The Present Railroad Crisis [Reprint 2016 ed.] 9781512815405

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T H E EDWARD E U G E N E LOOMIS FOUNDATION L A F A Y E T T E COLLEGE LECTURES

1939

THE PRESENT RAILROAD CRISIS

THE EDWARD EUGENE LOOMIS FOUNDATION LAFAYETTE COLLEGE PUBLICATIONS

The Vresent Railroad

Crisis

by WILLIAM J .

CUNNINGHAM

EDWARD EUGENE LOOMIS

THE PRESENT RAILROAD CRISIS By WILLIAM JAMES CUNNINGHAM James ]. Hill Professor of Transportation Graduate School of Business Administration Harvard University

Philadelphia U N I V E R S I T Y OF P E N N S Y L V A N I A PRESS London: Humphrey

Milford: Oxford 1939

University Press

Copyright 1939 UNIVERSITY

Manufactured

OF

PENNSYLVANIA

in the United States of

PRESS

America

FOREWORD THE profound truth of Adam Smith's words, "Division of labor is limited by the extent of the market," written in 1776 on the eve of the Industrial Revolution, can be seen in the light of the expanding industrial structure made possible through the development of transportation. Only bccause of this development of transportation have we had manufacture taken out of the home into the factory, and from the local factory serving its small adjacent community to the huge industrial plant producing for the world-wide market. The broad social consequences of this industrial evolution have been twofold. In the first place, it has given mankind the blessing of industrial progress with its fuller life; in the second place, it has brought baffling social problems such as concentration of industrial population, business depressions, mass unemployment, and international struggle for control of territory and raw materials. These all-important socio-economic phenomena point to the enormous significance of transportation in modern society. It is not an overstatement to say that it has been one of the most potent forces in making our present-day civilization what it is. N o w after a century of growth of the railroad, the whole transportation field presents us with one of our most complex national problems. The magnitude of V

VI

PRESENT RAILROAD CRISIS

this problem is indicated by Professor Cunningham in this volume on The Present Railroad Crisis when he calls attention to the fact that of our total railway net, one-third is bankrupt, one-third is in serious financial condition, and one-third is economically sound. In the United States this confronts us with a challenging problem of inestimable importance. The increased efficiency of railroad operation has unified and integrated our entire continent. The massing of millions of our people in large industrial centers, the continuous and effective access of our factories to raw materials distantly removed, and the uninterrupted and rapid distribution of the finished products of our industrial plants to markets nation-wide in scope, are dependent upon the smooth functioning of our railway system. In a real sense the very lives of untold millions living in our congested manufacturing cities depend upon transportation facilities. Professor C. J . Ratzlaff, Head of the Department of Economics at Lafayette College, well says: That we are not faced with a new and passing problem is clear when we recall that our federal regulation of railroads began more than fifty years ago, that is, in 1887. Another indication of this is seen in the fact that beginning with 1920 abandonment of railroad mileage has exceeded new construction. The mere size of the American railroad network accentuates the problem with which we are faced. When it is recalled that the railroad mileage in the United States (250,000 miles in 1930) exceeds by more than 10,000 miles the total mileage of Germany, France, Great Britain, India, Russia, and Canada combined, we can readily appreci-

FOREWORD

vii

ate the vastness, as well as complexity, of the social problem with which we must cope. Professor Cunningham's lecturcs on The Present Railroad Crisis, given under the auspices of the Edward Eugene Loomis Memorial Foundation of Lafayette College, are intended to define the problem with which we are faced in the field of transportation, and to suggest a constructive course of action. Edward Eugene Loomis gave strength to every enterprise with which he was connected. Decisive, intelligent, sound in his judgment of men and affairs, he was an outstanding figure in the many boards of which he was a member. He took his membership in these organizations seriously and gave much time and thought to their affairs. He was not only a great railroad executive, but a leader in economic thought. Mr. Loomis was deeply interested in having the problems of transportation understood by college students and by the public at large. The Edward Eugene Loomis Memorial at Lafayette College is an effective instrument in such dissemination of knowledge, and will, therefore, miake a real and permanent contribution to the public welfare.

CONTENTS Chapter

Page

FOREWORD

ν

By William Alather Lewis, President of College I.

RAILROADS TURY

DURING

THEIR

Lafayette

FIRST

CENι

The First Fifty Years The Beginnings of Governmental Regulation Railroad Operation during the World War The Transportation Act of 1920 II.

RAILROADS UNDER T H E N E W DEAL The Emergency Transportation Act of 1933 Extent of Present Railroad Financial Distress Effect upon Security Holders Effect upon Employees Curtailment of Railroad Purchases Effect upon Quality of Public Service Railroad Losses to Competitors Reductions in Total Transportation Demand Subsidies to Transportation Agencies Surplus in Transportation Facilities Railroad Capitalization ix

16

χ

P R E S E N T R A I L R O A D CRISIS

Chapter

Page Railroads N o t Attracting Ambitious Young Men Excessive Degree of Corporate Individualism Coordination of Railroad Facilities

III.

PROPOSED TION

TRANSPORTATION

LEGISLA56

Recommendations of the Committee of Six Declaration of National Transportation Policy Transportation Board Change in Rule of Rate-making Railroad Reorganization Court Consolidation of Railroads Wage Rates and Terms of Employment IV.

THE PRESENT OUTLOOK

81

I RAILROADS DURING

THEIR

FIRST

Τ be First Fifty

CENTURY

Years

FOR more than one hundred years the people of the United States have had a railroad problem. In the early days it was one of developing the technique and finding the capital to construct railroads so that every important community might have the benefit of the new form of transportation. In that first period, which extended from the 1830's to the reconstruction years following the Civil War, railroad construction was publicly encouraged and in many cases was given financial aid by individuals, by local communities and cities, by the states, and finally by land grants from the Federal Government. T h e problem was one of bringing the railroads into being. The next period, extending from the 1870's to the first dccade of the present century, had a problem of a different nature. The then developed sections of the country were fairly well equipped with rail transportation. T h e infant industry had come into vigorous manhood, and from the public viewpoint railroad management had got out of control. Railroads were regarded by their owners almost entirely from the viewpoint of private business enterprises. Their status as public utilities had scant recognition. The charges for transportation services were I

2

PRESENT RAILROAD CRISIS

too often unreasonably high and there w e r e many cases of abuse of the railroad p o w e r to make or unmake communities b y gross discrimination in rates and service. R e bates in freight charges and other forms of favoritism w o r k e d unfairly to the advantage of certain industrial companies and to the injury of their competitors. Financial maladministration in many eases caused heavy losses to investors. Public opinion in general became hostile, and the earlier problem of how to get railroads became one of h o w to curb and control them in public interest. The Beginnings of Governmental Regulation A f e w of the individual states took the initial steps in the creation of railroad commissions, and the intense resentment in the Middle W e s t against high rates and discrimination was crystallized in the anti-railroad G r a n g e r Movement of the 1870's. Because of the preponderance of interstate traffic and because the state laws regulating railroads went beyond constitutional limitations, state regulation proved to be ineffective and, after several years of study by Congressional committees and extended debate, the passage of the 1887 A c t to Regulate C o m merce and the creation of the Interstate Commerce C o m mission marked the beginnings of federal regulation of railroads. A s might have been expected, the original A c t was f o u n d to be defective in important respects, and several amendments w e r e necessary to achieve the purposes of the 1887 law. T h e H e p b u r n A c t of 1906 extended the Commission's powers over rates and accounts.

The

Mann-Elkins A c t of 1 9 1 ο authorized the Commission to

THE FIRST CENTURY

3

suspend proposed rates and require proof of justification before they became effective. Since 1 9 1 0 federal regulation of rates and many other features of rail transportation have been comprehensive and effective, and the state regulating authorities, even with added powers over intrastate matters, have played a minor part. T h e Supreme Court of the United States held * that the interests of interstate traffic are paramount. T h e year 191 ο was an important milestone in railroad history. It was not only the beginning of fairly complete control over rates and accounting by the Interstate Commerce Commission, but it also was the beginning of a period in which rising costs in operation, especially in higher wage rates, could not readily be offset by further economies and further increases in the volume of traffic. Railroad net income was ground between the upper millstone of higher operating costs and the lower millstone of reduced rates. T h e weaker companies were plainly in financial distress. T h e efforts of the railroads, acting collectivcly, to convincc the Interstate Commerce Commission of the justification f o r a horizontal increase in freight rates were unsuccessful, and several of the weaker roads w e r e forced into bankruptcy. In 1 9 1 5 , less than a year after the beginning of the W o r l d W a r , the situation was alarming. Approximately 42,000 miles, or one-sixth of the total of railroad mileage, was in receivership.t * Minnesota Rate case, 230 U.S. 352; Shreveport case, 234 U.S. 342; Wisconsin Passenger Fare case, 257 U.S. 563. + Railway Age Gazette, October 15, 1915. The mileage in receivership on January 1, 1915, was 21,048. Between January 1 and October 15, 1915, the additions of the Rock Island, Μ. Κ. & T., Missouri Pacific, Western Pacific, and nine others, brought the total mileage of 82 railroads of all classes to 41,988.

4

PRESENT RAILROAD CRISIS Railroad Operation during the World War

T o the war in Europe should be charged a part of the responsibility. The disturbance in economic conditions adversely affected the volume of traffic, caused further increases in costs, and made more difficult the refunding of maturing debt. T o the World War may be attributed also the remarkable improvement in railroad earning power in the following year, 1916, when our manufacturing plants were operated at full capacity to produce the munitions and supplies bought by the Allies. The very low year of 1915 was followed by a year of superlatively high railroad net earnings.* In 1916 the rate of return on railroad investment (nearly 6c/o) was higher than ever before, and it has not since been equaled. The higher volume of traffic in that year was handled successfully with relatively little addition to facilities and equipment, and therefore, under the economic law of increasing returns, was handled at low unit costs. When the United States entered the war in April 1917, the demand for rail transportation became even greater, so much greater in fact that it exceeded railroad capacity. The previous years of lean earnings had prevented the continuation of the earlier policy of the typical railroad to keep a step ahead of traffic demands by * During the year ended June 30, 191 j , the operating revenues of Class I railroads were $2,872,000,000 and their net income after charges was $316,000,000. During the year ended December 31, 1916, the operating revenues were $3,597,000,000 and the net income after charges was $647,000,000. Class I railroads are those which have operating revenues of $1,000,000 or more annually. T h e y constituted 90% of the total mileage, earned 9 7 % of the total operating revenues, and earned more than 9 9 % of the total net income.

THE FIRST CENTURY

5

additions and betterments to facilities and equipment; the priority demands of the several branches of the Government for preferred movement of troops and materials and supplies for the army, navy, shipbuilding plants, and other governmental activities, were demoralizing; the effect of enlistment and the draft was to transfer a substantial part of railroad employees into the army or navy and to make difficult their replacement, even by inexperienced substitutes. The cumulative effect of these and other factors unfavorable from the railroad viewpoint was such that notwithstanding the earnest efforts of the Railroads' W a r Board to meet the transportation demands, the railroads virtually broke down in the early winter months of 1917, when an appalling traffic congestion set in along the upper Atlantic seaboard where the greater part of the additional war-created traffic was centered. T h e likelihood that the United States would eventually be drawn into the European conflict was foreseen by the railroad executives, and plans were formulated early in 1917 for railroad operations under war conditions. In England, the Government had taken over the railroads immediately after war was declared in August 1914, and government operation had been conducted through a board consisting of the general managers of the principal railroads. The railroad executives of the United States realized before we entered the war that centralized control of railroads would be essential from the military viewpoint, but in planning for such centralized control they wished to retain management and avoid direct operation by the Government. The plan, put into

6

PRESENT RAILROAD CRISIS

effect a few days after our declaration of war against Germany, was the creation of a Railroads' War Board, composed of five leading railroad executives. T o that board all of the individual railroads gave full powers to coordinate operations during the war within a unified continental system, "merging during such period all their merely individual and competitive activities in the effort to produce a maximum of transportation efficiency." As ex officio members of the board were one representative each from the Council of National Defense and the Interstate Commerce Commission, and there were continuing contacts with all branches of the Government. From April until the early winter months the railroad transportation needs of the military authorities were met in a manner that brought praise from the Secretary of War * who joined with the Quartermaster General in the statement that "of those who are now serving the nation in this time of stress there are none who are doing so more wholeheartedly, unselfishly and efficiently than the railroad officials who are engaged in this patriotic work." The inability of the Board to prevent the traffic congestion and to correct it after the congestion became acute was due to several reasons. The first was the lack of surplus capacity to bear the heavy overload. The low earnings of the several preceding years had prevented the usual rate of additions and betterments. The second was the limited capacity of available ships to take the tonnage as soon as it reached seaboard. The third reason was the lack of central governmental authority to coordinate the * Annual Report for 191η, Secretary Baker.

THE FIRST CENTURY

7

demands of priority in movement of Government freight. The fourth reason was that notwithstanding the agreement to disregard individual and competitive interests, those interests actually had play and interfered with efficiency from the viewpoint of a unified national system. A fifth reason was that there was labor unrest because wages of workmen in industry had been increased and the Railroad Board held that railroad net income could not support higher wages for railroad labor. A sixth reason was of a financial nature. There was doubt as to the ability of some railroads to take care of maturing debt. A seventh reason was that the unification policies of the Board, with suppression of competition, were technically in violation of anti-trust and anti-pooling laws, and the Board was unable to get an assurance from the Attorney General that no action would be taken by his department against the Board or individual officers. Collectively these handicaps seriously interfered with the efficiency of voluntary unification. The seriousness of the situation in December, and its vital bearing upon the military program, focused the attention of the administration on the problem, and on December 26, 1917, President Wilson took possession of all railroads under authority contained in a rider attached to the A r m y Appropriations Act of August 29, 1916, when the United States was having trouble with Mexico and war with that country was feared. Federal operation of railroads began on January 1, 1918, and was terminated on February 29, 1920, when, under the provisions of the Transportation Act of that year, the pre-war status of private operation was restored.

δ

PRESENT RAILROAD CRISIS

T h e United States Railroad Administration was headed by a Director General of Railroads w h o had almost autocratic powers and was responsible only to the President of the United States. T h e Interstate Commerce Commission was temporarily shorn of most of its powers, but acted mainly in an advisory capacity to the Director General. Under the terms of the Federal Control A c t of March 2 1 , 1 9 1 8 , ratifying the action of the President in commandeering the railroads in the emergency, the G o v ernment was obligated to pay to each railroad corporation, as a rental for the use of its properties, a sum equal to the average net railway operating income * earned by that property during the three years ended June 30, 1 9 1 7 . T h e pre-war income of each carrier was thus assured, and the creditors and stockholders were protected. T h e Government took all of the gross earnings, but after the payment of expenses and taxes the remainder in net railway operating income fell short of the rentals. During 1 9 1 8 the deficit was about $240,000,000, but in 1919, with its much lower volume of traffic, the deficit was much larger. T h e total dcficit for the two years and two months was $1,696,000,000,! or at the rate of two million dollars per day. It would not be fair to say that the high cost was due primarily to Government operation. T h e railroads, as a branch of the Government, were operated primarily to * Net railway operating income is what is left out of operating revenues after the payment of operating expenses, taxes, and the net balance of debits and credits f o r rents f o r joint facilities and joint equipment. It is the reward to the capital invested in the railroad property. From it is paid interest on bonds, other fixed charges, and dividends. + Report of Director General Davis to President Coolidge, January 4, 1924.

T H E FIRST CENTURY

9

meet military needs, and the losses may be charged in greater part to the cost of winning the war. T h e deficits might have been avoided or at least materially minimized if in 1 9 1 9 the Director General had increased freight and passenger rates in the same degree that they were increased by the Interstate Commerce Commission in 1920 after private operation was resumed. President Wilson deliberately chose to incur the deficit, to be met by general taxation, rather than give another reason for further additions to the already alarming increases in commodity prices in the post-war period. Of significance greater than the deficit is the fact that during the war the railroads functioned with high efficiency in the production of essential transportation. Compared with the vital objective of making two ton-miles grow where one grew before, the expenditure in dollars was relatively unimportant. T h e congestion of the early winter of 1 9 1 7 was soon relieved, and in 1 9 1 8 , with comparatively f e w additions to plant, the railroads produced more ton-miles and passcngcr-milcs than were ever before produced, and the military needs were met with the minimum of hardship to the general public. T h e credit for the achievement should go in large part to the railroad officers who, as the staff of the Director General, served with loyalty and zeal, but the favorable results in transportation service would not have been possible without the centralization of power in the Director General and his staff, the sympathetic attitude of the administration toward labor in granting substantial wage advances, the use of Government funds for additions and betterments in trackage and equipment, and the ability, as a branch of the Govern-

ΙΟ

PRESENT RAILROAD CRISIS

ment, to secure the needed materials when the available supply was inadequate to meet all demands. The operation of the railroads by the U.S.R.R. A d ministration was continued more than a year after the signing of the Armistice, while Congress considered the many proposals for a national post-war policy. The proposals ranged from complete nationalization to a restoration, without change, of the pre-war status. Inasmuch as there was little public support of Government ownership, and even less advocacy of an indefinite extension of war-time Government operation, Congress decided in favor of the continuation of private ownership and restoration of private operation, and the railroads were returned to their owners on March i, 1920, under the terms of the Transportation A c t of that year. The Transportation Act of 1920

That A c t recognized the principle that the public is as much interested in the adequacy and quality of transportation as in the rates therefor, and gave a mandate to the Interstate Commerce Commission to set rates so as to permit the railroads collectively to earn a fair return on the Commission's valuation of the property dedicated to public service. T h e purpose of the A c t was clearly stated—so that the people of the United States might have adequate transportation service. Railroads could not provide such service without new capital for improvements in facilities and equipment. N e w capital could not be had unless railroad credit was assured by net income sufficient to yield a fair return. Hence the rate scales as

T H E FIRST CENTURY

ι1

a whole were to be such that a 6% return on the property value would be earned. Coupled with the new rule of rate-making in the 1920 Act were two related provisions. One was the so-called rccapture clause which provided that one-half of the net income in excess of 6c/c on the value of the individual railroad would be recaptured and impounded by the Commission as a fund from which loans could be made to the weak roads. T h e second was a mandate to the Commission to prepare and put into effect a plan under which the many separate railroads of varying degrees of earning power would be consolidated into a limited number of systems of fairly equal financial strength so that under uniform competitive rates each system might earn approximately the same rate of return on property investment. T h e relationship between the rule of rate-making, the rccapture clause, and the consolidation provision is found in the problem of the weak railroad. Rates were to be made regionally f o r all railroads in the region. T h e y were to be on a scale so that the aggregate net railway operating income of all of the railroads in a region would be equal to a fair return on the aggregate value of all of the railroads in that region. Competitive rates would necessarily be uniform on all competing railroads. T h e y would be based on average costs. Such uniform rates would, because of favorable operating and traffic characteristics of the strong roads, yield more than a fair return to the strong. Likewise, because of unfavorable characteristics of the weak roads, such uniform rates

i2

PRESENT RAILROAD CRISIS

would yield less than a fair return to the weak. T h e solution to the problem of the weak appeared to lie in a comprehensive plan of consolidation under which the weak lines would be absorbed by the strong, and eventually there would emerge from the many properties of vary ing degrees of strength a small number of consolidated systems of fairly equal financial strength which, under uniform rates on competitive traffic, would earn approximately the same rate of return. T h e recapture clause, under which the individual railroad earning more than 6'/c would turn over one-half of the excess to the Commission to create a fund from which loans could be made to the weak roads, was undoubtedly intended to be a temporary expedient to operate until the processes of consolidation were concluded. In theory the consolidated companies of fairly equal strength would be operating under rates which would yield no more than a fair return and there would be no excess to recapture. T h e 1920 A c t was regarded as a new bill of rights for railroads. N o previous act had affirmatively recognized the right to a fair return. T h e Commission proceeded promptly to carry out the new rate-making mandate and, effective in August 1920, authorized rate increases which, according to the estimates made by the railroad accountants and accepted by the Commission, would yield 6rft on the aggregate value tentatively set by the Commission. T h e increases in the Eastern District were 4 0 % in freight rates and 2 0 % in passenger rates. In other districts the freight rate increase was less, but the passenger rate increase in the basic fare (from 3 cents to 3.6 cents per mile) was uniform in all districts. Business

T H E FIRST CENTURY

13

was booming at the time, and the rate increases were accepted by shippers and travelers with little protest. T h e outlook from the railroad viewpoint in the latter part of 1920, therefore, was promising. That outlook, however, was seriously darkened by the 192 ι decline in business activity. A t that time the depression was looked upon as unusually severe, but it was mild compared to what has happened since 1929. It was sufficient, however, to upset all calculations as to railroad net income, and the expected return of 6 % on railroad property value in 192 1 actually was but 2 . 8 7 % . * In 1922 it was 3.59% and it was gradually increased to nearly 5 % in 1926. In 1929, the year of greatest gross revenues, it was 4 . 8 1 % . During the present depression and recession it ranged from 3.28% in 1930 to 1 . 2 4 % in 1932, and in 1938 it was about 1 . 4 3 % . T h e promise of a fair return—defined in 1920 as 6% and reduced by the Commission in 1922 to 5.75%— proved to be a mirage. There can be no doubt about the sincerity of Congress and the Commission in 1920. T h e intent of the Transportation A c t was to insure a fair return, but Congress apparently did not realize that net income is not determined solely by rates. It is the resultant of rates and the volume of traffic, and when that volume is subnormal a further increase in rates to maintain net income may and usually does cause a further decline in traffic. N o r did Congress foresee that the position of the rail* These percentages are based on railroad book values, which are slightly higher than the values used tentatively by the Commission f o r rate-making purposes. Figures taken from reports of the Bureau of Railw a y Economics, Association of American Railroads.

i4

PRESENT RAILROAD CRISIS

roads in the transportation situation was quickly to undergo a fundamental change. Up to the period of the World W a r the railroads enjoyed a virtual monopoly of inland transportation. Our lawmakers did not foresee the rapid development of highway transportation, although the potentialities of the truck had been indicated in its effective use in war time when the railroads were overburdened by emergency demands. N o r did Congress give due regard to the effect upon railroads of the large governmental expenditures on inland waterways. Unforeseeable also were the commercial development of air passenger service and the profound change in American traveling habits in the increasingly greater use of the private automobile and the bus as substitutes for rail service. Under a continuation of former conditions of monopoly the 1920 rule of rate-making might have achieved its objective of a fair return to railroads, except in depression years, but with the passing of rail monopoly and the rapid growth of competitive agencies, the level of railroad rates is set by competitive forces rather than by the income needs of railroads. The traditional railroad policy of charging what the traffic will bear has become unworkable. Under that policy the commodities which could bear higher than average costs were assessed rates higher than total average costs in order that low rates, based on direct or out-of-pocket costs, might be offered to commodities which otherwise would not move. Inasmuch as the railroad competitors are guided more by "the cost of service" theory than "the value of service" theory the railroads have been especially vulnerable to

T H E FIRST CENTURY

15

competition for the movement of merchandise and other high valued commodities which heretofore have borne more than their share of overhead costs so that the rates on basic commodities of low value might be relieved of all or a part of such costs. There is more than poetic license in the frequently heard statement that the trucks have taken the cream of the freight traffic, leaving the skim milk to the rails. T h e inland waterways, furthermore, are absorbing a part of the skim milk. In the field of passenger traffic the flexibility, convenience, and individualism of the automobile have cut deeply into the rail volume, the airplane is taking more and more of the "de luxe" travelers, and the bus is capturing a substantial proportion of the passengers who are influenced primarily by the economy appeal.

II

RAILROADS UNDER T H E NEW DEAL The Emergency

Transportation

Act of

IT was with disappointment and reluctance that railroad executives had finally to concede that the 1920 rule of rate-making, on which such high hopes had been pinned for a fair return on investment, was unworkable, and there was little opposition on their part to its repeal * in the Emergency Transportation A c t of 1933, one of the early legislative acts of the N e w Deal. T h e acquiescence in the repeal of what had formerly been regarded as a bill of rights was probably influenced by the hope of advantage in other forms. T h e substitute rule, still in force, says nothing about a fair return on value. Instead it provides that in the exercise of its power to prescribe just and reasonable rates the Commission shall, among other factors, give due consideration to the need of revenues sufficient to enable the carriers, under honest, economical, and efficient management, to provide the public with adequate and efficient transportation service. Having in mind that adequate transportation requires new capital for constant additions to and improvements in plant and equipment, and that such capital cannot be had • The recapturc clause was also repealed. 16

UNDER THE NEW DEAL

17

unless capital already in the enterprise is earning a return, the new rule by implication carries forward a part of the spirit of the old, but in indefinite terms; T h e primary emphasis in the new rule, however, is placed on giving consideration to the effect of rates on the movement of traffic. Five years of experience under the 1933 rule have not been satisfactory, mainly because its operation has been confined to a period of depression, and partly because, in the opinion of the railroads, the Commission has gone too far in assuming powers of management in setting rates primarily to encourage the free movement of traffic, with too little attention to the income needs of the carriers. A s has already been noted, the problem one hundred years ago was one of getting railroads; fifty years ago it was one of curbing railroads; now it is one of keeping the railroads alive.

Extent of Present Railroad Financial

Distress

T h e present railroad situation may be summarized in the statement that approximately one-third of railroad mileage is bankrupt and is being operated for the courts by receivers or trustees; approximately one-third of railroad mileage is hovering on the brink of bankruptcy; and only approximately one-third of railroad mileage is safely solvent. In no period in railroad history has the degree of financial distress been as serious. In more specific terms, there are now 1 1 1

railroad

companies, operating 78,016 miles, in the hands of re-

18

PRESENT RAILROAD CRISIS

ceivers or trustees.* T h i s is 3 1 % of the total railroad mileage of all classes and is the greatest mileage ever in the hands of the "courts at one time, whether measured in miles or in per cent of total miles. F o r railroads in Class I only, there are eleven in equity receivership and t w e n t y eight in process of reorganization under Section 77 of the Federal Bankruptcy A c t , a total of thirty-nine companies, operating 75,296 miles, in the hands of the courts. T h i s is 32 % of the total mileage of Class I railroads. T h e capitalization of the thirty-nine railroads is $5,618,000,000 or nearly 3 0 % of the Class I total. T h e investment in road and equipment (book value) is $5,472,000,000, or 2 7 % of the Class I total. T h e 1937 operating revenues were $918,000,000 or 2 2 % of the Class I total; and the number of employees affected are 267,000, or 2 4 % of Class I total. T h e s e relative percentages indicate one cause of the trouble. T h e book value of the thirty-nine bankrupt Class I railroads is 2 7 % of the book value of all railroads in that class; and their capital stock is 2 6 % of the total; yet their long-term debt is 3 3 % of the total. T h a t the companies n o w in reorganization are suffering f r o m a capital structure top-heavy with long-term debt is evident. F o r the bankrupt properties the long-term debt is 6 2 % of the total capitalization; f o r the remainder of the Class I railroads the ratio is 5 7 % . T h e majority of the bankrupt railroads are in the * T h e data in this and the following paragraph were taken from or based on " A Review of Railway Operations in 1938" by J . H . Parmelee, Railway Age, January 7, 1939, revised to March 15, 1939, and issued in pamphlet form, Special Series 67, Bureau of Railway Economics, Association of American Railroads.

UNDER THE NEW DEAL

19

Western and Southern districts. A m o n g the more important are the Chicago & Northwestern, the Chicago Great Western, the Chicago, Milwaukee, St. Paul & Pacific, the R o c k Island, the Denver & R i o Grande W e s t ern, the Minneapolis & St. Louis, the Missouri Pacific, the Mobile & Ohio, the Frisco Lines, the Cotton Belt, the Seaboard A i r Line, the Wabash, the Western Pacific, and the Wisconsin Central. T h e Eastern District, however, has not escaped. Included among the casualties are the Erie, the N e w Haven, the Rutland, and the N e w Y o r k , Ontario & Western. T h e railroads which are in financial distress but have thus far kept out of the reorganization courts are well distributed among all regions. It would not be considerate to be more specific. A s citizens of Easton, however, vou all know that of the five railroads serving your city and Phillipsburg one has been forced to default on its April ist bond interest, a second is engaged in direct negotiations with its bondholders to bring about a voluntary reorganization, and a third is not earning its fixed charges. O n l y two of the five are free of the cloud of impending reorganization. In 1938 the net railway operating income of Class I railroads, after payment of operating expenses, taxes, and rents f o r joint facilities and equipment, was $373,000,000. T h a t amount, plus some non-operating income, was insufficient to pay the fixed charges of interest on longterm debt and rentals of leased lines. T h e deficit was $123,000,000. In 1930, the first full year of the depression, the net income after charges was $524,000,000. In 1929 it was $897,000,000. During the eight years

20

PRESENT RAILROAD CRISIS

1 9 3 1 to 1938, including four years ( 1 9 3 2 , 1933, 1934, and 1938) in which there were deficits, the net income after charges was $15,000,000 per year, a sum equivalent to but 2 Vz % of fixed charges of approximately $600,000,000. A railroad ordinarily is bankrupt when it is unable to meet the interest charges on its debt or cannot pay off or refund such obligations when they mature. Before that condition develops there is ordinarily a period, more or less extended, during which the stockholders receive no dividends, when all available means are employed to reduce operating expenses, especially in the maintenance accounts, and when expenditures for additions and betterments are reduced to negligible amounts. T h e steps ordinarily preceding and following receivership or reorganization under Section 77 of the Bankruptcy A c t are painful to several interests—security holders, employees, producers of materials and supplies purchased by railroads, the communities whose prosperity depends in part on the prosperity of railroad workers, and the general public dependent in part on adequate transportation. Effect

upon Security

Holders

Security holders, consisting mainly of stockholders and bondholders, have suffered severely. Railroad stocks are widely distributed. T h e number of stockholders is approximately equal to the number of railroad employees, and the average number of shares per stockholder is slightly less than one hundred. In view of the commonly held belief that railroad stock is concentrated in a f e w wealthy hands, it is interesting to note that on

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21

December 3 1 , 1937, the number of stockholders of Class I railroads was 871,544, and the average holdings represented a par value of $9,320 * or 93 shares of $ 1 0 0 each. T h e severe loss in dividend payments—from nearly $500,000,000 in 1929 to $168,000,000 in 1937 *—has therefore been borne by many of the general public rather than by a f e w

financiers.

T h e number of railroad bondholders and the average number of bonds per holder are not known exactly. A large proportion of such bonds is held by savings banks, life insurance companies, colleges, and other

fiduciary

institutions. T h e suspension of interest payments on the bonds in default, the severe shrinkage in market value, and the prospective losses in reorganization when fixed interest bondholders may be forced to accept a part of the par value of their holdings in income bonds or capital stock, may bear heavily on these institutions and adversely affect the interest rate on savings banks deposits, the dividends on insurance policies, and the income available to colleges and other fiduciary institutions. T h e amount of defaulted interest, 1930 to 1938, is approximately $600,000,000.t Effect upon

Employees

T h e number of railroad employees in 1920, at the end of the period of federal operation, was slightly over t w o millions, the largest number ever on railroad pay rolls. In 1929, the year of greatest gross revenues, the employees numbered

1,660,850.* In 1938 the number was

* I.C.C. Statistics of Railways in the United States, 1929 and 1937. 1 1 . L. Sharfman, Yale Review, December 1938.

22

PRESENT RAILROAD CRISIS

939,505 * or 4 3 % less than in 1929. Railroad employees, therefore, have lost heavily in the number of jobs available, but the power of the labor organizations has been such as not only to maintain but to increase the average earnings of the employees retained in service. The average compensation per hour in 1929 was 66.6 cents.f In December 1938, the average was 71.1 cents, t The more important fact, however, is that in 1938, compared with 1929, there were 721,345 fewer employees. Those who were divorced from the pay rolls were the younger men. T h e average age per employee at this time is distressingly high. The greater part of those now employed as firemen are men who were once locomotive enginemen and have been demoted. The same observation applies in smaller degree to trainmen who once were conductors. Curtaibnent in Railroad Purchases The extent of the reduction in railroad purchasing power and its effect upon the industries which supply railroads with materials is indicated by a comparison of purchases during the pre-depression period and later years. From 1923 to 1930, inclusive, the purchases of fuel, products of the forests, iron and steel products, and other materials, exclusive of new locomotives and cars, were $1,383,517,000 per year. From 1931 to 1938, inclusive, the yearly average was $643,526,000. In addition to the purchases of materials and supplies currently used in maintenance and operation, the rail• J. H. Parmelee, op. cit. + I.C.C. Statistics of Railways in the United States, 1929 and 1937. 1 Quarterly statistical report, I.C.C., December 1938.

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23

roads normally make heavy annual expenditures f o r additions and betterments chargeable mainly to the investment account. These expenditures are for new equipment, additional track, heavier rail, additional ballast, shops and enginehouses and other improvements. T h e figures given below were the gross expenditures and represent the actual cash outlay. T h e net additions to the investment account were somewhat less because the retirement of old parts of the railroad plant required credit adjustment in the investment account. During the eight years 1923 to 1930, inclusive, the average annual gross capital expenditures of Class I railroads were $843,000,000. In the following eight years, 1931 to 1938, inclusive, the comparable annual average was $258,723,000. T h e gross capital expenditures last year were $226,937,000.* T h e decline in the expenditures for equipment alone is striking. T h e gross capital expenditures for locomotives and cars are included in the totals of the preceding paragraph but are here shown separately. During the eight years 192 3 - 1 9 3 0 they were $393,494,000 per year. During the following eight years ended with 1938 they were $ 1 1 1 , 7 0 7 , 0 0 0 per year. T h e effects on industry in general, especially on the durable goods industries, of these drastic curtailments in railroad purchasing power, are obvious. For ordinary materials and supplies used in maintenance and operation the purchases during the current depression have been less than half of those before the depression; the expenditures f o r new equipment have been less than one-third, * Bureau of Railway Economics, Association of American Railroads.

24

PRESENT RAILROAD CRISIS

and the total gross capital expenditures have been but little more than one-quarter. In normal years the railroads purchase about 2 3 % of the total production of bituminous coal, about 1 9 % of the fuel oil output, about 1 6 % of the total timber cut, and about 1 7 % of the total iron and steel output of the country.* Effect upon Quality of Public

Service

While the effects of reduction in net income have, as indicated, been severe upon investors, employees, and producers of materials and supplies, we find a peculiar anomaly in the effect upon the quality of railroad service to the public. Contrary to what might be expected, the quality of public service has progressively improved and is now better than ever before except in cases of lines or services which were so plainly unremunerative that abandonments or curtailments were authorized by the regulatory authorities. This improvement in service, however, has not been a result of impaired earning power but rather in spite of it. T h e improvement is the result of belated but now vigorous efforts on the part of railroad management to stem the losses of traffic to competing agencies. In passenger service the equipment is better than ever before and the speed of trains has been materially increased. In freight service there has been a substantial increase in speed and a betterment in the quality and regularity of service, with a general effort on the part of management to give the public what it wants. In other words, improvement rather than impairment in • Yearbook of Railroad Information, 1938 edition, Committee on Public Relations of the Elastern Railroads, N e w York.

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25

service has gone with lower earnings principally because of the spur of effective competition. Railroad Losses to Competitors

For agencies of transportation other than railroads the data relating to units of transportation product, revenues, costs, and net income are incomplete or fragmentary. Any comparison between railroads and other agencies, therefore, is not exact. The data for other agencies must be estimated, and the reliability of the available estimates depends largely on the validity of the basic assumptions. In an estimate of ton-miles by commercial trucks in intercity service competitive with railroads, for example, the only reliable data, beyond that furnished occasionally by traffic surveys for limited sections of the country and limited periods of time, are the records of truck registrations by states. In some cases the records show the truck capacities. From those figures as a starting point it is necessary first to make an assumption as to what proportion of the total trucks arc engaged in commcrcial inter-city service; next to make an assumption as to the average rated capacity; next as to the per cent of capacity utilized for the round trip; and next as to the mileage per truck per year. The frailty of a total based on so many assumptions is evident. This preface to the introduction of some comparative statistics is not to suggest that they are worthless but rather to sound a note of caution. In absolute figures they are weak, but when the same bases are used in periods not too widely separated they have value in indicating trends. In so far as the motor vehicles are concerned we

26

PRESENT RAILROAD CRISIS

have comparable data as to the number in use. In 1926 there were 19,237,171 passenger automobiles and busses registered. T h e comparable number in 1937 was 25,449,924. T h e registered trucks of all kinds increased from 2 , 8 6 3 , 6 5 2 in 1 9 2 6 to 5 , 2 7 5 , 2 8 1 in 1 9 3 7 .

In a report made to the President of the United States by the Committee of Six, appointed by him in September 1938, to consider the transportation problem and recommend legislation, certain comparative figures are given. One table in the report indicates that in 1936 the operating revenues earned by steam railroads, including Pullman cars and express, were 62.8% of the total of all agencies. T h e per cent earned by inland waterway carriers was 9.8; by common and contract motor carriers of freight, 1 1 . 0 % ; by common and contract motor carriers of passengers, 2.5 % ; by common carrier pipe lines, 3.2 % ; by interurban electric railways, 1 0 . 2 % ; and by air carriers (mail carriers only), 0 . 5 % . Of greater significance are the trends indicated by a comparison of ton-miles produced in 1926 and 1937 by all common and contract carriers. T h e steam railroad ton-miles in 1926 were 7 5 4 % of the total; in 1937 they were 64.6%. T h e inter-city trucks produced 3.9% in 1926 and 7.7 % in 1937. T h e steamers on the Great Lakes produced 1 5 . 2 % in 1926 and 16.6% in 1937. On other inland waterways the production in 1926 was 1 . 6 % and in 1937 it was 3.0%. T h e pipe-line production jumped from 3 . 7 % to 8.0%. E v e r y agency except railroads had an increase. Expressed in other terms, the railroad decrease in ton-miles in the eleven-year period was 1 8 . 9 % . F o r all other agencies there were increases: 84.4% f o r

UNDER THE NEW DEAL

27

inter-city trucks, 3.6% for the Great Lakes carriers, 76.9% for other inland water carriers, and 1 0 6 . 4 % f ° r the pipe lines. In passenger service the changes are even more striking. Between 1926 and 1937 the steam railroad proportion of total passenger-miles fell from 7 5 . 2 % to 5 2 . 5 % . T h e proportion by inter-city busses soared from 9.2 % to 4 1 . 7 % . * Passenger-miles by inland waterways fell from 3.9% to 2 . 8 % . T h e inter-city electric railways suffered heavily in a decline from 1 1 . 7 % to 2 . 0 % . * T h e airway passenger-miles in 1926 are not available. In 1937 they were 1 . 0 % of the total. While it may appear from the foregoing observations that competition of other agencies of transportation is the complete explanation of the low state of railroad earning power, such is not the case. It should be remembered that in 1929, when railroads as a whole were fairly prosperous, even though not earning the statutory rate of return on investment, all of the present competitive agencies of transportation were functioning, although not as effectively as at present. T h e potentialities of trucks and busses had been recognized, the private automobile was in extensive use, the pipe lines were taking a substantial part of the crude oil previously transported in tank cars, p o w e r transmission lines and natural gas pipe lines were furnishing power previously generated by rail-borne coal, the inland waterways had already had the greater part of the present total Government subsidies f o r their improvement, and passenger service by air was an accom* These changes were probably influenced in part by the substitution of motor busses for electrically operated cars.

28

PRESENT RAILROAD CRISIS

plished fact. Notwithstanding these forms of competition the railroads were doing fairly well. T h e present low state of railroad earning power, while accentuated by intensified competition, not only by the agencies herein referred to but also by the trucks, boats, and pipe lines owned and employed as private carriers * by large shippers, is due primarily to the low state of business activity. In other words, it is mainly the result of the depression, although the situation would be much less serious if competition were less effective and if the previously normal growth in total transportation demand had continued. Reductions in Total Transportation Demand

The normal growth in railroad-produced ton-miles during the generation which passed out in 1920 was an increase of about 8% per year. In passenger-miles the annual growth was about 6 % . In other words, except during periods of cyclical disturbance, railroad ton-miles doubled every twelve and one-half years and passengermiles doubled every sixteen years. In the life of the generation ended in 1920, railroad mileage had been continuously expanding and new territories were being developed by railroad extensions. During the nine years from 1920 to 1929, when the depression began, the growth in ton-miles was but 1 % per year and the trend • There are no available data indicating the extent to which private vehicles and vessels have been substituted for common and contract carriers, but it is large. The effect of private transportation on rates charged by common and contract carriers is profound. The shipper with financial capacity to acquire his own vehicles will pay no more for commercial transportation than the cost to him of furnishing his own service. That cost is the upper ceiling of the commercial freight-rate structure.

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29

in passcngcr-miles was reversed from an annual increase of 6r/c to an annual decrease of 4 % . T h e private automobile accounts in greater part for the change in rail passenger traffic, but as to freight service there were several factors other than the development of competitive agencies of transportation. In the first place, railroad building had come to a practical standstill. There were f e w new territories to develop. On the other hand, the depiction of forests, mines, and other natural resources, which certain railroad branches had been constructed to develop, left no traffic for such branches and they, together with mileage made unprofitable by highway competition, were abandoned. T h e total route miles of railroads in 1937 (the latest official figures of the Interstate Commerce Commission) were 2 3 8 , 1 6 1 , or 14,613 miles less than in 1 9 1 6 when they were 252,774. T h e miles abandoned have exceeded the miles of new construction. Consequently there has in recent years been little in traffic newly created by the railroad opening of new territories. In the second place, there has in recent years been a slower rate of growth in population, because of restrictions on immigration and other reasons. T h e growth in the period from 1900 to 1 9 1 0 was 2 1 % , while between 1920 and 1930 it was 1 5 . 7 % . There is a relationship between the population to be served and the total transportation demand. In the third place, the volume of tonnage of exports and imports has in recent years suffered a serious decline. T h e value of the total exports from 1920 to 1929, inclusive, was over five billion dollars per year. T h e compa-

3o

PRESENT RAILROAD CRISIS

rable figure f o r the period 1 9 3 0 - 3 7 was slightly less than t w o and one-half billions. This kind of traffic ordinarily has a fairly long haul and is of a kind that railroads are well adapted to handle. In the fourth place, there has recently been a marked change in distribution methods with extensive relocation of manufacturing plants and warehouses closer to the sources of raw materials or primary markets. T h e construction of assembly plants for automobiles in the lower price level is a case in point. Other instances are the transfer of cotton mills from N e w England to the South, shoe factories from N e w England to the Middle West, and slaughter-house operations from Chicago to the Corn Belt. All of these rcduce the total transportation demand. Finally, in the fifth place, the total transportation demand has been reduced as a result of technological improvements which make possible more units of finished products f o r a given volume of raw materials. Improvements in processes and greater utilization of by-products tend toward that result. A s a single example, taken from the railroad field, recent improvements in locomotive design and operating technique have reduced coal consumption per gross ton-mile by more than 3 0 % . This means that 3 0 % less fuel for railroad consumption is transported for a given production in railroad ton-miles. T h e foregoing recital of factors explains w h y the total transportation requirements have been growing less. T h e bearing upon railroads is clear, but when, in addition, the losses to competing agencies are considered, the implications are even more serious. In brief, the rate of increase in the grand total of transportation has been declining,

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31

and the railroads, because of intensified competition, are getting a smaller part of the smaller total. Subsidies to Transportation Agencies

The railroads have no more reason than have commerce and industry in general for complaining about the depression. In so far as decline in gross earnings is concerned, the degree of loss on the railroads has been little different from that suffered by other industries, but because of defects in railroad financial organization (to be discussed later) the unfavorable effect of the smaller gross upon railroad net earnings has been more serious. T h e railroads, however, have real cause for complaint on the score that the intensification of the competition with which they have to cope has been and is being fostered in part by governmental subsidy. The subsidy to inland waterways is substantial and definite. The subsidy to commercial operators on the highways is difficult of determination and it varies as between states. It is nevertheless real in its adverse effect upon railroads. This conclusion is not to be interpreted as an agreement with all of the assumptions and findings in the recent report * of three eminent engineers employed by the railroads to study and report upon the relationship between highway costs and the motor vehicle contributions toward such costs. Their conclusions were based on data f o r the twelve years 1 9 2 1 - 1 9 3 2 . Complete information could not be had for years later than 1932, but the statement is made that an analysis of available data for 1937 • Highway Costs by C. B. Breed, Clifford Older, and W . S. Downs, published by Association of American Railroads, January 30, 1939.

32

PRESENT RAILROAD CRISIS

shows that the subsidy in that year was no less than in 1932. T h e findings were that motor vehicles are properly chargeable with three-quarters of total cost of highways and city streets, and that the total payments made by motor vehicles for the use of the highways and streets were but 38% of the amount that fairly should have been paid. For the entire United States the amount of the alleged subsidy was at the annual rate of $813,000,000. According to the computations of the engineers the average passenger automobile actually paid $27.13 per year and it should have paid $42.40; the " f o r hire" 5-ton truck paid $369.81 and it should have paid $2,024.45; and the 20-passengcr common-carrier bus paid $441.61 and it should have paid $1,318.48. T o meet the indicated yearly deficiency the passenger car would be obliged to pay $ 15.27 additional, an increase of 56% in registration fees and gas taxes; the 5-ton "for hire" truck would pay an additional charge of $1,654.64 or 4 4 7 % more; and the payments by the 20-passenger common-carrier bus would be increased by $876.87, or 19870· While the results of these studies are consistent in varying degrees with those of studies made by the highway departments of the states of Washington, Missouri, and Illinois, and while the Illinois results have had the approval of the federal court in that district, there is reasonable ground for questioning some of the assumptions on which the conclusions are based.* Nevertheless the preponderance of evidence supports the general conclu• Such as the cost proportion of highway and city streets chargeable to motor vehicles in general and the charges to commercial vehicles for widening highways, construction of multiple lanes, and reductions in gradients and curvature.

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33

sion that any fair apportionment of inclusive highway costs indicates that commercial transportation on the highways enjoys public subsidy in a degree that makes the competition of that agency unfair to railroads. No fault can be found by the railroads with the competition of pipe lines for the transportation of crude oil and its derivatives, nor with the competition of power transmission lines or pipe lines for the distribution of natural gas. These agencies ordinarily can transport oils, gasoline, electric power, or natural gas with high efficiency, and they are economically superior to railroad transportation in tank cars or energy produced from railroad-borne fuel. Moreover they are privately owned and maintained, like the railroads, and are not subsidized by the Government. Nor can the railroads find fault with the competition of the steamers on the Great Lakes inasmuch as the public subsidy, confined largely to terminal facilities at the lake ports and light-house service, is relatively small. Transportation of bulk commodities, such as coal, ore, and grain, on the specially designed boats used on the Great Lakes, is at a ton-mile cost much lower than that of rail transportation. Public interest demands that the low-cost transportation on the lakes shall be utilized during the period of navigation. T h e same reasoning, however, does not apply to inland water transportation on the rivers which have been improved at heavy public expense. T h e carriers on those improved rivers, including the government-owned and operated Inland W a t e r w a y s Corporation, bear no part of the huge costs of public capital invested in improvements or any portion of the heavy expenditures for yearly

34

PRESENT RAILROAD CRISIS

maintenance. N o charge is made for taxes. It so happens that the principal beneficiaries of the subsidy are certain large corporations which have the financial capacity to provide their own boats and can thus reap the benefit of the expenditure of public funds. That these expenditures were justified in part by considerations of national defense and flood control should not be permitted to becloud the issue, as even with a generous apportionment of capital and maintenance costs to the non-transportation functions, the degree of transportation subsidy is large. T h e degree of subsidy in commercial air transportation also is substantial in its relation to the costs borne by the carriers. The air lines pay nothing toward the capital and maintenance costs of beacons and meteorological service. In many cases they assume little part of the cost of municipal landing fields, and their revenues from the G o v ernment for the transportation of mail are on a subsidy basis. Because the proportion of passenger traffic taken from the rails is as yet relatively small, the subsidy to air service is not nearly as important from the railroad viewpoint as the subsidies to highway and water carriers, but the volume of travel by air is steadily growing. In this form of transportation, more than in any other, there is the justification of encouraging a relatively new industry of very great importance from the viewpoint of national defense. National Surplus in Transportation Facilities

This discussion of the background of the present transportation problem will conclude with a brief reference to a factor of such economic importance that it might

UNDER THE NEW DEAL

35

properly have been given earlier emphasis. T h e nation is over-supplied with transportation facilities and equipment. There is a substantial surplus in the nation's capacity to supply present and prospective transportation needs. Inherent in such a situation are economic costs greater than are necessary. These costs, borne in the first place by those whose capital is sunk in surplus facilities not used or needed to meet the diminishing transportation demand, are ultimately passed along to and borne in many forms by the public at large. In Mr. Eastman's second report as Federal Coordinator of Transportation, transmitted to Congress under date of March 10, 1934,* attention is called to the enormous amounts of new capital, both public and private, invested in transportation facilities since 1920. Between that year and 1932 the railroads' investment in new lines, extensions, and additions and betterments, less retirements, amounted to $6,309,117,000. Companies engaged in the transportation of petroleum and its products by pipe lines which report to the Interstate Commerce Commission increased their investment by $423,613,000. Capital outlays on state, county, and local highways and city streets totaled $12,500,000,000. Appropriations by the Federal Government for improvements of rivers and harbors aggregated about $604,000,000. Electric railways reporting to the Interstate Commerce Commission, on the other hand, had $727,233,000 less investment, owing in large part to abandonments. T h e net total of the amounts mentioned is an increase of $19,110,000,000. In the twelve years following the • Senate Document 152, 73d Congress, 2d Session.

36

PRESENT RAILROAD CRISIS

World W a r the increase in investment devoted to public transportation service was equal to ι oo years' investment in railroads. T h e amount of the increase would be substantially greater if to the $ 19,110,000,000 were added an estimate of the additional investment in motor vehicles, garages, boats, and other privately owned water equipment, natural gas pipe lines, electric transmission lines, and pipe lines not reporting to the Interstate Commerce Commission, as well as the additional investment in aircraft, airports, and other air transport facilities, part of which have been financed by the Government. A f t e r making due allowance for facilities used in purely local transportation, or which are otherwise not in competition with established agencies of transportation, Mr. Eastman concluded that the twelve years' additional investment dedicated to transportation might conservatively be set as $25,000,000,000, or at the rate of over $2,000,000,000 per year. H o w that additional capital outlay can be supported by a volume of traffic which is now substantially below the pre-depression years, and which before that time had been increasing at a much slower rate than in the period before 1920, is a difficult national problem. Railroad Capitalization

When Congress passed the Transportation Act of 1920 the Interstate Commerce Commission was given a mandate to establish the rate scale as a whole so that the railroads of the country as a whole, in territorial groups to be defined by the Commission, might earn a fair return on the Commission's valuation of properties held for and

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37

used in the service of transportation. A fair return for 1920 and 1921 was defined by the act as 5 Vi % , but the Commission was authorized to allow an additional onehalf of one per cent, making 6% in all. The additional allowance was to provide in whole or in part for improvements, betterments, or equipment chargeable to capital account. Whether, after the first two years, the 6% rate should be continued, or made higher or lower, was left to the discretion of the Commission. Acting under that authority the Commission, in 1922, set 5 % % as the fair rate of return. Attention has already been called to the fact that the 5 % c/c return has not been earned. On the basis of the railroad book value, which is slightly higher than the valuation tentatively set from time to time by the Commission, the highest return earned by Class I railroads as a whole since the Act was passed was in 1926, when it was 4.96%. In 1929 it was 4.81 % . The lowest return was in 1932, when it was 1 . 2 4 % , and the next lowest was in 1938 when it was 1 . 4 3 ^ . The average return during the last eight years, 1 9 3 1 - 1 9 3 8 , was slightly less than 2%.* Obviously a business enterprise that earns such an inadequate return on invested capital cannot indefinitely continue on that basis. The railroad funded debt,t which comprises 6 1 % of the total capitalization, calls for interest charges of approximately 4 % . Recently issued bonds carry a somewhat lower rate. The average interest rate on mortgage bonds issued in 1937 was 3.93%, on * Percentages of return taken from studies published b y Bureau of Railway Economics, Association of American Railroads. t Bonds, equipment trust certificates, and other evidence of unmatured debt maturing more than t w o years from date of issue.

38

PRESENT RAILROAD CRISIS

equipment trust notes it was 2.65%, and on all obligations it was 3 . 2 5 % . The total net capitalization of all railroads, eliminating intercorporate holdings, on December 3 1 , 1937, was $18,319,000,000.* T h e Commission's physical valuation of Class I railroads for rate-making purposes is approximately $20,000,000,000.t From the viewpoint of physical valuation, therefore, the railroads are not overcapitalized. Whatever may have been the inflation of capitalization in earlier years by stock watering and other financial malpractice, that inflation has since been more than offset by the uncapitalized investment of earnings in the properties of the prosperous roads, and by the scaling down of capitalization of a large part of the weaker roads through reorganization. Yet even though the capitalization is conservative from the viewpoint of actual investment and physical value based on reproduction cost less depreciation, the capitalization is excessive from the viewpoint of prospective earnings. One weakness in the valuation figures lies in the fact that adequate allowance has not been made for physical property which is wholly or partially obsolete, property which is still carried as an asset in the investment account but is neither used nor useful. From the public viewpoint it is not reasonable for the railroads to expect a return on an investment in property that is obsolete or unused. What this obsolete or unused property amounts 'Statistics of Railways of the United States, 1937, Statement 21. B y "net capitalization" is meant the gross capitalization minus railroad securities held b y the railroads themselves and therefore not in the hands of the public. + 229 I.C.C. 4 5 1 . Bituminous Coal Rate case, N o v e m b e r 1938.

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39

to in per cent of book value is unknown and cannot be intelligently estimated because the degree of obsolescence and the extent of unused facilities and equipment are not uniform on all railroads. A physical survey recently made of one part of a property now in process of reorganization developed the fact that the book value of trackage, buildings, and other structures which were no longer necessary and no longer used was equivalent to one-seventh of its funded debt. T h e retirement of the obsolete and unused units meant, of course, that the investment account had to be written down accordingly. T h e reduction in the value on which the bonds are a lien was apparent but not real. T h e only value securing the bonds is the earning power, and the maintenance, in whole or in part, of the obsolete and unused property was a drain on that earning power. T h e retirement of the property resulted in substantial savings in maintenance expenses and in taxes. A second weakness in railroad financial organization is in the high proportion that funded debt bears to the total capitalization. A safe rule in business is that the owner should not borrow more than he himself is willing to risk in the enterprise. Until recent years the laws of Massachusetts prohibited railroad funded debt in excess of its capital stock. In England the debentures, which correspond in many respects with our bonds, may not be more than one-quarter of the total capitalization. Y e t in the United States the stockholders of the railroads have borrowed $ 1 . 5 9 f o r each dollar they put into the property themselves. T h e funded debt is 6 1 . 5 % of the total net capitalization.

4o

PRESENT RAILROAD CRISIS

T h e credit standing of a railroad, and its ability to raise new capital by the sale of stock, depend not only on earnings sufficient to meet fixed charges but also upon its capacity to earn enough additional to pay dividends on its stock. W h e n bonds, with their fixed charges, are much more than one-half of the total capitalization, the residual part of income, after payment of such charges, becomes uncertain in years of lean earnings, dividends must be reduced or passed, and the credit of the company is impaired. N e w capital then can be secured only by the sale of bonds, with a further increase in the proportion of debt to total capitalization. T h e position of the stockholder becomes more precarious and there is further damage to credit. A third weakness in railroad financial organization is in the general failure to provide for retirement of funded debt by the creation of sinking funds. That failure may be attributed to the false notion of earlier years that railroad fixed property is of permanent value. A t maturity the general practice has been to refund the bonds by a new and usually larger issue. Little effort has been made to retire the funded debt, in whole or in part, and replace it, when necessary, by the issuance of stock. T h e prevailing reason, no doubt, was that if the property could earn, say, 6 % on total capitalization, and money could be borrowed, say, at 4 % , it was good business to raise new capital by the sale of bonds at low interest rates so that dividends on the existing stock could be increased. T h e fallacy in the reasoning is that the railroad investment is not in permanent things. Their temporal nature has been painfully demonstrated. Railroad property, like

UNDER THE NEW DEAL

41

practically all other physical property, is subject to the relentless forces of obsolescence and supersession, and those forces, although latent in earlier years, are now, under the recent development of intensified competition of newer agencies of transportation, acting with devastating effect upon earning power. Unfortunately the realization of the mistake comes at a time when it is impractical to correct it quickly, as railroad earnings, present and prospective, are inadequate to assume the burdens of new charges for the amortization of debt. As a practical matter about all that can be done in the years immediately ahead is gradually to provide for amortization by attaching a sinking fund provision to all refunding or new issues of bonds. Such a process for correcting an error of the past would take time, but eventually all funded debt would be on an amortization basis. The Interstate Commerce Commission has, in certain recent cases, required the creation of sinking funds on new issues, and it may be that the requirement will become a fixed policy. T h e ability to carry out such a policy depends in part on the adequacy of future earnings and the soundness of the new capital structures of the many companies now in process of reorganization.* A fourth weakness in the railroad financial structure is found on roads which in past years have been low in earning power. In contrast to the policy of a few man* It may be noted here that in recent years the purchase of most of the new equipment in locomotives and cars has been financed by the sale of equipment trust notes which call for yearly payments on principal. This form of funded debt is paid off in fifteen or twenty years. The foregoing comment on the need of sinking funds does not apply to equipment trust securities. It applies to other forms of funded debt.

42

PRESENT RAILROAD CRISIS

agements of reinvesting but not capitalizing a substantial part of net income in the property, the majority of the companies disburse practically all of the net income in dividends and finance their additions and betterments in by far the greater part from funds acquired by the sale of additional securities. In rccent years, moreover, the medium has been bonds, because of the impracticability of marketing capital stock. In some of the plans for the reorganization of railroads now in bankruptcy we find recognition of that weakness by a provision that a stated sum, or a stated percentage of the net income after charges, shall be set aside annually for additions and betterments. In answer to criticism of the high percentage that funded debt bears to total capitalization, spokesmen for railroads call attention to the fact that while it is true that funded debt is 61 r/c of total net capitalization, that capitalization is but 71 % of the book value of the properties, and the funded debt therefore is but 4 4 % of that investment. Apart from the important fact that the security behind the bond is the earning power of the property rather than the physical property itself, the book value, as commonly used, does not recognizc the accrued depreciation on equipment and the unaccrued depreciation and obsolescence in way and structures. T h e book value includes, moreover, the investment in a substantial mileage in branch lines which under present conditions are not earning enough to pay their direct operating cost and, so far as can now be foreseen, will continue to be a liability rather than an asset, as well as the unused and

UNDER THE NEW DEAL

43

useless trackage, structures, and other facilities hereinbefore mentioned. A fifth weakness in the railroad balance sheet, therefore, is that there is practically no accounting reserve for depreciation and obsolescencc in way and structures. T h e rules of the Commission have, since 1907, required the current accrual of depreciation on locomotives and cars but, while recommending that a similar practice should be applied to fixed property, there is no requirement. Because such accruals are optional, vcrv f e w railroads have anv reserves for depreciation and obsolesccnce on fixed property and, to the extent that such reserves are not provided for, the investment account is overstated. On the combined balance sheet of Class I railroads, December 1, 1937,* the investment in road and structures was $13,879,000,000 and the accrued depreciation was $124,000,000, or 0.9'/o of the investment. With respect to locomotives and cars, the investment was $5,483,000,000, and the accrued depreciation was $2,504,000,000, or 4 6 % of the investment. T h e reserves for depreciation of equipment, therefore, are fairly adequate, but practically no recognition is given to the substantial degree of depreciation and obsolescence in the much larger investment in way and structures. It is not proper, therefore, to relate the funded debt to the book assets value of investment unless from that value are deducted the recognized liability item of accrued depreciation on equipment and an estimate of the unrecognized liability item of depreciation and obsolescencc in way * Statistics of Railways of the United States, I.C.C., 1937, Statement 42.

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PRESENT RAILROAD CRISIS

and structures. T h e s e facts should be f a c e d in realistic fashion. A thoroughgoing survey should be made to determine the degree of unrecognized obsolescence, and the investment account and the corporate surplus account should be revised to reflect the truth. Railroads Are Not Attracting Ambitious Young Men T u r n i n g f r o m problems of finance to problems of management w e find several weaknesses in railroad organization. T h e y may be classified as existing ( ι ) in personnel, and (2) in a degree of corporate individualism that is harmful to the collective good of the industry as a whole. A survey of the personnel of the official organization of the typical railroad will develop t w o facts: ( 1 ) that the average age of the general officers is relatively high and the proportion of y o u n g men in executive positions relatively l o w , and ( 2 ) that little effort is made systematically or continuously to attract to the industry y o u n g men w h o have had the ambition to acquire education beyond high school, whose abilities as students in colleges and graduate schools have been demonstrated, and whose promise of executive capacity is attested b y their instructors. T h e report of the Federal Coordinator of Transportation, under date of J u l y 19, 1 9 3 5 , entitled " R a i l r o a d T r a f f i c Organization," contains interesting data w h i c h throw light on the average age of the officers of one department in railroad organization. In 1 9 3 5 the average age of the chief executive officers of the traffic department was fifty-eight years. T h e average age of assistant

UNDER THE NEW DEAL

45

exccutivc officers was fifty-three years. For men who solicit traffic the average age was forty-four years. The group last named may be regarded as the "cubs" of the organization, yet their age is conspicuously high. Data for other departments were not made available, but the probabilitv is that it corresponds closely with that of the traffic department. The averages for 1935 are affected, of course, by the necessity during the depression for reducing expenses. The cut in pay roll costs was severe, especially among the "white collar" classes. In the process of retrenchment the younger men were naturally the first to be cut. The men in the traffic department are not governed by the principle of seniority in service as much as those in the operating department, where seniority is absolute among employee members of the labor organizations, but seniority had predominant influence in the traffic department as well. The effect of dropping the younger and retaining the older men was to increase the average age of those who were retained, yet even with due allowance for that factor, the average age is too high. If comparable age averages were available for the executive personnel of the highway and air transportation companies, the differences in favor of youth in the newer agencies would likely be impressive. This is not to suggest that there should be a ruthless purge of the older men but rather that there should be a dilution of the effect of age by a more generous admixture of younger blood. One criticism of railroad management is that the "oldsters" still look at things through the spectacles of the pre-war period and that they do not

4

6

PRESENT RAILROAD CRISIS

yet realize that the days of railroad monopoly in inland transportation have passed. Such a generalization is unfair to the many able, progressive, and youthful-minded executives in the older group, but there is enough truth in the generalization to give specific support to those who make it. Here and there throughout the country there have been many instances in which young men of demonstrated promise have been jumped over the hurdles of seniority, but in too many cases the younger men, who have more imagination and a better conception of what is needed in rates and service, are held down by their more conservative seniors who do not fully recognize the import of changed conditions. T h e well-being of the railroad industry as a whole would be better if there were a more general policy of seeking, within or without the organization, a liberal number of young men, acting either on their own responsibility or as assistants to the older executive officers, to leaven the mass with imagination in ideas and policies which will meet the changed conditions of the present. If need be, new positions might be created so that the organization might have the benefit of imagination, initiative, resourcefulness, and energy of youth, alive to present-day conditions, tempered by the wisdom and mature judgment of those with more years in the school of experience. It is unreasonable to require and vain to hope that those who recruit office boys, junior clerks, or apprentices in the shops, shall select for employment only those youngsters who can give proof of the possession of all of the

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47

natural qualities needed in the chief executive or the shop superintendent. Y e t it is true that in the typical organization too little attention is paid by those in charge of employment to the qualities needed not only in the position then to be filled but also in the higher positions beyond. A s a consequence the promising material from which junior executives may be selected is too often so limited in quantity as to restrict the choice, and the same inadequacy appears when a selection is to be made among the juniors to fill a vacancy in the higher executive positions. T o correct that deficiency in organization the practice of many industrial companies is deliberately to recruit cach year a f e w young men of exceptional promise so as to bring up the average capacity by stimulating the personnel of the "run of mine" variety and increase the potential in men available for promotion. T h e scouts for these companies plan to visit the colleges and graduate schools well in advance of the date of graduation so as to have early choice of the most promising candidates. Such a practicc evidently pays, because it is of long standing, is being continued, and the number of companies employing it is increasing. A m o n g the companies which have such a policy the railroads are conspicuously small in number. T h e railroad that deliberately recruits in that fashion is the exception rather than the rule. A t the Harvard Graduate School of Business Administration this spring w e have had an inquiry f r o m but one railroad. Since the Christmas recess the visits from the personnel or other officers of industrial organizations, and the making of arrangements f o r inter-

4

8

PRESENT RAILROAD CRISIS

views with students who will be graduated in June, have taken practically all of the time of the assistant dean in charge of placement. In fairness to railroads attention should be called here to their present acute financial distress and to the large number of furloughed men who have a moral claim on available jobs. T h a t condition, however, is common to business in general and is not peculiar to railroads. T h e conclusion is that railroad managers are not as conscious as are the executives of other large industries of the desirability of attracting broadly educated and otherwise promising young men into the business. Under the severe handicaps of the last decade, and the heritage from the past of faulty financial organization, the recent achievements of railroad management are creditable and deserve praise. T h e present situation would be much more serious if those in charge of the properties had not shown ability, resourcefulness, and zeal in their efforts to meet changed conditions. In loyalty to the companies they serve, in devotion to duty, and in willingness to work hard and continuously, railroad officers are outstanding among industrial organizations. T h e criticism of high average age and apparent disinclination to give greater opportunity to youth is not meant to minimize the praise for creditable achievement. Its purpose is to draw attention to the fact, widely recognized in other industrial organizations, that with greater difficulties to be overcome and heavier responsibilities to be carried there should be a more general and systematic policy of shifting a greater part of the load to younger shoulders.

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49

Excessive Degree of Corporate Individualism This critical rccital of railroad shortcomings will conclude with a discussion of the harmful effect upon the railroads collectively of an excessive degree of corporate individualism. At the outset, recognition must be accorded to the fact that railroad officers, from the lowest to the highest, are employed to serve the individual railroad which pays their salaries. T h e y are not employed by the railroads collectively. T h e y are responsible only to the board of directors and the stockholders of their own corporation, not to the industry as a whole. T h e stockholders—the owners of the property—have turned that property over to the directors, and the board has employed the president and departmental heads to administer the railroad in the interest of the stockholders. T h e prime responsibility of the executive officers is so to maintain and operate the property that, subject to the obligations which the corporation has to the public through the governmental regulating authorities, there shall be a reasonable financial reward to those whose capital has been invested in the enterprise. T h a t responsibility is both legal and moral. This concept of responsibility creates difficulties in the case of a coordination proposal which, if carried out, would reduce the total cost of transportation by all railroads affected, without injurious effect on the adequacy and quality of public service, but might adversely affect the interests of a single railroad. T h e benefit to that single railroad might be proportionately less than the benefit to others affected by the proposal, and the competitive posi-

5o

PRESENT RAILROAD CRISIS

tion of that railroad might be weakened. Or the proposal might require the single railroad to surrender an advantage in strategic position. In such a case the attitude of the officers of the typical individual property is that their legal responsibility to their stockholders requires them to reject the proposal even though it clearly would be to the advantage of the railroads collectively and would reduce the total transportation bill, which ultimately, in some form, will be paid by the public. T h e broad advantages to the railroad industry as a whole, and the lower cost to the general public, arc outweighed by the fear that the competitive position of the single railroad might be weakened. Coordination

of Railroad

Facilities

In view of the fact that coordination of railroad facilities would result in economies to railroads and thereby increase their net income, and the further fact that progress in coordination could not be achieved when one or more of the railroads affected by a proposal would block a proposal because of individualism, President Roosevelt, during the early part of his first year in office, put his influence behind legislation intended to expedite a program of coordination on a national scale. T h e Emergency Transportation A c t of 1933 created the office of Federal Coordinator of Transportation and clothed it with broad functions and authority. One of the principal purposes of the act was "to encourage and promote or require action on the part of the carriers . . . which will avoid unnecessary duplication of services and facilities of whatsoever nature and permit the joint use

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51

of terminals and trackage incident thereto or requisite to such joint use." T o the office thus created the President appointed Joseph B. Eastman, a member of the Interstate Commerce Commission and a man of exceptional ability, imagination, and courage. T h e A c t limited the life of the office to one year from June 16, 1 9 3 3 , but gave the President the power to extend it one year. Such an extension was made by executive order and, in 1935, Congress authorized another year's extension. In 1936 Mr. Eastman recommended a further extension, but Congress failed to act and the office went out of existence on June 16, 1936. T h e proposal for a fourth year had general public support but was opposed by the railroad labor unions because of Mr. Eastman's frankness in criticizing certain proposals advocated by labor leaders and because of alarm about unemployment (which might be accentuated by the displacement of men in coordination projects). Extension was opposed also by the railroad executives, who resented Mr. Eastman's criticisms and objected to many of the measures he advocated. During his three years as Federal Coordinator Mr. Eastman and his staff devoted a large part of their time to the study of coordination of physical facilities and service at terminals in cities served b y t w o or more railroads where there were unnecessary duplications of yards, enginehouses, stations, and other transportation facilities, and where it was possible to give practically the same quality of service at lower cost through joint use of one facility and abandonment of others. In addition to the central staff there were three regional directors of

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PRESENT RAILROAD CRISIS

coordination, each assisted b y a committee composed of railroad executives of the region. Altogether more than five thousand terminal situations were studied. T h e economic possibilities were found to be large. T h e estimate of the central staff was that annual savings of $56,093,498 could be effected, but that estimate was questioned b y the railroad executives.* T h e regional committees of railroad executives did agree, however, that in the projects which they considered practicable there were potential annual savings of nearly $25,000,000. There were t w o principal reasons w h y very little was accomplished in coordination of facilities and service. T h e first was the adoption of an amendment to the A c t , as originally introduced in Congress, providing that in the effectuation of coordination the number of employees should not be reduced below that of M a y 1 9 3 3 , after deducting the number w h o had been removed subsequent to that date by death, normal retirement, or resig• Apropos of the economies which might be achieved through coordination, Mr. Eastman, representing the Interstate Commerce Commission at hearings on the Lea bill before the House Committee on Interstate and Foreign Commerce, has more recently said: "The commission is convinced that there is a very large amount of waste in transportation operations as they are now conducted in this country, which could be avoided or materially reduced, so far as the railroads are concerned, by the process of consolidation or coordination, and, so far as the entire transportation system is concerned, by better integration of the different modes of transportation. Some of us, at least, believe that there is more to be gained for all concerned from progress along these lines than from any other means of improving transportation conditions. The commission is also convinced that if progress of this character is to be made, the Government must at least assume the leadership and perhaps must apply some measure of compulsion. The apparent interests of the carriers are too divergent, and there are far too many of them, to permit of the necessary leadership within their own ranks." (The New York Herald-Tribune, March 29, 1939.)

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53

nation. T h e number of deductions in any one year was not to be more than 5 % . In addition, the amendment provided that by the process of coordination no employee should have his wages reduced or be deprived of employment such as he had in M a y 1 9 3 3 . Inasmuch as the potential economies in coordination were principally in reduction of pay-roll expense, the amendment was a barrier to most of the proposals. T h e reductions in number of employees could not be greater than 5 % per year. T h e situation was aptly summarized by M r . Eastman when he stated that he had been transformed from a potential "doer of deeds into a prober of possibilities." T h e second reason was the disinclination of the railroads individually to go along with the idea of coordination. That state of mind has already been mentioned. T h e labor provisions did not entirely explain the lack of affirmative action. T h e y were of a temporary nature and would yearly g r o w less restrictive. T h e Coordinator had ground f o r the assertion that the importance of the labor proviso was exaggerated to divert attention from other reasons, that progress might have been made by conference and adjustment with employees without violating the law, and that corporate individualism was the real obstacle. Other reasons, however, were present. T h e r e were mortgage difficulties. Properties on which the mortgages were a lien could not, in many cases, be abandoned without specific authority f r o m the trustee. T h e r e were complications in the terms of existing contracts and other legal agreements. T h e local communities objected because of transfer of employees, the fear that the abandon-

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PRESENT RAILROAD CRISIS

ment of duplicate facilities might reduce the degree of competition in service, and the certainty that tax collections would be less. Yet the underlying impediment to coordination was and still is the disinclination of the individual carrier to surrender an advantage, real or imaginary, in strategic location and to share that advantage with a competing carrier under unified operation. When Mr. Eastman went out of office as Federal Coordinator and resumed his duties as a member of the Interstate Commerce Commission, he turned over to the Association of American Railroads all of his records and studies relating to the five thousand coordination projects which had been investigated. A n announcement from the Association promised that through appropriate regional committees the Coordinator's studies would be continued and that coordination would be brought about wherever practicable. Such committees were promptly appointed and since then there have been a few cases wherein coordination was brought about by voluntary action of the interested carriers.* T h e Association, created in November 1934, succeeded the former American Railway Association and the Association of Railway Executives. Neither of the former organizations had authority to bind the individual members to the adoption of or adherence to standards or policies. Their functions were merely advisory. T h e y * On M a y 21, 1936, a f e w weeks before the end of the Federal Coordinator's term of office, an agreement was reached, between the Association of American Railroads and the R a i l w a y Labor Executives Association, under which employees displaced by coordination projects would be paid dismissal compensation based on their years of service. T h e so-called "Washington agreement" removed one barrier to coordination but minimized the economies during the first five years.

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55

had little to do, f o r example, with traffic policies or with finance and accounting. T h e present organization has legislative power in all departments to require individual members, under pain of expulsion, to adopt and adhere to standards, rules, and policies approved by vote of threequarters of the membership. T h e potentialities of the Association have not yet been realized. T h e defects of an extreme degree of individualism still prevail. There is reason to believe that the Association hesitates to try to discipline the recalcitrant members because of the fear that the attempt would fail. T h e four-year record of the Association does not carry much promise of effective achievement in coordination where collective benefit depends upon concession of advantage by individual roads.

III PROPOSED

TRANSPORTATION

LEGISLATION The Report of the President's Committee of Six

W E may now turn our attention to the possibilities for railroad relief in the proposed bills at present under consideration by committees of Congress. W e may not here consider, identify, and discuss all of the many proposals. Instead we will in the main confine ourselves to House Bill 4862, submitted March 8, 1939. That Bill has had extensive hearings before the House Committee on Interstate Commerce.* It is based in large part on the recommendations made in a report of December 23, 1938, to President Roosevelt by a committee appointed by him on September 20, 1938, to consider the transportation problem and rccommend legislation. The Committee was not given an official name, but because it was made up of three railroad executives and three executives of railroad labor unions it is commonly referred to as the Committee of Six.t • A bill somewhat similar (S.2009) was introduced in the Senate on March 30, 1939, by Senators Wheeler and Truman. On the same date the two Senators introduced also S.1869, " A bill to protect interstate commerce from the dangers of unsound financial structures and to establish improved procedures and standards for financial rehabilitation of railroads engaged in interstate commerce, and for other purposes." t T h e members were President Clement of the Pennsylvania Railroad, President Norris of the Southern Railway, Vice-Chairman Gray of the

56

PROPOSED LEGISLATION

57

The report of the Committee was notable in the respect that as to the nature and scope of desirable legislation it reflects unanimous agreement between high-ranking representatives of railroad management and railroad labor. Yet even though the Bill was based upon the recommendations of three leading railroad executives, was written by the general counsel of the Association of American Railroads, and has the endorsement of the Association, there has been dissent by individual railroads. Furthermore, the President of the Brotherhood of Railroad Trainmen has voiced his opposition. Nevertheless, the Bill may be regarded as the consensus of opinion of the large majority of railroad managers and railroad employees. It is natural, of course, to find no reference to wage rates and working rules. Unanimity in that field could not have been expected. T h e report emphasizes the view that the things the Committee was asked to study are not merely a railroad problem but rather a national transportation problem. From that viewpoint the first recommendation is that the government should adopt a definite national transportation policy providing for fair and impartial regulation of all modes of transportation to be administered so as to preserve the inherent advantages of each. Then come the following recommendations: * Union Pacific Railroad, Grand President Harrison of the Brotherhood of Railway Clerks and Chairman of the Railway Labor Executives' Association, President Jewell of Railway Employees Department, American Federation of Labor, and President Robertson of the Brotherhood of Locomotive Firemen and Enginemen. * Summarized by Dr. J. H. Parmelee, Director, Bureau of Railway Economics, Railway Age, January 7, 1939.

58

P R E S E N T R A I L R O A D CRISIS

ι . Concentration in the Interstate Commerce Commission of power to regulate rates f o r all modes of transportation, with broader power over intrastate rates; also regulation of services, valuation, and accounting. A revised rate-making rule is suggested, applicable to all modes of transportation, which establishes three yardsticks f o r fair and reasonable rates, so that they shall be sufficient to (a) sustain an adequate national transportation system, (b) maintain credit to attract essential capital, and ( c ) afford fair treatment to investors. T h e report also recommended repeal of the long-and-shorthaul clause of the Interstate Commerce Act, and suggested changes in the provisions of the A c t dealing with reparations. 2. Establishment of a new and independent federal agency, the Transportation Board, which should have control, as to all modes of transportation, of certificates of convenience and necessity, abandonments and extensions, issuance of securities, consolidations, mergers, leases, etc. T h e Board would also be directed to investigate the relative economy and fitness of the several modes of transportation, and the extent to which any of them is being subsidized, with recommendations f o r corrective legislation. 3. Establishment of a separate reorganization court, which should handle all railroad reorganizations, with no further responsibility on the Interstate Commerce Commission in such matters. 4. Repeal of provisions of the Transportation A c t of 1920 calling f o r a general consolidation plan, and restoration of initiative in consolidation matters to the carriers, subject to approval by the Transportation Board. In granting approval, the Board should consider the public interest,

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59

the interest of all carriers involved directly or indircctly, and the interest of affected employees. 5. T h e report also recommended tolls for inland waterw a y s (not including the G r e a t L a k e s ) , elimination of the Government's Federal Barge Lines, repeal of

land-grant

rate reductions, and relief f o r the carriers from grade-crossing elimination costs and certain other impositions. It finally recommended simplification and liberalization of loans b y the Reconstruction Finance Corporation to railways, especially in the matter of loans for purchase or construction of new equipment, and loans for the financing of maintenance w o r k .

T h e prospect of legislation helpful to railroads in the current session of Congress is none too bright. T o some of the proposals, such as relief from assessment f o r gradecrossing elimination and bridges over improved waterways, payment of commercial rates by the Government to land-grant roads, and less restrictions on R . F . C . loans, there is little opposition. These things, however, are of minor importance and will provide relatively little relief. T h e proposal for a special court f o r railroad reorganization has been embodied in a separate bill sponsored by Senator Wheeler. It is intended to expedite the downward revision of the capital structures of the weak roads and give them a new start in life on a sounder financial basis. T h e repeal of the long-and-short-haul clause was almost accomplished in the last session of Congress as the Pettingiii Bill. Its chances n o w as a part of a broader bill, overweighted with more controversial issues, are not promising.

6o

PRESENT RAILROAD CRISIS

In the past a very large part of the cost of eliminating crossings of railroads and highways at grade has, under state laws, been imposed on railroads. When those laws were enacted in the horse-and-buggy days, highway traffic was small in volume. T h e belief then was that the railroads were the principal beneficiaries. Under present conditions the motor vehicles which use the crossings are many fold the number of trains, and the elimination of the crossings, usually at heavy cost, is primarily for the benefit of the motor vehicles. Some of the states (notably N e w York) have recently amended the laws governing apportionment of costs so that the burden on the railroads will be substantially lightened. The proposal now is that, by a federal law, the railroads will be required to pay no more than the amount of benefit to them in the elimination of such expense items as crossing watchmen, crossing gates, and the like. The proposed law would apply the same principle to the apportionment of the cost of changes in railroad bridges made necessary by improvements in waterways for navigation or flood control. Under the statutes by which grants of land were made by the Government in aid of the construction of 17,627 miles of railroad in the pioneer days, there was a stipulation that the Government forever should have the use of such roads for the transportation of troops and property of the United States without toll or charge. When the question later came before the Supreme Court the decision was that the statutes meant only that the railroads could be used by the Government in performing transportation for itself, and that inasmuch as the service was

PROPOSED LEGISLATION

61

performed by the railroads they were entitled to 50% of the commercial rate for performing the service. In the report of the Committee of Six there is an estimate that the so-called land-grant reductions, both on the land-grant roads and on other roads which for competitive reasons chose to meet the lower rates of the land-grant roads, now amount to $ 10,000,000 per year. On the ground that the Government in the period of the land grants received full consideration for the grants in the enhancement in the value of contiguous Government lands after the territory was opened up by the railroads, and that since the period of the grants the Government has saved large sums bv paying railroad rates substantially less than those found by its own regulatory agencies to be just and reasonable for the general public, the Committee of Six now recommends that the reduced rate provisions in the landgrant statutes be repealed. The recommendation has the support of the Interstate Commerce Commission and has general public approval. As to loans from the Reconstruction Finance Corporation, the recommendation is that the act creating the Corporation be amended to permit the Interstate Commerce Commission to approve applications for loans when, in the opinion of the Commission, there is reasonable assurance of the repayment of the loan and the protection of the Reconstruction Finance Corporation. Under the law as it now reads the Commission may not approve a loan, except for maintenance or purchase of equipment, unless the Commission finds that the railroad, on the basis of present and prospective earnings, may reasonably be expected to meet its fixed charges without a

62

PRESENT RAILROAD CRISIS

reduction thereof through judicial organizations. T h e proposed change is not favored by the Interstate Commerce Commission. N o r is it wholeheartedly supported by all of the railroads. As one railroad executive put it: " T h e railroads won't get anywhere if they keep on borrowing themselves out of trouble." T h e repeal of the long-and-short-haul clause (Section 4 of the Interstate Commerce A c t ) is not likely. It is too dear to the hearts of merchants in the inter-mountain cities, such as Spokane, Reno, and Phoenix, where memories of injustice in the days of railroad freedom in ratemaking are kept alive. T h e clause prohibits a railroad from charging more for a shorter than for a longer haul over the same route in the same direction, and was enacted to prevent railroads from making low rates, based on direct costs, to meet water competition at or near seaports, and charging higher rates to intermediate points not subject to water competition. T h e Commission, however, has power to grant relief from the rule if, in the opinion of the Commission, such relief is in public interest, and many exceptions have been permitted. T h e merchant or jobber in Reno would object, naturally, to paying more on freight from the East than is paid by the merchant or jobber in San Francisco, even when he is told that the rate to Reno, considered by itself, is just and reasonable from the viewpoint of total costs; that the rate to San Francisco, held down by water competition, must be based on a small margin over direct costs, else the railroad will not share in the traffic; and that the small profit over direct costs on the San Francisco traffic is of ad-

PROPOSED LEGISLATION

63

vantage to Reno because that profit, even though it be small, has a favorable influence on the Reno rate by holding down unit costs as a whole. On the assumption that under normal rates to San Francisco, instead of subnormal rates to compete with water carriers, the rails would lose the greater part of the San Francisco traffic, Reno would not gain anything in freight charges. Instead it might lose because unit costs on the smaller volume of freight moving through Reno might justify higher rates. This argument, however, would not appeal to the Reno jobber if he had to pay a f e w cents per hundred pounds more on merchandise from N e w York than is charged to a competing jobber in San Francisco, 243 miles farther from N e w York. T h e features in the proposed Bill which are highlv controversial and are most likely to result in prolonged and heated debate are those which would: (a) bring all modes of transportation under a degree of regulation equal to that now applying to railroads, place all under the Interstate Commerce Commission, and impose tolls on the improved inland waterways; (b) create a superbody to be known as the Transportation Board, and transfer to that Board a considerable part of authority now vested in the Interstate Commerce Commission; (c) revise the present rule of rate-making by eliminating the requirement that the Commission shall take into account the effect of proposed rates on the movement of traffic; and (d) amend the present consolidation section by giving more freedom to railroad initiative and removing the emphasis on preservation of competition.

64

PRESENT RAILROAD CRISIS Adoption

of a National Transportation Policy

The recommendation that Congress should adopt a national transportation policy, providing for fair and impartial regulation of all transportation agencies and the preservation of the inherent advantages of each agency, is sound. Under such a policy the regulating authority would determine and define the economic zones of each agency and exercise its regulatory authority in such manner that wasteful competition between agencies would be discouraged. Under present conditions such wasteful competition is found when the form of transportation which is economically superior to others is injuriously affected by the efforts of economically inferior agencies to share the traffic under rates which barely cover the direct costs and therefore yield no profit, or even at rates which are less than the direct costs and therefore entail an actual loss. The inferior agency makes nothing or next to nothing. The superior agency is injured by being deprived of the difference between fair and reasonable rates for the service and the lower subnormal rates forced by the uneconomic competition of the inferior agency. The argument frequently advanced, especially by the advocates of subsidized inland waterways, that the effect of such competition is beneficial to the public because it holds down the rates charged by the superior agencies, is fallacious. T h e benefits of the sub-normal rates accrue to a few favored shippers; the losses by other agencies are borne by many; the subsidy is paid by the taxpayers at large.

PROPOSED LEGISLATION

Creation of a Transportation

«5

Board

Sound also is the recommendation for the creation of a Transportation Board, although there may be question as to the necessity of a separate organization. T h e functions of the Board could be assumed by the Interstate Commerce Commission instead of a new Board without material change in its organization or substantial enlargement of the Commission's present authority and responsibility. T h e functions of the proposed Board, as outlined in the report of the Committee of Six, are to investigate and report to Congress on the relative fitness of the several modes of transportation, to determine the extent to which they are subsidized, and to make recommendations for further legislation. Thereafter the Board would have responsibility for administering, as to all modes of transportation, the regulatory provisions relating to certificates of public convenience and necessity, new construction or operations, and abandonment of facilities or operations, as well as the regulatory provisions applying to the issuance of new securities, the effectuation of consolidations, mergers, leases, and acquisition of control, the approval of interlocking directorates, and other things of the same general nature. Most of the functions to be exercised by the new Board are now exercised by the Interstate Commerce Commission over the carriers under their jurisdiction. Their transfer to the new Board would limit the activities of the Commission to the regulation of rates, services, valuation, and accounting. T h e recorded opposition of the

66

PRESENT RAILROAD CRISIS

Commission to the creation of a new Board is natural and understandable. It would seem that the proposed limitation of the Commission's powers, with consequent damage to the prestige of a body which has a fifty-two years' record unparalleled by any other governmental body in efficiency, achievement, and fidelity to trust, is unnecessary and unjustified. T h e functions of the new Board with respcct to all modes of transportation would include only one not now vested in the Commission with respect to the agencies now under its jurisdiction. T h e additional duty would be that of investigating and reporting to Congress concerning the relative fitness and economy of the several agencies and the determination of the extent to which each agency is subsidized, with recommendations for further legislation. T h e Commission is better qualified by experience and comprehensive records than would be a newly created body to determine relative fitness, and it, as well as a new Board, would have available the results of the exhaustive studies made by the staff of the Federal Coordinator to determine the extent of public subsidy to the several forms of transportation. Those comprehensive reports, in draft form, were made available confidentially to a few for criticism before the Coordinator's activities were discontinued, and the understanding is that they have since been revised, are being printed, and may soon be released as public documents. T h e studies were made under the direction of Dr. Morgan, an able economist, who was loaned to the Coordinator by the Commission and who returned to the Commission when the Coordinator's staff was disbanded.

PROPOSED LEGISLATION

67

A reorganization of the Commission could provide for the creation of a division in charge of planning and coordination. T h e new division could be put 011 a basis independent of other divisions of the Commission and could report to a permanently appointed chairman. T h e chairman could be relieved of divisional details. There seems to be no valid reason why an independent division of the Commission could not do all that a new Board could do, and probably do it better. Duplication of agencies, with the danger of overlapping of jurisdiction and controversy over authority and responsibility, would be avoided. There is no real basis for the belief held in some quarters that the Commission is railroad-minded and would unfairly favor railroads to the detriment of other modes of transportation. T h e problem is one of transportation in all of its forms. It is not one of railroads, or of trucks, or of busses, or of airplanes, or of pipe lines, or of river steamboats. National progress in transportation depends in large part on a wisely conceived and fairly administered policy of correlation. Such correlation can be brought about with maximum effectiveness only by lodging in one body the responsibility for regulation in all of its forms. Whether the work should be done by a new Board or by a new division of the Commission is not important. T h e important thing is that the work be done and done soon. T h e present situation, in which there is vast waste in uneconomic competition, and in which the highly subsidized agencies have competitive advantages over those agencies which enjoy small subsidies or none at all, is

68

PRESENT RAILROAD CRISIS

harmful to public interest. T h e facts should be established b y competent public authority. T h e broad public interest requires that true and inclusive costs should be impartially and competently determined and that all modes of commercial transportation should be put on a basis of equality with respect to regulation and subsidy. The Proposed Change in Rule of Rate-making T h e advisability of the proposed change in the rule of rate-making is questionable. T h e r e is little practical difference between the present and the proposed rule except in the elimination of the requirement in the existing rule that in fixing rates the Commission shall give consideration, among other things, " t o the effect of rates on the movement of traffic." T h e proposal is to repeal the present rule and to substitute therefor a rate-making rule, applicable to all modes of transportation, to the effect that it shall be the duty of the Commission to exercise its authority over rates, so far as is consistent with its duty to protect the public against the exaction of unreasonable and unjustly discriminatory rates, in such w a y as to permit the establishment by each mode of transportation of rates which, as a whole, will be adequate, under honest, efficient, and economical management: (a) to sustain a national transportation system sufficient at all times to meet the needs of commerce, of the postal service, and of the national defense; (b) to establish and maintain credit so that capital essential to provide the needed facilities and service may be attracted to the transportation industry; and (c) to afford fair treatment to those having

PROPOSED LEGISLATION

69

their money invested in the property held for and used in the service of transportation. The proposed rule is likely to meet with strong opposition. It gives but parenthetical weight to considerations which are of vital and tangible importance from the viewpoint of shippers and receivers of freight, namely, that rates shall be just, reasonable, and non-discriminatory. The emphasis is placed upon considerations which, though important from the broad public viewpoint, are of relative unimportance and of an intangible nature from the individual viewpoint of the man who pays the freight bill, namely the maintenance of an adequate national system, the protection of railroad credit, and fair treatment to security holders. The elimination of the phrase which directs the Commission to consider the effect of rates on the movement of traffic will not prohibit the Commission from giving in the future the same consideration it has given in the past to the question whether a proposed rate may or may not influcncc the movement of the traffic affected. A rate that would diminish the flow of traffic to such an extent that the net revenue under the higher rate and smaller volume would be less than under the lower rate and larger volume would be inconsistent with the enumerated objectives. In other words, the Commission must consider the effect of rates on the movement of traffic before it can reach conclusions as to whether such rates will aid in maintaining an adequate national system, in protecting railroad credit, and in giving fair treatment to investors.

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PRESENT RAILROAD CRISIS

There is basis for the suggestion that the real reason for eliminating the phrase is that railroad executives believe that it is an invitation to or has been taken by the Commission as justification for an unwarranted extension of Commission authority beyond the zone of regulation into the zone of management. T h e dividing line between the two zones is not clearly defined, and apparently the railroads hope that the proposed revision of the rule might deter the Commission from venturing too far in substituting Commission judgment for management judgment as to the rate the traffic will bear. A case in point is the Commission's order in 1936 reducing passenger fares in coaches in Eastern territory from 3.6 cents to 2 cents. In that specific case, however, the fare reduction actually increased the gross revenues and, with a reasonable allowance for the cost of the additional train miles and car miles, there was an improvement in net income. Nevertheless the decision was in effect an invasion into the field of management. As a matter of principle the Commission in the great majority of rate cases enters into that field whenever it disapproves management proposals, and substitutes its own judgment. T h e difference between the passenger fare case and the great bulk of rate cases is one of degree, not of kind.

The Railroad Reorganization Court With respect to railroad reorganization, the Committee of Six recommended and the Bill now under consideration provides that Section 77 of the Bankruptcy A c t be amended. That section was adopted in 1933 as an amendment to the Bankruptcy A c t and was intended to

PROPOSED LEGISLATION

71

expedite the process of railroad reorganization. Previously all such reorganizations had been through equity receiverships, and the process was ordinarily prolonged and costly. T h e hope was that under the 1933 amendment to the Bankruptcy A c t the time-consuming elements in equity receivership would be avoided, and plans of reorganization, when acceptable to three-quarters of the security holders affected, could be quickly made effective without the formality of equity receivership, foreclosure by the bondholders, and sale of the property to the reorganized company. T h e results, however, have been disappointing. A l though the present law has been in effect nearly six years, no major railroad reorganization has been accomplished under its provisions. T h e R o c k Island went into reorganization on June 8, 1 9 3 3 ; the Chicago & Northwestern on June 28, 1935; the Milwaukee on June 29, 1935; the N e w Haven on October 23, 1 9 3 5 ; and the Missouri Pacific on June i, 1936. T h e Minneapolis & St. Louis has been in equity receivership sincc J u l y 26, 1923, and the Wabash since December 1, 1 9 3 1 .* T h e Committee of Six in its report referred to the general dissatisfaction with the w a y in which Section 77 has worked out in practice, and expressed the view that the responsibility may be charged to duality of jurisdiction. A reorganization plan may not be made effective unless it is approved by both the Interstate Commerce Commission and the federal district court. Neither tribunal has power to effect its own conclusions in the event of lack of unanimity. * Railway Age, January 7, 1939.

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PRESENT RAILROAD CRISIS

The primary responsibility for and jurisdiction over reorganizations is committed to the Interstate Commerce Commission, even in respect to the allocation and distribution of new securities, a process which involves the determination of legal and equitable rights often involving problems of the utmost legal complexity which it would seem that the courts are clearly better equipped to deal with than is a regulatory commission. When, after hearings that are usually quite extensive, the Commission has finally succeeded in formulating a plan, it is given no authority to put the plan into effect but must refer it back to the court in which the bankruptcy proceeding is pending. If the court, after further extensive hearings thereon, finds it possible to approve the plan as referred to it by the Commission, it must be again referred to the latter for submission to all creditors and stockholders affected thereby in an effort to secure the necessary assents. After the Commission has performed that task, it is required to refer the results back to the court for entry of the decrees necessary to bind non-assenting creditors and stockholders. In the event the court finds itself unable to adopt the plan as submitted by the Commission, it has no alternative but to dismiss the bankruptcy proceedings, leaving the debtor to its own devices, or refer the plan back to the Commission with recommendations to see if that body is willing to modify its original conclusions. This may involve further shuttling of the matter back and forth between the court and the Commission.* In the opinion of the Committee this unwieldy procedure can and should be simplified. T o that end the first step should be to restore full control over all phases of * Report of Committee of Six, p. 26.

PROPOSED LEGISLATION

73

reorganization to the court where, the Committee believes, it belongs. Recognizing, however, the desirability of insuring as far as possible the handling of such a highly important and difficult matter in each instance by a court especially fitted therefor by training and experience, the Committee recommended the creation of a separate court, rather than vesting control in the federal district courts, and that the Commission should be relieved of all responsibility in connection with railroad reorganizations, either in ordinary equity receivership or in proceedings under Section 77 of the Bankruptcy Act. In the opinion of the Committee, reorganizations of the past have too frequently failed in not providing a capital structure which was reasonably calculated to safeguard against future insolvency and the necessity of further reorganization, because too much emphasis has heretofore been placed on the total funded debt of the reorganized company and its relation to the physical value of the property, and too little emphasis on the resulting fixed charges and the future earning capacity of the property in bad times as well as good. The recommendation of the Committee is that there should be appropriate statutory provisions to the effect that no reorganization plan should be approved by the court unless the fixed charges for which the plan provides are in amount within the ability of the property to earn at all times, as demonstrated by its past experience. In the light of the experience under Section 77 it is now clear that greater progress would have been made if a separate railroad reorganization court had been created in 1933. It is clear, furthermore, that if there are to be

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PRESENT RAILROAD CRISIS

many more reorganizations in the immediate future the creation of such a court would be desirable. If, however, the optimistic view is taken that the worst is over and that there are not likely to be any further substantial additions to bankrupt mileage in the immediate future, the advantages in a separate court may be overbalanced by the disadvantages. T h e district courts and the Commission are well informed as to the background and present and prospective conditions of nearly all of the properties to be reorganized. Substantial progress in most of them has already been made. A new court would need much time to go over the evidence with which the district courts and the Commission are already familiar. Instead of expediting reorganization there is danger that procedure before the new court might take even more time than would be required under existing law. Whether it would or would not be wise to make the change depends largely on the prospect of further bankruptcies.

Consolidation

of

Railroads

T h e proposal of the Committee of Six with respect to the important subject of railroad consolidation is, in effect, that some of the restrictive aspects of existing law should be removed and that all initiative should be left to the railroads themselves, subject to the final approval of the proposed Transportation Board. In the earlier discussion of the 1920 rule of ratemaking, reference was made to sections of the Transportation A c t of 1920 applying to railroad consolidation. T h e rule of rate-making (Section 15-a, paragraph 2), the

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75

recapture clausc (Section 15-a, paragraph 6), and the provisions for consolidation (Section 5, paragraphs 4 - 6 ) were interrelated. Rates were to be established on a scale that would yield to the railroads collectively a fair return on the value of the properties. But inasmuch as rates on competitive traffic are necessarily uniform, such uniform rates yielding a fair return to all railroads in a rate-making region would yield more than a fair return to some and less than a fair return to others. T o the former the recapture clause was to apply. T h e y were required to turn over to the Interstate Commerce Commission one-half of net railway operating income in excess of 6 % on the value of their properties to create a revolving fund from which loans to weak roads might be made. T h e other half was to be held by the railroad as a reserve fund for lean years. As to the railroads which earned less than 6 % on value, no way was provided for them to collect the deficiency. T h e recapture clause plainly was intended as a temporary expedient to operate until the provisions for grandscale consolidations had been made effective. T h e Commission was directed to prepare and adopt a plan for the consolidation of the railroads into a limited number of systems. In such consolidation competition would be preserved as fully as possible and wherever practicable the existing routes and channels of trade and commerce would be maintained. Subject to those requirements the several systems were to be so arranged that the cost of transportation as between competitive systems, and as related to the values of the properties were, as far as practicable, to be the same, so that consolidated systems

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PRESENT RAILROAD CRISIS

could employ uniform rates on competitive traffic and, under efficient management, could earn the same rate of return on the value of their respective properties, as determined by the Commission. A tentative plan was prepared and published by the Commission and prolonged hearings were held. The proceedings extended over several years, but little was accomplished. The Commission made several requests of Congress to be relieved of the task of preparing a final plan, but Congress failed to act. Early in the depression there was some likelihood that progress would be made toward the adoption of a four-party plan in eastern territory, but with the continuation of the depression the subject was dropped. In the meantime there have been several unifications under Section 5, paragraph 2, which authorizes the Commission to approve the acquisition of one railroad by another by lease, purchase of stock, or any other manner not involving the consolidation of such carriers into a. single system. The distinction between unification and consolidation is that under the former the corporate entity of the company would be preserved. Under consolidation there would be a merger with loss of corporate identity. Now the subject of consolidation is revived. The railroads ask that the requirement of a rigid plan be repealed and that all initiative be left to the railroads themselves. Such plans as the railroads may work out between themselves would be subject to approval by the Transportation Board, and in passing on the proposals the Board

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would be governed by the following considerations: (a) That the public interest would be served by assuring adequate transportation service. (b) The possibility that the consolidation would isolate and injure weak roads not included. The Board would have authority to require the inclusion of such roads upon equitable terms. (c) That the consolidation would not result in an increase in the total fixed charges. (d) That the Board would consider the interests of the employees affected, would examine into the probable results of the proposed consolidation, and require a fair and equitable arrangement to protect the interests of employees. Inasmuch as consolidation along sound lines is highly desirable from the viewpoints of restraint on uneconomic competition and reduction of preventable waste in needless duplication, and of solution of the separate problem of the weak road, and inasmuch further as the 1920 law on consolidations has not brought results, a revision of that law is desirable. There will probably be opposition to the omission of reference to the preservation of competition between railroads. When railroads had a virtual monopoly of inland transportation healthy competition between railroads was in public interest, but now that the monopoly has been broken by the newer modes of transportation statutory provisions to enforce competition between the separate railroad systems are not only unnecessary but may be harmful in encouraging needless waste in service and facilities.

7»

PRESENT RAILROAD CRISIS Wage Rates and Other Terms of

Employment

Notable for its omission in the recommendations of the Committee of Six is any proposal affecting labor's share of gross revenues. Just before the President of the United States appointed that Committee, the railroad managers and the railroad labor unions had been unable to agree upon the management proposal during the summer of 1938 that wages should be reduced because of the perilously low net income. W a g e rates had been increased in the fall of 1937 as a result of concerted action initiated by the unions earlier in the summer when earnings were improving and there was hope that a favorable reaction from the long-drawn-out depression was well under way. That hope, however, was dispelled by the recession after the middle of the year. During the last half of 1937, and throughout most of 1938, railroad net earnings were about as low as they had been at any time during the depression. If the extent of the recession could have been foreseen in October the railroad managers would probably have stood on their first refusal to grant the wage increase. T h e heavier pay-roll expense was an added burden on income already inadequate, and the attempt of management in the summer of 1938 to put a 1 5 % wage cut into effect met with determined resistance by the unions and a threat of a nation-wide strike. In the threatened emergency the President, in accordance with the law governing railroad labor controversies, appointed a Fact Finding Board. T h e Board found that the railroad wage scale as a whole was not unreasonably high and recommended that the order announcing the wage cut

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should be withdrawn. Under the circumstances the railroad managers withdrew the order, and no change has since been proposed. This parenthetical reference to the labor controversy of 1938 is to provide an explanation for the absence in the report of the President's Committee of Six of any reference to labor costs. T h e committee consisted of three railroad executives and three leaders of railroad labor. There was, of course, a natural desire on the part of the Committee to bring in a unanimous report. Their report was unanimous. Undoubtedly it would not have been unanimous if the management representatives had insisted upon recommendations unfavorable from the labor viewpoint. T h e Committee was appointed while the wage controversy was under w a y , and its report was written a few weeks after the Fact Finding Board had decided in favor of labor. While the finding of the Board that the railroad wage scale as a whole is not unreasonably high may be sound, the Board did not have before it specifically the question of the rules affecting wage payments, notably those governing men in train service who are paid on a mileage basis with guarantees of minimum miles per day. T h e general plan of rates per mile is essentially a piecework schedule with many protective clauses favoring the workers. It became the general basis of payment about the beginning of the century and was therefore made to fit conditions of forty years ago. Since then the situation has changed materially, notably in the substantial increases in train speed while in motion and in the reductions in stand-by time at terminals and on the road. These

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PRESENT RAILROAD CRISIS

improvements are attributable in the main to capital improvements in modern equipment, signaling, and facilities on line and at terminals. A passenger train crew now frequently makes its day's pay in three hours on duty, and on the longer runs makes two days' pay in less than eight hours. In smaller degree this is true also in freight service. T h e whole plan of payments to men in train and engine service needs revision in the light of changed conditions, and with that revision should go consideration of make-work rules which require penalty payments for work not done. These matters were not before the Fact Finding Board which passed on the wage dispute, but the Board suggested that management and men should get together and agree on a procedure which would eliminate such payments. This criticism applies only to the men in train and engine service, who comprise about 2 1 % of the total. T h e y are almost exactly equal in number to scctionmen and other maintenance-of-way workers. Shopmen make up about 2 7 % of the total. Employees in station and yard service arc about 1 4 % . T h e general office employees comprise about 1 6 % , and the officers and their staffs about 2 % .

IV T H E PRESENT

OUTLOOK

THE rccent improvement in railroad traffic and earnings has been encouraging, but the more recent ominous developments in Europe may retard the steps toward recovery of business activity. T h e fate of the railroad industry depends in greater part on how soon there will be a return to normal conditions. Other things may be helpful but they will be palliatives rather than a cure. If we are in for an indefinitely prolonged period of business uncertainty and inactivity, there appears to be no escape from the ultimate expedient of Government ownership of railroads. If, on the other hand, there should be an early resumption of business activity on pre-depression scale, the substantial improvement in railroad earnings would quickly push the railroad problem into the background, where it might remain until the next depression. Barring a new world war, the probability is that there will, in the near future, be an improvement in business but not on the scale of the years of Coolidge prosperity. Even a mild gain would immediately be reflected in rail earnings. T h e y almost invariably fall before the effect of a depression is felt generally, and they usually are reliable barometers from which business improvement may be predicted. Inasmuch as a relatively large part of railroad 81

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PRESENT RAILROAD CRISIS

costs is fixed and such a relatively small part varies directly with traffic, a moderate increase in traffic will quickly bring a substantial gain in net income. If, as may be the case, there is soon to be a moderate stimulation in business activity, the immediate increase in railroad net income will prevent further insolvency and may dispel the uncertainty concerning the properties which have been fighting desperately to keep out of reorganization. It should also expedite the reorganization of railroads now in the hands of the courts because in many cases it is difficult to formulate any reasonable plan under current earnings. And if with a moderate increase in traffic there should be some measure of relief in new legislation which would eliminate a substantial part of unfair and uneconomic competition by subsidized and inadequately regulated agencies, the railroads would gain substantially by the removal of or reduction in competitive handicaps. Aside, however, from the possibilities in a resumption of business activity, in equality of regulation, and in elimination of subsidy, the railroads should proceed vigorously to do the things that they themselves can do to better their condition. In financial organization the defects are the cumulative results of policies which appeared to be defensible in the former days of monopoly but are no longer defensible or workable. Changes are now difficult and at best can only be made gradually. A n earnest effort should be made, however, to hold down the relationship of funded debt to total capitalization. A substantial improvement in that factor will come from the processes of reorganization of

THE PRESENT OUTLOOK

83

nearly one-third of railroad mileage, but something f u r ther may be done by the companies still solvent in voluntary reorganization and in refunding operations by the substitution of contingent interest bonds f o r those calling for fixed interest. While difficult to accomplish in this period of depressed earnings, it is highly desirable from the long-time viewpoint to adopt a policy under which bonds hereafter issued shall have provision f o r a sinking fund. Such a policy would be belated recognition of the fact that the railroad investment is not in things imperishable. Related to the suggestion just mentioned is a further suggestion that realistic recognition should be given to obsolescence in physical structures, that comprehensive physical surveys should be made to determine what parts are no longer used and are no longer useful, with accounting adjustments on the books to reflect the facts and savings made in maintenance of and taxes on physical units no longer required. In the field of management a more earnest effort should be made to give the younger men an opportunity in executive positions, and a systematic policy adopted under which more men from colleges and graduate schools might be attracted to railroad service. Such a policy has been found advantageous by a large proportion of mercantile and industrial companies, but very f e w railroads show interest in that promising source of supply of junior executives. In the field of labor costs management's efforts to effect reductions in wage rates last year were disapproved by the President's Fact Finding Board. T h e findings of the

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PRESENT RAILROAD CRISIS

Board reflected the general attitude of the federal administration and appeared to have public support. N o fault can be found with management's decision to withdraw the notice of the wage cut, but management may fairly be criticized if it fails now to make a serious effort to revise the working rules under which certain classes of employees are paid substantial sums f o r work not done, and the operating expenses burdened by the unnecessary employment of men under the "make-work" rules. Finally, the railroads cannot expect to receive sympathetic support from the public in the plea for more net income when an opportunity to save large sums through coordination and unification is blocked by the selfish interests of individual companies who refuse to concede or modify an advantage when conccssion would be of unquestioned advantage to the railroads as a whole and would rcduce the total cost of transportation—a cost which the public must, in one form or another, ultimately bear. T h e railroads collectively are suffering because of an excessive degree of corporate individualism.