This section is from the "Practical Banking" book, by Albert S. Bolles.
A class of loans which has done more than any other to bring our banking institutions to grief, within the last twenty years, is that on railroad bonds. It is very pertinent, in spite of all that has been said and written about it, and while the experience is fresh and painful, to point out the reason why such loans were disastrous, and to indicate the inherent quality which made them so. This leads us to say a few words about commercial, or rather financial, crises, and the steps which lead to them. The soundest maxims and practices prevail in the business world after a crisis and liquidation. Convalescence and repentance go hand in hand, the world over. When business is fairly resumed, in the good time now coming, we shall see every class of business men proceeding with the greatest caution. Miners and manufacturers will be careful not to overstock the market; merchants will sell on short credit, and scrutinize the means and character of their customers; banks will keep their money in the till, rather than make doubtful loans; investors will be content with a low rate of interest, so long as the security is undoubted ; speculation and the speculator will be read out of all decent society, and the men who get up pools and corners will be avoided by all who need credit and are careful of their reputation. Contentment economy, and good morals will prevail, and for a time we shall constitute a model society. But by and by we shall tire of too much 'virtue; the wheels of industry and exchange will move more rapidly, competition will be sharper, accumulating profits will encourage more luxurious living, luxury will multiply wants faster than the increase of means, higher profits will be demanded and greater risks will be assumed to realize them; speculation, which is oftener the offspring of artificial wants than of the love of gambling for its own sake, will take the place of slow and plodding industry. This will be the progress of things in one direction. A progress more potential and not less dangerous will, at the same time, go on in another. Capital accumulates more rapidly in prosperous seasons, than the chances which offer for its employment. Surpluses accumulate, and with them the channels of investment widen. The first use of a surplus is to increase reproductive capital; but there is a limit to the use of such capital. To augment it too rapidly would lead to over-production and over-trading, and these will inevitably occur before capital consents to seek remoter and slower resting places. But seek them ultimately it must and ought, for otherwise civilization would cling to its old centers, and the extremities would never be opened up or enriched. This process involves the conversion of floating into fixed capital, or to use the more expressive European phrase, the immobilization of capital. Capital arising from the profits of business, and invested in lands, buildings, factories, railways, mines and furnaces, is thus immobilized. The degree of immobilization is greater or less, according as the resulting revenue from the investment is more or less remote. If a quick return is yielded, and that return does not involve over-production, the proceeding is wise and healthy. If, on the other hand, the return is uncertain, or very remote, there is great danger that capital, instead of being immobilized merely, may be absolutely lost. It is rarely possible to compute with accuracy the cost of a great undertaking, or foretell the period of its fruition. The disposition to spread present means over a great deal more ground than it can fairly fructify, is as universal as the disposition among farmers to cultivate too much land.
Now, let us apply these principles to our past railway constructions. The two dangerous elements to which we have adverted, speculation seeking illegitimate profits, and surplus capital driven to seek remote investments, cooperated to make it what it was. Men without capital did most of the speculating, men with more capital than they knew how to employ profitably furnished the means. But the means available proved to be sadly inadequate to the undertaken schemes. It became soon apparent, in almost all cases, that to save the surplus first invested, the capital, vital to business, must be encroached on. Thus, little by little, the working capital of the country—not its savings, but its life—was drawn into the fatal vortex. This working capital is like the grease which greases the wheels of the farmer's wagon. If not seasonably supplied, the heated axle utters its notes of alarm, and if this goes unheeded, the wheel is set fast and the vehicle is stopped. The wholesale construction of railways on credit was a business of which the country had no experience, and this is the only excuse for the gross violation of sound business principles which it involved. The banks were no wiser than the people. They began to lend moderately, on the security of railway bonds, before railways had been discredited, and when they had a surplus of capital to lend; and they ended by lending immoderately on the same security, after its treacherous character had been disclosed, in the vain struggle to save their past loans, or to assist customers whom they were unwilling to see go to the wall. Very largely, also, in 1871-2, and '73, they lent to railways, on railway securities, for the sake of illegitimate interest, by which we mean not such rates as merely violate the usury laws, but such as no healthy business ever did or ever can pay. They were lending to a spendthrift heir on the doubtful security of a post-obit bond. There is no danger that this folly will be repeated in our time, but there are always snares set for the unwary, and the next decade will doubtless disclose its own peculiar temptations, and a period of prosperity will hardly escape the usual dismal ending.