roads. Another Act limited the number of cars to a train to seventy. And others provided for a semi-monthly pay-day and required all engineers and conductors to have three years' previous experience. "It is said that these bills originated with a discharged employe of the Southern Pacific Railroad, and the electric headlight bill was obviously dictated by the Pyle Company, which owns all the patents for high candle-power electric headlights. 21 WHAT EVERY INVESTOR SHOULD KNOW Rumor has it that to make assurance doubly sure this company's representative sat in the halls of the Legislature while the bill was being passed. But whether all this is true or not makes no difference, for these bills represent the wishes of a majority of the people of the State. On November 5th they were sub- mitted to the popular vote by means of referendum petitions. And all except the bill requiring an ex- tra man on light engines and the three- year experience bill were upheld and are now duly incorporated in the statutes of the sovereign State. They tell a story down there now, that is, the railroad men do, about a young man who went to President Wilde of the Uni- versity of Arizona and said that he wanted to learn the railroad business, both prac- tically and theoretically, from the ground up, and wanted to know if the university had such a course. 22 COURSE OF RAILROAD INSTRUCTION Dr. Wilde said that he thought it could be arranged. "Well, what will it cost and how long will it take ?" asked the young man. The Doctor replied that it all depended on how much he wanted to learn. If he wanted to know as much about the rail- road business as men who had spent their lives at it, such as the division superin- tendents for example, it would take him about ten years and cost about ten thou- sand dollars. But if he only wanted to know as much about railroading as the first State Legis- lature of Arizona he thought it would take about fifteen minutes and cost just sev- enty-five cents. Texas and Arizona are examples, per- haps somewhat exaggerated, of a policy that is being applied in every State in the Union. What the net result of this policy of regulation will be for the people as a whole no one can say for many years to come. 23 WHAT EVERY INVESTOR SHOULD KNOW It has reduced freight and passenger rates, abolished rebates and forced the railroads to establish block signal systems and take numerous other measures of a similar nature. All of which is appar- ently for the common good. But its effect on the profits of the rail- roads, their credit standing, the market value of their securities and the progress of railroad development is perfectly plain and obvious to anyone who will take the trouble to look into the facts. Mr. B. F. Yoakum, head of the Frisco System, writing in , a recent number of World's Work on the "High Cost of Rail- roading," graphically pictures the critical situation which the railroad industry now faces. He first treats of the rise in the wage scale and shows that since 1899 the price of railroad labor has risen 33>3%. Or, in other words, the amount of railroad labor which could be bought in 1911 for 24 INCREASED COST OF RAILROADING $100 could have been purchased in 1899 for $75. In 1911 the railroads employed about 1,700,000 men and paid them in wages $1,200,000,000. If the wage schedule of 1899 had prevailed in 1911 these same men could have been employed to do the same amount of work for $900,000,000. So it cost the railroads $300,000,000 more to move the same amount of traffic than it would have cost them under the old schedule. And $300,000,000 is a sum greater than the total net dividends earned and paid by all the railroads in the United States in 1910. The cost of fuel has increased in the same way. In 1911 $8.05 out of every hundred dollars earned by the railroads went to pay coal bills. In 1900 this item represented only $6.09 in every hundred dollars of earnings. If coal could have been bought at the old rate this would have meant a saving of nearly $60,000,000 for the entire industry. 25 WHAT EVERY INVESTOR SHOULD KNOW With the exception of steel rails, which have remained stationary at $28 a ton, all of the other commodities which the rail- roads use for ordinary maintenance and reconstruction work have risen enor- mously in price. Taxes, too, have almost doubled. In 1899 every mile of railroad paid an aver- age of $247 in taxes. In 191 1, $446. For the industry as a whole this has meant an increase of some $63,000,000. Another important item is that of loss and damage claims, which have increased in amount about six times as fast as freight tonnage. A loss for the railroads of something like $21,000,000 if figured on the 1899 basis. All of these items taken together repre- sent an increased cost of over $400,000,- 000 annually. Moreover, in the past eight or nine years there have been small but gradual reduc- tions in both freight and passenger rates. These reductions have not been large at 26 REDUCTION IN RATES any one time, but there has been a constant lowering of rates on different articles due to rulings by Federal and State authorities, until the shrinkage as compared to the old rates amounts to about $135,000,000. The lowering of rates and the increased cost of operation, therefore, make an an- nual difference of about $535,000,000 in net railroad earnings. Every investor must realize as a funda- mental proposition that his protection lies wholly in net earnings. It is not the cost of construction or the cost of reproduction that determines the real value of a property for the investor. It is the ability of that property to earn interest and dividends. The bonds of a railroad which cost one million dollars in 1900 and would cost two million to reproduce today, will not be worth much unless that railroad is produc- ing earnings. And a railroad that is earning $50,000 annually, capitalized at 5 per cent, is worth 27 WHAT EVERY INVESTOR SHOULD KNOW one million dollars, irrespective of what it originally cost or what it could be repro- duced for. So that every dollar of earnings repre- sents twenty dollars of value. And when it is said that the earnings of the railroad industry have been curtailed to the extent of five hundred and thirty- five million dollars it means that the value of the industry as a whole has been reduced by just twenty times that sum. Up to the present time the increase in operating expense and the reductions in rates have largely been met by a constant saving in the actual cost of moving freight and passengers. Locomotives have been built heavier and larger, the capacity of cars has been increased and longer trains have been hauled. But the power to economize along this line has about reached its limit. And it is the opinion of those railroad experts who are best fitted to know that further de- 28 NET EARNINGS DECREASING RAPIDLY crease in earnings cannot be met through savings effected through mechanical ways and means. And this is confirmed by the figures for railroad earnings for the last three years. In 1909 the railroads earned two billion six hundred and seven million dollars gross and eight hundred and thirteen mil- lion dollars net. In 1911 the gross earnings increased with the increase in traffic to two billion eight hundred and fourteen million dollars and the net amounted to seven hundred and seventy-one million. Thus the most recent figures obtainable show during three years an increase of two hundred and seven millions in gross earnings. While the net actually de- creased by forty-three millions. This indicates that conditions in the railroad business are not growing better. If anything the contrary is the case. Very naturally railroad development is practically at a standstill. 29 WHAT EVERY INVESTOR SHOULD KNOW Texas, which has been one of the leaders in radical railroad legislation, built less than twenty miles of new road during the whole of 1912, whereas before the regula- tion policy was adopted 600 miles was the average. It is estimated that the State should have 10,000 miles of new railroads to adequately meet its growing needs. For the past thirty years the whole country has been building new roads at the rate of 6,000 miles a year. Today the only expansion is a matter of little exten- sions of spurs and feeders into sections of proven richness. No new lines of importance are being projected. The effect of these conditions on rail- road securities is too familiar for extended comment. It is just exactly what the investor of ten or fifteen years ago might have fore- seen had he informed himself concerning the tendencies of the times. An essay published as long ago as 1887 by Prof. William Graham Sumner, the 30 DEPRECIATION OF RAILROAD BONDS noted Yale lecturer, on Economics and Sociology, indicates that this keen ob- server foresaw clearly what would happen with the development of the policy of gov- ernment regulation. Investors of the present must profit by this experience. The great tendencies of the day are as obvious as daylight and their effect on investment securities is equally so. The appended table is a graphic illus- tration of what has happened and is still happening in the case of standard railroad bonds. Those listed have depreciated in value since 1899 an average of over ten per cent. It is our opinion, however, that the actual intrinsic value of railroads as secu- rity for investment bonds has depreciated a good deal more than ten per cent. The reasons that the bonds themselves have not fallen in value to a greater extent are two. First, because investors have been slow to change their good opinion of this class of bond. Its reputation was 31 WHAT EVERY INVESTOR SHOULD KNOW established a good many years ago when conditions in the railroad business were very materially different from those at present, and the tendency of investors has been to continue taking this reputation for granted. How Some Railroad Bonds Have Depreciated. Security 1899 1912 Loss Atch., Top. & Santa Fe Ry. Gen g 4s, 1995 99 06* 2^ Baltimore & Ohio. Prior Lien 3^s, 1925 Chicago, Mil. & St. Paul. Gen. g. 4s, Series A, 1989 Chicago & Northwestern. Gen g 3^s 1987 95 108^ 107^ 84 23 y 2 Illinois Central. 1st g 3^25 1951 104 91 13 N. Y. C. & Hudson River. G mtg 3^28 1997 109 *Penn. R. R. Co. Consol g 4s, 1997 106 102^ . **Southern Pacific. 1st gtd. ref. mtg. 4s, 1995 Wabash. 1st g 5s 1939 113 105 8 *Issued 1903. **Issued 1905. 32 LAWS GIVE BONDS FICTITIOUS VALUE And, second, because railroad bonds are to some degree given a fictitious value by the banking and insurance laws of many States. These laws stipulate strictly the kinds of investments which may be pur- chased by savings banks and insurance companies. The laws were passed when railroad bonds were a very high type of investment and they were consequently placed among the first on the list. This has forced a great demand for these bonds, thus keeping the price higher than would naturally be the case. Just so the Federal banking and cur- rency laws have created a fictitious mar- ket and price for government bonds by making it necessary for national banks to purchase them for deposit as security in the issue of bank notes. It is by no means our opinion that the great railroad systems are going to be forced to the wall by hostile and restrictive legislation in the next few years. In fact, there are strong indications of a reaction against such legislation. 33 WHAT EVERY INVESTOR SHOULD KNOW For example, it is reported that the dom- inant political party in Texas has incor- porated in its platform a plank expressly condemning the State's past anti-railroad policy. And there is undoubtedly a strong cur- rent of opinion in this direction through- out the whole country. But this is a reaction against "fool" leg- islation only. It means that the era of unreasonable and vicious laws is passing. But there is not the slightest indication of a rejection of the general policy of gov- ernment regulation. Quite the contrary is the case. This policy has been irretrievably adopted by the American people. From now on it will be applied in a more sensible manner. But it is not going to be dis- carded or restricted simply to the rail- roads. It is going to be extended. Railroad rates will continue to be fixed, not by competition and the natural play of 34 NEW CONDITIONS MEAN LOWER VALUES economic forces, but by State and Federal Commissions. And however sensibly this policy may be applied or however beneficent it may be for the country as a whole, it means just one thing for the investor. It means that the era of high profits in railroading is past. It means that re- quirements for safety appliances and other betterments will greatly add to the over- head operating expense of the business, while freight and passenger rates are held stationary or reduced until the net earn- ings of the industry reach the lowest pos- sible point consistent with solvency. Railroad bonds will always be good "fair-weather" bonds and their ready mar- ketability will keep them in favor -with banks and other investors for whom it is imperative that their assets be always as "quick" as possible. But every investor must realize that the new conditions have enormously impaired the safety of these bonds. 35 WHAT EVERY INVESTOR SHOULD KNOW And that panics, industrial depressions, short crops, wars or other adverse condi- tions will have greater and greater power to injure the railroad business and to de- preciate the securities based upon it to a much greater extent than has ever been the case before. CHAPTER III. Effect of Government Regulation on Pub- lic Utilities Three-Cent Car Fares Regulation of Express Companies. IT is not possible to investigate the effect of government regulation on public utilities as closely as we have done in the case of the railroads. For the agencies of government regulation in this case are a multitude of State and City com- missions instead of a single Federal body, and their reports and statistics are not readily available. Moreover, the policy of government regulation has been applied much more extensively and during a longer period to the railroads than has been the case with the various industries classed as public utilities. But the analogy between the situation in the railroad business and conditions in 37 WHAT EVERY INVESTOR SHOULD KNOW these other industries is so close that for our present purpose very little beyond a simple reference to this analogy is neces- sary or desirable. In nearly every State and in most of our large cities today there are Corporation Commissions or Public Service Commis- sions whose duties comprehend the fixing of rates and supervision of public utility corporations, such as gas, electric lighting, street car, telephone and water companies. The ultimate purpose of these commis- sions is the regulation of rates and charges of the industries within the scope of their authority. And the practical meaning of rate regulation is rate reduction. It must be understood that the natural, almost the inevitable, result of rate regula- tion by a body of men accountable to the people at large will be regulation of a sort that the people at large believe for their best interests. And this must always mean regulation of rates downward. For on the surface of things nothing 38 REGULATION RETARDS DEVELOPMENT seems more apparent than that a reduction of rates or prices must benefit the majority of people, whatever harm it may do to a small minority. Thus the people of Ari- zona and Texas have been unable to see why they should not have as low railroad rates as New York and Massachusetts. Rates are the surface manifestations. The effect of regulation on the develop- ment of. an industry or a State and on the investment of capital is apparently too deep below the surface of things to be un- derstood or seriously considered. The reduction of public utility rates is going on everywhere the whole country over. Already a number of cities have three-cent street car fares. And if the present agitation for a three- cent coin is successful, as it doubtless ulti- mately will be, we may expect that street railway companies generally throughout the country will be forced to make this reduction. To the public the difference between five-cent and three-cent fares 39 WHAT EVERY INVESTOR SHOULD KNOW seems very small. But it means a reduc- tion of 40% in the gross earnings of the industry concerned. The cost of operating public utilities has increased in the same way that the cost of railroading has. Taxes also have in- creased enormously. Up to now these in- dustries have been able to meet much of this increased expense by improvement in mechanical ways and means. For example, in the street railway busi- ness, double tracks, larger cars and the pay-as-you-enter improvement. But the law of diminishing returns makes it certain that this cannot continue much longer. Each new improvement costs more and saves less. In the end the increasing cost of operation must come out of earnings. The appended table shows the deprecia- tion which has taken place in a number of standard listed public utility bonds be- tween 1899 and 1912. 40 SIGNIFICANT FIGURES Depreciation of Standard Public Utilities. Security 1899 1912 Loss Brooklyn Rapid Transit. Gen 5s, 1945 105^ 102J/2 3 Brooklyn Rapid Transit. 1st ref. cons. g. 4s, 2002. Issue 1902 111 92 19 *Detroit United Rys. 1st con. g. 4J/s, 1932. Issue 1902 96 V 2 73^ 23 Interborough Met. Col. tr. g. 4^s, 1956. Issue 1906 90 1 A 80->4 9J/2 New Orleans Ry. & Lt. 4 l / 2 s, 1935. Issue 1905. . United Rys. of St. Louis. 1st g 4s 1934 92J4 94 86 73^4 6J4 20*4 **United Rys. of S. Francisco. S. F. 4s, 1927. Issue 1902 Brooklyn Union Gas Co. 1st con. g. 5s, 1945 Laclede Gaslight Co., St. L. 1st g 5s 1919 80'4 116 107^2 67 106^ 101 *4 I3tf 9% 6J4 People's Gas & Coke Co. 1st con. g. 5s, 1943 120 115% 4^ *First quotation 1905. **First quotation 1903. Note. Where above securities were issued later than 1899 the first quotation is of the year of issue unless otherwise noted. 41 WHAT EVERY INVESTOR SHOULD KNOW Entering into the causes of this depre- ciation are other factors besides govern- ment regulation. The rates charged by some of these corporations have never been reduced at all by government inter- ference. Yet we believe this policy to have been the main factor in depreciating these bonds as a class. For, although applied only in individual cases, the possibility of its general applica- tion has harmed the credit of all public service industries. Government regulation seeks only to ait rates. It inevitably reduces net earnings, injures the credit and depreciates the se- curities of the industries subject to regula- tion. In dealing with this subject the reader must discriminate between his interests as an investor and his interests as a citizen. We are discussing here neither the morals nor the economics of government regula- tion. But, simply accepting it as a fact, 42 EXPRESS COMPANIES AFFECTED we seek to discover its effect on invest- ment securities. The express companies have lately been found to be within the scope of the Inter- state Commerce Commission's authority. The regulations forced upon them have enormously increased the efficiency of their service to the public. No one can deny this. As yet little has been done in the way of rate regulation. But much may be ex- pected. These small beginnings are of the great- est importance to investors in express company securities, for they indicate that the era of great profits in the express business is at an end and that the earnings of the business will be curtailed by gQv- ernment regulation with a consequent in- jury to the value and safety of express company securities. 43 CHAPTER IV. Extension of Government Regulation The Trust Problem Hoiv Trust Securities Will Be Affected. AT this point it is necessary to warn the reader again against letting his own prejudices or politics or desires color his analysis of the conditions affecting his investment interests. He must see things as they are, not as he wishes them to be. The policy of government regulation has been of inestimable benefit to Amer- ican laborers men, women and children. It has shortened hours of work, provided for compensation in case of accident, and brought on a new era of sanitation and safety. But for the purposes of our present in- quiry all this is aside from the point. 45 WHAT EVERY INVESTOR SHOULD KNOW We are concerned with, just this one fact, that, wherever and however govern- ment regulation has been applied.it has re- sulted inevitably in increasing the operat- ing expenses and decreasing the profits of the industries regulated. And this in turn has caused a deprecia- tion of the bonds or stocks based on these industries. For, as has been pointed out heretofore, it is fundamental that the one factor which finally determines the margin of safety of an investment is profits or net earnings. And when profits are cut the investment must depreciate. We have seen how this policy has been applied to the railroads and to the various public utility industries and how it is now about to be applied to the express com- panies. Let us see what extensions of the policy may be expected. One of the great problems before the country today is that of the trusts. And 46 EFFORTS AT TRUST CONTROL many methods of solving this problem have been proposed. Federal incorpora- tion, the Sherman anti-trust law, a Corpo- ration Commission, regulation of competi- tion, and government ownership, are some of these methods. During the recent presidential campaign this subject was given especial attention by the Socialist party and the Progressive party. And these two parties are the rad- ical elements in our politics. The one stands for government owner- ship and the other for a Federal Corpora- tion Commission. Inasmuch as neither of the other two parties seems to have reached any really definite conclusions as to trust control, we may expect that no matter what party is in power the ideas of the radicals will have great weight in finally shaping the govern- ment's policy toward the trusts. It is more than likely that some modifi- cation of the Federal Corporation Commis- 47 WHAT EVERY INVESTOR SHOULD KNOW sion, proposed by the Progressives, will ultimately be the means adopted. The Interstate Commerce Commission is a precedent in this direction and its suc- cess in dealing with the railroad problem, to the satisfaction of the people, makes it extremely unlikely that anything else will be tried in dealing with the trust problem. That this will ultimately result in regu- lation by the government of both wages and prices in our great trust industries is our opinion. This is what has happened in the rail- road industry and this is the solution of the trust problem advanced by the Pro- gressive party. In making a prediction as to the direc- tion a tendency is likely to take, one must lay special stress on the program of the radical element. This element, whether in power or not, always either colors or directs the changes in government policy. Just so the radical Western States in- itiate new ideas such as equal suffrage, 48 WESTERN STATES MORE PROGRESSIVE the single tax, the initiative, referendum and recall, and these ideas gradually spread to the more conservative Eastern States. To learn what the principles of govern- ment in Massachusetts a hundred years hence will be, one must study the tenden- cies in Oregon today. To predict what conservatism will mean in the years to come one needs only to define correctly the radicalism of the present. During the recent campaign the Pro- gressive party stood for a Federal Corpo- ration Commission. The purposes and powers of this Commission were definitely set forth in an editorial in the September 28th number of the Outlook, the acknowl- edged party organ, from which we quote as follows: "It (the Commission) proposes to say to the person, whether corporate or individual, You shall not control the prices, ^ve will control them; you shall not deteriorate the quality, we 49. WHAT EVERY INVESTOR SHOULD KNOW will punish you if you do not keep the quality up to our standards ; you shall not impose on your working people any conditions you like, you shall pro- vide such wages, hours and conditions of labor as we prescribe, etc." And we believe that some modification of this plan will ultimately be tried. But whether this prediction as to the form that government regulation of the trusts will take is correct or not makes little difference for the purposes of our present inquiry. The point is that regulation of our big industries in some form or other is a prac- tical certainty in the very near future. And to understand what effect this will have on the investment securities based on these industries one only has to consider what has already happened in the railroad field. However great a boon legislation insti- tuting shorter hours for labor, minimum 50 DEVELOPMENT SLOW BUT SURE wage scales, employers' liability, compen- sation for injured employes, safety and sanitary appliances, regulation of competi- tion, regulation of prices, or regulation of wages may be for the country as a whole, the result of such legislation for the indus- tries affected is perfectly plain and obvious. Overhead and operating expenses will be increased or income curtailed so that net earnings will inevitably be reduced. And a reduction of net earnings will mean a depreciation of the securities de- pending on these earnings for their safety. This policy of trust control and indus- trial benevolence will continue to develop slowly but surely, just as has been the case up to date. Its effect on the great indus- tries will not be noticeable for five, ten or perhaps fifteen years. But its result is an absolute certainty and must be taken into consideration by the intelligent investor, whatever his per- 51 WHAT EVERY INVESTOR SHOULD KNOW sonal sentiments in favor of or opposition to the policy of regulation may be. The bonds and stocks of the country's great industries are certain to suffer de- preciation in value through the application of the policy of government regulation, just as railroad securities have done. 52 CHAPTER V. Socialism What It Is A Modification Effect on Investment Securities. i increasing Socialist vote in this country and the wide spread of Socialism over the whole world makes necessary a word here concerning the effect that Socialism would probably have on investment securities. In the first place, the reader will please rid himself of the idea that Socialism means the confiscation of all property by the government and a new distribution of it on an equal per capita basis; or that Socialism has any necessary connection with dynamite, assassination or anarchy. Socialism simply aims to substitute some form of government interference for free contract, competition and the other nat- ural economic forces in fixing the relations 53 WHAT EVERY INVESTOR SHOULD KNOW of the different organs and classes of society to one another. It will regulate the prices of commodi- ties and services and the wages of all the members of society. It will fix transpor- tation rates and the cost of bread and steel rails, the wages of laborers, promoters, doctors and lawyers. All this as a substitute for allowing each to get as much as possible for his labor or product or services in the competition of life with all the other members of society. However much one may disagree with this idea it must be admitted that, accord- ing to its light, it is rational and aims at the welfare of all. It is only a step or two further in the direction in which the thoughts of the peo- ple are already turned. It is the policy of government regulation carried out to its fullest extent and to a logical conclusion. In an interview on the business situation published in the March 16th, 1912, num- 54 DRIFTING INTO SOCIALISM her of the Outlook, Mr. Frank Trumbull, chairman of the Boards of Directors of the Chesapeake & Ohio and M. K. & T. Railroads, said, "We must not forget that every step along the road of regulation of business is a step in the direction of State Socialism. Unless we have de- termined that end to be desirable it behooves us to weigh carefully each proposal to move further toward it. Otherwise we may thoughtlessly gain such headway that we cannot apply the brakes/' If we are drifting into Socialism the change will come without revolution or perceptible upheaval. It will be the nat- ural development of tendencies already fully established. There is no logical stopping point for a policy of regulation once it has been en- tered upon. For partial regulation is sim- ply legislation for the benefit of certain 55 WHAT EVERY INVESTOR SHOULD KNOW parts of the people to the exclusion of the others. And once the precedent is established, those previously excluded will demand ad- ditional regulation in their own behalf. And their demands will have to be met. Something like this has already hap- pened. The first example of the policy of government regulation was the protective tariff. This was regulation for the benefit of a certain class of capitalists or investors. In the years that followed, labor organized into unions and federations, and has now become an important factor in politics. So that the policy of regulation is now be- ing applied to benefit this other class. It is the irony of fate that a policy first employed to give a special privilege to a certain class should later be applied so as to work this same class a special injury. Socialism is still a theory. It has never been tried under conditions similar to those of the present day. In its evolution 56 DOCTRINES TO BE MODIFIED some of its old doctrines are certain to be modified. In the light of present development it is likely that one of these will be the doctrine of government ownership. For the purposes of Socialism can be accomplished equally as well and much more easily simply by extending the policy of government regulation so that the gov- ernment will control prices, wages and other conditions in all lines of human activity. We have seen a modification analogous to this take place in the single-tax move- ment. Henry George, the father of the single tax idea, proposed that the govern- ment actually confiscate all land in order that it might take for itself the benefit of the unearned increment. But his followers have discovered that the same result can be attained by simply taxing away the unearned increment and leaving the present system of land titles alone. So the single taxers of the present 57 WHAT EVERY INVESTOR SHOULD KNOW expressly disavow an intention to confis- cate the land. Such a revolutionary measure is no more necessary for them than government ownership is for the Socialists. We believe that the tendencies of the whole country are strongly socialistic. A majority of the American people certainly believe that the solutions of many of our economic and industrial problems are to be found in some form of government reg- ulation. A large proportion of these people are horrified at the mere thought of Socialism, but their ideas are socialistic nevertheless. We do not believe that Socialism will be ushered in by revolution or that its coming will necessarily mean calamity for the United States. No one's opinion as to whether it is a good thing for the country or not is of much value until it has been tried. We are certain, however, that the drift is strongly in that direction, and we believe 58 POLICY AFFECTS CERTAIN INVESTMENTS that we should look the situation squarely in the face. As Socialism is simply an extension of the idea of government regulation, it fol- lows that, as far as the investor is con- cerned, what has already been said about the effect of this policy on investments based on our railroads, public utilities and other great industries will apply with equal or greater force here. Government regulation, to whatever in- dustry or business it is applied, zvill always result, first, in a reduction of profits; and, second, in a depreciation of the securities based on the industry affected. It is true that this may be remedied by additional legislation or regulation to pro- tect the investor, but there is no indication of any such measure being taken at the present time. Socialism is stronger in England than anywhere else in the world. Compara- tively speaking, the movement in this country is still in its infancy, but there can 59 WHAT EVERY INVESTOR SHOULD KNOW be no doubt that we are strongly inclined to follow England, though we are still far in her rear. It is claimed that Socialism in England has already had the effect of impairing in some degree the credit of the country. We quote from an article by Charles John- ston in a recent number of the North American Review: "The mention of England brings me inevitably to the plans of Mr. Lloyd George, which have already made such revolutionary progress there. It is not my purpose here to discuss whether those reforms do more good than harm. But I wish to point out, what is more to the purpose in the present discussion, that they are extremely costly. Note the im- paired credit of England, as evidenced by the relentless fall of Consolidated , Government Stock, the so-called Con- sols. Far above par before the South African War ; now down in the seven- 60 THESE REFORMS COSTLY ties and still falling. Note also the increasing difficulty of the struggle to keep up the battleship strength of the nation, in the face of Germany's naval programme. These are signs of the times, that all may read. "That socialistic plans like those of Mr. Lloyd George must of necessity be costly, in the long run ruinously costly, is almost a logical necessity. For look what they amount to, in principle; to give to the less effective the same reward as to the more effec- tive, or, to speak in Darwinian terms, to suspend the struggle for existence and the survival of the fittest. "An immense increase in cost, that is inevitable. And if the principle were made the basis of government, in other words, if the Socialist party were to win at the polls, and carry through their programme, it would mean an enormously costly govern- 61 WHAT EVERY INVESTOR SHOULD KNOW ment, with increasing burdens of taxation." It is our opinion that socialistic legisla- tion has not been the only cause, or per- haps not even the main one, to which might be attributed the fall in Consols. It is plain, however, that such legislation as that providing for old-age pensions or employment insurance is bound to be a great financial burden for any govern- ment. And if this tendency were carried far enough it would certainly impair the country's credit and result ultimately in a depreciation of its bonds. And U. S. Government bonds might be affected in this way as well as British Consols. 62 CHAPTER VI. The Single Tax Modified in Practice Effect on Railroads Public Utilities Mortgages Land Speculation. single-tax movement is an- other growing tendency which will affect certain kinds of invest- ment securities. Since the publication of Henry George's book, "Progress and Pov- erty," in 1879, this movement has grown steadily until now it has a body of enthu- siastic propagandists in almost every civ- ilized country on the globe. In England, Germany, Australia, New Zealand and Canada the single-tax move- ment is especially strong, while in the United States the number of its adherents is increasing with great rapidity. During 1912 Oregon, California and Missouri voted on constitutional amend- G3 WHAT EVERY INVESTOR SHOULD KNOW ments which would have made possible a trial of the single-tax idea in those States. And Ohio gave much attention to the sub- ject in its convention assembled to draft a new constitution. The movement was defeated in all of these cases, but it is likely that this was no more than a temporary check and really served as a means for gaining many new converts. In estimating the strength of this ten- dency it is well to remember that the single tax or some modification of it is also a doc- trine of the Socialists. The following is taken from the 1912 platform of the Socialist party : "The collective ownership of land wherever practicable, and in some cases where such ownership is im- practicable, the appropriation by tax- ation of the annual rental value of all land held for speculation or exploita- tion." 64 TRIAL OF SINGLE TAX CERTAIN So the single-tax movement may count on the Socialists for support. With the initiative in their hands it seems certain that sooner or later the sin- gle taxers will win out in this country, at least sufficiently to give their theory a fair trial. The following definition of the single tax is a quotation from one of Henry George's writings on the subject: "I shall briefly state the funda- mental principles of what we who advocate it call the single tax. "We propose to abolish all taxes save one single tax levied on the value of land, irrespective of the value of the improvements in or on it. "What we propose is not a tax on real estate, for real estate includes improvements. Nor is it a tax on land, for we would not tax all land, but only land having a value irre- spective of its improvements, and 65 WHAT EVERY INVESTOR SHOULD KNOW would tax that in proportion to its value. "Our plan involves the imposition of no new tax, since we already tax land values in taxing real estate. To carry it out we have only to abolish all taxes save the tax on real estate, and to abolish all of that which falls on buildings or improvements, leav- ing only that part which now falls on the value of the bare land, increasing that so as to take as nearly as may be the whole of the economic rent, or what is sometimes called the 'un- earned increment of land values/ "That the value of the land alone would suffice to provide all needed public revenues municipal, county, state and national there is no doubt." The idea is that land values are created by the whole community and that any in- crease in the value should go to the com- munity rather than to the individual land- 66 FUNDAMENTAL SECURITY UNAFFECTED owner. That the value of a business cor- ner is determined by the number of people who walk past it. The single taxers hold that if the com- munity appropriated this value by taxa- tion all other taxes could be abolished. It is not within the scope of this inquiry to discuss the expediency or justice of this theory. What we are concerned with is, how will it affect the value of investment securities. In the first place, the single tax would mean the removal of all taxes on personal property, including the taxes on money, bonds, stocks and mortgages. This would be a great advantage to in- vestors, at least to those who are in the habit of paying taxes on these forms of property. But as it would have no effect on the fundamental security on which the investments in which we are interested are based, we will not discuss it further. The experience of the cities which have tried the single tax seems to indicate that 67 WHAT EVERY INVESTOR SHOULD KNOW in its practical application a modification of the original theory takes place. It was the idea of Henry George that the State should take the entire "unearned incre- ment" even though it might be many times what would be necessary to run the gov- ernment. But at the present time the single-tax system has come to mean simply the aboli- tion of all taxes except the tax on land. And instead of attempting to tax away all land value, only so much is taken as is nec- essary for the needs of the government, irrespective of the rate at which the "un- earned increment" may accumulate. Thus Vancouver, B. C., adopted the sin- gle tax by gradually abolishing all other taxes. It was not found necessary to in- crease the tax rate on land, which remains at 22 mills on the dollar the same as it was before the single tax was adopted. Between the years 1900 and 1909, however, the value of Vancouver real property prac- tically quadrupled, this "unearned in- 68 A TAX ON VALUE OF LAND crement" amounting to something like $35,000,000.00. This modification in the application of the single tax has led to some suggestions for changing the name of the movement. And one often hears the terms "Scientific Taxation" or "Natural Taxation." In our discussion of the single tax we will assume this modification. The single tax is a tax on the value of land. Whether it will affect the value of a property or industry or business or not depends altogether on whether under this new system the total amount of taxes to be paid by the property or business or indus- try will be increased or decreased. If the total taxes are decreased the property will be benefited; if they are in- creased it will be injured. And as a property is benefited or injured the securities based upon it will increase or depreciate in value. Now, at first glance it would seem that the railroads, street car lines, gas and 69 WHAT EVERY INVESTOR SHOULD KNOW electric light plants, water works, tele- phone companies and all other public utili- ties would benefit immensely by the single- tax system. For railroads own compara- tively little land, often no more than their rights-of-way and terminals, and it would seem that the increased tax on these would be much more than offset by the exemption of rolling stock, stations, track and other improvements from taxation and the re- moval of the very burdensome special rail- road and corporation taxes. And this would seem to be all the more true of other public utilities, a telephone company, for instance, which apparently owns no land at all except what is neces- sary for its exchange and office buildings. But that this is far from the true state of affairs we will let Mr. Thomas G. Shearman, a leading single taxer, demon- strate. The following is taken from his book, "Natural Taxation" : "It has already been mentioned that the professed defenders of farmers and other 70 CORPORATIONS BITTERLY OPPOSED owners of small homesteads oppose the con- centration of taxation upon ground rents, on the plea that this would exempt all fran- chises and monopolies, including railways, express companies, telegraphs, telephones, gasworks, electric lighting works, oil-pipe lines and the like. If this were the fact we may be sure that the shrewd managers of such monopolies, assisted as they are by the most sagacious and experienced advisers in the country, would have discovered it by this time. We may also be sure that the Legislatures of two-thirds of the States, owned as they are, body and soul, by corpo- rations of this precise class, would hasten to avow their aversion to the principle of tax- ing ground rents and to embody it in their statutes. The Senate of the United States would before now have passed any neces- sary amendment to the Constitution by a two-thirds vote. "But do we see the slightest tendency in this direction? Is the proposal received with favor by the managers of a single great railway or telegraph or of any great monop- oly? On the contrary, is it not notorious that they are unanimously and bitterly op- posed to it ? 71 WHAT EVERY INVESTOR SHOULD KNOW "These gentlemen are not deceived. They know well enough that their valuable fran- chises represent exclusive rights to the use of land, and that they neither have nor can have any exclusive rights to anything else, except to patent rights, which are very costly and which only last for a few years. "Take one of our great railway lines, for example. Add up either the market value or the cost of replacing its rails, equipment, building improvements and chattels of every kind, whether movable or immovable, and at a most liberal valuation. The total will never come to within millions of its nominal debt, and will never touch its capital stock. What gives value to the enormous amount of stock? The exclusive privilege of using a narrow strip of barren land, five hundred, a thousand, or two thousand miles long, un- broken by highways or other rights over land, whether public or private. Under the present system railway managers persuade local assessors that this land should be val- ued no higher than the equally barren land in adjoining farms; and the farmers' special advocates insist that this is the true basis of valuation. But it is absurd. "The value of all land depends upon the 72 USE OF LAND DETERMINES ITS VALUE value of the use which can be made of it. No farmer can use his land for the carriage of goods or passengers, beyond the limits of his own farm. If all the farmers between New York and San Francisco agreed to build a railway, without forming a railway corporation, they would be compelled to break their line at every highway, to dis- mount their passengers and unload their freight. Therefore, nobody outside of a rail- way company can use his land for this most valuable purpose. And this privilege of using an unbroken strip of land, with loco- motives running forty miles an hour, is all which gives to the stock of any American railway company its market value; while it generally covers from one-third to one-half of its bonds, in addition. "The notion that such privileges on land are to be appraised by the acre, like farm lands, can be readily tested by applying the same principle to any other land. In great cities land is often sold at a price estimated by the square foot. Some lots containing 2,000 square feet are salable for $200,000, or $100 per foot. But if a single foot of this land were sold by itself, with the knowl- edge that no more could be had, who would 73 WHAT EVERY INVESTOR SHOULD KNOW give even a dollar for it, except as a means of blackmailing the owner of the rest? Just so, the value of a strip of land un- broken for a thousand miles, for use as a railway, is something immense ; while the same land cut up in a thousand sections, never to be united, would be almost value- less. For purposes of transportation it would have no value whatever. "Again, the value of land depends upon the variety of uses to which it may lawfully be put. Steam railways, although very use- ful, are to some extent a nuisance. The gov- ernment cannot permit them to be operated upon every tract of land. Consequently land owned by individuals is generally restricted to other uses ; and it is, therefore, worth less than land owned by railway companies. "The franchise of a telegraph company is of the same nature. It is absolutely nothing but an exclusive privilege to extend its wires over land. But this is a privilege of enor- mous value. The founders of the Western Union Telegraph Company have managed to sell this privilege to investors in its stock, for at least $50,000,000. "The franchises of gas companies, electric light companies, steam heating companies, 74 ENORMOUS VALUES UNTAXED waterworks and the like, consist so obviously of mere privileges to use unimproved land as to need no explanation. Street railroads, also, so palpably own no privileges other than the mere right to run over land, that it seems almost an insult to the understanding of any reader to explain the case. None of these corporations have any other franchises than these rights over land. "Under the present system, in most cases, all these enormous values go untaxed. The law of New York distinctly exempts fran- chises from taxation ; although it is well settled that they would be taxable as land except for this legislative interference. Un- der the system here proposed all these values would be fairly taxed." That the taxes of the railroads and other public utilities under the single-tax system would be enormously increased is, there- fore, clear. And an increase of taxes like any other expense would mean a reduction of profits. And a reduction of profits in any indus- try inevitably operates to decrease the margin of safety of investments based 75 WHAT EVERY INVESTOR SHOULD KNOW upon that industry and to depreciate their value. However great a good the single-tax system might be for humanity as a whole and indeed with those who urge this reform it is raised almost to the dignity of a religion, for they believe it will abolish poverty, stimulate industry and cure all our troublesome economic ills for all time to come it will certainly injure the bonds and stocks based on the industries men- tioned in a permanent and lasting way. It is not so clear as to how the single tax would affect the average industrial bonds and stocks. This would depend on the proportion of land to other property owned by the industry in question. One with large land holdings, a coal mining company, for instance, would probably have to pay more taxes and would be in- jured thereby, while one with propor- tionately small land holdings, such as a clothing factory, would have to pay less taxes and would reap a benefit. 76 STILL IN EXPERIMENTAL STAGE It is likely that this latter would result in the majority of cases and the securities based on such industries would gain in value. The single tax, like Socialism, is still in the experimental stage. It has not been tried on any scale large enough to prove or disprove its merits or to make it possi- ble to state exactly what its entire effect will be. We must form our judgments in large measure by the arguments for and against it made by the single taxers and those who oppose them. There is some question in our mind as to whether the adoption of the single tax would operate to injure city, county, state, district or other tax-secured bonds. If this system curtailed the power of a com- munity to raise as much money as neces- sary for its needs by taxation, certainly the bonds of such a community would be injured thereby. This situation might arise in a com- 77 WHAT EVERY INVESTOR SHOULD KNOW munity where land values were at a stand- still or on the decline. In such a case there would be no "unearned increment" for the community to appropriate. The single taxers hold that there is no danger from this source. But, on the other hand, during the recent election in California, in which a vote was taken on a single-tax amendment to the Constitution, the Anti-Single Tax League of California contended that "This amendment, if car- ried, will so affect the integrity of our tax system that it would make municipal bonds unsalable and seriously harm the credit of the entire State" This statement was made over the names of the Los Angeles Chamber of Commerce, the San Francisco Chamber of Commerce, the City Club of Los An- geles, the California State Realty Federa- tion, the California State Grange, the Civic League and Improvement Clubs of San Francisco, the Los Angeles Realty Board, Prof. Carl C. Plehn of the Depart- 78 EFFECT ON MORTGAGE INVESTMENTS ment of Economics of the University of California, and many other organizations and prominent individuals. It is obvious that such a radical change in the system of taxation would be at- tended with a certain amount of danger to the holder of tax-secured bonds. But it is impossible to say how great this danger would be or whether an injury to a com- munity's credit resulting from such a change would necessarily be permanent or not. The effect of the single tax on mortgage investments can be ascertained with some- what greater definiteness. In the case of mortgages on unimproved land, whether city lots or farm property, it is obvious that great injury would be done. For taxes on unimproved land would be very materially increased. In some cases this would very likely amount prac- tically to confiscation, and all security for 79 WHAT EVERY INVESTOR SHOULD KNOW a mortgage based on such land would be destroyed absolutely. It is not possible to make a general statement as to whether the single tax would increase or decrease the total taxes on farms. The single taxers make very strong claims tending to show that their system would be of inestimable benefit to the farmers. And, on the other hand, the farmers have been the most consistent opponents of the plan, for they believe it would very materially increase the burden of taxation which they must bear. The effect that the single tax would have on the amount of taxes of a particular farm would depend on the ratio which the value of the improvements bore to the total value of the farm. If the improvements made up more than half the total value, then the exemption of improvements from taxation under the single tax would more than offset the increased taxes on the bare 80 SOME FARMERS BENEFITED land. And the total taxes for the farm would be reduced. But where the improvements constitute less than half the value, the taxes of the whole farm would be increased. In a district of small, highly-improved farms and intensive methods of cultivation the single tax would probably lighten tke farmers' burden. But in a new country, where farms are larger than is necessary and many farmers buy extra land for the firewood that is on it or for pasture or for speculation or just because it is cheap, the ratio of the value of improvements to the total value grows smaller. And wherever it is less than half, such a farm would pay an increased amount of taxes under the single tax. And where taxes grow heavier, the farm affected will decrease in value and the safety of a mortgage based upon it will be impaired. The effect of the single tax on improved city property may be ascertained with 81 WHAT EVERY INVESTOR SHOULD KNOW greater accuracy. First, because the ratio of the value of improvements to land does not vary so widely as it does with farms. And, second, because the single tax has already been put into practice in a few cities and this experience throws some light on the subject. Almost invariably in the cities the im- provements are worth more than the bare land on which they rest. You will find a $2,000 cottage on a $1,000 lot and a $10,000 house on a $5,000 lot. Generally the improvements are worth from two- thirds to three-fourths of the total value. And this is especially true of residence property. From the cheapest up to the costliest, practically the same ratio holds. It follows that in the majority of cases improved city property will pay less taxes under the single-tax system, and mort- gages based on such property instead of being injured will be afforded a greater margin of security. This has been the experience in Van- 82 AIMS AT LAND SPECULATION couver and Edmonton, two Canadian cities which have adopted the single tax. There is another kind of investment, or rather speculation, which is more likely to be affected seriously by the single tax than any other, and that is the buying of acre- age or city lots in a new community with a view to taking the profit from the increase in land values as the country grows up. There is a great land boom now going on all along the Pacific coast, but especially in the Northwest and in the Western part of Canada. Settlers are pouring in and new towns are springing up, some of which are cer- tain to be great cities before many years have passed. For the country is rich in natural resources and has great agricul- tural and commercial possibilities. And the land agent is busy. The maga- zines are filled with his alluring advertise- ments and the mail heavy with his "litera- ture." The temptation is strong either to 83 WHAT EVERY INVESTOR SHOULD KNOW pull up stakes and emigrate to the new country or to buy a little raw acreage or town lots as a speculation. But those who are tempted to invest their capital in this latter way should bear in mind the fact that Canada and our Northwest are the very strongholds of the single-tax movement. Already some cities there have adopted the system with great success. And the movement is likely to spread rapidly. The single tax is aimed directly at the land speculator. It proposes to take away from him the increase in land values due to the growth of the community. In a new country, where many of the landowners are absentees who have bought land or lots as a speculation, the temptation is especially strong to adopt the single tax because it will fall heaviest on those who are far away and are adding nothing to the prosperity and development of the community. In answer to questions of the writer's 84 ADVANTAGES ENUMERATED on the points just discussed, Daniel Kiefer, chairman of the Joseph Pels Fund Com- mission, which is the leading single-tax organization of the country, stated: "1. The single tax will decrease the total taxes on average improved city residence property. "2. It will decrease the total taxes on average improved city business property. "3. Decrease taxes on manufactur- ing plants. "4. Probably no more than 10% of all revenue will come from the farms, so the tax on average farms must be largely decreased. "5. Railroad taxes now equal but y 2 of 1% of franchise value. Under the single tax they would pay very much more. "6. It will not decrease the power of a municipality to raise enough revenue for all things which muni- cipal revenue is required." 85 CHAPTER VII. Growth of Cities Effect on Realty Values Strengthens Mortgage Investments. f ^HE last census brought to light another tendency which is of M much importance to investors. This is the rapid growth of our cities. The rate of growth of cities during the ten years from 1900 to 1910 was more rapid than during the preceding ten years. And the rate of growth of medium-sized cities was more rapid than that of the larger cities. It appears that whereas cities which at the present time have a population of 25,000 or more showed an increase of sub- stantially 32*/2 per cent between 1890 and 1900, these same cities showed an increase of a little more than 35 per cent between 1900 and 1910. The proportion of the population of the United States residing in cities of 25,000 87 WHAT EVERY INVESTOR SHOULD KNOW inhabitants or more was, in 1880, 17.2 per cent; in 1890, 22.2 per cent; in 1900, 26 per cent, and in 1910 between 31 and 32 per cent. Rapid growth is not confined to a few cities or to cities in any particular section of the country. As might be expected, the highest rates of growth have been in cer- tain Southern, Southwestern and far Western cities. Confining attention to cities having 100,000 or more inhabitants, the most re- markable rates of growth are as follows: Per cent of Population increase 1910 1000 to 1910 Birmingham, Ala 132,685 245.4 Los Angeles, Cal 319,198 211.5 Seattle, Wash 237,194 194.0 Spokane, Wash 104,404 183.3 Portland, Ore 207,214 129.2 Oakland, Cal 150,174 124.3 Atlanta, Ga 154,839 72.3 Detroit, Mich 465,766 63.0 Other cities of this class showing an in- crease in excess of 40 per cent were 88 PER CENT OF INCREASE Bridgeport, Cleveland, Columbus, Denver, Kansas City, Minneapolis, Newark and Richmond. Cities between 25,000 and 100,000 inhabitants which showed a rate of increase exceeding 100 per cent were, in the order of percentage of increase, Oklahoma City, Muskogee, Okla. ; Pasa- dena, Cal. ; Berkeley, Cal. ; Flint, Mich. ; Fort Worth, Tex. ; Huntington, W. Va. ; El Paso, Tex. ; Tampa, Fla. ; Schenectady, N. Y. ; San Diego, Cal. ; Tacoma, Wash. ; Dallas, Tex.; Wichita, Kan.; Waterloo, la., and Jacksonville, Fla. The following are the changes in popu- lation of the eight largest cities of the United States: Population 1900 1010 Per cent of increase New York . . Chicago 3,437,202 4,766,883 1 698 575 2 185 283 38.7 28 7 Philadelphia 1 203 697 1 549 008 19 7 St. Louis . . , , 575 238 687 029 19 4 Boston 560 892 670 585 19 6 Cleveland 381 768 560 663 46 9 Baltimore . . , 508,957 558 485 9 7 Pittsburg 451 512 533 905 18 2 89 WHAT EVERY INVESTOR SHOULD KNOW The rate of increase for all cities of more than 25,000 inhabitants was 35 per cent, while the rate of increase for the country as a whole during these ten years was only 21 per cent. This tendency for the cities to grow faster than the rest of the country must have its effect on the business of railroads, public utilities and productive industries. But the relation is hardly close enough and there are so many other factors enter- ing into the situation that it is impossible to draw any definite conclusions as to just what this effect is. The rapid growth of urban population, however, has a very direct bearing on the values of city real estate. Between the years 1900 and 1910, for example, while the population of St. Louis was increasing 19.4 per cent, the value of its city real estate increased over 50 per cent. St. Louis is a mature city. There is nothing erratic or excited or "boomy" 90 ST. LOUIS' GROWTH NORMAL about its growth. It has certain natural advantages in location and resources which cause it to grow. This growth is absolutely normal. And real estate values have grown more than twice as fast as population. In the cities of most rapid growth, like Los Angeles, Atlanta, Detroit and Kansas City, the increase in realty values during the ten years was almost unbelievable. Los Angeles real estate increased in value almost 500 per cent; Atlanta over 100 per cent; Detroit 75 per cent, and Kansas City over 100 per cent. It is not possible to formulate any gen- eral rule concerning the relations between the growth of city population and real es- tate values, but it is evident that the rela- tion is a very close one and that in many cases realty values will grow more rapidly than population. Real estate mortgages are the invest- ments most affected by this condition, and the effect is a most important one. 91 WHAT EVERY INVESTOR SHOULD KNOW The tendency of the cities to grow at a more rapid rate than the rest of the coun- try, together with the fact that city real estate increases in value even more rap- idly than population, makes such real estate the safest basis for mortgage in- vestments. It is superior to farm property because it increases more rapidly and more cer- tainly in value. And it is superior. to industrial property because its increase in value is due to a .widespread and fundamental sociological tendency, rather than to local or tempo- rary conditions. Any property farm, manufacturing or transportation may increase in value, and any property into which the investor puts his money should show promise of doing so. But there is no class of property where the increase in values is so certain or so little likely to be affected by adverse conditions, such as leg- islation or politics, as city real estate. 92 CHAPTER VIII. New. Standards Mrs. Harriman's Invest- ments Stock Exchange Regulation Effect on Listed Securities The Safest Type of Investment Back to the Land. WE have now examined the four main tendencies of the times which bear directly upon the fundamental security of the different classes of investments. The most important and far-reaching of these tendencies is the extension of the policy of government regulation. The ap- plication of this policy has a very intimate relation to the value of all railroad, public utility and industrial bonds and stocks. For it must inevitably reduce the profits of these businesses and in turn depreciate the value of their securities. Some form of Socialism is the logical 93 WHAT EVERY INVESTOR SHOULD KNOW development of this policy, and the differ- ence in its effect upon investments from that of government regulation would be one of degree only. The single-tax tendency is compara- tively of minor importance, for it is still in its infancy. But all signs point to a time when the experiment will be made in this country and it behooves the investor to un- derstand thoroughly just what its effect on investments would be. Unquestionably it would be of great damage to railroad and public utility bonds and stocks, to mort- gages based upon unimproved land and to the securities of industries using a great amount of land, such as mining and lum- ber enterprises. The effect of the single tax on farm mortgages would depend on whether the farms in question were highly improved or not. And its effect on mortgages based upon improved city property would, as a rule, be beneficial. 94 CITY PROPERTY MORE VALUABLE Industries not using much land, such as most manufactures, would be benefited. For their taxes would be reduced. And investors as a class would be bene- fited through the exemption of stocks, bonds, and mortgages from taxation. The tendency for our cities to increase at a faster rate than the population as a whole has a very direct effect upon the safety of city mortgages. For it insures that city property will generally increase in value and at a faster rate than farm or raw lands. These are by no means the only tenden- cies which the observer might discover. Burso far as investors are concerned they are the main ones, and in every case they have attained such strength that a consid- eration of their various effects is no longer a matter of mere guesswork, but of dealing in perfectly obvious facts. An examination of these facts indicates that many of our old investment standards are sadly in need of revision. 95 WHAT EVERY INVESTOR SHOULD KNOW It explains the report that in the few years since Mr. E. H. Harriman's death his widow has disposed entirely of his vast holdings of railroad bonds and stocks. And that recently one of the high officials of the Southern Pacific, a man of consid- erable wealth, stated, publicly, that he had not a penny invested in railroad securities. The bonds and stocks of our great rail- roads, public utilities and industries are usually listed on the New York Stock Ex- change. This is of inestimable benefit to the investor. For at all times and under all conditions the New York Stock Ex- change affords an instantaneous market for the securities listed there. This market has as many phases as the weather. And is as uncertain. It is in- fluenced by many conditions which bear no relation whatever to fundamental values. The market price of a listed secur- ity may in no way indicate its true worth. Yet the importance of instantaneous marketability is so great with many kinds 96 STOCK EXCHANGE REGULATION COMING of investors as to far outweigh these obvi- ous disadvantages. Safety dictates, for example, that banks shall keep a large part of their funds invested in securities which can be quickly converted into cash, and bonds listed on the New York Stock Ex- change fulfill this requirement better than any other kind of investment. The policy of government regulation, however, is operating to modify this condi- tion in a very material way. First, be- cause it is being directed against just the classes of industries whose securities are most likely to be listed on the New York Exchange. And is greatly impairing the safety of these securities. And, second, because the Exchange itself is pretty sure to come in for its share of "regulation" before many years have passed. The Congressional investigation of the "Money Trust" and the hyphenated bunkum of Mr. T. W. Lawson, entitled the "Remedy," in Everybody's Magazine, are the current indications of this. 97 WHAT EVERY INVESTOR SHOULD KNOW The Stock Exchange represents Wall Street, and there is a great popular demand for legislation directed against Wall Street which must soon be met. For Wall Street is our modern devil. As William Graham Sumner, the econ- omist, says : " 'Wall Street' takes the place which used to be assigned to the devil. What is that 'Wall Street' which is currently spoken of by editors and pub- lic men as thinking, wanting, working for certain things? There is a collective in- terest which is so designated, which is real, but the popular notion under 'Wall Street' is unanalyzed. It is a phantasm or myth." The indications are that the popular prejudice against the devil, "Wall Street," will in the end be satisfied by some restric- tive legislation directed against the New York Stock Exchange. Mr. Lawson's contribution stands as a colossal example of faulty reasoning, bad writing and monumental self-assurance. 98 LAWSON CREATING SENTIMENT Yet it is a very close reflection of popular ideas. Cato, the sturdy old Roman senator, succeeded in stirring the Romans to action against Carthage by adopting as his slogan, "Carthago est delenda" Car- thage must be destroyed and impressing it upon the minds of the people at every occasion. Lawson has chosen a "Carthago est delenda" in his phrase, "the Stock Ex- change must be closed." He attributes the high cost of living and all our other economic ills to Stock Ex- change gambling. His explanation of the high cost of liv- ing is very simple and easy to understand. It amounts to this, that the great corpora- tions of the country that supply us the necessities of life through unbridled stock watering have increased their capitaliza- tions to such an extent that they have found it necessary to charge double or triple prices for their products in order to 99 WHAT EVERY INVESTOR SHOULD KNOW pay satisfactory dividends to their stock- holders. Thus, if fifty per cent of the stock of the Steel Corporation is water then steel prices must be twice as high as they would be if there were no water. For twice as much must be paid to the stockholders in dividends. Supply and demand, the currency and the tariff, are no longer factors in the sit- uation. Now that Mr. Lawson has let the "Sys- tem's" cat out of the bag we may, no doubt, expect further rapid rises in prices. For soon everybody will be "doin' it." The outlook for the salaried man would certainly be discouraging, but happily a remedy suggests itself by which he can raise his salary at will and thus keep abreast of the times. Let him incorporate. Jones, the $l,000-a-year bookkeeper, may form the Jones Bookkeeping Com- pany. With a capital of $20,000 his pres- ent salary will pay 5 per cent dividends. 100 CORRECTING MISTAKES NECESSARY To double his salary all he need do is to reorganize with a capital of $40,000. It is obvious that in order to keep on paying 5 per cent dividends he will simply have to draw a salary of $2,000 a year instead of $1,000. This flapdoodle is an excellent example of a tendency to superficiality, which has become almost a national characteristic. Instead of searching rigorously for the causes of whatever economic ills we are subject to, instead of digging to the very bottom of our currency and taxation ques- tions, for example, we are coming to be- lieve that we can benefit ourselves more by injuring those who have profited by our mistakes than we can by correcting the mistakes themselves. "Stop thief" is ever on the tips of our tongues. The man who is more fortunate or more industrious or more thrifty or more far-sighted than ourselves we are prone to call "Robber," and to seek to de- prive him of what he has accumulated by 101 WHAT EVERY INVESTOR SHOULD KNOW passing laws which ultimately will only operate to deprive us of what we, our- selves, may save. Like the doctor who dopes his patient with morphine, or asperin, or bromides to stop the pain and goes no farther toward eradicating the real cause of the pain, we are doping our social system with laws which, though they may afford temporary relief, will only result in the end in under- mining the very foundations of the struc- ture itself. There probably has never been a period in all history when it was easier for the individual, be he laborer or banker, doctor or mechanic, through ordinary industry and thrift to live comfortably, raise a fam- ily and accumulate a competency than it is right here and now in ipij in the United States of America. But legislation is not now and never can be a substitute for industry and thrift, and no amount of bunkum will make a states- man. 102 MUCH LEGISLATION PREPARED Every investor should take to heart this example of our eagerness for legislative dope, which has no relation to the real cause of our troubles, and he should take steps to place his investments beyond the power of the quacks who prescribe it. Already much legislation along the lines proposed by Mr. Lawson has been pre- pared for the Federal and State govern- ments to consider and a good part of it will likely be enacted into law. What effect will this have upon the functions of the Stock Exchange? There is no question but what a large part of the business of the Exchange is in the nature of gambling. Mr. Lawson makes the statement that "the legitimate business transacted by the Stock Exchange is infinitesimal compared with its gambling business." It is just this speculative element, how- ever, that makes it possible for the Ex- change to perform so perfectly its function 103 WHAT EVERY INVESTOR SHOULD KNOW of providing at all times an instantaneous market. No matter how tight money becomes or how shaken the public confidence, the New York Stock Exchange is always able to produce a buyer at some price for what- ever securities are offered for sale there. This is because someone is always willing to take a chance. But if all gambling or speculation were eliminated, the business of the Exchange would be cut down to an "infinitesimal'' part of what it now is under natural condi- tions, and its efficiency in providing an in- stantaneous market would be impaired to the same extent. Mr. Lawson's "Rem- edy" may be a sure specific for all our trou- bles, but it will injure investors in this way. . It follows therefore that the present-day investor should contract his holdings of securities listed on the New York Stock Exchange to the narrowest possible limits. For the safety of these securities is being 104 REAL ESTATE MORTGAGES SAFEST impaired and their marketability is likely to be restricted also. This applies especially to railroad and public utility bonds and in a lesser degree to industrial bonds. Securities belonging to any of these classes and not listed on the New York Stock Exchange should be avoided, for such securities while being depreciated in the same way as the listed ones by rate re- ductions and other regulation do not com- mand a ready market and hence give the investor very little chance of escape once he finds himself in wrong. The class of investments which seems least likely to be affected adversely by any of the modern tendencies is real estate mortgages. The powerful tendency of government regulation has no application to this class of investments whatever. Neither, appar- ently, have any of the socialistic tenden- cies. The single tax would have no material 105 WHAT EVERY INVESTOR SHOULD KNOW effect except upon mortgages based upon unimproved land. It probably would af- fect mortgages on a certain type of farms to a small degree injuriously, and as a rule would strengthen mortgages based on city property. The main tendency affecting this class of investments is the constant growth of our population. This growth inevitably and unceasingly increases the value of all real estate farm and city and operates to benefit and strengthen mortgage invest- ments based on such real estate. Of the two types of real estate mort- gages, city mortgages receive a greater benefit from the growth of the population than farm mortgages, because the rate of growth of our city populations is much greater than for farms. The slogan, "Back to the Land," has as much meaning for the investor as for the city dweller who seeks emancipation from the drudgery of urban life. This is a period of economic, political 106 BEST BASIS FOR INVESTMENT and industrial readjustment. In the pro- cess we have seen how the security and value of most forms of investment are be- ing or are about to be affected. Of all the bases for investment the land alone can be relied upon to stand the shock of changing conditions and to increase constantly and certainly in value. 107 CHAPTER IX. Mortgage Investments Ours Compared with the German Mortgage System Mortgage Bonds in the United States. F I ^HE original and most familiar type of the real estate secured in- M vestment is the straight or indi- vidual mortgage. The objections to straight mortgages as investments are their lack of convertibility and their incon- venience. There is no market for mort- gages. The investor must hold them until they fall due or sometimes may sell them at a discount. And they come in odd amounts and carry with them the burden of watch- ing taxes and insurance renewals. Several plans or systems have been evolved in this country and abroad for the purpose of overcoming these objections, but during the last century the tendency 109 WHAT EVERY INVESTOR SHOULD KNOW practically the world over among civilized countries has been toward the adoption of the German Mortgage System. We will here compare that system with the one in general use in the United States. In this country, if you want to borrow money on your real estate, you go to your banker or mortgage broker, or real estate agent, and give your mortgage and exe- cute mortgage notes to the amount he will loan, paying him, in addition, a commis- sion for the negotiation of the loan. The broker, however, has not taken the mort- gage for his own investment, he is simply a middleman. A third party the investor is ultimately the real lender. Having the right amount of idle savings he buys from the broker, at par and interest, your mortgage. The broker is then out of it. His profit is represented by the commis- sion charged the borrower. Now let us see how this system works out for the borrower, and then for the lender. no TIME TOO SHORT TO PAY OFF As we saw above, the middleman is mak- ing loans to sell. He must make them in the form most attractive to investors; the borrower's needs are not considered. This form is more or less standardized. It generally means a straight loan of three or five years, without privileges of pay- ment before maturity, or of reduction of principal by periodical installments. Now, three or five years is too short a time in which to pay off a real estate loan. Theoretically, every loan, no matter what its character, should be repaid from the accomplishment of the purpose for which it was made. A loan to a farmer to help him buy a farm should be paid from the crops raised on the farm. A loan to a householder to buy a home should be re- paid as the rent would otherwise be paid. The income from real estate is slow and three or five years is too short a time for doing this. The borrower meets his inter- est payments promptly enough, but at each maturity of his loan depends on a renewal 111 WHAT EVERY INVESTOR SHOULD KNOW to take care of the principal. Every re- newal means a new commission and some- times rates are high and money tight and a foreclosure hangs over his head. Then we have a touch of what the French have called the "Mortgage Leprosy/' We say "have called," because that was a long time ago. They don't have it any more. And now about the investor. The mortgage was made to suit his needs. What does he get? His is a short term investment, paying a comparatively high rate of interest and based on security fundamentally the best. As an invest- ment, however, it is open to several more or less serious objections. First of all, mortgages are not converti- ble. There is no public market for them as there is for bonds and stocks. To sell a real estate mortgage generally means a discount of at least one per cent. Then again, mortgages come in odd amounts, generally too large for the small investor and often inconvenient for the 112 PERSONAL EQUATION IN SALE large one. An attempt has been made by some mortgage dealers to obviate this by dividing one large mortgage note into a number of smaller notes, all secured by one mortgage really a small bond issue. But many experienced mortgage investors ob- ject strongly to this. The personal equation is a strong ele- ment in the sale of all investments. Per- haps 90 per cent of every sale is dealer's recommendation and 10 per cent buyer's judgment. The mortgage broker says: "I am an expert. I have investigated this property thoroughly and after doing so loaned my own money on it. I recommend it to you." And the investor says: "All right, That's enough for me. I'll take it." And yet the broker becomes in no way responsible for the mortgage he has sold. Should the mortgagor default in payment, the investor would have no recourse on the broker on whose recommendation he made the investment. As a matter of fact. 113 WHAT EVERY INVESTOR SHOULD KNOW the broker's interests in the matter may be directly opposed to those of the investor. For example, if the broker is also a dealer in real estate, he may make many loans simply to aid in the sale of properties. These loans must be made as full as pos- sible. From the investor's standpoint, how- ever, loans should be made with the widest possible margin of security instead of the least, and where the broker makes his loans as a real estate seller instead of as an investor, his recommendation becomes tainted with a self-interest that makes it worthless. So much for our American System. It is true that we get along with it pretty well, just as we do with our faulty cur- rency and banking system, but the objec- tions pointed out above are very real ones and, as we shall presently see, such things as an inflexible, harsh and unfair loan plan, an investment dealer with responsi- bilities but illy-defined, and a mortgage in- 114 EUROPEAN MORTGAGE SYSTEM vestment with faults such as ours, are matters of ancient history abroad. A certain traveler, famous in English fiction, patronizingly adopted as his slogan, "One does these things better in France." It is true in this case not only of France, but of practically all of Conti- nental Europe. The modern European Mortgage Sys- tem dates back to the early part of the reign of Frederick the Great. The old warrior's vigorous military campaigns, one of which was the Seven Years' War, had greatly depleted his country's resources. Crops had been destroyed, cattle driven away and barns and farm buildings left to the ravages of time and tempest. Under these conditions, when peace finally came, investors refused to put their money into farm mortgages, thus leaving the farmers without funds for making their crops and rebuilding their homes. Ruin stared the country in the face. Into this crisis stepped Buering, the 115 WHAT EVERY INVESTOR SHOULD KNOW Berlin merchant. From the vantage point of the outsider, he had seen the trouble coming and out of his clear business brain had formulated an ideal plan the fairest and soundest in finance. His Mortgage System with but few changes was destined to become a component part of the mone- tary system of every great country in Con- tinental Europe. Much credit also is due the great king, who, when the plan was laid before him, personally contributed the first funds necessary. The success of Buering's idea was im- mediate. It soon spread throughout all Germany and shortly the first mortgage banks were organized. The system works something like this. As is the case here, there are three parties to every real estate loan transaction the borrower, the mortgage bank and the lender. If you want a loan on real estate in Germany today, you go to a mortgage bank and give your mortgage and notes 116 LONG-TIME LOANS MADE exactly as you do in this country. The mortgage bank, however, though the mid- dleman, does not sell your mortgage directly to the investor. And this is the crux of the whole system. Instead of turning over your mortgage in the form made by you to the investor, the mortgage bank holds the mortgage among its assets and issues its mortgage bonds to the amount of the loan made you, which bonds are then sold to investors. To get the whole idea clearly in mind, let us see how it applies to each of the three parties concerned. In view of the fact that the loans as made are not sold directly to investors, the form may be varied to suit each individual borrower's needs. Accordingly, practi- cally all loans are made for terms of from ten to fifty years and on what is called the amortization or installment plan. Under this plan, provision is made for periodical payments on the principal of the debt as well as the interest. The borrower may 117 WHAT EVERY INVESTOR SHOULD KNOW pay off his loan at any time or make pay- ments ahead as he gets extra money. Thus the loan becomes his savings account. It is made for a term long enough to make possible its repayment out of the in- come from the property mortgaged. Its very form helps the borrower pay it back. Every year he finds himself just so much ahead of the game and when the term of his loan ends, he has his property free and clear of debt. Needless to say, foreclos- ures are infrequent under this system. The mortgage bank, instead of selling the mortgages it takes directly to investors, holds them among its assets and issues its mortgage bonds against them. These are direct obligations of the bank, secured by all its assets. They bear a rate of interest from a quarter of one per cent to one per cent lower than the mortgages securing them, and this difference represents the mortgage bank's profit. This means that the investor, instead of 118 MARGIN OF SECURITY INCREASES a straight mortgage, gets a bond secured by at least an equal amount of first mort- gages, and, in addition, by all the other assets of the mortgage bank. In other words, he gets the same first mortgage security that he had under the old system, together with the absolute guarantee of the mortgage bank issuing the bonds. Moreover, the mortgage security is of a better class than under the old way. This is true because the amortization plan of making loans gives the borrowers every chance and greatly decreases foreclosures. Also the periodical principal payments re- quired under this plan steadily increase the margin of security behind the bank's mortgages making them better and bet- ter with each payment. Then, too, the Mortgage Bond held by the investor is se- cured, not by a single mortgage, but by all the mortgages held in the bank's assets. These mortgages mutually insure one an- other. Should any one mortgage fail no investor would be injured, for the other 119 WHAT EVERY INVESTOR SHOULD KNOW mortgages and the bank's other assets in- sure against this. Besides these advantages in point of security the investor gets an investment convenient as to denominations and form and one that may be listed on the Stock Exchanges and sold in the public market, thus assuring convertibility. So beautifully has the mortgage system formulated by the German merchant worked out that today it is in use in prac- tically all the countries of Continental Europe. Interest rates in those countries have been reduced, violent fluctuations in rates are a thing of the past, and the in- troduction of much foreign capital for lending on real estate has been made pos- sible. Today over six billion dollars' worth of Mortgage Bonds are listed on the various European Stock Exchanges and so highly are they esteemed by investors that they are sold at prices to yield from 4 l / 2 per cent down to as low as 3 per cent, and it 120 MORTGAGE BONDS FLUCTUATE LESS has been noted that over a large period of years Mortgage Bonds have fluctuated less than any other class of listed securities, government bonds not excepted. In this country the German Mortgage System is by no means unknown. For years certain trust companies in New York, Chicago, St. Louis, Philadel- phia and other of our large cities have been successfully working under this plan until today millions of dollars of domestic Mortgage Bonds are held by investors. We have made one great improvement over the European system. Here a com- pany issuing Mortgage Bonds, instead of holding the mortgages it makes in its own assets, places them in the hands of a trustee, generally another trust company, to be held in trust for the security of the bondholders. Thus the investor obtains a specific security in mortgages equal in amount to the bond issue, and in addition is protected by all the other assets of the company as well. In the trust agreement 121 WHAT EVERY INVESTOR SHOULD KNOW securing the bonds, provisions are made specifying exactly what kind of mortgages will be accepted as security, what character of property must secure them and what percentage of the actual value of the prop- erty may be loaned. In most of our States, compliance with such terms is made certain by periodical examination under the direction of State Banking Commissions, and, in addition, in New York, Chicago and St. Louis, the affairs of banks and trust companies are regularly audited and examined by the expert accountants connected with the local Clearing House Association. These additional provisions safeguard- ing investors make Mortgage Bonds, where they can be obtained, the ideal of conservative, non-speculative investments. They are superior to straight first mort- gages in point of security, convertibility and convenience. The security, generally improved city home property, is funda- mentally stable and non-fluctuating in 122 YIELD A HIGHER RATE character. It is not affected by legisla- tion, strikes or panics. In addition. Mort- gage Bonds in this country yield a higher rate of income than is obtainable from any other investment of the same security. 123 CHAPTER X. The St. Louis Mortgage Bond Company Methods of the Title Guaranty Trust Company How Its Loans Are Made. IN St. Louis, for example, the Mort- gage Bond company is the Title Guaranty Trust Company. This Company was organized in 1901 under the trust company laws of the State of Missouri and is subject to the super- vision and examination of the State Bank Commissioner. It conducts a general trust company business in all its branches, with the exception of the acceptance of time and demand deposits. This business includes the examination and guaranteeing of titles to real estate, the rental of safe deposit boxes, the acting as trustee under bond issues, registrar and transfer agent for corporations and the 125 WHAT EVERY INVESTOR SHOULD KNOW making of real estate loans and issuing Mortgage Bonds secured thereby. The Company owns and occupies the. twelve-story Title Guaranty Building at Seventh and Chestnut streets. Its officers and principal employes are men who have spent the better part of their lives in the business, and twenty-five successful St. Louis business men compose its Board of Directors. The Title Guaranty Trust Company has a full-paid capital of $2,500,000 and total resources of over $3,500,000. It is not engaged in the banking business and has no demand deposits or other liabilities sub- ject to call, thus obviating the possibility of unexpected drains upon its resources to which other financial institutions may be subjected. The Mortgage Bonds of this Company are secured by the deposit of first mort- gages on improved city real estate, with the American Trust Company, trustee. For this purpose it is provided that the 126 NOT A SINGLE FORECLOSURE Trustee shall accept first mortgages on improved city real estate and nothing else. Loans on farms, vacant property, churches, clubs, theatres, second mort- gages, leaseholds and undivided interests are excluded. The loans made by this Company and used as security for its Mortgage Bonds average less than fifty-five per cent of the appraised value of the property on which they are based. They are made on a serial plan requiring reduction by periodical pay- ments, which insures against loss through depreciation and greatly increases the margin of security. The high character of these first mort- gages and the conservative methods of the Company are demonstrated by the fact that during a period of twelve years, in which nearly three thousand loans aggre- gating approximately six million dollars have been made, not a single foreclosure on account of default in payment has been necessary. 127 WHAT EVERY INVESTOR SHOULD KNOW The Title Guaranty Trust Company is ideally constituted to conduct a Mortgage Bond business in the most conservative and scientific manner. The Company's only obligations are its Mortgage Bonds. These are issued for any length of time the investor desires, and the maturities are thus diffused over a long period. Hence, only a small pro- portion of the whole amount of bonds can 'fall due in any one month, or, indeed, in any one year. The Company guarantees its bonds and binds itself to buy them back at par and interest on any interest date on receipt of thirty days' notice. Interest dates are dis- tributed through the twelve months of the year, so that only a fraction of this liability can possibly accrue at any one time. Let us compare this with the liability of a bank receiving demand deposits, savings deposits payable on thirty days' notice, and time deposits payable at stated periods, and the solidity of the Title Guaranty 128 DEMAND DEPOSITS PAID FIRST Trust Company's position will be em- phatically demonstrated. Such a bank may be called on for all or any part of its demand deposits at any time and will have to meet the demand or close its doors. With a reserve of fifteen per cent or more, this is perfectly safe business both for the bank and for the de- positor. Danger arises only in times of financial disturbance or panic, when con- fidence may become impaired and all the depositors attempt to withdraw at the same time. In such a case both depositors and bank must suffer. The provision for thirty days' notice be- fore the withdrawal of savings deposits is a protection to the bank, but actually in- creases the risk of the savings depositor. For in a time of stress the bank will have to pay its demand deposits first and the savings depositor must take what is left. This is also true of the time depositors or those holding time certificates of de- posit 129 WHAT EVERY INVESTOR SHOULD KNOW The savings and time deposits of a bank are secured by exactly the same assets as the demand deposits, but the demand de- positor holds the position of a preferred creditor because he can enforce payment of his account ahead of the others. These elements of danger both to the bank and the depositor and it must be un- derstood that wherever there is danger for the one there is danger for the other are totally absent in the case of the Title Guaranty Trust Company and its Mort- gage Bondholders. The Company accepts no demand depos- its which might be subject to a "run" in times of panic. Its only obligations are its Mortgage Bonds, and, as explained above, only a small fraction of these could possibly fall due at any one time. And it has no other obligations which could in any way be preferred to its Mort- gage Bonds. Moreover, these bonds have behind them 130 THESE BONDS DOUBLY SECURED not only the general assets of the Com- pany, but, in addition, are secured by spe- cific mortgages which are separated from the other assets of the Company and de- posited with another trust company, the trustee, for this particular purpose and no other. These specific mortgages afford an im- portant additional element of strength in the situation in that they supply a constant inflow of cash which may be utilized at any time to pay off bonds as the demand arises. This supply of cash is independent of the Company's other resources and is of itself more than sufficient to meet any de- mands which the bondholders are likely to make on the Company. It consists of payments made on the mortgages in the hands of the trustee. These payments average each year an amount greater than twenty-five per cent of the total bonds outstanding. Ordina- rily this money is reloaned as fast as it 131 WHAT EVERY INVESTOR SHOULD KNOW comes in. But in case of need the Com- pany has only to stop making loans and the cash will pile up. Furthermore, the Title Guaranty Trust Company does not engage in the buying and selling of real estate. A company that does engage in this business is not the best investment agent. For in buying and sell- ing real estate it is often necessary to "boost" values to an unwarranted extent and to make full loans in order to put over sales. This Company does not deal in real es- tate as an agent nor does it speculate in real estate on its own account. It has no interests adverse to its investment busi- ness, the business of lending money safely. It specializes in loaning money upon real estate, and the business is so organized that the security behind every dollar loaned is appraised and investigated under the most thorough and scientific methods. Each applicant for a loan is required to make an accurate statement of all condi- 132 THOROUGHNESS OF INVESTIGATION tions within his knowledge affecting the value of the property. He must give ref- erences and other proofs of financial responsibility. The property is then examined and ap- praised by an expert who has made this his lifework one whose knowledge of building methods, costs and property values particularly fits him to judge accur- ately the worth of both real estate and the improvements thereon. The appraiser makes a detailed written report containing photographs, plans, statistics and other facts summed up in actual figures as to his judgment on the property. His report is then submitted to the Company's Executive Committee, which is composed of the president, four vice-presi- dents and seven directors, five of whom are real estate experts. This committee exam- ines every loan application, revalues the property and renders its decision thereon. Of the applications that reach the commit- tee many are rejected. Only the choicest loans are made. 133 CHAPTER XL The Guarantee in Merchandising Why Investments Should Be Guaranteed A Guaranteed Mortgage Bond The Most Convenient Form The Ideal Invest- ment. i last forty or fifty years have witnessed a revolution in the principles and practices of mer- chandising. Under the lead of such men as Marshall Field, A. T. Stewart and John Wanamaker business has discovered that the Golden Rule is golden. That it pays. It was once thought that a bargain had but one side, and that the shrewd busi- ness man always got the best of his cus- tomer. Caveat emptor, let the buyer be- ware, was the legal expression of this attitude. Now we know that there should be two 135 WHAT EVERY INVESTOR SHOULD KNOW profitable sides to every bargain. And that the best bargain is the one that profits both parties the most. The modern merchant says to his cus- tomer: "These goods are guaranteed to be exactly as represented. Your money back if not satisfied." Gloves, socks, automobiles, pickles and pants are sold this way. Investments, however, are generally not guaranteed. The investor who buys a mortgage from a real estate agent or a bond from a broker does so on trust on his own risk. Neither the agent nor the broker guarantees his goods. And this puts the investor at a peculiar disadvantage. In buying a pair of gloves he can test the goods for fit and the most cursory examination will disclose any de- fect in the manufacture before he buys. But all mortgages and bonds look and feel alike. The ordinary investor's judg- ment on real estate values is not worth much and he knows it. And as for judg- 136 DIFFICULT TO JUDGE INVESTMENTS ing the security behind a railroad bond only the expert can pretend to do that and it is mostly pretense with him. The investor can never know whether he has made a bad investment or not until he fails to receive his principal or interest. And then it is too late to apply a remedy. So ordinarily investments must be bought on trust without a guaranty. The investment dealer says to his customer: "Here is a bond into which I have just put my own money. I have investigated the security to the best of my ability. I be- lieve it is good and I recommend it to you as a safe investment." This is the best the investor can get and he has got to make the most of it. But without reflecting on his honesty, the in- vestor cannot help but feel that the dealer has a pecuniary interest in the sale, which makes his recommendation more or less biased and that although he has put his own money into the investment he is get- ting it out again as fast as possible. 137 WHAT EVERY INVESTOR SHOULD KNOW He cannot help but suspect that the broker will make more out of selling him a risky investment than a certainly safe one. Now, these are some of the reasons why investments should be guaranteed. We realize that many investment houses proudly boast that no client of theirs has ever lost a cent on investments made through them. And we do not doubt that in many cases such statements are founded on fact. For it is plain that the successful investment house will be the one which offers its clients the least number of bad investments. It is obvious, however, that on the whole the investor is not sufficiently protected. The technical nature of investments is such that he must buy them almost wholly on trust, and where he misplaces his trust or where those in whom he trusts make errors in judgment he is forced to suffer through no fault of his own. This risk is entirely eliminated in the 138 THESE BONDS GUARANTEED case of Mortgage Bonds. For these bonds are guaranteed and can be cashed at the option of the holder at par and interest without discount or expense. The Mortgage Bond issued by the Title Guaranty Trust Company of St. Louis is secured by a deposit of first mortgages on improved city real estate with the Amer- ican Trust Company as trustee. And in addition this bond is the direct obligation of and guaranteed by the Title Guaranty Trust Company. And the Company absolutely binds itself to cash the bond at the option of the holder at par and accrued interest without dis- count or expense on any interest date on receiving thirty days' prior notice. This is provided in the bond itself. Thus this bond must always be worth 100 cents on the dollar. It cannot fluctu- ate in value, and its security cannot be impaired by legislation, politics, strikes, panics or market manipulation. The Title Guaranty Mortgage Bond is 139 WHAT EVERY INVESTOR SHOULD KNOW issued as a registered bond. That is, in- stead of being made payable to bearer, having interest coupons attached and com- ing in fixed denominations and for a fixed period, it is made payable to the purchaser alone and is registered in his name. In- terest is paid by check mailed to the owner every six months. And this bond may be issued in any amount from $50 up and for any length of time from one year up. The registered bond thus has a number of obvious advantages. It may be transferred from one owner to another only by presentation at the office of the Company. Hence, no one but the real owner can obtain either the in- terest or the principal, and the risk of loss or theft is eliminated. The payment of interest by check in- stead of coupons has been found to be a great convenience for the investor. He may select any interest dates he desires, and as the checks are mailed to him auto- matically he is saved the bother of clipping 140 EXCEPTIONAL ADVANTAGES coupons and keeping track of the periods when they fall due. Perhaps the greatest advantage in con- nection with this bond lies in the fact that it may be had for any amount and for any length of time. It is no longer necessary for the investor to make his investments in units of $1,000 and be forced to allow anything under that amount to lie idle. He may now invest any sum from $50 up. Even odd amounts like $330 or $1,750. And he may arrange his investment so that it will come due at any time he desires. Thus he is enabled to keep all of his money invested all of the time. Title Guaranty Mortgage Bonds are also issued in the form of coupon bonds in denominations of $100, $500 and $1,000. And, lastly, the income from this bond is the highest consistent with perfect safety. The Title Guaranty Mortgage Bond yields 5 per cent net. Abroad mortgage bonds yield from 3 per cent to 4^/2 per cent. And in this 141 WHAT EVERY INVESTOR SHOULD KNOW country the best railroad and public utility bonds yield from 4 per cent to 5 per cent. But this bond, guaranteed, cashable at par and superior in point of security and con- venience, yields full 5 per cent net. Is this not then the ideal investment? At a period when most other forms of in- vestment are being affected adversely by such well-founded and far-reaching eco- nomic tendencies as government regula- tion, socialistic legislation and the single tax, here is one which not only is not affected by any of these, but is actually strengthened by another tendency equally strong that of increasing real estate values due to the rapid growth of city population. And this investment is absolutely guar- anteed, yields 5 per cent net and is cash- able at par at the option of the holder. 142 .RETURN TO the circulation desk of any University of California Library or to the NORTHERN REGIONAL LIBRARY FACILITY Bldg. 400, Richmond Field Station University of California Richmond, CA 94804-4698 ALL BOOKS MAY BE RECALLED AFTER 7 DAYS 2-month loans may be renewed by calling l-yeaMotrfsma? be recharged by bringing books Renewa^and recharges may be made 4 days prior to due date - DUE AS STAMPED BELOW YB 18232 UNIVERSITY OF CALIFORNIA LIBRARY