Certificates

Certificate types cataloged in this project

This project divides certificates into three main "types."

• Stocks – abbreviated as "S" in the database
  • certificates represent undivided, direct ownership of companies
• Bonds – abbreviated as "B" in the database
  • certificates represent company promises to repay loans
  • category includes equipment trust certificates *
• Others – abbreviated as "O" in the database
  • certificates represent wide-ranging purposes related to stocks, bonds, and ownership of those certificates

* Equipment Trust Certificates (ETCs) actually represent a fourth type of security document. ETCs are a hybrid security that share aspects of both stocks, bonds, and mutual funds. This project lists equipment trust certificates and "car trust" certificates among bonds because they strongly resemble bonds are denominated in currency.

Obvious differences between stocks and bonds

Everyone who watches the evening news is familiar with daily reporting about "the market," primarily the New York Stock Exchange. Viewers may not pay much attention, but almost everyone has an inkling of whether the market is up or down, at least with the stock market. I think it is fair to say that most casual observers ignore the bond market completely.

By ignoring the bond market, viewers fail to appreciate that more investment money is tied up in the bond market than in the stock market. Since there is more general knowledge about stocks, let's build on that foundation and then decode the mystery of bond ownership.

The stock market

The first stock market, as we define it today, was founded in Antwerp, Belgium in 1531. Eighty years later, the Dutch East India Company became the first genuine stock used for speculation and investment. The need for multiple owners, both then and now, is that very few single individuals had sufficient money to start and fund large companies on their own. Certainly not the kinds of companies that could afford to send fleets of ships around the earth.

Once founded, companies sold part interest in the form of "shares," to wealthy individuals. If companies were successful, profits were divided among all the various owners in proportion to the numbers of shares they owned. Ownership was not permanent, so shares were bought and sold as investors' situations demanded.

Shares are called "equity investments." "Equity" is the difference between the resale value of an asset and the amount owed on it. For example, "equity" in someone's residence is the difference between what a home could sell for and the amount owed on an underlying home loan. If a home can be sold for $500,000 and there is an outstanding loan of $400,000, then the equity is $100,000.

Calculating the equity value of shares in companies is more complicated because companies create ever-changing amounts of income. Nonetheless, if the value of a company's combined assets and income potential is worth $500,000 and its debt is $400,000, then the value of its outstanding stock is $100,000. If that stock is divided into 1,000 shares, than each share should be worth $100.

That does not mean shares sell for their equity values. Both buyers and sellers view share values differently and agree only at the moment of sale. Traders' views of share values change constantly and quickly throughout a trading day. The stock market is made up of many companies, so overall value is changing every second of every trading day. Since the stock market is considered a bellwether of the financial health of a country, it is reported every day for average observers.

The bond market

Where stock represents equity, and individual shares represent the percentage of ownership of that equity, bonds represent debt. While it is easy to say that — and it's true! — let's build the logic.

It would be nearly impossible for average citizens to buy expensive assets like homes and automobiles without access to substantial amounts of third-party money. In the case of a purchase of new or different homes, buyers pay part of their purchase prices with down payments and borrow the rest through home loans from banks and other sources.

The creation of companies works much the same. Company organizers usually invest some of their own money, but raise the rest of their "down payment" by selling shares of stock. They inevitably need to raise much more money through loans.

It is true that companies can and do borrow money from banks. However, banks are risk averse. They do not like to lend money to risky businesses. The riskier the business, the less likely a bank will lend money. If convinced to lend money, banks usually demand higher interest rates and shorter payback periods as their assessment of risk increases.

Let's face it, every railroad wanted to be big. And every railroad wanted to be the first to lay track into underserved areas. The question, though, was whether railroads could develop carry sufficient tons of freight and numbers of passenger to offset the costs of acquiring land, laying track, building bridges, and tunneling through hills. Even though business and population was expanding steadily across the continent throughout the 1800s, there weren't many businesses that were larger AND riskier than railroads. Banks were never thrilled to lend money to risky ventures like railroads and mines. In short, banks thought there was just too much risk of failure in both types of businesses.

If banks weren't lending, where could big-time projects like railroads going to get money? A few raised money from governments entities, but most had no choice other than turn to private investors.

Railroad companies, miners, and practically every business owner everywhere knew investors could be found in every nook and cranny on the continent. Moreover, every would-be investor needed to put their money to work and keep it working. As a general rule, private investors wanted to earn more interest than banks were paying on deposits. Never mind that large numbers of banks in the early 1800s were financially shaky, possibly riskier than investing in companies like railroads.

What if companies could secure loans from investors, similar to selling shares of stock? Instead of securing one large loan, why not borrow smaller amounts of money from many investors?

THAT is the exact concept of bonds.

Once companies decided to borrow money from individuals instead of banks, they needed to devise efficient methods of attracting lenders. What if a railroad or mine could give 6% or 7% annual interest to investors and pay them back in ten or twenty years after track was laid, mines were opened, and business developed? Instead of paying interest every month or every quarter, why not decrease labor costs and pay interest twice a year?

Using such concepts, companies devised documents that promised to pay interest twice a year and repay the whole borrowed amount in a lump sum several years in the future. Companies formalized their promises with paper documents called bonds. When investors bought bonds from companies, they were actually lending money and receiving physical evidence of companies' binding promises to repay on specific dates and to pay specific interest on specific schedules until that time.

Buying and selling bonds

Railroad companies, and most other industries in later years, created their own debt and "sold" that debt to investors in the form of bonds. It is not uncommon to see bonds with repayment fifty years in the future. In fact, it is not at all uncommon to see bonds with terms of 100 years and more. While bondholders might live for twenty, thirty, or even fifty years after lending money, none could survive much longer. However, debt obligations do survive. They survive, regardless of who lent money originally. Bond debts, and their promises of repayment, exist regardless of who owns them.

Every bondholder has the express right of "selling debt" to another investor. In the case of bearer bonds, sales of bonds took place without ever needing to tell the issuer. With registered bonds, sellers did need to contact issuers, but only so issuers would know where to send interest payments and principal at the time of redemption

Terms

The word "term" means two things in the world of lending. Bonds spell out conditions or "terms" of repayment and the remedies lenders can seek if borrowers can't or won't pay. "Term" also represents the length of time between lending and repayment. If a bond stipulates repayment in ten years, then the bond has a ten-year term. Paradoxically, terms of loans are always specified in the written "terms" that appear on most bonds.

The majority of railroad and mining company bonds embody terms that explain what investors are entitled to in case companies default. Perhaps the most common remedy is to pledge company property (and possibly other collateral) to investors. When railroad companies failed, committees of lenders (i.e. bondholders) commonly gained control of companies and re-sold them to other, stronger companies. It does not appear than many companies were liquidated and parts sold off for cash.

Denominations

It is important to appreciate that, in the early 1800s, the U.S. dollar had a much greater buying power than today. In other words, the dollar was worth dramatically more in the past. While railroad companies have always preferred borrowing from the fewest numbers of investors, many early companies were able to sell sufficient numbers of bonds only by issuing them in smaller denominations.

If companies wanted to borrow $100,000, they would have preferred to sell ten $10,000 bonds instead of one hundred $1,000 bonds. While very large-denomination bonds are realistic today, companies in the 1830s often needed to issue less expensive bonds, some even as small as $50. The problem with selling small-denomination bonds was the increased amount of labor required to make semi-annual interest payments.

Interest payments

In today's highly computerized environment, interest payments, no matter their schedule, are only a line of computer code away. Prior to the 1870s, almost all interest payments were made by redeeming small "coupons" printed with or attached to bonds. Investors would clip coupons and convey them to companies either in person, by mail, or through brokers and bankers.

In some cases, companies "registered" their bondholders and forwarded interest payments directly to them without needing to handle large numbers of small coupons. Registered bonds began gaining popularity in the 1870s, Coupon bonds survived in decreasing numbers until the 1980s when the U.S. formally outlawed them.

Bond values

The values, and hence prices, of both stocks and bonds rise and fall in response to ever-changing financial forces. No matter the cause, as financial stress and the threat of default increases, the less investors are willing to pay. The more robust companies appear, the more investors are willing to pay. The length of time until issuers repay principal also affects prices. Very short-term bonds are less attractive than bonds of moderate length. Conversely, very long-term bonds, 30-years or longer, tend to be discounted more than mid-length bonds.

Bankruptcy

Collectors of stocks and bonds know that almost every railroad company teetered on the edge of bankruptcy at some time during their lifetimes. So what happened with stocks and bonds when a company collapsed?

In ideal circumstances, stronger companies might have been willing to buy failing companies in order to acquire additional markets, locomotives, rolling stock, and access to areas otherwise blocked off. In such cases, rescuing companies often bought all the stock of failing companies, allowing stockholders to recover some of their investments for cash. More commonly, larger companies traded their own stock for the old company's stock in some ratio acceptable to both sides.

Of course, some failed companies had no assets attractive to their competitors. In those cases, bankruptcy courts ordered "liquidation" and sold off assets for whatever amounts those assets attracted at auction. Proceeds were then divided among stockholders on a per-share basis.

Bankruptcy was never quite that easy because practically every company owed some kind of debt. In bankruptcy, regardless of where bankruptcy takes place, creditors must be paid first.

In some cases, bankruptcy courts allowed companies to "reorganize." Every reorganization was different, but the general pattern was for courts to appoint "receivers" to take over management of failed companies. Receivers would then attempt to deal with creditors to restructure debt in some favorable manner. Some creditors might have forgiven some portion of debt. Or they might have been willing to suspend interest payments for a few years. Some creditors accepted lower interest rates or pushed repayment dates further into the future.

Some companies were so crucial for the local economy that courts could not allow them to collapse. In some cases, receiverships lasted for years and their reorganizations were highly complex. Conversely, many smaller companies were simply not worth saving and were auctioned off in pieces.

During liquidation, courts paid creditors first.

Records are much too scarce to confirm, but it appears bankruptcy courts always forced companies to repay all creditors before dividing up remaining funds among stockholders. Creditors are always repaid in the order in which they file legal actions. Since bondholders were usually the largest creditors, they were usually the first in line to foreclose on companies that missed interest payments. Bondholders were often owed so much money, that it was relatively common for bondholder "committees" to acquire companies in their entirety.

Investors normally devalued both stocks and bond when companies started showing signs of reduced income and difficulty paying bills. If astute buyers were able to buy large quantities of bonds at very low prices during those times, they could force companies into bankruptcy and acquire railroad assets at steep discounts.

Although there were many such buyers, the most astute — and arguably the most ruthless — investor was Jay Gould (shown above.) Gould made himself very rich by manipulating companies through his bond ownership.

What about stock ownership?

Collectors often how wonder stock holders fared when companies went bankrupt. The answer, at least for the railroad industry, appears to be, "not well at all."

Since stockholders have always been considered part owners of companies, stockholders received money from liquidation of bankrupted companies only after all creditors were fully paid. If company debts outweighed asset values, then stockholders received nothing.

Even when stockholders were entitled to proceeds from liquidated companies, there was a "pecking order." Holders of preferred stock are always "in line" ahead of holders of common stock. But even preferred stock holders were not necessarily equal. Holders of "first preferred" stock received payment before holders of "second preferred" or "second class preferred" stock and so forth. Decoding the order of stockholders is, of course, a moot point to collectors. While there are rarely any noticeable differences in prices paid for different classes of collectible stock certificates, preferred stock certificates are usually much scarcer than those labeled as "common" or "ordinary."