The Problem of Weak Railroads: Their Relation to an Adequate Transportation System [Reprint 2016 ed.] 9781512816853

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T H E PROBLEM OF WEAK RAILROADS

T H E PROBLEM OF WEAK RAILROADS Their Relation to an Adequate Transportation System By

J A M E S M. H E R R I N G , PH.D. Instructor in Geography and Industry Wharton School of Finance and Commerce University of Pennsylvania

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 1929

PRINTED I N T H E U N I T E D STATES OF AMERICA

C O P Y R I G H T 1929 UNIVERSITY

OF P E N N S Y L V A N I A

PRESS

TO MY W I F E J O S E P H I N E WEAVER HERRING

CONTENTS Foreword

xi

I

T h e R u l e of R a t e - M a k i n g of 1920

13

II

The Weak Road Problem

33

III

Valuation for R e c a p t u r e

49

IV

T h e R e c a p t u r e Clauses in O p e r a t i o n

79

V

Consolidation as a Solution of t h e W e a k Problem

Road 99

VI

T h e P r o b l e m , One of I n d i v i d u a l R a i l r o a d s

125

VII

Conclusion

149

Appendix A

158

Β

163

Bibliography

174

IX

FOREWORD

T

HE establishment and maintenance of a system of transportation adequate to supply the needs of producing and consuming interests throughout the United States must be the central policy of a sound regulatory system. T h e national Congress, in the T r a n s p o r t a t i o n Act of 1920, recognized the importance of such a policy as a guide to the Interstate Commerce Commission and placed upon its shoulders the responsibility of providing in each section of the country the transportation machinery necessary to the economic life of that section. In carrying out such a policy, however, the Commission is faced with m a n y diverse and complex problems. Adequate transportation may not be considered solely from the standpoint of the desires of the users of transportation services. It would be natural for shippers in less developed sections to desire services similar to those received by shippers in more developed sections, yet the payments forthcoming for the services would not be sufficient in many cases to w a r r a n t the performance of such services by the transportation agencies. Neither may the problem be considered f r o m the standpoint of the carriers alone. It would benefit m a n y railroads to abandon certain unprofitable mileage which public policy demands shall be continued in operation in the interests of the communities and industries served. T h e problem thus becomes one of measuring the benefits received from a given transportation service as against the cost of furnishing it. In attempting to provide adequate transportation for the whole country, Congress and the Commission have been confronted with the fact that there are in the United States many miles of railroad which must be continued in operation, but which are not capable of earning enough to sustain t h e m

in i n d e p e n d e n t o p e r a t i o n . T h e p r o b l e m constitutes t h e s u b j e c t m a t t e r of this m o n o g r a p h . T h e principles e m b o d i e d in t h e Act of 1920 are examined in so f a r as t h e y a r e conc e r n e d with w e a k railroads, t h e effectiveness of t h e m a c h i n e r y set u p is tested in t h e light of nine y e a r s of experience, a n d suggestions a r e m a d e as t o t h e m a n n e r in which t h a t m a c h i n e r y m a y be b e t t e r a d a p t e d t o serve t h e p u r p o s e s f o r which it was designed. A c k n o w l e d g m e n t is here m a d e t o m a n y w h o h a v e assisted t h e a u t h o r in t h e p r e p a r a t i o n of this w o r k . Special a c k n o w l e d g m e n t is m a d e to D r . J o h n F r e d e r i c k , w h o read p a r t s of t h e m a n u s c r i p t , a n d to D r . E m o r y R . J o h n s o n , D e a n of t h e W h a r t o n School of F i n a n c e a n d C o m m e r c e , f o r w h o s e s y m p a t h e t i c a n d able counsel t h e a u t h o r is deeply g r a t e f u l .

xu

CHAPTER I THE RULE OF RATE-MAKING OF 1920 1917. President Woodrow Wilson,

by

virtue of the authority of an act of Congress, August

On D e c e m b e r 2S,

29,

1 9 1 6 , issued a p r o c l a m a t i o n b y w h i c h t h e F e d e r a l ment

assumed

railroad

the

of

States.

the

in-

managements,

The

Governimportant for

railroad

United

most

necessity

of

of t h e

of

such a proclamation had arisen from the demonstrated capacity

systems

operation

operating

competing

systems, to solve successfully the new and unusual transportation problems occasioned b y the entry of the United States i n t o t h e W o r l d W r ar.

I n the great emergency the railroads

had to be operated primarily with a view to the successful prosecution of the war, a n d such a purpose demanded railroad

managements

a

t h a n t h e y c o u l d effect. which

established

Federal

control

the

was

greater

measure

of

However, the Federal Control terms

to

be

and

conditions

exercised,

under

provided

Act, which

that

such

c o n t r o l s h o u l d c o n t i n u e o n l y d u r i n g t h e period o f t h e and for a reasonable

period thereafter,

of

co-operation

war

which was not

to

e x c e e d " o n e y e a r a n d n i n e m o n t h s n e x t following t h e d a t e o f the

proclamation

by

the

President

of

the

exchange

of

ratifications of the t r e a t y o f p e a c e . " L o n g b e f o r e t h e e x p i r a t i o n o f t h e period set b y t h e F e d e r a l Control Act, regulating commissions, members of Congress, railroad executives, shippers, and m a n y other groups

inter-

e s t e d in t r a n s p o r t a t i o n p r o b l e m s b e g a n t o c o n c e r n t h e m s e l v e s seriously with t h e m a t t e r o f t h e ultimate disposition of t h e railroads of the U n i t e d S t a t e s .

I n general there were three

courses of action, a n y o n e of which Congress followed.

might

have

B e s i d e s t h e p o l i c y o f r e t u r n i n g t h e roads t o t h e i r

private owners which Congress 13

finally

adopted, government

14

WEAK

RAILROADS

operation might have been continued, at least for a time, or a policy of outright government ownership and operation might have been adopted. In the hearings which were held b y the appropriate committees of both Houses of Congress all three of these plans found many advocates. All interested parties, even those who favored the return of the railroads t o their private owners, were convinced that there were certain elements in the transportation situation that needed study and investigation, certain defects in the system of regulation which had prevailed before the Federal Government had taken over the railroads t h a t needed rectifying. It was generally felt that the time had arrived for the adoption of a permanent policy for the regulation of the railroads of the whole United States, and t h a t the aim and purpose of such a policy should be the establishment of an a d e q u a t e transportation system for the whole country, adequate t o furnish the transportation necessary in the public interest, and t o move traffic expeditiously. T h e most unsatisfactory element in the entire situation was the condition of railroad credit. F o r a long time it had been apparent, not only to railroad executives, but to the general investing public that railroad credit in general had been on a decline. T h a t condition was revealed before the Senate and House Committees in evidence that could not be refuted. Paul M . W a r b u r g , in an address at the monthly meeting of the C h a m b e r of Commerce of the State of N e w York, in N e w York City, F e b r u a r y 6, 1919, said that railroad credit had been practically destroyed. Only a few companies felt confident of their ability to sell their obligations in sufficiently large amounts to enable them t o provide adequate facilities, and only about ten carriers of importance remained in a position to sell stock at par or above. 1 Daniel Willard, president of the Baltimore and Ohio Railroad, 1 Cf. Hearings on Extension of Government Control of Railroads, U. S. Senate, 65th Congress, 3rd session, 1918-19, p. 1108.

RULE OF

RATE-MAKING

15

testified t h a t it was an inescapable fact t h a t since 1910 t h e clearly established t r e n d of railroad credit in t h e U n i t e d States h a d been steadily d o w n w a r d . 2 W a l k e r D . Hines, t h e n D i r e c t o r G e n e r a l of R a i l r o a d s , stated t h a t t h e principal cause of t h e u n f o r t u n a t e railroad situation was w e a k railroad c r e d i t . 8 Commissioner Woolley, of the I n t e r s t a t e C o m m e r c e Commission, m a i n t a i n e d t h a t although a few systems like t h e P e n n s y l v a n i a , the Burlington, a n d the S a n t a Fe, f o u n d it possible t o d o new financing, the m a j o r i t y did not have sufficient credit for m o r e t h a n their b a r e s t n e e d s . 4 T h u s ran t h e t e s t i m o n y f r o m n u m e r o u s sources, t e s t i m o n y t h a t was sufficient to establish b e y o n d d o u b t t h a t railroad credit was l a m e n t a b l y weak. T h e weakness in railroad credit h a d m a n i f e s t e d itself directly in the inability of m a n y roads t o provide a d e q u a t e e q u i p m e n t a n d facilities for the handling of traffic. I n various hearings before the I n t e r s t a t e C o m m e r c e C o m m i s s i o n f r o m 1910 t o 1917 m a n y railroad executives confessed t h a t t h e i r railroads were not being maintained t o t h e highest point of efficiency. N e c e s s a r y improvements like t h e elimination of g r a d e crossings, construction of new stations a n d terminal facilities, double tracking, etc., were not being m a d e , the results being congestion and inefficient handling of traffic. Serious car shortages were of f r e q u e n t occurrence. T h e conditions h a d become so grave in the fall of 1916 t h a t the I n t e r s t a t e C o m m e r c e Commission made a lengthy investigation and rendered a f o r m a l decision J a n u a r y 18, 1917. I n this decision t h e Commission said t h a t t h e conditions of car distribution a t t h a t time h a d no parallel in t h e history of o u r railroads. Cars were not available in some territories for t h e t r a n s p o r t a t i o n of staple articles of commerce, such as coal, grain, lumber, fruits, and vegetables. P e r i s h a b l e products of g r e a t value h a d consequently b e e n d e s t r o y e d 2 ibid., p. 1221. » Ibid., p. 933. * Ibid,, p. 239.

16

WEAK

RAILROADS

a n d h u n d r e d s of carloads of food p r o d u c t s h a d b e e n d e l a y e d in reaching their n a t u r a l m a r k e t s . 5 I n a series of rate hearings a few m o n t h s later it was c o n t e n d e d b e f o r e t h e C o m m i s s i o n t h a t t h e car s h o r t a g e s were not wholly, if in great p a r t , d u e to a lack of freight cars. Shortages in motive power a n d i n a d e q u a t e facilities h a d p l a y e d a n i m p o r t a n t p a r t in c r e a t i n g car shortages.® I t was a s s e r t e d t h a t m a n y of t h e railroads h a d lacked sufficient credit t o j u s t i f y e x p e n d i t u r e s f o r new facilities, a n d t h a t c o n s e q u e n t l y imp r o v e m e n t s in line a n d t e r m i n a l facilities h a d not k e p t pace with t h e d e m a n d s f o r t r a n s p o r t a t i o n service. Conclusive proof of t h e physical inadequacies of t h e railroads a n d of the i m p e r a t i v e need of additional p e r m a n e n t facilities a n d d e f e r r e d i m p r o v e m e n t s was f u r n i s h e d M r . M c A d o o a little more t h a n a m o n t h a f t e r t h e railroads h a d been t a k e n over by t h e F e d e r a l G o v e r n m e n t w h e n he called u p o n t h e railroad c o r p o r a t i o n s whose lines were u n d e r F e d e r a l control t o p r e p a r e a n d send in b u d g e t s of i m p r o v e m e n t s i m m e d i a t e l y required t o increase capacity a n d efficiency a n d p r o m o t e safety in operations. T h o s e b u d g e t s a g g r e g a t e d $1,329,000,000 for e x p e n d i t u r e s c h a r g e a b l e t o capital a c c o u n t . 7 H o w e v e r , the failure of t h e railroads t o provide t h e facilities necessary for an a d e q u a t e t r a n s p o r t a t i o n system d u r i n g t h e y e a r o r two preceding federal control h a d not b e e n d u e entirely t o weak c r e d i t ; prices were high, labor was scarce, a n d financing u n u s u a l l y difficult. D u r i n g t h e first year of f e d e r a l operation providing additional railroad facilities was f u r t h e r complicated b y t h e severe limitations placed u p o n t h e u s e of certain m a t e r i a l s f o r o t h e r t h a n w a r purposes, a n d in t h e following y e a r b y t h e u n c e r t a i n t y in t h e railroad s i t u a t i o n d u e t o t h e a p p r o a c h i n g end of federal control. M o r e o v e r , a d e q u a t e a p p r o p r i a t i o n s were lacking a n d t h e railroad c o m 5 Cf. Statement of W . G . McAdoo, Hearings on Railroad Revenues Expenses, United States Senate, 67th Congress, 2nd session, p. 1705. β Ibid., p. 1708. τ Ibid., p. 1713.

and

R U L E OF R A T E - M A K I N G

17

panies were unwilling to furnish money for new equipment because of the uncertainty as to their own f u t u r e . 8 T h e deficiency in railroad investment was estimated at varying amounts, ranging from three to five billion dollars. Samuel O. D u n n , editor of the Railway Age, in a study of such deficiency, showed that the increase in freight and passenger business from J u n e 30, 1915, to October 1, 1919, had been 57 per cent and 32 per cent, respectively, whereas in the ten years ended J u n e 30, 1915, the increase had been 61 per cent and 45 per cent, respectively. In the earlier period new investment in facilities had been $5,300,000,000, and assuming that new investment in the later period should have been proportionate to t h a t in the earlier, the railroads from J u n e 30, 1915, to October 1, 1919, should have added about $5,000,000,000 of new investment. Actually the new investment was less t h a n $1,900,000,000, and this in a time of rising prices. 9 T h e r e was little doubt in the minds of those who appeared before the Senate and House Committees in 1919 that railroad credit was weak and that such a condition was undesirable from the standpoint of public welfare. However, there was substantial disagreement as to the causes responsible for that condition. Important groups contended that the reasons for the decline of railroad credit lay in certain vicious practices in the history of railroad financing. M r . W a r b u r g , in the address to which reference has already been m a d e , 1 0 said t h a t the history of American railroads, with few exceptions, abounded in illustrations of "excessive capitalization and of ill-advised construction or purchase of properties at exorbitant prices." In most cases, he said, the security owners had paid for these discrepancies, and that 8 Cf. W . D . Hines, Address delivered before t h e annual convention of t h e American Mining Congress. St. Louis, Mo., October, 1919. 9 Cf. S. O. D u n n , "Will New Legislation Cause Railroad Expansion?" Railway Age, 67: 735, Oct. 10, 1919. 10 Cf. Hearings on Extension of Government Control, supra, p. 1108.

18

WEAK RAILROADS

the average capitalization of all railroads at that time could not be considered excessive, although the process of squeezing out the "water" had not been an even one and had not run its course. Financial dictation in railroad operation was charged by the Interstate Commerce Commission itself in presenting to the Senate Committee its recommendations as to new legislation. Commissioner Ε. E. Clark, appearing for the Commission, recommended that railway operation be removed from financial dictation. There had been many instances in recent years, he said, in which, through inexcusable financial practices, railroad properties had been bankrupted or saddled with almost overwhelming burdens of indebtedness. These burdens had not improved the service, they had not added to the value of the railroad properties, and they had increased the charges for the service. The records in investigations made and reported upon by the Commission suggested the advisability of adopting some measures by which a transportation line operating under grant of public authority should no longer be a "football of speculation." 11 It was contended, on the other hand, that the weakness in railroad credit was the result of a niggardly policy with regard to railroad revenues on the part of the Interstate Commerce Commission. Frequently from 1910 to 1917, in a series of cases in which railroads in various sections had appealed for rate advances, it was contended by the carriers that the general level of freight rates yielded them insufficient revenues to maintain their credit. In the so-called Five Per Cent Case, concerning an advance in rates in Official Classification territory the carriers demonstrated that from 1907 to 1913 their gross operating revenues had remained fairly stationary while operating expenses had risen and property investment had continued to expand. Thus, net revenues, from which increasing interest and dividend charges had to » Ibid., pp. 235-36, also pp. 295-96.

RULE OF

RATE-MAKING

19

be met, were being squeezed out between a c o n s t a n t level of gross revenues a n d a m o u n t i n g level of expenses. T h e Commission f o u n d t h a t t h e situation on t h e whole h a d been correctly depicted b y t h e carriers, although m a n y factors contributed t o a complete explanation of t h a t situation. One cause of the d e p r e s s e d ratio b e t w e e n gross o p e r a t i n g revenues and the p r o p e r t y i n v e s t m e n t h a d been t h e m a k i n g of expenditures on capital account for " u n p r o d u c t i v e " imp r o v e m e n t s — i n v e s t m e n t s in e q u i p m e n t of i m p r o v e d types, displacing other e q u i p m e n t of equal capacity which h a d not been worn out, t h e elevation of tracks a n d the construction of terminals in cities. Such expenditures, while a d d i n g t o the value of the service r e n d e r e d , did not yield p r o p o r t i o n a t e returns in revenue. T h i s ratio h a d been u n f a v o r a b l y affected, in the second place, b y a reduction in gross earnings d u e t o increases in the relative lengths of hauls, a n d t o a n increase in the volume of traffic t a k i n g low rates. F u r t h e r more, there had been m a n y reductions in freight rates, some voluntarily by the carriers themselves. T h e Commission found, however, t h a t the chief cause of railroad difficulties in official territory, in 1914, lay in t h e fact of declining net earnings. I t was f o u n d t h a t whereas f r o m 1907 to 1913 t h e ten most prosperous carriers in t h e t e r r i t o r y h a d e a r n e d an a v e r a g e net o p e r a t i n g income of 8.55 p e r cent on t h e i r p r o p e r t y i n v e s t m e n t accounts, t h e three largest systems ( t h e P e n n s y l v a n i a , t h e N e w Y o r k Central, and the B a l t i m o r e a n d Ohio) h a d e a r n e d an a v e r a g e of only 5.16 per cent, a n d t h e five N e w E n g l a n d systems an average of 5.56 per cent, while the seventeen remaining systems of those investigated barely e a r n e d 2.15 per cent. T h e Commission expressed t h e opinion t h a t t h e n e t o p e r a t ing income of these carriers, t a k e n as a whole, was "smaller t h a n is d e m a n d e d in t h e interest of b o t h t h e general public and the r a i l r o a d s . " 1 2 I t was f u r t h e r held t h a t t h e low n e t « The Five Per Cent Case, 31 I. C. C, 351, 384.

WEAK

20

RAILROADS

earnings were in part due to insufficient gross earnings, and a S per cent increase in rates was ordered. A similar situation with regard to all class I carriers was pointed out t o the S e n a t e and House C o m m i t t e e s , in 1919. T h e return on the property investment accounts for all class I carriers, for the years 1908 t o 1917, inclusive, as c o m puted b y the Commission's own statisticians, was as follows: Y e a r ended

R a t i o of Railway Operating Income to I n v e s t m e n t

Y e a r ended

Ratio of Railway Operating Income to I n v e s t m e n t ^

(per cent)

June 30, 1908 1909 191 0 191 1 191 2 191 3

4.89 5.38 5.68 4.92 4.69 5.01

(per cent)

June 30, 1914 1915 1916 Dec. 31, 1916 1917

4.12 4.17 5.90 6.17 5.31

I t was not contended, even b y the representatives of the carriers, that the return on the property investment account was an infallible guide t o the prosperity of the railroads I t was recognized t h a t in m a n y cases those accounts did not represent the actual situation, b u t it was pointed out that since 1907 the Commission had had supervisory control over railroad accounts, and t h a t the Commission had often maintained t h a t the return on the investment accounts affords the best available basis of comparison between railroads. T h e representatives of the carriers contended that the railroads as a whole would have t o earn at least 6 per cent on their i n v e s t m e n t accounts in order t o maintain their credit. T h e failure of the railroads t o earn the required amount in every y e a r b u t one from 1908 to 1917, they said, had been due t o insufficient revenues. C o m m i s s i o n e r C l a r k took exception t o the statement frequently m a d e in the hearings t h a t the regulation b y the Commission had been niggardly with regard t o railroad 13 Taken from Thirty-ninth

Annual Report of I. C. C., p. 79.

RULE OF

21

RATE-MAKING

revenues. H e presented to the Senate Committee on Interstate Commerce a mass of statistics to show t h a t the condition of railroad credit had improved, rather t h a n depreciated, under government regulation. F r o m 1906, the year in which the Commission had obtained a measure of effective control over rates, up to 1917, he said, the increase in revenue of the railroads of the United States had kept pace with increased investment, the operating income had increased more than the increase in the n u m b e r of miles of road, and the surplus had increased marvelously. Railroad credit had not been destroyed. In the period mentioned the railroads had added about $3,172,000,000 t o f u n d e d debt, and about $1,940,000,000 at face value, to capital stock. W h a t e v e r decline in credit had taken place had been the result of a combination of causes, not the least of which had been the financial practices to which the Commission had referred in its recommendations to the Senate C o m m i t t e e . 1 4 M r . A. P. T h o m , counsel for the Association of Railway Executives, reviewing the statistics introduced b y Commissioner Clark, showed that they lent themselves to more t h a n one interpretation. Although the period preceding 1910 had witnessed considerable growth in railroad prosperity, he said, since then the situation had materially altered. With the exception of 1913 there was a much lower operating income each year up to 1916 t h a n for 1910, and in each of these years there had been a large addition to investment. In no year after 1910 and before 1916, except 1913, were earnings sufficient to pay the interest and dividends which had been paid, thus necessitating a drain upon income from other sources, from which also the surplus to which M r . Clark referred had been accumulated. M r . T h o m f u r t h e r contended t h a t inadequate revenues had been responsible for the fact that the railroads of the United States had 14 Cf. S t a t e m e n t of Ε. E . C l a r k . Hearings Control, supra, p. 251, also pp. 295-96.

on Extension

of

Government

22

WEAK

RAILROADS

passed the danger line with regard to the proportion of stocks to bonds, since more than 60 per cent of the total outstanding securities of the railroads were bonds. F r o m 1910 to 1916 the total funded debt had increased about $1,200,000,000 while the stock had increased only £733,000,000; in other words, the funded debt had increased approximately twice as rapidly as the stock. 1 5 T h e situation to which M r . Thorn called attention was generally felt to be a serious one. With the railroads needing huge sums of new capital each year they could not go on year after year raising t h a t capital by borrowing, because of the menace of disproportionate fixed charges. T h e fact that investors preferred railroad obligations to stocks was attributable, according to M r . Thorn and many others, to insufficient earnings to pay dividends. T h e crying need in new legislation, therefore, was t h a t of making provision for adequate railroad revenues. This view was successfully maintained before the Senate Committee. One of the earliest conclusions which t h a t committee reached was t h a t revenues would have t o be sufficient to enable the railroads to raise the capital necessary for their transportation purposes, and to raise a large proportion of it through the sale of stock. It was realized t h a t railroads bidding in the open market for capital would come into competition with other industries, and t h a t capital would flow into railroads only on a basis which would compare favorably with the treatment such capital might receive in other fields into which it might go. M a n y and widely varying proposals were made to the committees of Congress for the solution of the problem of re-establishing and maintaining railroad credit through adequate revenues. T h e r e were m a n y who favored outright government ownership and operation of the railroads of the 15 Cf. Statement of A. P. Thom, Hearings on Extension Control, supra, pp. 487-90.

of

Government

RULE OF

RATE-MAKING

23

United States. One such plan, proposed by Glenn E . Plumb, had the backing of the four great railway brotherhoods and of ten other railway labor organizations affiliated with the American Federation of Labor. This plan involved the ownership of the railroad properties by the Federal Government, with government provision for the financing of the acquisition, construction, equipment and working capital of the roads. It was contended by M r . Plumb that in this way not only could an adequate transportation system be provided, but the capital necessary to maintain it would flow readily into the railroad field. T h e demands of investors would be fully met when they should obtain complete security with adequate returns. T h e security offered by a government bond was superior to that which a private corporation could offer, and the guaranty of a government enterprise would assure a stable return to investors. As a consequence, ample capital to maintain an adequate system would not only be attracted to the railroad industry but it would be obtained at less cost than under private ownership. 1 8 Former Director General of Railroads, William G. McAdoo, and his successor, Walker D. Hines, suggested that the period of Federal Control be extended five years. T h e y made the proposal, not with the purpose of putting off a day of reckoning, but in full appreciation of the seriousness of the transportation situation. There were many elements in the problem that merited lengthy and exhaustive investigation, and no permanent disposition of the roads should be made until after a full investigation. Furthermore, they contended, the advocates of government ownership were at that time under a disadvantage owing to the deficits incurred during federal operation and they were entitled to have their case heard under more favorable circumstances. l e Cf. Statement of Glenn E. Plumb, Hearings ment Control, supra, p. 994.

on Extension

of

Govern-

WEAK

24

RAILROADS

J u d g m e n t passed on government ownership as a public policy, based on the accomplishments and failures of war time operation, would be hasty and probably incompetent. T h e late Senator A. B. Cummins, in a searching analysis of the railroad p r o b l e m , 1 7 pointed out as one of the f u n d a mentals in its solution, that the return upon railroad investments would have to be made ample and certain. Appeal to investors for railroad capital could be made on either of two bases: the promise of high, speculative profits, or of an ample and assured return. It had come to be generally recognized t h a t investors in railroad securities could not expect high and speculative profits, accordingly there was great need that the return be made certain. It was necessary, Senator C u m m i n s said, to remove once and for all one cause of the dispute which had been going on throughout the period of government regulation in the commissions and the courts, in political conventions, and in state and national legislatures over the reasonableness of rates in general. Furthermore, honest investment in railroad properties was entitled to protection and the public to the lowest rates consistent with the necessity of providing an adequate transportation service. Senator Cummins suggested that the best plan of assuring a stable return upon railroad investments would be for the Federal Government to guarantee an adequate return. This suggestion was made on the theory t h a t if the Federal Government should guarantee a return it could justly reduce that return to a rate of interest which such a government obligation ought to bear. T h e guaranty, he said, would lower the cost of obtaining railroad capital and would result in a substantial annual saving to the users of railroad transportation. Such guaranty, however, was to apply only upon the return from railroad property as a whole, it was not to apply to the individual railroad properties. T h u s , there 17

Senate

Document

No. 19, 66th Congress. 1st session.

RULE OF

25

RATE-MAKIXG

would remain an incentive for the individual road t o strive for a good showing, since individually the various railroads would reap the benefits of their efficiency. M o s t of those immediately concerned with railroad legislation in 1920, however, regarded with disfavor proposals t h a t involved either government ownership or government guaranty of railroad returns as a permanent policy. Opponents of such proposals contended, in the first place, t h a t railroad positions would become political " p l u m s " and t h a t such a policy would be bound to pollute our political and social life. In the second place, it would deaden railroad initiative and efficiency; it would mean unprogressive and costly operation, resulting in poor service and high rates; as a consequence, whatever saving might occur through the use of the credit of the Federal Government might be more t h a n made up for by the loss resulting from higher costs of operation. Prominent among the opponents of government operation were various organizations of shippers. M r . Guy M . F r e e r , 1 8 appearing before the Senate Committee on Interstate Commerce for the National Industrial Traffic League, a nation-wide organization of shippers, said that the League had adopted resolutions unalterably opposed to government ownership, or long-continued government operation of the railroads. It early became apparent to the investigating committees t h a t neither government ownership nor direct government guaranty would be expedient, and that overwhelming sentiment prevailed for the return of the railroads t o their private owners. However, considering the general testimony as to the weakness of railroad credit, it was evident t h a t the railroads should not be returned to private ownership without some definite provision in the new legislation t o remedy that u n f o r t u n a t e condition. T h e representatives of the carriers ably demonstrated that under the legislation up 18

Cf. Hearings

on Extension

of Government

Control,

supra,

p. 1184.

W E A K RAILROADS

26

to the time of federal operation the rate-making powers of the Commission had been largely limited to the determinaof the reasonableness of individual rates, and that although the Commission had from time to time given heed to the return upon railroad investments when considering the reasonableness of rates in general, as in the Five Per Cent Case, it was lacking in power to consider the adequacy of rates from the standpoint of the revenue needs of the carriers. The Commission itself had interpreted its powers as lacking in that respect. In 1911, in a case concerning advanced rates in the Eastern Trunk Line Territory, the justification for the advances presented by the carriers was their need of additional revenue. The cost of operation had so increased that although gross operating income had continued to grow, net operating income had become and was insufficient. With regard to this matter, the Commission said: Strictly speaking, this Commission has no jurisdiction to hear and determine that question. We have no authority as such to say what amount these carriers shall earn nor to establish a schedule of rates which will permit them to earn that amount. Our authority is limited to inquiring into the reasonableness of a particular rate or rates and establishing that rate or practice which is found lawful in the place of the one condemned as unlawful. 1 9 From such a limited construction of its rate-making powers the Commission soon departed. In the Five Per Cent Case, and in the consideration later of many scales of rates the Commission gave weight to the question of the adequacy of rates to provide necessary railroad revenues. Nevertheless, the policy pursued was a halting one, not a confident exercise of power, and it was felt that the law should definitely lay upon the Commission the duty of 19

248.

Advanced

Rates in Eastern

Trunk

Line Territory,

20 I. C. C., 247,

RULE OF

27

RATE-MAKING

c o n s i d e r i n g t h e r e l a t i o n s h i p of t h e g e n e r a l level of rates t o t h e p r o b l e m of m a i n t a i n i n g r a i l r o a d credit. M a n y plans e m b o d y i n g such a rule of r a t e - m a k i n g w e r e submitted to the Senate and House Committees. The N a t i o n a l Association of O w n e r s of R a i l r o a d Securities p r e s e n t e d a plan h a v i n g as o n e of its c a r d i n a l f e a t u r e s t h a t t h e r e be established A m i n i m u m rate of r e t u r n on t h e p r o p e r t y investm e n t in t h e railroads, fixed b y Act of Congress, t h r o u g h rates a d j u s t e d as occasion m a y d e m a n d , in o r d e r t h a t t h e securities of t h e railroads m a y be stabilized a n d their credit established o n a basis necessary to secure t h e m o n e y t o p r o v i d e t o t h e shippers a n d traveling public a d e q u a t e facilities a n d service.20 T h e Association of R a i l w a y E x e c u t i v e s , t h r o u g h its s t a n d i n g c o m m i t t e e p r e s e n t e d a plan which involved t h e d e c l a r a t i o n of a similar policy with r e g a r d t o r a t e regulation. T h i s plan p r o p o s e d t h a t T h e s t a t u t e itself should p r o v i d e t h e rule of r a t e - m a k i n g , a n d should r e q u i r e t h a t rates be not only w h a t has been called reasonable, b u t a d e q u a t e a n d sufficient to e n a b l e t h e carriers t o p r o v i d e safe, a d e q u a t e , a n d sufficient service, t o protect existing i n v e s t m e n t , a n d t o a t t r a c t t h e new capital necessary in t h e public i n t e r e s t . 2 1 T h e I n t e r s t a t e C o m m e r c e C o m m i s s i o n , while not r e c o m m e n d i n g a special rule of r a t e - m a k i n g , t o o k t h e following position with regard t o new législation: T r a n s p o r t a t i o n service a n d a d e q u a t e service a r e demanded by the welfare, the industry, the comm e r c e a n d t h e social life of t h e whole people. Securing t h a t class of service is m o r e i m p o r t a n t t h a n is t h e question of w h e t h e r it shall b e f u r n i s h e d at a slightly higher or a slightly lower charge. A n a d e q u a t e service c a n n o t b e p r o v i d e d except f r o m 26 Hearings on Extension 21 Ibid., p. 310.

of Government

Control,

supra,

p. 793.

28

WEAK

RAILROADS

a d e q u a t e revenues and as a result of adequate expenditures for maintenance, improvement, and expansion. P r i v a t e capital can not be induced t o invest in railroad securities unless it can be reasonably assured of the security of the investment and an appropriate return thereon. I t necessarily follows t h a t the patrons of the transportation companies m u s t p a y rates t h a t will yield revenues sufficient t o j u s t i f y rendering the q u a n t i t y and c h a r a c t e r of the service d e m a n d e d . 2 2 O n e of the most comprehensive programs for new legislation was that submitted b y the N a t i o n a l T r a n s p o r t a t i o n C o n f e r e n c e called b y the R a i l r o a d C o m m i t t e e of the C h a m b e r of C o m m e r c e of the U n i t e d States. T o this conference were s u m m o n e d representatives of all the principal interests which had been devoting their efforts t o a proper solution of the railroad problem. T h e s e men listened t o the proposals of shippers and m a n u f a c t u r e r s , of farmers, of financiers, and of railroad employees, with a view t o developing a program which would include the most desirable features of all plans. A f t e r much deliberation the Conference r e c o m m e n d e d with regard t o r a t e - m a k i n g : T h a t a s t a t u t o r y rule be enacted b y Congress requiring that railroad rates and fares, to be e s t a b lished by public authority, shall b e designed to yield the railroad companies in each traffic section of the United States (as shall b e designated b y federal a u t h o r i t y ) aggregate revenue sufficient t o produce, a f t e r proper provision has been m a d e for renewals and depreciation, a net return (which shall be available for interest and dividends) of not less than six ( 6 ) per cent per annum upon the aggregate fair value of the property of the railroads devoted t o the public service in each of the several sections.23 Thirty-third Annual Report oj the 1. C. C., 1919. p. 6. National Transportation Conference. Program cj Railroad Washington, D. C., Oct., 1919, p. 22. 22

23

Legislation,

R U L E OF

RATE-MAKING

29

R u n n i n g through all these plans, and through others submitted, was a recognition of the fact t h a t the need for adequate railroad revenues was such that it could no longer be left to the chances of the system of rate regulation which had prevailed during the period of private operation preceding Federal Control. It was believed that Congress should adopt a definite policy of rate-making which would give to the carriers reasonable assurance of adequate revenues, without involving the Federal Government in a g u a r a n t y of earnings and without laying on the public unduly heavy transportation burdens. A f t e r a long series of hearings the Senate Committee drew up a bill containing the rule of rate-making substantially as suggested by the National T r a n s p o r t a t i o n Conference. This bill was introduced into the Senate in September, 1919, and, after amendment, was passed on December 20, with the rule unchanged. T h e House Committee included a similar statement of principle in its measure, although the provisions were not as specific as those in the Senate bill. I t provided t h a t in determining the justness and reasonableness of a rate, the Commission should " t a k e into consideration the interest of the public, the shippers, the reasonable cost of maintenance and operation (including the wages of labor, depreciation, and taxes), and a fair return upon the value of the property used or held for the service of transportation." However, the above clause was stricken out of the bill on the floor of the House, and the final House bill contained no rule of rate-making. Opposition in the House t o a rule of rate-making, as suggested in the various plans, was based on the belief t h a t there was an implied or modified form of g u a r a n t y involved in such a rule, and t h a t it was as objectionable as a direct guaranty. It was contended t h a t under such a plan the government would assure the holders of railroad securities t h a t the Commission would, under all circumstances and

W E A K RAILROADS

30

regardless of fluctuations in traffic, so adjust the rates that they would produce the specified return on the aggregate value of the property. It was further objected that such a plan was unworkable, as well as undesirable. A regulatory commission would find it impossible so to adjust rates that the carriers, year after year, would be enabled to earn a fair return on a fair value. Railroad rates fluctuate, and the fluctuations may be due to drought, or pests, or floods, or to economic causes national or international in scope, matters which are beyond the control of a regulatory commission. Besides, the fixing of a percentage return by act of Congress would introduce undesirable political considerations into railroad regulation. If certain powerful groups should become convinced that the returns fixed by Congress were too high, or too low, the percentage return would become the football of politics, and the standards of reasonableness of rates objects of political strife. When the conferees met to discuss their differences the House conferees 2 4 refused to accept the rule of rate-making in the Senate bill. The Senate conferees 2 5 further helped to deadlock the conference by refusing to accept any measure that did not contain the rule. Railroad regulation, they said, had formerly been only the regulation of unfair discrimination, the time had arrived for the adoption of constructive principles. Meanwhile the conferees were subjected to a great deal of pressure from the outside, especially the Senate conferees. Representatives of 147 shippers' organizations, having a combined membership of more than one million shippers handling livestock, coal, grain, lumber, oil, furniture, brick, dairy products, and various other commodities, aggregating more than 75 per cent of the railroad tonnage for the whole country, addressed a communication to the Joint Conference opposing "any permanent form of a 24 25

Representatives Esch, Barkley, H a m i l t o n , Sims, and Winslow. Senators C u m m i n s , Kellogg, Poindexter, Pomerene, and Robinson.

RULE OF

RATE-MAKING

31

g u a r a n t y of, or limitation upon, the earnings of railway companies." T h e National Industrial Traffic League also opposed the rule. T h e rule of rate-making was a stumbling block over which the conferees labored for m a n y weeks. T h e Senate conferees held their position, however, and although they had t o sacrifice other distinctive features of the Senate bill they forced into the Conference measure statutory recognition of the principle involved, and it was adopted without change by both Houses of Congress in F e b r u a r y , 1920. T h e phraseology of the rule was modified somewhat f r o m that of the original Senate bill but its essentials were included. As written into section 15a of the Interstate Commerce Act it reads: In the exercise of its power to prescribe just and reasonable rates the Commission shall initiate, modify, establish or a d j u s t such rates so t h a t carriers as a whole (or as a whole in each of such rate groups or territories as the Commission may f r o m time to time designate) will, under honest, efficient and economical management and reasonable expenditures for maintenance of way, structures and equipment, earn an aggregate annual net railway operating income equal, as nearly as m a y be, to a fair return upon the aggregate value of the railway property of such carriers held for and used in the service of transportation: Provided, t h a t the Commission shall have reasonable latitude to modify or adjust any particular rate which it m a y find to be unjust or unreasonable, and to prescribe different rates for different sections of the country. T h u s was enacted a principle in rate regulation t h a t m a r k s a turning point in the policy of the Federal Government. Regulation was no longer to be confined to the correction of abuses, nor was the test of the reasonableness of rates to be solely the effect upon the shipping public. T h e I n t e r state Commerce Commission, in its a d j u s t m e n t of rates in

32

WEAK

RAILROADS

general, was entrusted with the duty of giving proper consideration to the revenue needs of a railroad system designed to furnish for the people of the whole United States an adequate transportation service.

CHAPTER II THE WEAK ROAD PROBLEM T h e a d d i t i o n of Section 15a t o t h e I n t e r s t a t e C o m m e r c e Act gave s t a t u t o r y recognition t o principles which were not altogether n e w . Really t w o principles were i n v o l v e d : one, t h e g r o u p i n g of railroads f o r r a t e - m a k i n g p u r p o s e s ; t h e o t h e r , t h e consideration of t h e r a t e of r e t u r n u p o n t h e i n v e s t m e n t in railroad properties a m e a s u r e of t h e reasonableness of rates in general. As f a r b a c k as 1909 t h e I n t e r s t a t e C o m m e r c e C o m m i s s i o n h a d recognized t h e force of these principles. In t h e S p o k a n e C a s e t h e r e was u n d e r consideration t h e reasonableness of c e r t a i n rates b e t w e e n S p o k a n e , W a s h i n g t o n , a n d St. P a u l , M i n n e s o t a . T h e shippers m a i n t a i n e d t h a t the C o m m i s s i o n should t a k e t h e least expensive of t h e routes serving t h e s e t w o points a n d d e t e r m i n e r a t e s on the basis of t h e i n v e s t m e n t in t h a t route. T h e railroads held t h a t every carrier is entitled t o a fair r e t u r n u p o n its p r o p e r t y a n d t h a t t h e C o m m i s s i o n should t a k e not t h e m o s t favorable, because t h a t w o u l d d e n y all others a fair r e t u r n , b u t the least f a v o r a b l e . I n this case it was held t h a t In d e t e r m i n i n g w h a t a r e reasonable rates b e t w e e n t w o points neither t h a t railroad Avhich can a f f o r d t o h a n d l e traffic at t h e lowest rate nor t h a t whose necessities m i g h t justify t h e highest rate should be exclusively considered. R a t e s m u s t b e established with r e f e r e n c e to the whole s i t u a t i o n . 1 In the s a m e decision, with r e g a r d t o t h e r e t u r n u p o n railroad i n v e s t m e n t s , t h e C o m m i s s i o n s a i d : If t h e p r e s e n t system of p r i v a t e o w n e r s h i p is to be c o n t i n u e d , sufficient i n d u c e m e n t m u s t b e ext e n d e d t o p r i v a t e investors. i Ciiy oí Spokane v. X. P. Ry. Co., I. C. C. 376, 417. 33

WEAK RAILROADS

34

Capital will seek investment in railways for the same reason that it does in other enterprises, the amount forthcoming depending upon the attractiveness of the investment It seems certain that in the immediate future very large sums of money must be expended in improving and extending the railroad facilities of this country, and it is therefore extremely important t h a t railroad investments should be made sufficiently attractive so that the necessary money for these improvements can be obtained. 2 Again, in the case concerning a proposed rate advance in Eastern T r u n k Line T e r r i t o r y 3 in 1911, the Commission grouped the Pennsylvania, the New York Central, and the Baltimore and Ohio in order to judge the reasonableness of rates in this territory. T h e grouping was not like t h a t required by section 15a, however. These were prominent roads which could be used as a practical device in determining reasonable rates. Section 15a requires the grouping of all roads in a territory whether typical or not typical of the general situation. T h e S u p r e m e C o u r t , in t h e New

England

Divisions

Case,

has pointed out that the principle of grouping railroads for rate-making purposes did not originate with the Act of 1920: For many years before the enactment of the Transportation Act of 1920, it had been necessary from time to time to adjudicate comprehensively upon substantially all rates in a large territory. When such changes were applied for, the commission made them by a single order, and, in large part, on evidence deemed typical of the whole rate structure T h u s the practice did not have its origin in the group system of rate-making provided for in 1920 by the new section 15a. It was the actual necessities of procedure and administration which had led to the adoption of that method a Ibid., p. 417. 3 20 I. C. C. 243,

supra.

THE

PROBLEM

35

in passing upon the reasonableness of proposed rate increases. 4 T h e necessity of considering railroads as a whole, or in groups, where the question of adequate railroad revenues, as well as reasonable rates to shippers, is involved arises out of a peculiar underlying situation. In many sections of the United States there are railroads competing for the same traffic which under the same schedule of rates demonstrate great disparity in earning power. Some will prosper greatly, some less so; others will struggle along barely able to avoid falling into the hands of receivers. Senator Cummins, in his analysis of the railroad situation in 1919, 5 showed that f o r the three years 1915, 1916, and 1917, the most prosperous the railroads had experienced up to that time, the class I railroads of the United States, after paying fixed charges, h a d earned on their capital stock all the way from nothing to more than 100 per cent. In the eastern district, although the average net operating income on the property investment had been 5.21 per cent, 17 class I roads had earned more t h a n 6 per cent on their investment accounts while 38 had earned less than 5 per cent. In the southern district, where the average return had been 5.36 per cent, 4 roads had earned more than 7 per cent, and 21 less than 5 per cent. I n the western district the average return had been 5.15 per cent; 3 of 63 class I carriers had earned more than 6 per cent, and 45 less than 3 per cent on their property investment accounts. If it had been the design of Congress in 1920 that all these roads, operating under such vastly different conditions and circumstances, should have been permitted to earn a fair return on their individual properties, obviously it would have been necessary for the Commission to have adopted separate schedules of rates for the individual carriers. How4 B

The New England Divisions Case, 261 U. S. 184. Senator A. B. Cummins, op. cit., pp. 3-6.

36

WEAK

RAILROADS

ever, no such plan was, or ever can be, practicable. M u c h of the traffic of the railroads of the United States is competitive traffic, and competitive rates must be the same, otherwise the traffic will move by roads charging the lowest rates. Moreover, on local traffic, the rates must be uniform over considerable areas, since business men on different lines are in competition with each other. I t was evident to the members of the investigating committees, in 1919, t h a t if the credit of the railroads as a whole, including those of lesser earning capacity with those of greater, were to be established and maintained this would have to be done under a substantial uniformity of rates throughout a given territory. It was clear also that rates would have to be based on average conditions. T o have required the a d j u s t m e n t of rates on the basis of the needs of the carriers whose operating costs are higher than the average would have resulted in giving certain roads an income which the commonest sense of justice would forbid. On the other hand, to have required the a d j u s t m e n t of rates according to the needs of the better than average roads would have resulted in starving roads which must be maintained as essential parts of an adequate national transportation system. It was inevitable, then, that rates should be based on average revenue requirements and t h a t the rates should be made with reference t o the total requirements of all roads of a given district, even though from rates thus made some roads would receive more, some less, than a fair return upon their properties. Only in this way would the railroads as a whole, or as a whole in groups, receive the total cost of transportation, and the shippers pay no more than the necessities of an adequate system would require. Senator Cummins contended, in 1920, t h a t the railroads which might be called weak, in the sense that they were not self-sustaining, 'carried about 30 per cent of the traffic of the whole country. M a n y of them were weak because of

THE

PROBLEM

37

heavy capitalization, b u t in t h e m a j o r i t y of cases w e a k n e s s was d u e t o a n u n f a v o r a b l e location with r e g a r d t o traffic, or t o u n f a v o r a b l e o p e r a t i n g conditions. Representative Black, s p e a k i n g in t h e H o u s e of R e p r e s e n t a t i v e s in behalf c: t h e E s c h - C u m m i n s bill, held t h a t of t h e 162 class I railroads or s y s t e m s studied b y S e n a t o r C u m m i n s , 109 o p e r a t e d u n d e r conditions which come u n d e r t h e h e a d of "less f a v o r ably s i t u a t e d , " a n d t h a t these 109 roads h a d a total mileage of 120,755, serving d o u b l e t h e area of t e r r i t o r y served b y the 53 r e m a i n i n g systems.® T h e r e were m a n y , however, w h o c o n t e n d e d , a n d w h o d o siili contend, t h a t weakness in railroads is not solely, not even largely, d u e t o less f a v o r a b l e situation. M r . J o h n E . O l d h a m , an i n v e s t m e n t b a n k e r of B o s t o n , M a s s a c h u s e t t s , read a p a p e r b e f o r e t h e A c a d e m y of Political Science in N e w Y o r k City, N o v e m b e r 21, 1919, in which he p r e s e n t e d with g r e a t clarity t h e p r o b l e m of weak r a i l r o a d s in t h e U n i t e d States. T h e w o r k d o n e b y M r . O l d h a m was so c o m p r e h e n s i v e a n d e x h a u s t i v e in n a t u r e t h a t his p a p e r was e l a b o r a t e d a n d p u b l i s h e d later, u n d e r t h e title of " A C o m p r e h e n s i v e P l a n for R a i l r o a d C o n s o l i d a t i o n , " b y t h e C h a m b e r of C o m m e r c e of t h e U n i t e d States. M r . O l d h a m c o n t e n d e d t h a t t h e n u m b e r a n d i m p o r t a n c e of r a i l r o a d s t h a t a r e " w e a k " because "less f a v o r a b l y s i t u a t e d " h a d b e e n g r e a t l y e x a g g e r a t e d , a n d t h a t o t h e r conditions w e r e r e s p o n sible for t h e poor showing of m a n y w e a k railroads. I n t h e c o u r s e of his s t u d y M r . O l d h a m m a d e a c o m p a r i s o n of t h e statistics of o p e r a t i o n for t h e " T e s t P e r i o d " ( t h e t h r e e y e a r s e n d e d J u n e 30, 1917) of 16 recognized s t r o n g r o a d s w i t h 16 o t h e r large carriers, most of which h a d not p a i d d i v i d e n d s in recent years, t h e 32 s y s t e m s h a v i n g a n a g g r e g a t e gross o p e r a t i n g income a m o u n t i n g t o a p p r o x i m a t e l y 60 p e r c e n t of t h e gross o p e r a t i n g income of all t h e r a i l r o a d s in t h e U n i t e d States. T h e c o m p a r i s o n showed t h a t t h e s e t w o β

Congressional

Record—v.

69, 66th Congress, 2nd session, p . 3294.

38

WEAK

RAILROADS

groups of railroads, strong and weak, operated under similar conditions and with remarkably similar results from operation. T h e two groups carried about the same proportion of freight and passenger traffic; they had a similar tonnage, divided in about the same proportions between products of mines, forests, agriculture, manufactures, and miscellaneous; the rates per ton mile and per passenger mile were about the same for both groups; they spent approximately the same for maintenance; and their track, equipment and terminals were alike in quantity and character. T h e outstanding difference between these groups of strong and weak carriers lay in the proportion of net income which went to pay fixed charges. T h e strong roads used about 23 per cent of gross earnings to pay fixed charges and maintain dividends, while the weak roads used 22 per cent for the same purposes. However, the strong roads used only 12 per cent for fixed charges and 11 per cent for dividends, whereas the weak roads used 21 per cent for fixed charges, leaving only 1 per cent for dividends. F r o m a traffic standpoint, M r . Oldham said, neither of these groups was "more favorably situated" or "less favorably situated." Weakness in the weak group was primarily due to the amount and form of the capitalization. Summarizing his work for the railroads of the whole United States, M r . Oldham contended that the roads which handle about 85 per cent of the total traffic do so at such similar costs t h a t the net results of operation are similar for all of them. Of these roads, those which carry 60 per cent of the country's business are able under rates deemed adequate for the system as a whole to pay fixed charges and dividends on the outstanding capital stock, distributing about 80 per cent of their net income about equally divided between fixed charges and dividends. T h e remaining roads of the 85 per cent group, those which carry about 25 per cent of the total traffic, likewise distribute 80 per cent of net income, but practically the whole of it goes to pay fixed charges.

THE

PROBLEM

39

Thus, the railroads whose costs of operation or whose locations with regard to traffic are such as to prevent t h e m f r o m obtaining similar net incomes handle not more t h a n 15 per cent of the total traffic of the country. 7 T h e conclusion following logically f r o m M r . Oldham's study is that, except for the financial problems of certain large carriers, the problem of weak roads is a problem primarily of the short lines, which include a few class I carriers with earnings of less than $10,000,000 a year, and the class I I and class I I I carriers. This was the contention made b y representatives of the short lines in 1920, and which has been made by t h e m repeatedly since t h a t time in various hearings on railroad consolidation. T h e short lines, m a n y of them, operate under great disadvantages as compared with their strong competitors. Some were built originally to serve mining or logging operations. T h e y prospered along with such industries, but often found t h e m selves unable to develop sufficient traffic in the territory served to sustain them when the m a j o r source of traffic had declined or disappeared altogether. Yet their continued operation had become essential to the communities which had grown up about them. Others have operating handicaps, such as excessive grades, sharp curves, poor tracks and light equipment which they have not been able to replace because of insufficient credit. Furthermore, most of the short lines suffer u n d e r a permanent disadvantage in that they cannot induce new industries and institutions to locate on their lines when those same industries are able to obtain better services and greater assurances of permanent transportation facilities b y locating on larger, stronger systems. Both the Senate and the House Committees, in f r a m i n g railroad legislation in 1919, fully appreciated the necessity of making some provision for weak, necessitous carriers. 1 Cf. Memorandum submitted to the I. C. C.. Nov. 1923, by John E. Oldham, quoted from Hearings on S. 2224, 68th Congress, 1st session, p. 51.

40

WEAK

RAILROADS

T h e a d e q u a t e transportation system which they hoped t o establish and maintain would have to include more than the strong carriers, more even than the larger weak systems whose problems were mainly financial; it would have t o include most of the railroad mileage of the United States. As S e n a t o r C u m m i n s expressed it, the great general public had the right t o ask of its government such a system of regulation as would give to each community " t h e transportation upon which its life, its growth, its development d e p e n d s . " 8 I t was also quite generally recognized that the most difficult problem to be faced in providing for such a system was the problem of maintaining the transportation service of the short and weak lines. Various plans were suggested for the solution of the weak road problem, and m a n y of them merited and received lengthy consideration. N o n e of t h e m , however, proposed t h a t the weak carriers b e placed in a position to maintain themselves in independent operation, since fixing rates t o enable t h e m t o do so would give t o their strong competitors an u n r e a s o n a b l y high rate of return and would result in much higher freight rates than the necessities of the situation would d e m a n d . M r . E . J . R i c h , 9 presenting the so-called " X e w E n g l a n d P l a n , " suggested that any railroad which could not sell its stock at par should be permitted t o appeal to the F e d e r a l G o v e r n m e n t for the g u a r a n t y of new loans to raise capital t o provide the services necessary to the territory served. T h e credit of weak roads would thus be established b y g o v e r n m e n t g u a r a n t y of loans, and in return the F e d e r a l G o v e r n m e n t should have control over the use of such funds and b e represented on the boards of directors of roads whose loans should be thus guaranteed. Such a 8 Cf. A speech delivered in the Senate by Sen. Cummins, Nov. 4, 1919, quoted by Dr. C. S. Duncan, Hearings on H. R. 11212, 69th Congress, 1st session, p. 15. 9 Mr. Rich, formerly general counsel for the Boston and Maine Railroad, appeared before the Senate Committee for the Associated Industries of Massachusetts.

THE

PROBLEM

41

plan, it was suggested, besides affording possibilities of better and cheaper transportation service to the communities served by the weak carriers, presented an immediate solution which could be put into operation without involving the railroads in difficulties at a time when they would be faced with numerous problems a t t e n d a n t upon the return to private ownership. Senator Cummins, in a report to the Senate from the Senate Committee on Interstate Commerce, on November 10, 1919, said that government ownership and operation of the railroads was one way by which provision for the continuance, the betterment and growth of weak carriers might be made, but in the judgment of the committee such a plan was attended with so m a n y disadvantages t h a t it would have to be discarded. In the absence of government ownership there was but one other solution—it was consolidation. So long as there should remain in competition with each other railroads with great disparity in earning power the problem of adjusting rates t o maintain an adequate transportation system would be difficult, if not impossible, to solve. T h e Committee therefore determined in favor of the gradual unification of all the railroads of the United States into not less than 20 nor more than 35 systems, and t h a t in such grouping the rule should be observed t h a t the systems should be so arranged t h a t operating under a uniform schedule of rates in competition with each other, they would be able to earn approximately the same rate of return on their respective properties held for and used in the service of transportation. Consolidation as a p e r m a n e n t policy found favor in both the Senate and the House of Representatives. T h e Senate bill included a provision t h a t such a policy not only be adopted but t h a t consolidation be made compulsory a f t e r a period of seven years, if during t h a t time the railroads should not have been consolidated voluntarily b y the carriers themselves in accordance with the purposes of the act, b u t

42

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RAILROADS

t h a t provision was lost in conference. M a n y objections to the adoption of a policy of consolidation had been raised during the hearings held by the two committees. It was feared that a more or less artificial grouping of railroads would interfere with existing channels of trade and commerce and would stifle competition. Any substantial lessening of competition between carriers, it was widely held, would be fraught with evil both from the standpoint of service and of rates. Although impressed with the potency of these objections a large majority of the members of Congress believed that consolidation of weak roads with strong roads into a limited number of systems of equal earning power represented the only practicable solution for the problem of adjusting the general level of rates so as to keep the weak carriers running without giving to the more fortunate properties excessive incomes. Consequently, there was incorporated into the Act of 1920 a definite m a n d a t e to the Interstate Commerce Commission t h a t it should "as soon as practicable prepare and adopt a plan for the consolidation of the railway properties of the continental United States into a limited number of systems." These systems were to be so arranged t h a t "the cost of transportation as between competitive systems and as related to the values of the properties" should be the same, so t h a t these systems could "employ uniform rates in the movement of competitive traffic and under efficient management earn substantially the same rate of return upon the value of their respective railway properties." T h e adoption by Congress of a consolidation program was not necessarily giving recognition to a new and untried policy. In the several traffic sections of the United States consolidations had already been effected which had resulted in systems reaching from end to end of such territories, sharing in the varied business of the different parts, and experiencing varied operating conditions, both favorable and unfavorable. M r . Oldham had pointed out the similarity

THE

PROBLEM

43

between the operating statistics of the P e n n s y l v a n i a and the New Y o r k Central in official territory, and had held that the similarity in operating results between these systems, and between the larger, typical systems in other territories was not a m a t t e r of chance but of design. T h e policy of Congress was designed t o further development along clearly defined lines which previous experience had demonstrated to be of advantage t o the railroads and to the public, with the added purpose of sustaining weak carriers which were essential parts of an adequate transportation system. Although there was widespread sentiment, at the time, in favor of a consolidation program, not even the most enthusiastic supporters of such a program believed that it could be accomplished immediately. M a n y years would elapse before the completion of the consolidations c o n t e m plated. M e a n w h i l e , the Commission would be under the obligation of initiating rates adequate to provide for transportation needs in general, which rates, in the inevitable distribution of earnings, would give to some carriers very high returns, and t o others returns consistently below the level necessary for them to provide adequate facilities for an increasing transportation service. B o t h the National T r a n s portation C o n f e r e n c e and the National Association of Owners of R a i l r o a d Securities suggested that Congress place a limit t o the earnings which any individual carrier should be entitled t o under rates designed to produce adequate revenues for the railroads as a whole, or as a whole in certain groups which might be established. In the plans of these two organizations it was suggested t h a t a net return a b o v e 6 per cent per annum on a fair valuation of the carrier's property be considered an excess return. T h e two plans, however, differed as to the method of determination of a fair value, and as to the disposition of excess earnings above a fair return. T h e real genesis of the plan followed b y Congress in dealing with this particular situation, although m a n y of its

44

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RAILROADS

provisions were not adopted, is found in the suggestion of the Association of Railroad Security Owners. T h e proposal was made t h a t if any railroad should earn in any one year a net return in excess of 6 per cent on the value of its property Congress should provide t h a t such excess be set a p a r t and divided as follows: one-third for the benefit of railroad employees, one-third for the railroad itself, and one-third to be used for transportation purposes in general, especially to provide funds for carriers with weak credit. T h e r e was, however, considerable opposition manifested to any limitation of railroad earnings and to appropriation of so-called "excess" earnings by the government. T h e carriers contended that the rates prescribed in the first instance by the Commission would be reasonable rates, and the carriers would be entitled to all t h a t they could earn under them. T o deprive them of any portion of such earnings would be to take away their rightful property in an unconstitutional manner. F u r t h e r objection to such a plan was raised, both b y carriers and by shippers, because of its probable effect upon the transportation service. It was contended that railroads whose earnings were such that a portion would be subject to recapture would be without a proper incentive to economical operation, and t h a t consequently the service would deteriorate and the costs of transportation rise. Congress was not unmindful of the force of such objections to the limitation of railroad earnings. However, the majority of congressmen realized t h a t the public would not tolerate the high returns which some railroads would receive under rates designed t o maintain the entire system, especially since the Commission was to adjust rates with that end in view. F u r t h e r m o r e , the excess earnings above a fair return on individual railroad properties would provide a sort of equalization f u n d from which the weak roads might be provided with capital which, because of their weak credit position, they could not obtain by other means, and thus be maintained as parts of the national transportation system.

THE

PROBLEM

45

Consequently, Congress incorporated into the T r a n s p o r t a tion Act of 1920 t h e so-called " r e c a p t u r e " clauses, t h e p r i n c i p a l f e a t u r e s of which a r e e x p r e s s e d in t h e following language: I n as m u c h as it is impossible ( w i t h o u t regulation a n d control in t h e interest of t h e c o m m e r c e of t h e U n i t e d S t a t e s c o n s i d e r e d as a w h o l e ) t o establish u n i f o r m rates u p o n c o m p e t i t i v e traffic which will a d e q u a t e l y s u s t a i n all t h e c a r r i e r s which a r e e n gaged in such traffic a n d which a r e i n d i s p e n s a b l e t o t h e c o m m u n i t i e s t o which t h e y r e n d e r t h e service of t r a n s p o r t a t i o n , w i t h o u t e n a b l i n g s o m e of such carriers t o receive a net railway o p e r a t i n g income s u b s t a n t i a l l y a n d u n r e a s o n a b l y in excess of a f a i r r e t u r n u p o n t h e v a l u e of their r a i l w a y p r o p e r t y held for a n d used in t h e service of t r a n s p o r t a t i o n , it is h e r e b y d e c l a r e d t h a t a n y c a r r i e r which receives such an income so in excess of a f a i r r e t u r n , shall hold such p a r t of t h e excess, as h e r e i n a f t e r p r e scribed, as t r u s t e e for, a n d shall p a y it to, t h e United States. If, u n d e r t h e provisions of this section, a n y carrier receives f o r a n y y e a r a net r a i l w a y o p e r a t i n g income in excess of 6 p e r c e n t u m of t h e v a l u e of t h e railway p r o p e r t y held f o r a n d used b y it in t h e service of t r a n s p o r t a t i o n , one-half of such excess shall b e placed in a reserve f u n d established a n d m a i n t a i n e d b y such carrier, a n d t h e r e m a i n i n g o n e half thereof shall, w i t h i n t h e first f o u r m o n t h s following t h e close of t h e period f o r which such c o m p u t a t i o n is m a d e , b e recoverable b y a n d p a i d t o t h e c o m m i s s i o n f o r t h e p u r p o s e of establishing and maintaining a general railroad contingent f u n d as h e r e i n a f t e r described T h e g e n e r a l railroad c o n t i n g e n t f u n d so t o b e recoverable b y a n d paid to t h e commission a n d all accretions thereof shall b e a revolving f u n d a n d shall be a d m i n i s t e r e d b y t h e commission. I t shall be used b y t h e c o m m i s s i o n in f u r t h e r a n c e of t h e public i n t e r e s t in r a i l w a y t r a n s p o r t a t i o n either b y m a k i n g loans t o c a r r i e r s t o m e e t e x p e n d i t u r e s f o r capital a c c o u n t o r t o r e f u n d m a t u r i n g securities

46

W E A K RAILROADS originally issued for capital account, or by purchasing transportation equipment, and facilities and leasing the same to carriers, as herinafter provided

The policy here outlined by Congress involved the limitation of the earnings of individual railroads in the interest of transportation in general. It was not intended to be an absolute limitation, however. A railroad having excess earnings was to be permitted to retain one-half of such excess because it was considered necessary in the interests of efficient and economical operation. The other half was to be used primarily in helping weak carriers provide necessary facilities. The constitutionality of the recapture provisions was contested by the railroads in Dayton-Goose Creek Ry. Co. v. U. S., 263 U. S. 456. This case involved an appeal from a decree of the District Court of the United States for the Eastern District of Texas, dismissing a bill to restrain the enforcement of an order of the Interstate Commerce Commission requiring the surrender of excess earnings. The Dayton-Goose Creek Railway Company was the sole complainant, but nineteen other railway companies, as amici curia, filed briefs in support of its appeal. In this case the Supreme Court not only upheld the constitutionality of the limitation placed on railroad earnings, but declared that the recapture clauses are the key provisions in the plan of rate-making inaugurated by the Act of 1920. With regard to the limitation of earnings the court said: The carrier owning and operating a railroad, however strong financially, however economical in its facilities, or favorably situated as to traffic, is not entitled, as of constitutional right, to more than a fair net operating income upon the value of its properties which are being devoted to transportation. By investment in a business dedicated to the public service the owner must recognize that, as compared with investment in private business, he

THE

PROBLEM

47

cannot expect either high or speculative dividends, but that his obligation limits him t o only fair or reasonable profit. 1 0 And further, as to the contention of the carriers t h a t cutting down the income actually received by a carrier for the performance of a service is appropriation of its property without compensation: T h e statute declares the carrier to be only a trustee for the excess over a fair return received by it. Though in its possession, the excess never becomes its property, and it accepts custody of the product of all the rates with this understanding. It is clear, therefore, t h a t the carrier never has such a title to the excess as to render the recapture of it by the government a taking without due process. 1 1 In the course of the decision the court construed at length the purposes of the rate-making provisions of the T r a n s p o r tation Act of 1920. U p to 1920, the court said, interstate commerce legislation had been designed primarily to prevent unreasonable or discriminatory rates, but the act of t h a t year had added a new and important object to previous legislation. T h e new act sought "affirmatively to build up a system of railways prepared to handle promptly all the interstate traffic of the country." It sought to accomplish t h a t purpose through the proper a d j u s t m e n t of rates. B u t rates would have to be uniform, and under uniform rates sufficient to sustain all the roads in a group some railroads would earn more, some less, than a fair return on their properties. Those carriers which earn more are to hold the excess "primarily to preserve their sound economic condition and avoid wasteful expenditures and unwise dividends," while those which earn less are to be given help b y credit secured through a fund made up of recaptured excess earnings. Hence, the court said: 10 Dayton-Goose Creek Ry. v. U. S., 263 U. S. 456, 481. » Ibid., p. 484.

WEAK

48

RAILROADS

B y t h e r e c a p t u r e clauses Congress is e n a b l e d t o m a i n t a i n u n i f o r m rates for all shippers a n d yet k e e p t h e net r e t u r n s of railways, w h e t h e r s t r o n g or w e a k , t o t h e v a r y i n g p e r c e n t a g e s which are fair respectively f o r t h e m . T h e r e c a p t u r e clauses a r e thus t h e k e y provision of t h e whole p l a n . 1 2 I n s u m m a r y , t h e g r e a t central policy of t h e T r a n s p o r t a t i o n A c t of 1920 was a c o n s t r u c t i v e one. I t h a d as its o b j e c t i v e t h e e s t a b l i s h m e n t of a n a d e q u a t e t r a n s p o r t a t i o n s y s t e m f o r t h e whole c o u n t r y , first b y p r o v i d i n g a d e q u a t e revenues for t h e r a i l r o a d s as a whole, or as a whole in rate g r o u p s , t h r o u g h t h e level of rates, a n d second by m a k i n g specific provision f o r r a i l r o a d s t h a t were not self-sustaining. W e a k r o a d s were u l t i m a t e l y t o be consolidated with s t r o n g roads i n t o a limited n u m b e r of s y s t e m s of a p p r o x i m a t e l y e q u a l e a r n i n g p o w e r a n d t h e p r o b l e m of initiating rates t o sustain t h e e n t i r e s y s t e m in t h e presence of individual roads with g r e a t l y differing e a r n i n g capacities was to be simplified, if not c o m p l e t e l y solved. T h e territories served b y w e a k carriers were t h u s t o b e u l t i m a t e l y assured of t r a n s p o r t a t i o n . I n t h e m e a n t i m e , while t h e consolidation p r o g r a m was being w o r k e d o u t , t h e c a p i t a l n e c e s s a r y t o enable t h e w e a k carriers p r o p e r l y t o f u r n i s h t r a n s p o r t a t i o n services was t o b e p r o vided f r o m a f u n d c o n t r i b u t e d b y t h e users of t r a n s p o r t a t i o n f o r t h e m a i n t e n a n c e of a n a d e q u a t e s y s t e m — a f u n d collected f r o m individual r a i l r o a d s in t h e f o r m of excess earnings t o which t h e y h a d n e v e r o b t a i n e d a title. 12 ibid.,

p. 480.

CHAPTER III VALUATION FOR RECAPTURE T h e p r o g r a m of railroad legislation adopted in 1920 represents a noteworthy attempt on the part of Congress to establish a constructive and forward-looking policy with regard to railroad regulation. However, certain parts of the regulatory machinery then set up have failed to function as the f r a m e r s of the act had hoped they would function. T h e recapture clauses especially have not been effective. D e signed primarily to provide a f u n d from which the weak carriers were to be given aid during the process of consolidation, they have been of no service to such carriers. T h e amounts of excess earnings actually paid over to the C o m mission have been small, a n d the f u n d thus accumulated has not been available for the purposes contemplated in the act. T h e most important single cause of the failure of the recapture clauses to function has been the lack of a proper basis for the calculation of excess earnings. T h e railroads have been m a k i n g their reports of excess earnings largely on the basis of a balance-sheet value as expressed in their property investment accounts. T h e investment accounts have been repeatedly suggested as indicative of the value of railroad properties. When the question of fair value c a m e up in connection with the rule of rate-making in 1920 both the National T r a n s p o r t a t i o n Conference and the National Association of Owners of R a i l r o a d Securities proposed that the investment accounts of the carriers b e used, at least until the C o m m i s s i o n h a d finally determined such value. T h e railroads themselves have consistently contended that those accounts in the aggregate, if not in individual cases, a p p r o x i m a t e fair value. Such claims a r e m a d e on the basis of the fact that since 1907 these accounts 49

50

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have been under the supervision of the Commission. An a m e n d m e n t to the Interstate Commerce Act, J u n e 29, 1906, gave to the Commission authority to establish and require the keeping of uniform accounts b y all the carriers subject to the act, and within a short time there were set up, with the aid of the Association of American Railway Accounting Officers, detailed accounting rules covering operating expenses, operating revenues and expenditures for road and equipment. With the promulgation later of orders for a uniform system of financial accounts, and the classification of expenditures for additions and betterments, a general system of uniform accounts was established which gave to the Commission control over railroad accounting practices. T h e Commission's supervision of railroad accounts since 1907 has been of such a nature t h a t there is at present little suspicion attached to the accounts set up since t h a t time. However, m a n y of the roads were in existence long before the Commission received the power to supervise their accounts. Often these accounts, when originally set up, were not much more than journal entries to balance the par value of securities which had been issued. T h e r e was absolutely no uniformity of practice among the railroads in keeping them. Conservative managements had swelled the actual value of the investment, without its appearing in the investment accounts, by charging the cost of additions and betterments t o operating expense. On the other hand, less honest, or less fortunate managements had permitted the original plant t o wear out without changing the assets. In 1908, the Commission spoke in no uncertain terms of the weaknesses in the property-investment accounts. I n its annual report for t h a t year it said: N o court, or commission, or accountant, or financial writer would for a moment consider t h a t the present balance-sheet statement purporting to give the "cost of p r o p e r t y " suggests, even in a remote

VALUATION FOR

RECAPTURE

51

degree, a reliable measure either of money invested or of present value. 1 I n 1920 Congress recognized the infirmities in the propertyinvestment accounts of railroads. T h e d u t y of determining the value of railroad property for rate-making and for recapture purposes was placed upon the Commission with the following provisions in paragraph 4 of section 15a: T h e Commission m a y utilize the results of its investigations under section 19a of this act, in so far as deemed by it available, and shall give due consideration to all the elements of value recognized by the law of the land for rate-making purposes, and shall give to the property investment account of the carriers only t h a t consideration which under such law it is entitled to in establishing values for rate-making purposes. Congress contemplated that ultimately the value for rate-making and recapture purposes should be the value determined by the Commission pursuant to the provisions of section 19a of the act to regulate Interstate Commerce. Section 19a had been added to the act in M a r c h , 1913, to provide for a physical valuation of all railroad property in the United States. T h e r e was no definite statement of the purposes for which such valuation was to b e made in the Valuation Act. T h e law merely provided t h a t the final valuations should be published and should constitute "prima facie evidence of the value of the property in all proceedings under the act to regulate commerce as of the date of the fixing thereof, and in all judicial proceedings for the enforcement of the act." In the Act of 1920 Congress specified t h a t such valuations, when completed, should constitute the bases for calculations in rate-making and recapture. T h e task assigned the Commission by the Valuation Act was one of huge proportions. T h e Commission was required to ascertain and report in detail as to each piece of property 1

Twenty-second

Annual Report of the I. C. C , 1908, p. 85.

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RAILROADS

of the carriers subject to the act: (1) the original cost to date, (2) the cost of reproduction new, and (3) the cost of reproduction less depreciation. It was f u r t h e r required t o submit an analysis of the methods by which each of these several costs had been obtained, and the reasons for differences between them. With regard to lands the Commission was required to report in detail and separately from improvements "the original cost of all lands, rights of way, and terminals owned or used for the purposes of a common carrier, and ascertained as of the time of dedication to public use, and the present value of the same, and separately the original and present cost of condemnation a n d damages or of purchase in excess of such original cost or present value." Finally, the Commission was instructed to report separately "other values, and elements of value," and an analysis of the methods used in arriving at such values. Within the 60 days required by the law, the Commission established a separate division of valuation and work was begun as soon as possible thereafter to carry out the provisions of the law. It was decided t h a t the United States be divided into five districts, each embracing about 50,000 miles of railroad, and t h a t in each district a single railroad should be selected for the initial work, one whose maps were in fairly good condition and which was thought to offer a variety of problems. T h e roads selected were:

Southern Central Pacific

Length2 (Miie.s)

Road

District

900 .. 600 . . . .New Orleans, Texas and Mexico. . . . . . 175 . . . .Texas Midland 122 . . 1,000

T h e first tentative valuation served under the Act of M a r c h , 1913, was that of the Texas M i d l a n d Railroad, served on the carrier on October 21, 1916. F r o m t h a t time 2

Twenty-eighth

Annual

Report

of the I. C. C., 1914, P . 62.

VALUATION FOR

RECAPTURE

53

on tentative valuations have been served on the various carriers as the underlying accounting, engineering, and land reports have been completed. I n its annual report for the year 1928 the Commission announced t h a t the service of all tentative valuation reports upon the steam railroads had been completed, b u t up to December 1, 1928, final valuations, after hearings upon the tentative valuations, had been reached in only 715 cases, covering 79,314 miles of railroad. 3 Manifestly there still remains a vast amount of basic valuation work to be done by the Commission. Moreover, when the final valuations shall have been ascertained by the Commission those valuations may be, and m a n y of them probably will be, contested in the courts, consequently a long period of time m a y be expected to elapse before the valuation work under section 19a will have been completed. In the meantime the work has cost both the government and the railroads huge sums of money. F r o m J u n e 30, 1913, to December 31, 1927, the Commission spent $30,128,970, and the railroads $106,372,541, a total of $136,501,511 for valuation purposes. 4 T h e magnitude of the problem can be best appreciated by a consideration of the actual investigations the Commission has been called upon to make. T h e determination of original cost to date has been impossible in most cases because of a lack of accounting records, and the diversity of accounting practices before the Commission prescribed uniform accounts. T h e methods of treating construction expenses varied with the different companies, so t h a t when the Commission turned to these accounts for figures as to original cost it was found t h a t they did not set forth correctly or adequately the cost of construction of the different parts of the railroads. 5 T h e Commission has construed original cost to mean "primarily 3 Fortv-second Annual Report of the I. C. C. : 1928. p. 57. * Cf. Slason Thompson, Railway Statistics of the U. S. for 1927, Bureau of Ry. News and Statistics. Chicaeo, 111., p. 94. 5 Texas Midland R. R„ 75 I. C. C. 1, 10.

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the actual cost of construction or acquisition, or, in other words, the actual original cost of the property to the carrier at the time of its initial dedication to public use." 6 Original cost has been reported as fully as it can be determined with certainty, b u t the Commission has refused, except within comparatively narrow limits, to include estimates. If the actual cost of all the property of a railroad cannot be determined, the Commission reports the cost of such property as can be determined, and supplements it in other sections of the report by a full statement of the financial history of the carrier, including the issuance of securities. Also, while the act does not require the Commission t o ascertain and report the investment in road and equipment, the Commission often does so to throw additional light upon the original cost which it has not been able to determine. T h e Commission does not, however, regard the investment account as the full equivalent of original cost to date. 7 I t has been consistently maintained by various railroads, on the other hand, t h a t original cost to date is ascertainable. One c a r r i e r 8 argued t h a t the sum included as the recorded investment represented its original cost. In 1923 the National Conference on Valuation 9 submitted a petition to the Commission requesting t h a t every tentative valuation proceeding then pending be recommitted to the Bureau of Valuation for the purpose, among others, of ascertaining the original cost to date of each piece of property owned or used by a common carrier, costs which the Commission had refused to report because they would have involved a number of more or less important estimates. Commissioner Potter, while concurring with the majority of the Commission in denying the prayer to remit the proceedings, did not concur 0 New York. Philadelphia y Norfolk R. R. Co.. 97 I. C. C. 273, 275. 1 Charleston tí Western Carolina Rv., 121 I. C . C. 721, 722. 8 Augusta Northern Ry„ 125 I. C. C. 14, 15. 9 T h e N a t i o n a l Conference on Valuation was a voluntary organization formed in M a y , 1923.—See Petition of National Conference on Valuation, 84 I. C. C . 9.

VALUATION FOR R E C A P T U R E

55

in the reasons for its action. ' T h e m a j o r i t y , " he said, "assumes t h a t there is difficulty and takes f a r too seriously the burdens of finding original cost. Like most impossible tasks, it can be done. We are not directed t o report book entries. W e are to investigate and report a conclusion, and we are not relieved from that task if some one has made it more difficult by destroying records. W e arrive at our conclusion the same way we arrive at other conclusions—by using the best competent evidence t h a t is available. W h e r e cost is the question and records are not available, evidence as to what the cost should have been is always competent. An estimate may, in fact, be much more reliable t h a n a book entry of actual p a y m e n t . " 1 0 T h e majority of the Commission, however, have interpreted their duties with regard to finding original cost as fact-finding ones and have refused to include estimates. I n the Texas M i d l a n d case, at page 165, it was held t h a t " a n attempt to estimate original cost would in many cases involve not the exercise of good judgment b u t rather of pure speculation." Original cost to date, hence, has been reported only in part, the Commission believing t h a t the reporting of the amounts t h a t can be exactly determined, with supplemental information, constitutes as "full and substantial compliance with the requirements of the a c t " as it can "reasonably m a k e . " 1 1 With regard to the cost of reproduction new the Commission has proceeded upon a definite theory. T h e road is assumed not to be in existence, but all other conditions are taken as they exist on valuation date. T h e engineer then prepares what he conceives to be the "most practicable a n d economical p r o g r a m " for the construction of the road as it exists in operation on the valuation date. H e tries t o conceive of an entirely new venture without facing the uncertainties that were faced in the original construction. 10 ibid., pp. 14-15. 11 Charleston ίί Western

Carolina Ry. Co., supra, p. 724.

56

WEAK

RAILROADS

M a t e r i a l s for reproduction of the road c o m e from the most available present source and are transported b y present transportation means. Present, and not original, topographical conditions govern reproduction, and allowances for contingencies are largely governed by what is known at the valuation date. U n i f o r m prices for all reproduction estimates are then applied to the quantities which m a k e up t h e physical property, t o these sums are added the estimated cost of placing the items in position as of the valuation date, including certain overhead charges, and the result arrived at is the cost of reproduction n e w . 1 2 T h e a b o v e method of estimating cost of reproduction new was a t t a c k e d b y the M i n n e s o t a R a i l r o a d and W a r e h o u s e C o m m i s s i o n on the grounds that such a method was prohibited b y the S u p r e m e Court in the M i n n e s o t a R a t e Cases. T h e r e the C o u r t had s a i d : M o r e o v e r , it is manifest that an attempt to e s t i m a t e what would be the actual cost of acquiring the right-of-way, if the railroad were not there, is to indulge in mere speculation. T h e railroad has long been established; t o it have been linked the activities of agriculture, industry, and trade. C o m munities have long been dependent upon its service, and their growth and development have been conditioned upon the facilities it has provided. T h e uses of property in the communities which it serves are to a large degree determined by it. T h e values of property along its line largely depend upon its existence. I t is an integral part of the commercial life. T h e assumption of its nonexistence, and at the s a m e time that the values that rest upon it remain unchanged, is impossible and can not be e n t e r tained. T h e conditions of ownership of the property and the amounts which would have to be paid in acquiring the right-of-way, supposing the railroad to be removed, are wholly beyond reach of a n y process of reasonable determination. T h e cost-ofreproduction method is of service in ascertaining 12 Texas Midland

R. R., supra, p. 11.

VALUATION FOR R E C A P T U R E

57

the present value of the plant, when it is reasonably applied and when the cost of reproducing the property may be ascertained with a proper degree of certainty. But it does not justify the acceptance of results which depend upon mere conjecture. 1 3 T h e Minnesota Commission asserted t h a t the term " p l a n t " h a d been used advisedly by the C o u r t for the purpose of condemning t h a t particular method of determining cost of reproduction, not only of the land but of all other property of a railroad. T h e Interstate Commerce Commission did not accept the view of the Minnesota Commission. In its opinion the language of the court related to "railway rights of way, yards, and terminals, and not to railroad property other than l a n d . " 1 4 F o r land the Valuation Act had made special provision, but estimating the cost of reproduction new of a railroad, the Commission said, can mean nothing more nor less than that "a railroad actually being operated is conceived of as non-existent and then theoretically brought into existence by a succession of steps well known t o competent engineers." 1 5 T h e Commission has accordingly compiled its estimates of cost of reproduction new along the plan outlined, and has included such estimates in its tentative valuation reports. M o s t of the items included in such estimates, however, have been the subject of controversy between the railroads and the Commission, and much time has been consumed in holding hearings on the disputed points. U n d e r the Commission's method of valuation the reported cost of reproduction new represents the estimated cost of physical property determined b y the application of unit p r i c e s 1 6 to actual quantities or units in use on valuation d a t e . 1 7 13

Minnesota Rate Cases, 263 U. S. 352. 452. Texas Midland R. R., supra, pp. 12-13. i s ibid., p. 14. le Unit prices are fixed for all cost of reproduction estimates as of J u n e 30, 1914. based on averages for t h e 5 or 10 years preceding. « Death F alley R. R„ 103 I. C. C. 27, 28. 14

58

WEAK

RAILROADS

I n addition to reporting the cost of reproduction new of each piece of property, the Valuation Act required the Commission to report the cost of reproduction of such property less depreciation. T h e railroad property after having been reproduced new, is then conceived of as being worn to the age and condition of the existing road and e q u i p m e n t . 1 8 T h e B u r e a u of Valuation of the Commission has treated depreciation as the "exhaustion of capacity for service." Of the capacity for service which existed in a piece of property when new it has inquired how much has been used up, has subtracted this from the cost of reproduction new, giving due consideration to salvage or scrap when it exists, and has reported the remainder as the cost of reproduction less depreciation. 1 9 Various carriers have insisted t h a t this conception of depreciation is wrong, that the inquiry should be whether the property is being operated 100 per cent efficiently. So long as its efficiency is 100 per cent, so long as there is no deferred maintenance, there can be no depreciation. 2 0 T h e carriers have asserted t h a t "until units of property are replaced in the routine of normal maintenance, they serve every function t h a t new units would serve, and the railroad as a whole is no less valuable because of the age of some of the units so long as it is normally m a i n t a i n e d . " 2 1 In other words, although there may be depreciation in a single, simple unit of property, a railroad is composed of multitudes of such units all at different stages of depreciation. It is a composite unit and if each individual unit is replaced at the proper and most economical time there is no depreciation in the composite unit. I n the Texas Midland case the Commission discussed fully its theory with regard to cost of reproduction less 18 Homer B. Vanderblue, Railroad Valuation, Harvard University Press, 1920. p. 39. 19 Texas Midland R. R., supra, p. 48 20 Ibid. 21 Chicago y Illinois Midland Ry. Co., 119 I. C. C. 202, 210.

VALUATION FOR R E C A P T U R E

59

depreciation. At the time the Valuation Act was passed, the Commission said, the phrase "cost of reproduction less depreciation" had come to have a clearly defined meaning. Valuators and utility commissioners had universally adopted the view that depreciation means decline in value due t o loss of capacity for service. Moreover, the Supreme Court of the United States had declared in the Knoxville case: T h e cost of reproduction is one way of ascertaining the present value of a plant like a water company, but that test would lead t o obviously incorrect results if the cost of reproduction is not diminished by the depreciation which has come from age and u s e . 2 2 And in the Minnesota Rate Cases: T h e depreciation in question is not that which has been overcome by repairs and replacements, but is the actual existing depreciation in the plant as compared with the new o n e . 2 3 T h e Commission gathered from these and other statements of the Court t h a t depreciation and deferred maintenance were not synonymous. Depreciation had acquired a definite meaning, a meaning which it must be assumed Congress was cognizant of when it used "depreciation" in connection with the cost of reproduction in the Act of M a r c h 1, 1913. T h e r e was, consequently, both legislative and judicial authority for deducting depreciation, as construed, from cost of reproduction to derive its cost-of-reproduction-less-depreciation estimates. Such estimates have been included in the valuation reports. T h e Valuation Act required with regard to land t h a t the reports made by the Commission shall state in detail and separately from improvements the original cost of all lands, rights of way, and terminals owned or used for the purposes of a 22 The I. C. C. quoting from Knoxville v. Water Co., 212 U. S. 1, 9-10, in Texas Midland R. R., supra, p. 49. 23 Minnesota Rate Cases, supra, p. 457.

60

WEAK

RAILROADS

c o m m o n carrier, and ascertained as of the time of dedication t o public use, and the present value of the same, and separately the original and present cost of condemnation and damages or of purchase in excess of such original cost or present value. I n attempting to determine the original cost of land the Commission has experienced much the same difficulty t h a t it has with the original cost of other property. T h e records of the carrier, county and municipal records, court deeds, and other sources of information have been consulted, b u t in cases in which it could not be shown what the c a r r i e r did actually pay for the lands no estimate has been made. As a consequence, statistics of the original cost of c a r r i e r lands have not been complete, and the Commission has refused t o supplement them with estimates, on the t h e o r y that attempts to m a k e such estimates would involve not the "exercise of good judgment but rather of pure s p e c u l a t i o n . " 2 4 P r e s e n t value of railroad lands, as determined b y the Commission, is " n e a r l y synonymous with m a r k e t v a l u e . " 2 5 T o the acres of carrier lands are applied prices corresponding t o the value of similar land adjoining or in the immediate vicinity, consideration being given t o land which has a special value for transportation purposes. One of the chief controversial points between the carriers and the Commission in the early valuation proceedings was the m a t t e r of reporting the excess cost of condemnation and damages or of purchase over the original cost or present value of lands. In its valuation reports up to 1920 the Commission had refused t o include estimates of such excess on the ground t h a t the question involved was as t o the cost to a particular railroad of procuring its right of way at the present time if it were obliterated and were obliged to reacquire its lands, and that such estimates would depend " u p o n considerations and elements which the Commission can by no possibility Texas Midland 2-'> Ibid. 24

R. R., supra, p. 167.

VALUATION

FOR

d e t e r m i n e with a c c u r a c y . " 2 6

RECAPTURE

61

I n thus refusing t o follow t h e

m a n d a t e o f the V a l u a t i o n A c t t h e C o m m i s s i o n was relying upon t h e declaration in the M i n n e s o t a R a t e C a s e s , t h a t t h e m a k i n g of such e s t i m a t e s would involve " m e r e s p e c u l a t i o n . " T h e Kansas City Southern Railway C o m p a n y brought

an

a c t i o n of m a n d a m u s in t h e S u p r e m e C o u r t t o require

the

Commission

to

find

and

report

such

excess

cost, a n d

in

1 9 2 0 t h e court h e l d 2 7 t h a t t h e C o m m i s s i o n was u n d e r t h e duty

of

finding

the

excess

irrespective

of

its

evidential

usefulness as an element in railway value. T h e C o m m i s s i o n proceeded t o c o m p l y with the o r d e r of t h e C o u r t , as f a r as possible, b u t r e c o m m e n d e d to C o n g r e s s t h e e n a c t m e n t of an a m e n d m e n t to the I n t e r s t a t e C o m m e r c e A c t t o relieve t h e m of a r e q u i r e m e n t which t h e y impossible of fulfillment.

regarded

O n J u n e 7, 1922, in response t o

this r e c o m m e n d a t i o n , C o n g r e s s relieved t h e C o m m i s s i o n of t h e necessity of reporting " t h e original a n d present c o s t of c o n d e m n a t i o n a n d d a m a g e s or of p u r c h a s e in excess o f such original cost or p r e s e n t v a l u e . "

A t present t h e C o m m i s s i o n

reports only original value of lands as f a r as can b e d e t e r mined e x a c t l y a n d the p r e s e n t value, which has b e e n defined as almost s y n o n y m o u s with m a r k e t value. F i n d i n g original cost to d a t e , or cost of reproduction new, or cost of reproduction less depreciation, however, does not n e c e s s a r i l y c o n s t i t u t e the road as a whole.

Such

finding findings

of a " v a l u e " for t h e railusually produce

different

results, a n d unless one or a n o t h e r is a c c e p t e d a final single s u m value m u s t be d e t e r m i n e d b y b r i n g i n g t o g e t h e r

many

diverse factors. W h e n the final report on the T e x a s M i d l a n d p r o p e r t y was m a d e in 1918 it c o n t a i n e d n o s t a t e m e n t o f a final

single

sum.

required t h e property.

Certain

finding

Other

carriers

insisted

that

the

Act

o f a single s u m as t h e v a l u e o f t h e

parties

to

the

same

proceedings

were

28 Texas Midland R. R., supra, p. 169. 27 United States ex rei. Kansas City Southern Railway Co. v. I. C. C., 252 U. S. 178.

62

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RAILROADS

equally insistent t h a t the Act did not permit finding such a single sum, a n d that the Commission was required to report only the sums arrived at by obeying the specific provisions in the paragraph entitled First, in section 19a, as t o original cost, etc. T h e Commission held t h a t although no single sum value was given in this particular instance, it was of the opinion that it was authorized by the Act to find a single sum value, and that it was the ultimate purpose of the Commission to make such a finding for each p r o p e r t y . 2 8 T h e policy announced in Texas Midland has been followed throughout by the Commission. A single sum has been stated in each report, such sum being the " v a l u e " of the property for the purposes of the Commission. T h e Commission has further declared that the value which it finds is a value for rate-making purposes, as distinguished f r o m values for other uses. It has been consistently maintained b y the Commission t h a t railroad properties may have more t h a n one value, depending upon the use to be made of the value determined. In the San Pedro, Los Angeles and Salt Lake case the Commission called attention t o the fact t h a t public utilities commissions generally and the Supreme Court and other courts of the United States in a number of cases have been particular in instances when they were considering values to specify the purposes for which the values under consideration were to be u s e d . 2 8 And in the K a n s a s City Southern case it was said: T h e determination of the methods of valuation for regulatory purposes depends upon the use which is to be made of the resultant figure. W h a t ever the limitations may have been upon the original meaning of the term value, it is certain that at the time the valuation act was passed the term was generally used with recognized but widely 28

Texas Midland R. R., supra, p. 6. 28 San Pedro, Los Angeles Ü Salt Lake R. R. Co., 75 I. C. C. 463, 506.

VALUATION FOR R E C A P T U R E

63

varying meanings. Valuation for capitalization, consolidation, taxation, and rate-making purposes and estimates of exchange value can not all be made upon the same b a s i s . 3 0 Carriers have repeatedly contended t h a t the property they devote to the public service can have b u t one value. T h e y assert t h a t whatever the purpose for which the value is determined, whether as a rate base, or for any other purpose, there is b u t one value of the property, a n d it must always be determined in the same w a y . 3 1 T h e United States District Court for Southern California in a case involving the valuation of the Los Angeles and Salt Lake Railroad upheld the contention of the carriers that there is only one value which m a y be attached to railroad property. In this case the Commission had refused to include in its final value the full recorded sums for working capital, materials and supplies on the grounds that those accounts included much material for purposes of extensions, additions, or betterments, the cost of carrying which was properly a charge t o capital account and not to operating expense. I n addition some of the materials and supplies consisted of scrap material which should be classed, along with the material held for betterments, as non-carrier property for purposes of valuation. T h e Commission had not included the above items because it held the opinion that in determining a value for ratemaking purposes it was necessary t o determine the specific property that is being used in rendering the common-carrier service for which rates are to be c h a r g e d . 3 2 T h e C o u r t held: T h e reports of the Commission we think clearly show that its action was based upon the view t h a t the property of the railroad company in question has more than one kind of value. And in our opinion the view constituted its f u n d a m e n t a l error, 30 Kansas City Southern Rv. Co., 84 I. C. C. 113, 116. San Pedro, Los Angeles ii Salt Lake R. R. Co., supra, p. 506. 32Los Angeles S. L. R. R. Co. v. U. S„ 8 Fed. (2nd) 747, 753. See also, Kansas City Southern Ry. Co., supra, p. 116. 31

64

WEAK

RAILROADS

a n d consists in its failure t o d o w h a t t h e s t a t u t e in express and, as we think, clear a n d u n m i s t a k a b l e t e r m s , authorized it t o do as t h e basis u p o n which t o fix the rates to be charged b y the railroad comp a n y : t h a t is to say, the t r u e actual value of all of t h e p r o p e r t y of the c o m p a n y at t h e time used in its t r a n s p o r t a t i o n business In no place in any of the statutes bearing u p o n t h e question d o we find even an implication of any a u t h o r i t y on the p a r t of t h e Commission t o find t h a t a n y of the p r o p e r t y of any c o m m o n carrier used in its t r a n s p o r t a t i o n business has t w o kinds of v a l u e . 3 3 T h e above decision was rendered on D e c e m b e r 7, 1 9 2 5 . 3 4 Since t h a t time, however, the Commission has again called attention to its finding of value under section 19a as a value f o r r a t e - m a k i n g purposes. I n t h e Riverside, R i a l t o a n d Pacific case, decided D e c e m b e r 10, 1926, the Commission said: T h e values found b y us u n d e r section 19a of t h e I n t e r s t a t e C o m m e r c e Act are not values for p u r chase a n d sale b u t values for r a t e - m a k i n g p u r poses T h e s e are physical properties, a n d t h e costs or values referred t o must necessarily be considered a valuation for r a t e - m a k i n g purposes, whereas for purposes of purchase and sale t h e y m a y be relatively u n i m p o r t a n t . 3 5 T h e final single sum value which the Commission determines is also the value of the p r o p e r t y of the carrier devoted t o t h e public service at the time t h a t it is so devoted. T h i s interpretation has been laid down b y the Supreme C o u r t in a n u m b e r of valuation decisions. In Smyth v. Ames t h e C o u r t said: W e hold . . . . t h a t the basis of all calculations as t o the reasonableness of rates to be charged 33

Los Angeles y S. L. R. R. Co. v. U. S., supra, p. 756. T h e decision of t h e District Court \vas reversed b y t h e S u p r e m e Court in U. S. v. Los Angeles y S. L. R. R. Co., 273 U. S. 299, b u t t h e C o u r t did not discuss t h e problem involved here. 35 Riverside, Rialto V Pacific R. R. Co., 119 I. C. C. 728, 735. 34

VALUATION FOR

RECAPTURE

65

by a corporation maintaining a highway under legislative sanction must be the fair value of the property being used by it for the convenience of the public What the company is entitled to ask is a fair return upon the value of that which it employs for the public convenience. 3 6 And later, in San Diego Land and Town Co. v. National City Co. : . . . what the cmpany is entitled to demand in order that it may have just compensation, is a fair return upon the reasonable value of the property at the time it is being used for the public. 3 7 In determining the single sum value of a railroad the Commission does not follow any single criterion of such value. Original cost has not been used, even when it had been ascertained with a fair degree of certainty, because of the infirmities in the investment accounts, to which reference has been made, and because of the fact that many of these accounts had been vitiated by improvidence, waste and dishonesty. Commissioner Eastman, in a dissenting opinion in the San Pedro, Los Angeles and Salt Lake case, reviewed a number of decisions in which the Supreme Court had held that the property may have cost more than it ought to have c o s t , 3 8 or that the original cost had been inflated by improper charges and injudicious expenditures, 3 9 or that the acquisition of more property than necessary had saddled upon the carrier a burden of improvident investment. 4 0 T h e infirmity in the use of the cost figure as the value of a railroad was clearly pointed out by the Supreme Court in the Minnesota R a t e Cases. There the Court said: It is clear that in ascertaining the present value we are not limited to a consideration of the amount 3β Smyth v. Amts, 169 U. S. 466, 546. 37 San Diego Land l¿ Town Co. v. National City Co., 174 U. S. 739, 757. 3» ¡bid., 174 U. S. 758. 39 S'.in D,ego Land V Town Co. v. Jasper, 189 U. S. 439, 442. *« Stanislaus County v. San Joaquin C. tí I. Co., 192 U. S. 201, 214.

66

WEAK

RAILROADS

of t h e actual investment. If t h a t h a s been reckless or i m p r o v i d e n t , losses m a y be sustained which t h e c o m m u n i t y does not u n d e r w r i t e . 4 1 T h e use of cost of reproduction alone also raises difficulties, according to t h e Commission's views. T h a t it is an element which o u g h t t o be considered t h e C o m m i s s i o n has n o d o u b t ; it accepts t h e rule laid down in t h e Knoxville case a n d t h e M i n n e s o t a R a t e Cases t h a t cost of reproduction is a m e t h o d of ascertaining p r e s e n t value, b u t refuses to accept t h a t m e t h o d t o t h e exclusion of all o t h e r s . R e p r o d u c t i o n a t p r e s e n t prices, d u e t o t h e great increase in t h e general price level resulting f r o m t h e W o r l d W a r , would produce a higher v a l u e t h a n would be o b t a i n e d b y t h e o t h e r m e t h o d s which h a v e b e e n useful in the v a l u a t i o n process. I t m u s t be said for t h e carriers as a whole t h a t t h e y h a v e not c o n t e n d e d f o r values swollen in h a r m o n y with t h e rise in t h e general price level. I n 1920, w h e n t h e C o m m i s s i o n a u t h o r i z e d general increases in rates b a s e d on an aggregate v a l u e less t h a n t h e a g g r e g a t e recorded i n v e s t m e n t in road, e q u i p m e n t , a n d w o r k i n g capital, t h e carriers asked t h a t their i n v e s t m e n t accounts b e used as t h e b a s e . 4 2 I n 1922, t h e C o m m i s s i o n in reducing rates, used an a g g r e g a t e value similar t o t h a t used in 1920 a n d t h e reduction was not contested b y t h e c a r r i e r s . 4 3 Similarly in 1926, in asking for an increase in rates in t h e western district t h e carriers, while a r g u i n g t h a t t h e c u r r e n t price level w a r r a n t e d a f a r higher value, asked only t h a t their a g g r e g a t e recorded i n v e s t m e n t accounts be used as a b a s e . 4 4 H o w e v e r , t h e y h a v e c o n t e n d e d t h a t in fixing a final single s u m value t h e C o m m i s s i o n should lay more stress t h a n it does u p o n r e p r o d u c t i o n cost. I t is interesting t o note t h a t t h e carriers have not always c o n t e n d e d for reproduction cost as a m e t h o d of d e t e r m i n i n g 41

Minnesota Rate Cases, supra, p. 454. « Increased Rates, 1920, Ex Parte 74, 58 I. C. C. 220. « Reduced Rates, 1922. 68 I. C. C. 676. « Revenues in Western District, 113 I. C. C. 3.

VALUATION FOR

67

RECAPTURE

v a l u e , a n d t h a t t h e i m p o r t a n c e of t h e question has b e e n m a g n i f i e d b y t h e recent rise in prices. W h e n Smyth v. Ames w a s being a r g u e d in t h e S u p r e m e C o u r t , William J e n n i n g s B r y a n , counsel f o r t h e appellants, s u p p o r t e d t h e r e p r o d u c t i o n cost t h e o r y as firmly as t h e carriers s u p p o r t it now. I n t h a t case it a p p e a r e d t h a t t h e cost of r e p r o d u c t i o n of t h e railroad p r o p e r t i e s in question, because of a decline in t h e general price level, was not only less t h a n t h e " a c t u a l " original cost, b u t also t h a n t h e " r e a s o n a b l e " original cost. T h e carriers w e r e c o n t e n d i n g for original cost. C o m m i s s i o n e r E a s t m a n , in calling a t t e n t i o n t o t h e a b o v e situation, m a i n t a i n e d t h a t if r e p r o d u c t i o n cost is s o u n d in principle it w o u l d b e s o u n d in a period of falling prices as well as in a p e r i o d of rising p r i c e s . 4 5 C o m m i s s i o n e r M e y e r , writing t h e decision of t h e C o m mission in t h e O T a l l o n case, pointed out t h a t t h e cost-ofr e p r o d u c t i o n d o c t r i n e is subject to practical as well as t o t h e o r e t i c a l difficulties. T h e essential objection to its use as t h e basic m e a s u r e of fair value, he said, m a y best be p r e s e n t e d b y a brief s u r v e y of t h e railroad situation a n d c o n s i d e r a t i o n of t h e results which would follow its application. T h e g r e a t p u r p o s e of t h e T r a n s p o r t a t i o n Act of 1920 is t o establish a n d m a i n t a i n an a d e q u a t e t r a n s p o r t a t i o n s y s t e m . U n d e r p r i v a t e ownership this c a n n o t be done unless t h e n e c e s s a r y capital can b e a t t r a c t e d t o t h e railroad i n d u s t r y , a t t r a c t e d p r i m a r i l y on t h e basis of stability of income a n d r e t u r n . Stability of r e t u r n can not b e g u a r a n t e e d unless t h e r e is, first of all, stability in t h e rate base. B u t with conditions as t h e y h a v e b e e n since 1920 t h e rate base, if d e t e r m i n e d on t h e basis of cost of reproducing t h e properties a t p r e s e n t prices, w o u l d h a v e been s u b j e c t t o violent fluctuations. T a k i n g 18 billions as a base, because it c o r r e s p o n d s closely t o t h e $18,900,000,000 aggregate value used in Ex Parte 74 at t h e t i m e of t h e general rate increases in 1920, 45 Cf. Commissioner E a s t m a n , dissentine opinion in San Angeles Salt Lake R. R. Co., supra, pp. 533-34.

Pedro,

Los

WEAK

68

RAILROADS

a n d applying the b u r e a u of valuation's ratios he showed t h a t " t h e value of precisely t h e same structures would h a v e become 41.4 billions in 1920, 35.1 billions in 1921, 28.3 billions in 1922, a n d 31.3 billions in 1923. In other words, a s s u m i n g a static p r o p e r t y t h e r e would have been a gain of 23.4 billions in 1920, a loss of 6.3 billions in 1921, a f u r t h e r loss of 6.8 billions in 1922, and a gain of 3 billions in 1923. T h e s e huge 'profits' a n d 'losses' would h a v e occurred without change in t h e railroad p r o p e r t y used in t h e public service other t h a n t h e theoretical and speculative change derived f r o m a shifting of general price levels." F u r t h e r m o r e , he pointed out t h a t determination of changes in t h e prices for railroad materials d u r i n g the period 19201923 was not only difficult, it could not be done with a n y m a r k e d accuracy because of the fact t h a t very little new railroad construction h a d been u n d e r t a k e n in those years. 4 ® Because of the manifest difficulties in using cost of reproduction as t h e basic value of railroad properties t h e Commission has chosen t o consider it as only one element in t h e determination of such value. T h e Commission has steadfastly refused to a d o p t a n y single formula for deriving final single-sum values a n d has refused t o give an analysis of its methods. In reply to the petition of the N a t i o n a l Conference on Valuation, in 1923, t h a t the Commission furnish along with the final single-sum value an analysis of the methods by which it had been obtained, the Commission reviewed the terms of t h e Act of 1913 with regard to analyses of methods. I n the first place, the Act requires analyses of the methods b y which original cost to date, cost of reproduction new, and cost of reproduction less depreciation are obtained. T h e s e have always been reported. In the second place, the Commission is required to report analyses of the methods by which " o t h e r values and elements of v a l u e " are obtained. T h i s requirement, in the opinion of the C o m m i s -

se Excess

Income

oj St. Louis

ΰ O1 Fallon Ry. C., 124 I. C . C . 1, 29-36.

VALUATION FOR

RECAPTURE

69

sion, has reference to the so-called "intangible" values, such as going value, franchise value, appreciation, etc. In the cases thus f a r decided, although the Commission has often recognized the existence of such elements of value, it has not found intangible values to which a money value could be ascribed, and has chosen t o make allowance for such elements, where necessary, in the final single-sum value. T h e third mention of analysis of methods is found in connection with evaluating property held by carriers for other t h a n common carrier purposes. T h u s , there is nothing in the Valuation Act which requires an analysis of the methods used in fixing a final v a l u e . 4 7 T h e Commission has consistently maintained that the finding of final value is essentially a matter of judgment. Where such a duty reposes in a number of individuals they m a y reach conclusions in which they all are agreed, although each m a y have given different weights to different factors, and they may have arrived at their conclusions through materially different processes. Support for such interpretation, the Commission says, is found in the language of the Court in the Minnesota R a t e Cases, at page 434: The ascertainment cf that value is not controlled by artificial rules. It is nor a matter of formulas, but there must be a reasonable judgment having its basis in a proper consideration of all relevant facts. T h e number and the complexity of the problems which we have briefly reviewed explain fully why the valuation work of the Commission is only partially completed after fifteen years of activity. Unfortunately for the enforcement of the recapture clauses it will take probably many years to finish the task. T h e valuations which have been made final—and this is true for only a small percentage of the railroad mileage, as we have said—represent only basic valuations as of certain valuation dates. It is probable also that some of these valuations will be overturned by the courts, since Petition

oj National

Conference

on Valuation,

supra, p. 12.

WEAK

70

RAILROADS

the correctness of the findings and the inclusion or exclusion of specific findings can be contested by the c a r r i e r s . 4 8 B u t in order that these valuations may be used for recapture purposes, they must be brought down to date, and for every year, since section 15a requires that a part of the excess earnings shall be paid over to the Government for every year in which such excess occurs. Valuation order No. 3 requires the carriers to report to the Commission all additions, betterments, and retirements made subsequent to the date of inventory of the original valuation. M a k i n g such changes is in itself a considerable task, involving the examination and checking of carrier records, often for a number of years, since some carriers have an original valuation date of 1914. I t is only with the approach of the completion of the basic valuations that the Commission has been enabled to employ its forces, to any great extent, in the operation of bringing basic valuations down to date. T h e various railway properties of the country in the original valuations have valuation dates as follows: N u m b e r of Properties

Valuation Date June

30—

Valuation Date June

71

1920

.

185

1921

.

475

1922

1914 1915 1916 1917

..

N u m b e r of Fropertics4y

30— 6 ....

3 1

478

1918

548

1919

210

TOTAL

. ..

1,977

T h e real difficulty which the Commission faces in bringing valuations down to date, however, is found in paragraph f of section 19a, which reads in p a r t : Upon the completion of the valuation herein vided for the Commission shall thereafter in manner keep itself informed of all extensions improvements or other changes in the condition « See: U. S. and I. C. C. v. Los Angeles U . S. 299,

312.

« Thirty-seventh

Annual Report

'J Salt Lake

prolike and and

R. R. Co., 273

of the I. C. C., 1923. p. 17.

VALUATION

FOR

71

RECAPTURE

v a l u e o f t h e p r o p e r t y o f all c o m m o n c a r r i e r s , a n d shall a s c e r t a i n t h e v a l u e t h e r e o f , a n d s h a l l , f r o m t i m e t o t i m e , r e v i s e a n d c o r r e c t its v a l u a t i o n s . In

its a n n u a l

report

for

1923 the C o m m i s s i o n

said

its e x p e r i e n c e p r o m p t e d " s e r i o u s d o u b t s as to t h e b i l i t y o f p r o c e e d i n g in ' l i k e m a n n e r ' in b r i n g i n g down

to date."

The

obtaining the basic

employment valuations

some, the valuations

of the

valuations

methods

used

would not only be

obtained would always

that

practicain

cumber-

b e in

arrears

o f the t i m e of use, and C3timates would h a v e to bridge considerable interim. of

"correcting

retired

and

the

Furthermore,

original

adding

units

the physical

inventory installed

by

eliminating

subsequent

a

magnitude to

units

date

of

v a l u a t i o n , a n d r e c l a s s i f y i n g t h e p r o p e r t y in a c c o r d a n c e w i t h or use as o f the

conditions

new date, for

the purpose

of

m a k i n g e s t i m a t e s o f r e p r o d u c t i o n n e w a n d r e p r o d u c t i o n less depreciation of ways and structures," and the reappraisal of l a n d s for t h e p u r p o s e of

finding

present value, would involve

expenditures the propriety of which might be questioned. M o r e o v e r , b r i n g i n g v a l u a t i o n s d o w n t o l a t e r d a t e s , in " l i k e m a n n e r , " as C o m m i s s i o n e r M e y e r h a s p o i n t e d o u t , 3 0 difficulties

with cost

of

reproduction

estimates.

raises

Such

esti-

m a t e s in t h e b a s i c v a l u a t i o n s a r e m a d e o n t h e b a s i s o f u n i t prices found to obtain years, This has

and

in s o m e

is d o n e

because

recognized

comparable date

of the

the

J u n e 30,

instances, from

1914, and during the

the

10 y e a r s ,

prior

the beginning the

advisability

as b e t w e e n various basic valuations,

of

making

Commission

such

estimates

railroads, regardless of

and

five

thereto.

also because

it

aids

the in

e s t a b l i s h i n g a b a s e f o r f u t u r e u s e in fixing v a l u e s as o f l a t e r dates.51

J u n e 30, 1914, was chosen because the Commission

f e l t t h a t " t h e c o s t o f p r o d u c i n g a n d e q u i p p i n g a r a i l r o a d in most parts of this country on that date, was a fair B0

B. H. Meyer. Chairman, concurring, San Pedro,

Lake R. R. Co., supra, p. 591. S' San Pedro, Los Angeles ii Salt Lake

Los

average

Angeles

R. R. Co., supra, p. 474.

d

f

Salt

WEAK

72

RAILROADS

for at least the 20 years preceding." 5 2 Adjusting values to later dates involves consideration of the changes in the general price level during the war. Although there is little doubt that consideration should be given to higher prices in connection with net additions to properties since valuation date it remains at least a matter for debate as to whether or not such prices should be applied in the determination of the value of the entire property of a railroad as of a date subsequent to the date of the basic v a l u a t i o n . 5 3 T h e manifold difficulties which the Commission would experience in using the same methods in bringing valuations down to dates subsequent to the date of the basic valuation, and the doubts raised with regard to its powers to do otherwise, have caused the Commission to recommend to Congress that the act be amended so as to define clearly the duties of the Commission under paragraph f of section 19a. T h e Commission has suggested amendments embodying different theories as to the proper method to be adopted, one of which proposes that it be empowered to bring the valuation t o date " b y adding to or subtracting from its original basic valuation of the property the net property changes, measured in dollars and cents, t h a t are properly chargeable to or deductible from property a c c o u n t . " 5 4 Such an amendment would afford practical administrative results, but it would raise the question of the right of Congress to prescribe an investment or original cost basis for valuation, at least of the property acquired since the basic valuation date. T h e Commission has recognized this possibility and has suggested other short-cut methods of bringing valuations to date. So far, however, Congress has refused t o act upon the recommendations of the Commission, and there still remains the necessity for interpretation of its duties in this 82

Texas Midland R. R., supra, p. 140. Cf. Commissioner M e y e r , concurring in San Pedro, Los Angeles Salt Lake R. R. Co., supra, p. 591. M Thirty-seventh Annual Report of t h e I. C. C. ( 1923, p. 18. 83

li

VALUATION FOR

73

RECAPTURE

p a r t i c u l a r . T h e whole situation tends to o b s t r u c t t h e work of valuation, especially with respect t o t h e use of results u n d e r section 19a for r e c a p t u r e purposes. T h e non-availability of valuations u n d e r section 19a has d r i v e n t h e C o m m i s s i o n t o t h e adoption of a short-cut m e t h o d of v a l u a t i o n f o r r e c a p t u r e in t h e case of excess income of t h e St. Louis a n d O ' F a l l o n R a i l w a y . T h e carriers in this case c o n t e n d e d t h a t v a l u a t i o n for r e c a p t u r e m u s t be o b t a i n e d u n d e r section 19a, a n d t h a t it is " p r e m a t u r e " on t h e p a r t of t h e C o m m i s s i o n t o set u p a v a l u e a n d proceed to r e c a p t u r e excess earnings on t h e basis of it w h e n t h e w o r k u n d e r t h e Valuation Act is not completed. T h e C o m m i s s i o n held, however, t h a t t h e provisions with regard to t h e d e t e r m i n a tion of t h e value of railroad properties a n d with regard t o r e c a p t u r e m u s t b e considered in connection with t h e whole of section 15a a n d in t h e light of t h e p u r p o s e s of t h e Act of which t h e y a r e a p a r t . I t was not c o n t e m p l a t e d in t h e Act t h a t t h e benefits which it was hoped would accrue t o t h e carriers a n d t o t h e public should be d e f e r r e d t o an indefinite f u t u r e , until t h e w o r k u n d e r section 19a h a d b e e n c o m pleted. A c c o r d i n g t o t h e C o m m i s s i o n , in t h e m a j o r i t y decision, t h e l a n g u a g e of section ISa indicates t h a t t h e p r o g r a m be put into o p e r a t i o n as soon as possible. Section 15a requires t h a t t h e C o m m i s s i o n "give consideration to all t h e elements of v a l u e recognized b y t h e law of t h e land f o r r a t e - m a k i n g p u r p o s e s , " b u t it requires also t h a t t h e aggregate value of r a i l r o a d p r o p e r t i e s b e d e t e r m i n e d " f r o m t i m e to t i m e a n d as o f t e n as m a y be n e c e s s a r y . " T h e r e is a n entire lack of direction t o t h e C o m m i s s i o n regarding m e t h o d s of p r o c e d u r e in m a k i n g such valuation, a n d c o n s e q u e n t l y the C o m m i s s i o n has c o n s t r u e d t h e whole section as p e r mitting t h e m t o m a k e v a l u a t i o n s u n d e r section 15a "in a more s u m m a r y m a n n e r t h a n v a l u a t i o n s u n d e r section 1 9 a . " 5 5 T h a t t h e C o m m i s s i o n h a d decided t o m a k e t h e O ' F a l l o n 85

Excess

Income

of St. Louis

li O'Fallon

Ry.

Co., supra,

pp. 7-8.

74

WEAK

RAILROADS

case a test case in v a l u a t i o n p r o c e d u r e is evident in the l a n g u a g e of t h e decision. I n a n s w e r t o t h e r e q u e s t of v a l u a tion counsel for western carriers t h a t t h e case be d i s p o s e d of b y itself a n d on its own merits t h e C o m m i s s i o n s a i d : W e are dealing here with one small railroad. Nevertheless, w h a t we d o in this case we m u s t in principle d o for all t h e railroads in t h e U n i t e d States. W h a t e v e r our decision, its effect in dollars a n d cents is relatively u n i m p o r t a n t in this p a r t i c u l a r case. B u t , having in mind, as we m u s t , t h e whole railroad situation, the decision is of t h e greatest consequence f r o m both p r i v a t e a n d public viewpoints.56 T h e m e t h o d of arriving at a final single-sum value in the case of t h e p r o p e r t y of t h e O ' F a l l o n was briefly t h i s : I n o r d e r t o d e t e r m i n e t h e value of t h e p r o p e r t y d e v o t e d to c o m m o n c a r r i e r service d u r i n g t h e r e c a p t u r e periods covered in the case, t h e C o m m i s s i o n s t a r t e d with t h e v a l u a t i o n or invent o r y d a t e of J u n e 30. 1919. T h e units in existence on t h a t d a t e being k n o w n , t o t h e m were applied t h e unit prices of 1914 for an e s t i m a t e d cost of r e p r o d u c t i o n in their condition on t h a t d a t e . I t being f o u n d , f u r t h e r , t h a t t h e actual cost of installing units b e t w e e n 1914 a n d 1919 exceeded t h e cost of r e p r o d u c i n g such units at 1914 unit prices, a s u m representing price increases on t h e units installed d u r i n g t h a t period was a d d e d . F o r t h e period f r o m J u n e 30, 1919, d o w n t o t h e end of each r e c a p t u r e period e s t i m a t e was a b a n d o n e d , a n d t h e r e was a d d e d t h e net cost of a d d i t i o n s to p r o p e r t y less r e t i r e m e n t s . L a n d was t a k e n at its c u r r e n t v a l u e as m e a s u r e d b y t h a t of neighboring l a n d s . 5 7 T h e principal objection raised t o this m e t h o d of v a l u a t i o n w a s t h a t which we h a v e discussed before, the f a i l u r e t o m a k e r e p r o d u c t i o n estimates on t h e basis of p r e s e n t prices. W i t n e s s e s for t h e B u r e a u of V a l u a t i o n i n t r o d u c e d composite s e Ibid., p . 26. 57 C f . C o m m i s s i o n e r H a l l , d i s s e n t i n g o p i n i o n . Excess t í O'Fallon Ry. Co., supra, p . 60.

Income

of St.

Louis

VALUATION FOR

75

RECAPTURE

i n d e x n u m b e r s t o s h o w t h a t w i t h unit prices of 1914 b e i n g c o n s i d e r e d as 100, t h e i n d e x f o r D e c . 31, 1920, w o u l d h a v e b e e n 2 3 0 ; f o r D e c . 31, 1921, 195; f o r D e c . 31, 1922, 157; a n d for D e c . 31, 1923, 1 7 4 . 5 8 I n r e s p o n s e t o t h e c o n t e n t i o n s t h a t the refusal to m a k e reproduction estimates at present p r i c e s does n o t give p r o p e r w e i g h t t o i n c r e a s e d cost of c o n s t r u c t i o n in t i m e s of a d v a n c i n g price levels t h e C o m m i s s i o n h e l d t h a t it h a d given w e i g h t t o such c h a n g e s . C h a n g e s in t h e price level w e r e c o n s i d e r e d w h e n t h e d i f f e r e n t i a l w a s a d d e d on n e t a d d i t i o n s t o i n v e s t m e n t f r o m 1914 t o 1919 f o r t h e d i f f e r e n c e b e t w e e n cost of r e p r o d u c t i o n e s t i m a t e s a n d a c t u a l cost, w h e n n e t a d d i t i o n s t o i n v e s t m e n t f r o m 1919 t o t h e v a r i o u s r e c a p t u r e d a t e s w e r e t a k e n a t cost figures, a n d w h e n land was valued at the m a r k e t values prevailing at t h e t i m e of r e c a p t u r e . Such practices, t h e C o m m i s s i o n said, c o n s t i t u t e t h e o n l y m e t h o d of giving w e i g h t t o price c h a n g e s t h a t is n o t " d e p e n d e n t on c a p r i c e , " a n d w h i c h does n o t i n v o l v e t h e c o m p l e t e a c c e p t a n c e of t h e c u r r e n t r e p r o d u c t i o n cost d o c t r i n e . 5 9 T h e u s e of e s t i m a t e d r e p r o d u c t i o n cost f o r t h e p r o p e r t y as of J u n e 30, 1914, w a s j u s t i f i e d b y t h e C o m mission o n t h e p r i n c i p l e laid d o w n in t h e T e x a s M i d l a n d c a s e a n d f o l l o w e d t h r o u g h o u t in m a k i n g r e p r o d u c t i o n estim a t e s , t h a t such cost r e p r e s e n t e d a f a i r a v e r a g e f o r a t l e a s t 2 0 y e a r s p r e c e d i n g . M o r e o v e r , it h a d b e e n i m p o s s i b l e t o d e t e r m i n e t h e original cost of t h e O ' F a l l o n b e c a u s e t h e c a r r i e r ' s a c c o u n t i n g r e c o r d s for t h e period Trom t h e d a t e of its i n c o r p o r a t i o n , J u n e 1, 1896, t o J u n e 1, 1908, w e r e missing.80 T h e advantages which m e t h o d of v a l u a t i o n a r e a p p l i c a t i o n a n d involves the underlying inventory completed. It assures fair

the Commission claims for this m a n y . I t is s i m p l e a n d e a s y of n o g r e a t e x p e n s e o r d e l a y , since w o r k u n d e r section 19a h a s b e e n treatment to the investor because

88

ibid., m a j o r i t y o p i n i o n , p . 22. •Γ·® Excess Income oi St. Louis li O'Fallon

«« Ihid.. ρ- 20.

Rx.

Co., supra,

p. 39.

76

WEAK

RAILROADS

a fair return will be obtained on the money that has gone into the railroads, provided the traffic is available. T h u s will be given the assurance necessary to induce investors t o place their funds in railroad enterprises. Finally, by the adoption of such a method there will be achieved the stability of rate base which the Commission finds essential to a wise and just plan of public regulation. 6 1 T h e O'Fallon company applied to the Federal courts for an injunction to restrain the enforcement of an order of the Interstate Commerce Commission directing the company to pay over to the government excess earnings calculated on the basis of the value so determined. A decision was rendered in the United District Court for the Eastern District of Missouri, December 10, 1927, by a special court of three Federal judges. One of the grounds on which the order was attacked was that it was "based upon an erroneous and inadequate finding of value," that the Commission had measured such value upon the "assumed prudent investment basis" and had failed to give "effective and dominant consideration to the cost of reproduction at the price levels existing at the time the issue arises." 6 2 T h e attorneys for the United States contended that no question of confiscation was presented in this case and that therefore it was not necessary for the court to examine the accuracy of the values found by the Commission or the methods used in determining such values. T h e court found that, after deducting the excess which was to be paid over to the Government by order of the Commission, the net return was ample enough to avoid the issue of confiscation, even when the values claimed by the O'Fallon Company were used. T h e application was accordingly denied, and no review was made of the Commission's findings. On M a y 20, 1929, the Supreme Court handed down a decision reversing the decision of the lower court and an01 Ibid., p. 58. 62 St. Louis ii O'Fallon

Ry.

Cu. v . U. S„ 22 Fed. ( 2 n d )

980.

VALUATION FOR

RECAPTURE

77

nulling t h e r e c a p t u r e order of the Commission t o t h e O ' F a l l o n railroad. T h e Supreme C o u r t held t h a t the f u n d a mental question presented was whether the Commission acted as directed by Congress in applying the law of t h e land, and not t h e question as to whether or not the income retained b y the O ' F a l l o n was sufficient t o avoid actual confiscation. T h e m e t h o d s employed by the Commission in determining t h e value of the O ' F a l l o n were attacked on the grounds t h a t reproduction estimates for the bulk of the p r o p e r t y were based u p o n 1914 prices, and t h a t no consideration was given t o prices which prevailed on the recapture dates. T h e doctrine a d h e r e d t o by t h e C o u r t was stated in Southwestern Bell Telephone v. Public Service Commission, and is as follows : It is impossible to ascertain w h a t will a m o u n t to a fair r e t u r n u p o n properties devoted t o public service w i t h o u t giving consideration to the cost of labor, supplies, etc., at the time the investigation is made. An honest and intelligent forecast of probable f u t u r e values, m a d e upon a view of all the relevant circumstances, is essential. If the highly i m p o r t a n t element of present costs is wholly disreg a r d e d such forecast becomes impossible. Estimates for t o m o r r o w cannot ignore prices t o d a y . 0 3 T h e C o u r t declared t h a t in its decision t h e Commission had carefully r e f r a i n e d f r o m stating t h a t " a n y consideration whatever was given to present or reproduction costs in estimating t h e value of t h e carrier's p r o p e r t y . " F u r t h e r m o r e , the C o u r t said, f o u r dissenting commissioners declared t h a t reproduction costs were not considered, a n d " t h e report itself confirms t h e i r view." T h e C o u r t then quoted f r o m Commissioner Hall's a n a l y s i s 6 4 of the methods employed in evaluating t h e O ' F a l l o n p r o p e r t y (in which the C o m m i s sioner c o n t e n d e d t h a t for t h e m a j o r p a r t of t h e carrier's « Southwestern

04

See r a g e 74.

Bill Telephone Co. v. P. S. Comm., 262 U. S. 276, 287.

78

WEAK

RAILROADS

p r o p e r t y no consideration was given t o costs a n d prices obtaining on recapture d a t e s ) , saying t h a t it accurately described the action of the Commission. I n thus failing t o consider present prices, the Court held, the Commission has disregarded the "approved rule" which the C o u r t "in the exercise of its proper function has declared the law of the land concerning valuations for rate-making purposes," a n d "has t h e r e b y failed t o discharge the definite d u t y imposed by Congress." T h e significance of the O'Fallon decision from the s t a n d point of this chapter is that the Commission will not be able to use the short-cut method of valuation adopted to facilitate the enforcement of the provisions of section 15a. T h e C o u r t held t h a t present reproduction costs must be considered, b u t in holding t h a t " t h e weight to be accorded t h e r e t o " was not before t h e Court, it left to the Commission the d u t y of determining such weight. As Associate Justice Stone has said in his dissenting opinion, the Court has not held t h a t the evidence of such costs m a y not be outweighed b y other considerations affecting value. T h e Commission, therefore, will have t o go on with its valuation work under section 19a, and a n y railroad not satisfied with the value placed upon its p r o p e r t y will have, as before, the right of appeal t o the courts. Meanwhile, the present unsatisfactory enforcement of the recapture provisions will be perpetuated to an indefinite f u t u r e , for the determination of the fair value of a railroad p r o p e r t y is an antecedent condition to the determination of excess income subject to recapture. T h e valuation work of the Commission, as we have seen, is still f a r from completion, even the basic valuations, and there remains the problem of bringing such valuations down to recapture dates in some m a n n e r satisfactory t o the individual railroads and to the courts. Until this w o r k has been completed we cannot look for effective enforcement of the recapture clauses so as to accomplish the purposes contemplated in the Act of 1920.

CHAPTER IV THE RECAPTURE CLAUSES IN OPERATION U p to the time of the issuance of its report for the year 1928, the Interstate Commerce Commission had served eight general orders upon all carriers subject to section 15a of the act to regulate interstate commerce, calling upon them to report excess earnings that had accrued t o them. I n response to these orders the carriers had filed reports showing the following results with respect to excess net railway operating income: N u m b e r oí Reports 991 A p p l i c a b l e period, 1 9 2 0 . . . . . . Period

N u m b e r of R e p o r t s in Which E x c e s s I n c o m e is R e p o r t e d 34

Total Amount of E x c e s s I n c o m e Reported1 £2,505.006.17

Calendar year,

1921 . . . . .

973

27

458,535.72

Calendar year,

1922.. . . . .

929

50

1,865,153.46

Calendar

6,878,593.92

1923.. . . . .

897

52

Calendar year,

1924

....

894

23

1.191,603.75

Calendar year,

1925

. . ..

886

24

2.275.050.68

Calendar year,

1926 . . . . .

874

15

1,033,497.02

Calendar year.

1927

821

8

170,807.25

Total

year,

$16,378,247.97

Excess

T h e above computations of excess income have not been made upon values fixed by the Commission. Under the Commission's orders the carriers have been permitted t o compute their claimed values upon such basis as they have deemed proper, consequently many different bases have been used. When the Commission shall have determined values for recapture purposes the number of carriers found to have earned excess income and the amounts thereof m a y differ substantially from the foregoing statements. 1

T a k e n f r o m Forty-second

Annual 79

Report

of t h e I. C . C . , 1 9 2 8 , p . 5.

80

WEAK RAILROADS

I t should be further understood that not all excess above 6 per cent upon the value of railroad property need be reported. P a r a g r a p h 18 of section ISa provides: Any carrier, or any corporation organized to construct and operate a railroad, proposing to und e r t a k e the construction and operation of a new line of railroad may apply to the Commission for permission to retain for a period not to exceed ten years all or any part of its earnings derived from such new construction in excess of the amount heretofore in this section provided, for such disposition as it may lawfully make of the same, and the Commission may, in its discretion, grant such permission, conditioned, however, upon the completion of the work of construction within a period to be designated by the Commission in its order granting such permission. T h e Commission has received numerous applications for permission to retain excess earnings on new construction, most of which have been granted, although many have been denied. T h e Commission has held that paragraph 18 does not apply to construction begun before the date of the effective operation of section 15a, 2 that it has no application to operations of leased lines, 3 and that the right to retain such excess is lost by a carrier when control of it is obtained by another carrier. 4 Applications have been denied in cases in which the additional system income promises to be ample to sustain the new line, 5 and in cases in which no additional equipment is required and no additional changes to road and equipment accounts are contemplated. 6 P a r a g r a p h 18, the Commission says, was designed primarily to encourage enterprises in a territory which is deficient in transportation facilities, consequently its application should not be extended 2 Lease of Virginian ü lFestem Ry., 72 I. C. C. 454. 3 Operation of Line by G. M. & N. R. R., I l l I. C. C. 583. * Control of / . ü E. Ry., I l l I. C. C. 587. 5 Construction by St. Louis, Brownsville W Mexico Ry., 117 I. C. C. 307. « Construction by Fordyce l¿ Princeton R. R., 117 I. C. C. 720.

RECAPTURE IN OPERATION

81

t o construction which is principally in the interest of the carrier, and only indirectly for the benefit of the general public. 7 Applications have also been denied on the grounds t h a t it is often difficult to segregate earnings and expenses which may rightfully be charged to a part of a s y s t e m 8 and t h a t such practices might operate to defeat the recapture of excess earnings. 9 N o t all the excess, which according to the reports of the carriers is subject to recapture, has been paid over to the Commission, and the bulk of the payments have been made under formal protests and reservations. 1 0 Consequently, the general railroad contingent fund, which was to be made up of such earnings and to be used primarily for the benefit of weak carriers, has not been available for the uses contemplated in the Act of 1920. Contingent f u n d moneys are held in the T r e a s u r y of the United States as a trust f u n d for investment in obligations of the United States as required by paragraph 10 of section 15a. T h e status of the f u n d as of December 1, 1928, was as f o l l o w s : 1 1 Payments by Fayments by ments Interest from Interest from

carriers of excess income $8,007,208.39 carriers of interest on overdue p a y 20,559.09 b a n k balances and investments in U. S. obligations. . . . 1,157,210.62

T o t a l credits t o tingent f u n d

the

general

railroad

con$9,184,978.10

T h e conclusion which inevitably follows even a cursory examination of the Commission's reports is t h a t the recapture clauses have not operated to help the weak roads. T h e sums that have been recaptured are relatively small, ''Kansas, Oklahoma o f-T

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BIBLIOGRAPHY Annual Report« of the Interstate Commerce Commission—1908,1914,1916— 1927. Congressional Record—vols. 65, 67, 69. Senate Document No. 19, 66th Congress, 1st session. HEAIUNCS—Senate Committee on Interstate Commerce: Consolidation of Railroad Properties, S. 2224, 68th Congress, 1st session. Consolidation of Railroad Properties, S. 4892, 69th Congress, 2nd session. Consolidation of Railroad Properties, S. 1175, 70th Congress, 1st session. Extension of Government Control of Railroads, 65th Congress, 3rd session. Railroads, Revenues and Expenses, 67th Congress, 2nd session. Various Bills to Repeal Section 15a of the Interstate Commerce Act, 68th Congress, 1st session. House Committee on Interstate and Foreign Commerce: Railroad Consolidation, H. R. 11212, 69th Congress, 1st session. Railroad Legislation, H. R. 6359, etc., 69th Congress, 1st session. U N I T E D STATES D I S T R I C T COURT AND SUPREME C O U R T D E C I S I O N S :

Chicago, etc., Ry. Co. v. Wellman, 143 U. S. 339. Dayton-Goose Creek Ry. v. U. S., 263 U. S. 456. Knoxville v. Water Co., 212 U. S. 1. Los Angeles it S. L. R. R. Co. v. U. S., 8 Fed. (2) 747. Minnesota R a t e Cases, 230 U. S. 352. New England Divisions Case, 261 U. S. 184. San Diego Land & Town Co. v. Jasper, 189 U. S. 439. San Diego Land & Town Co. v. National City Co., 174 U. S. 739. Smyth v. Ames, 169 U. S. 466. Southwestern Tel. Co. v. Pub. Serv. Comm., 262 U. S. 276. St. Louis & O'Fallon Ry. Co. v. U. S., 22 Fed. (2d) 980. Stanislaus County v. San Joaquin C. & I. Co., 192 U. S. 201. U. S. ex rei. Kansas City Southern Ry. Co. v. I. C. C., 252 U. S. 178. U. S. v. Abilene & So. Ry. Co., 265 U. S. 274. U. S. v. Los Angeles & S. L. R. R. Co., 273 U. S. 299. INTERSTATE COMMERCE COMMISSION

Abandonment Abandonment Abandonment Abandonment Abandonment Abandonment

DECISIONS:

by B. & M. R. R., 117 I. C. C., 679. by C. B. & Q. R. R., 117 I. C. C. 637. by Y. H. & B. R. R., 117 I. C. C. 695. of B. G. R. R., 131 I. C. C., 513. of C., O. & G. R. R., I l l I. C. C. 81. of E. K. Ry., I l l I. C. C. 476. 174

BIBLIOGRAPHY

175

Abandonment of S. P. Co., I l l I. C. C. 577. Abandonment of W. & M. R. Ry., 131 I. C. C. 145. Abandonment of Branch by P. R. R. Co., 117 I. C. C. 139. Abandonment of Branch by Pere Marquette, 72 I. C. C. 267. Abandonment of Branch by Pere Marquette, 72 I. C. C. 303. Abandonment of Branch Line by S. P. Co., 72 I. C. C. 404. Abandonment of Branch Line by T . & N. O. R. R., 131 I. C. C. 1. Abandonment of Branch Line of P. M. R. R., 105 I. C. C. 817. Abandonment of Branch Line by C., R. I. & P., 94 I. C. C. 717. Advanced Rates in Eastern Trunk Line Territory, 20 I. C. C. 247. Artemus-Jellico R. R. Co. v. L. & N. R. R. Co., 123 I. C. C. 182 Augusta Northern Ry., 125 I. C. C. 14. Charleston & Western Carolina Ry., 121 I. C. C. 721. Chicago & Illinois Midland Ry. Co., 119 I. C. C. 202. City of Spokane v. N. P. Ry. Co., 15 I. C. C. 376. Consolidated Southwestern Cases, 123 I. C. C. 203. Consolidation of Railroads, 63 I. C. C. 455. Construction and Repair of Ry. Equipment: Penna. R. R., 66 I. C. C. 694. Construction and Repair of Ry. Equipment: N. Y. C. R. R. C., 66 I. C. C. 732. Construction and Repair of Ry. Equipment: N. Y., N. H. & H. R. R. Co. 107 I. C. C. 721. Construction by Fordyce ic Princeton R. R., 117 I. C. C. 392. Construction by M. & R. R. R., 117 I. C. C. 727. Construction by St. Louis, Brownsville & Mexico Ry., 117 I. C. C. 307. Control of G. & S. I. R. R. Co., 99 I. C. C. 169. Control of J . & E. R y , 111 I. C. C. 587. Death Valley R. R , 103 I. C. C. 27. Deficit Status of U. S. & Canada R. R , 76 I. C. C. 455. Excess Income of the St. Louis & O'Fallon Ry. C o , 124 I. C. C. 1. Federal Valley R. R. Co. v. T . & O. C. Ry. Co., 68 I. C. C. 499. Finance Docket No. 5690. Five Per Cent Case, 31 I. C. C. 351. Fort Smith, S. & R. I. R. R. Co. v. A. & V. Ry. C o , 102 I. C. C. 708. Increased Rates, 1920, 58 I. C. C . 220. Kansas City Southern Ry. C o , 84 I. C. C. 113. Kansas, Okla. & Gulf Extension, 72 I. C. C. 392. Lease of Virginian & Western R y , 72 I. C. C. 454. Minnesota Western R. R. v. A , T . & S. F. Ry. C o , 109 I. C. C. 127. New England Divisions Case, 62 I. C. C. 513; 66 I. C. C. 196. New York, Phila, & Norfolk R. R. C o , 97 I. C. C. 273. Operation of Line by G , M. & N. R. R , 111 I. C. C. 583.

WEAK RAILROADS

176

Petition of National Conference on Valuation, 8 4 I. C . C . 9. Public Convenience Certificate to D . & Ν . M . R y . , 71 I. C . C . 7 9 5 . Reduced R a t e s , 1922, 68 I. C. C. 676. Revenues in Western District. 113 I. C . C . 3. Riverside. R i a l t o & Pacific R . R . Co., 119 I. C . C . 7 2 8 . S a n Pedro, Los Angeles & Salt Lake R . R . Co., 75 I. C . C . 463. Southern Class R a t e Investigation, 100 I. C . C . 5 1 3 ; 109 I. C . C . 3 0 0 ; 113 I. C. C . 2 0 0 ; 128 1. C. C. 567. T e x a s Midland R . R . , 75 I. C. C. 1. Virginian & Western Extension, 72 I. C . C. 55. Wichita Northwestern R y . Co. v. C., R . I. & P . R y . C o . , 81 I. C . C . 513. SECONDARY

SOURCES

American Economic Association, Round table discussion, Amer. E c o n . R . , Supplement, M a r c h 1924. American Short Line Railroad Association, R e p o r t of t h e president, Bird M . Robinson, its 1925 proceedings. Capper, Arthur, "Victimizing the F a n n e r , " Forum, 7 1 : 4 9 2 - 6 , April 1924. Goldsmith, Joseph M . , " H o w Will t h e Recapture Clause Decision Affect Railway Securities," Magazine of Wall Street, 3 3 : 6 7 8 - 9 , F e b . 16, 1924. Hall, Henry C., "Proposed Consolidation

Law C h a n g e s , "

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435-7, F e b . 13, 1926. Holden, Hale, "Should Section 15a be Repealed.'," Congressional

Digest,

3 : 1 , 17, Oct. 1923. Kelley, J . Paul, "Proposed Valuation for R e c a p t u r e , " R y . Age, 8 0 : 1 0 7 9 - 8 2 , April 17. 1926. Locklin, D . Philip, " T h e A t t a c k upon Section 15a of the I n t e r s t a t e Commerce A c t , " J l . of Pol. Econ., 2 3 : 4 , Aug. 1925. R y a n , J . T . , "Should Section

15a be Repealed?," Congressional

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3 : 1 , 1 8 , Oct. 1923. Thorn, A. P., "Our Transportation Problems," Traffic World, 3 6 : 1 5 , Oct. 10, 1925.

" R a i l r o a d Consolidations as a R e m e d y , " R y . Review. 7 7 :

554-6, Oct. 10, 1925. Vanderblue, Homer B . , " R a i l r o a d Valuation," Harvard University 1920.

Press,