Funding the tube

A century ago London’s Underground was renovated using private bond investment. The American financier responsible, Charles T Yerkes, had no trouble raising the funds, but investors learnt an early lesson in the pitfalls of financing railways, as Philip Moore explains

Those twenty-first century workers who make their way into London’s Square Mile on a daily basis would certainly have sympathised with the frustration expressed by the journalist writing for The New York Times. “One only had to attempt a journey to the City this week to realize the costly delays and vexations to which business is subjected under present conditions,” said the paper’s London correspondent. “The main artery, [from] Trafalgar Square to Bank, is so torn up that it takes cabs....thirty or forty minutes to cover a journey of less than two miles.”

London’s congestion charge notwithstanding, that description could have been written in 2004. Instead, it was published in September 1900, by which time Greater London had a population in excess of six million, a figure that was forecast to reach a staggering 11 million by 1930.

That prediction turned out to be an exaggeration. By 1931 there were a little over eight million people living in Greater London and by 2000 the population had dipped to about seven million. Nevertheless, if life was uncomfortable enough for the commuters of 1900 on London’s streets, it was fast becoming hellish for those relying on the City’s subterranean transportation system, which by then had been in operation for almost four decades.

The world’s first underground railway, linking Paddington and Farringdon Street, had opened in January 1863, and by the start of the twentieth century London’s outdated, steam-powered metropolitan railway was in urgent need of rehabilitation. The Chicago Tribune described the situation at the turn of the century in suitably dramatic fashion: “The tunnels were begrimed with the smoke of locomotives, the air was poisoned with their gases and the public was beginning to clamor for modern methods.”

That noxious mix was starting to have a very damaging influence on passenger numbers and hence on operators’ profitability and share prices. But salvation was to come in the form of a 63-year-old American financier named Charles T Yerkes.

Chequered history
Yerkes had established his formidable reputation in Philadelphia, where he was born in 1837. There, he specialised in dealing in first-class government, state and city bonds, scoring his most notable coup by digging the city’s Treasury out of a hole soon after the end of the American Civil War in 1865.

But it was in Chicago in the 1880s and 1890s that Yerkes amassed his fortune, principally by spotting and exploiting the potential for railway electrification. At the same time, he developed a reputation for a degree of financial chicanery that would have made Enron look transparent by comparison, and for ruthless commercialism. When asked why he deliberately under-invested in additional capacity to meet demand for his street-railway business, he famously replied: “It is the strap-hangers that pay the dividends.” As the majority of modern-day metropolitan commuters who seldom enjoy the luxury of sitting down in urban subways will testify, he had a point.

It was not just his success in America that had brought Yerkes to the attention of those who needed capital to rehabilitate the Metropolitan District Railway in 1901. Having exploited the opportunities in Chicago to the full, Yerkes had arrived in London in 1900, acquiring the Charing Cross, Euston and Hampstead Underground Railroad (forerunner of today’s Northern Line) for £100,000 and pledging that his syndicate would invest £4 million in upgrading the line.

The Daily Telegraph detected new elements of American financial imperialism in the way in which electrification of the London tube was being financed, expressing its surprise that all the funding had been subscribed in the New York and Boston markets by the Yerkes syndicate, with not a penny sourced in Britain. As recently as 1895, said the broadsheet, European capital had saved America from economic disaster. Now, not only were American capitalists buying “English war loans and Exchequer bonds and German Treasury Bills...but an American syndicate declares its intention of spending several millions in order to build a railway in London on which, at best, the profit can be but moderate.”

History has proved the Telegraph’s warning to have been entirely justified, says Michael Cassidy, who in 1998 wrote a paper entitled A Private Sector Underground for London: Return of the Ghost of Charles Yerkes. Cassidy, who is now a partner at the Hammonds law firm, was part of a team that put together an unsuccessful PPP bid for part of the Underground at the end of the 1990s. As he points out in his paper on the subject, Yerkes’s enterprise, by now transformed into the Underground Electric Railways Company, was more successful in improving operational efficiencies than in producing the targeted returns. “Profits were miserable, well below the £200,000 that had been achieved during the later steam years,” says Cassidy.

Rail enthusiasts
If the London Underground venture was to prove so risky and unrewarding to its backers, why was Yerkes himself so beguiled by its potential? Why too did London’s tube excite the attention of John Pierpont Morgan (who, unusually, lost out to Yerkes in the London Underground project) as well as thousands of American bondholders?

“I think investor demand reflected the huge enthusiasm there was for railway projects throughout the world at the time,” says Cassidy. “Remember that the London scheme was relatively minor in comparison with projects such as the Panama Canal, the cross-US railways and the trans-Canadian link. There was tremendous enthusiasm for projects that people thought would transform certain parts of the world, which of course they did.”

One must not forget, too, that Yerkes imported a degree of financial dynamism and complexity that the British neither understood nor trusted. That, at least, is what the Chicago Tribune argued when it reported that “there were some things doing that the British hardly understood” and that “Western financial methods were employed” that were quite beyond the British. “There began to appear company on company, bond issue on bond issue, and all the bewildering fabric of financial companies,” said the newspaper.

So it is clear that London owes many of the foundations of its tube to Yerkes and to the American shareholders and bondholders who ultimately lost virtually all of their investment in the project, just as those who backed the construction and expansion of the New York subway did.

The losses sustained by investors in London and New York around that time more or less anticipated a trend that would characterise railway funding for the next 100 years. Paul Davies, a partner at PricewaterhouseCoopers who advised on the recent Public Private Partnership (PPP) arrangement for London Underground, says that there is not a single privately operated and financed railway anywhere in the world that pays for itself. He adds that it is easy enough to grasp why railway projects have historically tended to be unrewarding for private sector investors, given that their costs, revenues and time horizons are all unknown. And yet even as recently as the mid-1980s, the enthusiasm with which backers embraced the Eurotunnel project suggested that this was a penny that had still failed to drop. Eurotunnel overran in terms of costs and time, and has so far under-delivered in terms of revenues.

It seems that Eurotunnel was an expensive lesson that has now been learned, albeit belatedly and painfully. “The emphasis today,” says Davies, “is on learning the lessons of the last 100 years and making sure that people aren’t exposed to the same risks.” In the case of the solution to which the London Underground is now committed, he adds that the PPP has less to do with ensuring that the funding is available, and much more to do with making certain that the right people are fully incentivised to deliver on their pledges over the long term. “The start-ups where you have no certainty as to costs, revenues or completion times would be nigh-on impossible to finance these days,” says Davies.

Perhaps. But as far as London’s commuters for much of the last century were concerned, it was just as well that this particular dictum was not observed by Charles Yerkes.