Subsidies for canals, as we observed, were common. States and municipalities, competing with one another for railroad lines they thought would bring everlasting prosperity, also helped the railroads, though on a smaller scale. They purchased or guaranteed railroad bonds, granted tax exemptions, and provided terminal facilities. Several states subscribed to the capital stock of the railroads, hoping to participate in the profits. Michigan built three roads, and North Carolina controlled the majority of the directors of three roads. North Carolina, Massachusetts, and Missouri took over failing railroads that had been liberally aided by state funds. Outright contributions from state and local units may have reached $250 million—a small sum compared with a value of track and equipment of $10 billion in 1880, when assistance from local governments had almost ceased.
In contrast to the antebellum period, subsequent financial aid from the federal government exceeded the aid from states and municipalities, although by how much we cannot be sure. Perhaps $175 million in government bonds was loaned to the Union Pacific, the Central Pacific, and four other transcontinentals, although after litigation, most of this amount was repaid. Rights-of-way grants, normally 200 feet wide, together with sites for depots and terminal facilities in the public domain and free timber and stone from government lands, constituted other forms of federal assistance. But the most significant kind of federal subsidy was the grant of lands from the public domain.
In this form, Congress gave a portion of the unsettled lands in the public domain to the railroads in lieu of money or credit. Following the precedent set by grants to the Mobile and Ohio and to the Ohio and Illinois Central in 1850, alternate sections (square miles) of land on either side of the road, varying in depth from 6 to 40 miles, were given outright for each mile of railroad that was constructed. The Union Pacific, for example, was granted 10 sections of public land for each mile of track laid; five on each side of the track alternating with sections retained by the government. The alternate-section provision was made in the expectation that the government would share in the increased land values that would result from the new transportation facilities. Land-grant subsidies to railroads were discontinued after 1871 because of public opposition, but not before 79 grants amounting to 200 million acres, reduced by forfeitures to just over 131 million acres, had been given.88 This amounted to about 9 percent of the U. S. public domain accumulated between 1789 and 1904 and was slightly less than the amounts granted to the states.
Note, however, that aid to the railroads was not given unconditionally. Congress required that companies that received grants transport mail, troops, and government property at reduced rates. (In 1940, Congress relieved the railroads of land-grant rates for all except military traffic; in 1945, military traffic was removed from the reduced-rate category.) While land-grant rates were in effect, the government obtained estimated reductions of more than $500 million—a sum several times the value of the land grants when they were made and about equal to what the railroads received in land grants with an allowance for the long-run increase in the value of the land. The land grants, moreover, were in some ways a better incentive than alternative subsidies. A railroad could best realize the value of a land grant by quickly building a good track. In contrast, as we noted in the case of the Union Pacific, cash subsidies or loans based on miles of track completed or similar criteria encouraged shoddy construction (Economic Reasoning Proposition 3, incentives matter). Subsidies added to the profits and, thus, to the incentives of railroad builders until the early 1870s, but the bulk of both new and replacement capital came from private sources. The benefits of railroad transportation to farmers, small industrialists, and the general public along a proposed route were described in glowing terms by its promoters. Local investors responded enthusiastically and sometimes recklessly, their outlay of funds prompted in part by the realization that the growth of their communities and an increase in their personal wealth depended on the new transportation facility. Except in the industrial and urban Northeast, however, local sources could not provide sufficient capital, so promoters had to tap the wealth of eastern cities and Europe.
Thus, as the first examples of truly large corporations, railroad companies led the way in developing fundraising techniques by selling securities to middle-class investors. Even before 1860, railroads had introduced a wide range of bonds secured by various classes of assets.89 After the Civil War, these securities proliferated as railroads appealed to people who had been introduced to investing through purchases of government debt during the war. Although conservative investors avoided the common stock of the railroads, the proliferation of such issues added tremendously to the volume of shares listed and traded on the floor of the New York Stock Exchange.
The modern investment banking house appeared as an intermediary between seekers of railroad capital in the South and the West and eastern and European investors, who could not easily estimate the worth of the securities offered them. From the 1850s on, the investment banker played a crucial role in American finance, allocating capital that originated in wealthy areas among those seeking it. J. Pierpont Morgan, a junior partner in the small Wall Street firm of Dabney and Morgan, joined forces in 1859 with the Drexels of Philadelphia to form Drexel, Morgan and Company. Along with Winslow, Lanier and Company and August Belmont and Company, Morgan’s house grew rich and powerful by selling railroad securities, particularly in foreign markets. European interests eventually owned a majority of the stock in several railroads; English, Dutch, and German stockholders constituted important minority groups in the others. In 1876, European holdings amounted to 86 percent of the common stock of the Illinois Central, and at one time, two directorships of the Chicago and Northwestern were occupied by Dutch nationals. By 1914, Europeans, mostly English, owned one-fifth of all outstanding American railroad securities. We will discuss the role of these investment bankers in more detail in chapter 19.
World History
