The Erie Canal and Municipal Bonds

The long-term benefits of a great project often have little to do with its exact timing, especially for undertakings years away from completion anyway. These extensive works must be planned and launched without a firm understanding of how the world will look once they are completed. The Erie Canal, which connects the Great Lakes, and thus the American Midwest, to the rest of the world was launched in a period of prosperity that soon gave way to panic. Nonetheless, work on the canal went on, proceeding in spite of the many naysayers, daunting costs, economic depression, and engineering challenges. Bond financing was crucial to making this so.

Canal

The Erie Canal was completed in 1825, connecting Lake Erie to the Hudson River and the Atlantic. Along its route, 83 locks with lifts ranging from six to twelve feet each, ascended and descended horse and mule pulled boats along its 363 miles length. At the time, the Erie Canal was more than ten times as long as any other canal in the United States and more than twice as long as the next longest canal in the western world.

There were also many impressive pieces of accompanying infrastructure. Eighteen aqueducts lifted the canal over rivers and gorges segmenting the route. The longest of these, at over 800 feet, lifted the canal over the Genesee River in the city of Rochester. The Erie Canal would be just one of many in New York and was perhaps the most significant in setting off a canal building boom in the United States. Like these later canal projects and in contrast to the railroads that would follow, the Erie Canal was government built and operated. However, it was financed by private investors in New York and abroad.

Visionaries and Skeptics

Perhaps the most vocal and important supporter of the Erie Canal project in the years preceding its construction was the former U.S. Senator and then mayor of New York City, De Witt Clinton. While those living along the proposed canal route had reason to cheer the project on, they were largely alone.

Politicians in both New York and Washington D.C. were mostly skeptical. Thomas Jefferson, President of the Unites States at the time, did not believe that such a canal could be built, at least at reasonable cost. The President thought it an idea a century ahead of its time. His two successors were also critical of the project, largely on cost grounds. At home, taxpayers in New York also questioned the value of such a canal. Opposition was strong from legislators in New York City itself, one of the canal’s eventual beneficiaries.

Realizing that aid from the federal government would not be forthcoming, the state went it alone. De Witt Clinton was elected Governor of the State of New York in 1816 and work on the canal would commence the following year, just three days after the new governor took his oath of office. It was built from the inside out. Construction began on a middle section between the cities of Utica and Syracuse, with the final connections to the Hudson River and Lake Erie being the last sections completed.

Financially, it was an era of optimism as the economy recovered from a slump that followed the end of the War of 1812 and the Napoleonic Wars. A postwar deflation had ended and real estate and stock prices rose. The money supply grew as people regained confidence in the banking system, confidence lost during the fearful war years. Dozens of new American banks were formed as well, bringing the total in operation by 1818 to nearly four hundred. One of these was the newly chartered Second Bank of the United States which had also begun lending liberally. Government infrastructure spending rose, as did that by private developers building and managing new toll roads.

It was in this period of prosperity that the canal project was launched, and not a moment too soon. The economy was soon about to turn, in part because the Second Bank of the United States had come to recognize the dangers of lending fueled by the excessive issuance of banknotes. It reversed course, bringing about a financial panic in 1819. Prices began falling yet again. Had the political groundwork only begun to be laid now, the canal project may very well have never broken ground.

Costs and Financing

The cost of building the Erie Canal was estimated to be $7 million. The work would be labor intensive. Between two and three thousand men and 700 horses were hired to complete the first middle section of the canal between the Mohawk and Seneca Rivers.

Laborers working on the project were paid between $8 and $12 a month. Engineers earned many times more; assistant engineers made $4 a day while the principal engineers were paid salaries of between $1,500 and $2,000 a year. Contractors were paid between 10 and 14 cents per cubic yard of earth removed, with rates as high as $2 paid for shale or other rock. These were small operators and so there were many of them as well. A typical contractor worked on a section of the canal no longer than a few miles and some completed sections as short as a quarter-mile.

Bonds were issued to finance the construction of the Erie Canal. These are said to have been the first municipal government bonds issued in America. They are in any case among the most historically significant municipal bond issues, a compelling case study in the power of bond financing for public works projects undertaken by local governments.

The bonds were to be repaid by toll revenue generated once the canal opened. Further taxes on salt, goods sold at auction, and steamboat passengers were allocated to repay the debt as well. Legislation also allowed for a new tax on properties located within twenty-five miles of the canal, another source of revenues with which to service the debt, though this tax seems to have never been implemented.

A five-member board of commissioners was established to organize the construction and handle expenditures; it was also the body given authority to borrow money to finance the works. Banks were also hired to sell the canal bonds to investors including the New York State Bank formed in Albany in 1803. Many bonds were sold to investors outside New York, and some to investors outside the United States altogether, but the initial demand came locally. The first bond issues were too small to see distribution abroad; $200,000 was raised both in 1817 and 1818 by the sale of bonds earning 6% interest.

From there, the borrowing increased and $1.1 million was raised over the next two years. Bonds paying 6% interest were issued in 1820 and found ample demand, selling at a premium; the next year, the commission tried its luck issuing lower interest rate bonds. A 5% bond raised $1.4 million in 1821, the year the state government decided to guarantee the bonds, offering further security to investors. The canal project was paying less to borrow than the state government had a few years earlier.

Among the investors in the canal bonds was another pet project of De Witt Clinton, the Bank for Savings in the City of New York. This was a bank created to encourage thrift among poorer savers; it bought $263,000 in canal bonds in 1820. By 1821, it held almost 30% of the canal bonds outstanding. Though the initial issues were sold mostly to locals, foreign investors would hold most of the $7.9 million in bonds outstanding by 1829, having seen their value, albeit belatedly.

Results

As soon as the first sections of the canal were completed, the financial success of the project became apparent. This was one of the reasons why discerning foreign investors, particularly in London, became more interested in the canal bonds towards the end of the project’s construction. In fact, by 1822, some two hundred miles of the canal were already navigable and earning toll revenues. To complete the final stretches, just under $2 million more was borrowed between 1822 and 1824. The first iteration of the Erie Canal was finally completed in 1825, eight years after work started. Still governor, De Witt Clinton ceremoniously travelled the entire length of the canal carrying water from Lake Erie which he poured into the Atlantic after arriving in New York City on November 4, 1825.

Together, the cost of the Erie Canal and its sister-project, the Champlain Canal which connected the Hudson River to Lake Champlain, came in ‘only’ 46% above the initial cost estimate. In its first year in operation, the canal generated revenues of $1 million, a figure healthy enough to ensure the bonds performed well; they were repaid by 1836. The canal was of even greater economic value than its toll revenues suggested; it reduced travel times and freight costs, opening up the interior of the continent to eastern cities and Atlantic trade.

Further improvements came to the Erie Canal with time. Work began on widening it from forty feet across to seventy feet in 1836, as soon as the original bonds were paid off. Part of the reason for enlargement was to increase the canal’s capacity which proved to be too limited to satisfy the heavier-than-expected traffic volumes. The canal would eventually be replaced with a new Barge Canal in 1918, able to support vessels carrying six times the freight. This too would become more-or-less obsolete with the completion of the St. Lawrence Seaway in the late 1950s.

Lesson

To Thomas Jefferson and his immediate successors, a canal connecting the Great Lakes to the Atlantic through New York seemed infeasibly and extravagantly expensive. However, once work got underway, the project was completed in just eight years and the debts associated with the construction were extinguished only eleven more years after that.

Bond financing was crucial to facilitating the Erie Canal project and, in a sense, helped turn the unrealistic into reality. Indeed, analysis of any project must consider not just its expected fruits but also the availability of financing. Unfortunately, the turbulent inclinations of capital markets can sink even the most profitable projects while bizarrely enabling the least worthwhile. Nonetheless, they could, and routinely do, facilitate both much needed and even visionary improvements.

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Read about how railroads fostered the development of America’s bond market. The Suez Canal was another canal project with financial significance. Also, consider subscribing to this blog’s newsletter here.