Not long ago, I paid $25 at an antiques store to buy an old $1,000 bond that now hangs, framed, in our office in Scarsdale, N.Y.
The beautifully engraved bond was issued by the Lehigh Valley Terminal Railway Company, a newly organised subsidiary of the Lehigh Valley Railroad, on Oct. 1, 1891. It recites that the railroad “acknowledges itself indebted to the bearer hereof in the sum of One Thousand Dollars in gold coin of the United States of America of the present standard weight and fineness, of which sum the said company agrees to pay in like gold coin to the bearer” on Oct. 1, 1941.
In other words, this was a 50-year bond. It carried a coupon interest rate of 5 per cent, together with that promise to repay principal, in gold coin, a half-century after it was issued.
That promise was never kept. In fact, it could not legally have been. In 1933, one of President Franklin Roosevelt’s first acts was to nationalize all American gold holdings. He devalued the dollar by 75 per cent and ordered all U.S. citizens and companies to exchange their gold for the paper money that was declared legal tender for all debts, public and private. So, by 1941, the railroad could not have redeemed its bonds for U.S. gold coin, but only for paper money. It did neither.
Having survived the Great Depression, the railroad apparently did not find itself in a position to retire the bonds. Britain was struggling to hang on against Hitler’s Third Reich, and America was shipping Lend-Lease goods for the Allies as fast as they could be hauled and loaded. The bond was extended to 1951.
But it was not repaid in 1951, either. The railroad’s key freight business, hauling anthracite coal from the Pennsylvania mines, went into a steep decline after World War II. Passenger service also became unprofitable as travellers took to the new turnpikes in their equally new automobiles. Somehow, the railroad prevailed upon bondholders to grant another extension, to 1979.
By 1962 most of the Lehigh’s operations had been folded into the Pennsylvania Railroad, which staggered into a 1968 merger with the New York Central to become the Penn Central. The Penn Central itself went bust in 1976, when the federal government combined it with five smaller lines to form Conrail. By that time, my bond’s only value was decorative.
If you think this tale is just a bit of quaint economic history that has no relevance today, note that railroad titan Norfolk Southern Corp. recently sold $250 million worth of 100-year bonds with a 6 per cent interest rate. The company had originally planned to sell only $100 million of the bonds, but investors were so eager to hand money over to the railroad for a century that it decided to increase the size of the offering.
Although they have enjoyed occasional periods of limited popularity, century bonds are rare. The last time an American company offered such long-term bonds was in 2005, when Norfolk Southern sold an earlier round of $300 million in century bonds.
There is a good reason why these bonds are so uncommon: A hundred years is a long time. As my old bond demonstrates, even half that span brought world-changing events that nobody could have imagined in 1891, including two global wars, an unprecedented depression, the rise of totalitarianism and the outlawing of gold currency.
Why would anyone want to lend money for a century? And, especially, why would anyone today lend money for 100 years to a railroad, a 19th-century business that will need to survive well into the 22nd century to repay the debt?
To be fair, railroads remain the most efficient means of moving bulky, heavy freight across long distances over land. Warren Buffet’s 2009 decision to acquire Burlington Northern Santa Fe (like Norfolk Southern, one of the country’s four major transcontinental lines) for $26 billion was, if not wise, at least not irrational. But Buffet bought an entire railroad. Norfolk Southern’s bondholders are merely buying a 100-year promise.
Even if the railroad industry remains strong, the fates of individual railroads can rise and fall. Railroads, after all, are prisoners of their route systems. When economic growth shifts to new geographic areas, the railroad can’t just pick up its tracks and follow the customers. Betting on a specific railroad for an extended time, therefore, carries extreme risk. The largest railroads are counting on their geographic reach to diversify this risk. But, of course, even the largest North American railroads are mainly confined to one country. If economic activity moves overseas, the railroads can do little to make up for the lost business.
In the present low-interest-rate environment, companies have good reason to lock in long-term financing. They must pay a little extra to investors compared with short-term financing, but they do not need to worry about having to refinance the debt later when rates might be less favourable. Nofolk Southern spokesman Robin Chapman explained: “We decided to reopen these 100-year bonds based on the current low interest rates and the strong appetite among buyers for them.”
That “strong appetite” basically shows that bond buyers are, at present, delusional. They are chasing high yields in today’s low-yield environment, heedless of all the economic, credit and interest rate risk (these bonds’ values will plunge when rates rise) they are assuming. Because those risks are not factors today, bond buyers are convincing themselves they will not arise in the future — even though, over a century’s time, they assuredly will. Investors foolishly persuade themselves that a single company’s 100-year promise is less risky than a diversified basket of stocks. Many of these investors are pension funds and insurance companies that are, absurdly, pretending that a 100-year bond aligns well with their own cash needs over the next two to seven decades.
They won’t even get a pretty wall hanging to show for it. Modern bonds are issued in “book entry” form, existing only as bytes of data. No beautiful engravings. No 119-year old piece of paper to remind future investors of all the things that are going to change, even if today’s investors want to imagine that the 22nd century will look just like the 21st.
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