Salvaging Our Railroads
I
OUR rail transportation system is one spot in our diseased financial and economic structure that is susceptible of fairly effective remedy. With a net investment of about 19 billions, the market value of the railroad stocks and bonds has, during the past summer, run from less than 7 billions to about 10 billions on October 1. About three fourths of this 10 billions — or 7½ billions — represents the market value of over 12 billions of bonds; the balance — 2½ billions — about 7 billions of stock. The latest reports of the Interstate Commerce Commission indicate that Class 1 roads will, in 1932, fall short of earning their interest charges by over $200,000,000.
Only radical changes in organization, in management, and in control can save from tremendous losses the millions of owners of these bonds and stocks. The securities are now largely held by our savings banks, insurance companies, public charities, and trust estates. If the necessary changes were effected, a reasonably good salvage result might be obtained.
No substantial progress has been made, in twelve years, in the consolidations contemplated by the Transportation Act, effective March 1, 1920. It took the Commission over nine years to adopt a plan. No appreciable steps have been taken under that plan. The recent approval of the four-party consolidation scheme may possibly indicate a belated and inadequate adoption of the doubtful policies of that Act. Whether Congress can, directly or through powers vested in its agent, the Interstate Commerce Commission, force consolidation of statechartered corporations is a question fraught with grave constitutional difficulties, too involved for detailed discussion here. It is enough now to note that, in its main purpose of shortly consolidating our railroads into a few large systems which should wholesomely compete with each other, the Transportation Act is a demonstrated failure.
We still have 697 operating railroad companies, many of them wildly competing with each other for traffic. Only in telephony is the call for coördinated, unified operation more requisite. Competition between railways, never of much value, has long been harmful. Most inter-company junctions are points of friction, confusion, and waste; competitive solicitation of freight traffic is worse than waste. Cars should have no homes; they should be repaired where and when they develop need for repair. Our competing railroad companies are still wasting tens of millions in futile advertising, and in buying duplicating equipment — now in large part standing in idle, rusting deterioration. But they have improved the speed and reliability of their freight service. Their operating staffs are, in general, made up of competent and faithful men, essential in any reorganized system.
On March 1, 1932, there were 1008 railroad executives with salaries (after a 10 per cent, or more, reduction) ranging from $135,000 to $10,000. Never were there more than three or four railroad executives whose abilities and services entitled them, even under normal business conditions, to a salary as large as $50,000. No railroad man ever lived worth $100,000 to his company. Many of these 1008 executives would be overpaid if they received a salary as large as that of a Supreme Court Justice — $20,000.
The existence of this large number of overpaid and not very competent managerial forces is one cause of the failure to consolidate and coördinate our railways. These forces are more interested in keeping available a large number of highly paid official positions than they are in the public need for improved and cheaper rail service, or in the rights of their security holders.
Perhaps it ought not to be expected that the holders of overpaid places of power should agree on formulating and making effective a policy which would necessarily reduce the number of such places. Men have been known to burn job-limiting, labor-saving machinery. Our railroad managers have reduced the number of moderately paid jobs by about 800,000; so far, however, they seem to have kept, for themselves, most of these overpaid and pleasant positions of power. This accords with the present American policy of ’rugged individualism.’
A sketch of the Pennroad Corporation will indicate to what extent the official forces of the railroads are entitled to confidence as safe guides to the investing public. This holding company was organized and controlled by the officials of the Pennsylvania Railroad, as a device (of doubtful legality) in that company’s career of expansion. They offered Pennsylvania stockholders Pennroad shares at $15, and thus obtained (in round figures) $150,000,000 from the investing public — of which over $5,000,000 was paid as underwriting commission to Kuhn, Loeb & Company, their bankers. The balance of this $150,000,000 was invested mainly in stocks of other railroads, such as the New Haven and Boston & Maine, at around 120. If we doubtfully assume that sound judges of railroad securities were warranted in buying, with other people’s money, New Haven and Boston & Maine stocks at these boom prices, the same thing cannot be said of the investment of over $4,500,000 in common stock of the Seaboard Air Line. This stock never had any intrinsic value; it represented merely stockholders’ votes. The company is now in receivership. Much of the 150 millions of other people’s money thus administered by these leading railroad men now seems to have been lost. The lowest quotation of Pennroad was $1.00; on October 15 it had risen to $2.25.
The Van Sweringen snarl of corporations, nominally controlled through the Alleghany Holding Company and backed by J. P. Morgan & Company, is, as a piece of railway financing set-up, at least as bad as the Pennroad. Such are the outstanding phenomena under the Transportation Act.
Clearly, neither Congress nor the widely scattered owners will derive any substantial help in solving our railroad problem from the managers, whose policies and performances are marked by excessive intellectual frugality. Constructive measures must come from without.
This is my justification for outlining roughly in the following pages a possibly available plan.
II
General consolidation is the plain remedy, available only by national mandate. Let Congress create a Federal corporation with an authorized capitalization not to exceed 15 billions — an outside figure for the present and prospective value of our railroad properties. About one half of this capitalization should be bonds (probably 4’s), guaranteed by the Federal Government; the other half, stock, with a standard dividend of 5 per cent and a maximum of 6 per cent, contingent on the achieved results of efficiency, prosperity, and so forth. A mandate should be given for rates sufficient to maintain the properties and to pay interest on the bonds and the standard dividend, any surplus earned above the maximum of 6 per cent to be used as a stabilization fund for less prosperous times and for amortizing the public investment in an obsolescent industry.
This corporation should be controlled by a board of not less than seven nor more than eleven directors, with salaries equal to those drawn by members of the Interstate Commerce Commission; a majority of the directors should be appointed by the President and confirmed by the Senate, for reasonable terms. Minority representation might well be granted to stockholders, and perhaps also to employees, on a scheme of representation to be worked out in detail by the Interstate Commerce Commission. But control must be by, and in behalf of, the public. Stockholders will want the 6 per cent dividend earned and paid; employees will want to absorb earnings in higher wages.
This corporation should be given large powers of exchanging its stocks and bonds for the stocks and bonds of the existing railroads, on terms fixed by its board of directors. Power to take stock, as well as property, by eminent domain, should be included. (Cf. Offield v. New York, New Haven & Hartford R. R., 203 U. S. 372.) The assumption of outstanding bonds, bearing 4 per cent or less, now substantial in amount, should also be authorized.
The Interstate Commerce Commission, reduced in number and relieved of much of its present intolerable burden, should be kept as a rate regulator. Possibly it should be given only appellate jurisdiction on rates, leaving their initiation to the directors. But shippers will always need some competent tribunal to settle the delicate and difficult rate questions certain to arise between different sections and different commodities.
Such a corporation, so organized, with wide trading powers to be exercised by and in behalf of essential public interests (which include safety of investment in railroad securities), would probably get effective possession of the controlling rail transportation facilities without condemnation proceedings. This control would accrue if a majority of the stockholders of the Class 1 roads exchanged their stocks for the stock or bonds of the Federal corporation. Eminent domain could be used, so far as necessary, to complete the government ownership. Almost certainly enough stock would be offered on acceptable terms, in exchange for the new stock and bonds, to give speedy control of enough of the rail transportation facilities so that, with the resultant control of the main streams of traffic, no effective hold-ups could be made by recalcitrant security holders, whatever their motives. We may fairly expect that most holders of rail securities would prefer 4 per cent bonds, guaranteed by the Government, and 5 per cent or 6 per cent stock, grounded on a service-at-cost mandate, to their precarious rights under the disintegrated and ill-managed present system.
To provide consolidation and government ownership, by a workable, security-swapping scheme, is the gist of this plan.
The economies resulting from such unification would clearly be great. Dr. E. S. Mead, Professor of Corporations and Finance at the University of Pennsylvania, is reported as having estimated that a mere speed-up in consolidation, plus abandonment of many miles of unremunerative lines, would result in an annual saving of about 500 millions. This doubtless intelligent estimate seems unduly optimistic, but present conditions are probably as wasteful and inefficient as when, about twenty years ago, Mr. Brandeis (now Mr. Justice Brandeis) startled the country by saying that the railroads might, by improved methods, save a million dollars a day.
This plan is essentially the same as one which I published about ten years ago, with two important differences. Then, I thought nearly all the bonds could properly be assumed by the new corporation, and therefore so provided, leaving to the Commission merely power to eliminate, or reduce the cost of, a few bond issues not fairly representative of sound values. But the railroad financial situation is now much worse than ten years ago. In spite of a large increase in investment (about 6 billions) during the last twelve years, the railroads now seem worth less than they then did. The new money has been sunk. Many of the outstanding bonds must be scaled down — a difficult but necessary job, already anticipated by market prices.
Obviously, to scale about 12 billions of debts to three fourths or even five sixths of that sum, for the benefit of stockholders, is an undertaking of great doubt and difficulty. Only a careful, detailed analysis to determine how many of these socalled bonds are merely income bonds, and how many are inadequately secured mortgage bonds, will show whether the job is impossible. But even if the debts have to be paid nearly in full there will still be, on the assumed valuation of 15 billions, a substantial surplus above present market prices for the stockholders.
The other difference is that ten years ago the stocks might have been taken over ‘on the basis of an annual return not exceeding the average dividends on the old stocks during, say, five to ten years past.’ That opportunity has also passed. To-day the stocks are not worth the average dividends of the designated, reasonably prosperous period. This is especially true of some of the leading railroads. Here again the directors of the new corporation must be given discretion for the difficult job of trading for the old stocks on a sound basis.
There is little prospect of such return of traffic as to produce annual net earnings of more than 600 to 700 millions, on fair rates. This would warrant 4 per cent on 8 billions of bonds — 320 millions — and 5 per cent on 7 billions of stock — 350 millions: a total of 670 millions; 6 per cent on the stock would make a total of 740 millions. But to justify this public assumption of such large liabilities for a railroad transportation system there must be full provision both for depreciation and for obsolescence. The Government must not indulge in the reckless and unsound financial methods that have always characterized our banker-controlled railroad financing. Undeniably railroads are now largely obsolescent, and likely to go into a discard comparable (except perhaps in degree) to that of the trolleys. The fate of investors in the trolleys and in textiles, and generally in many of our large manufacturing plants, should teach us that most of our industries are merely temporary devices, and mortal; that each generation should pay for its fair share of all its used productive devices, and not load posterity with debts for things dead and useless.
Many other obviously necessary details are omitted, as this purports to be only a rough sketch of essentials. Perhaps additional capital investment for possible electrification should be provided for; but probably the enterprise should be made self-sustaining, both currently and in furnishing itself with any supposedly improved equipment. Provision for amortization from earnings, of the bonds, should clearly be included.
III
Doubtless Professor William Z. Ripley is correct in his expressed view that a continuation of railroad transportation is essential to the ongoing of American life, as we now know it; but it is incontestable that a very large share of our present railroad mileage of about 260,000 miles is, even under normal traffic conditions, unremunerative. We have many thousands of miles that ought never to have been built.
As far back as 1917, the traffic managers of the New Haven and Boston & Maine systems testified that not over one third of either system was operated on a remunerative basis. Many years ago a man knowing much more about railroads than the writer expressed the opinion that 50,000 to 60,000 miles would have to be abandoned as creating an intolerable financial burden on the rest of the lines. It is at least doubtful if more than one third of the present lines are, or can be, operated on a remunerative basis. It does not follow that all unremunerative lines should be junked. This is a problem of social welfare, too involved for a present attempt at solution.
Moreover, the theory of basing rates upon reproduction cost has, by the great drop in prices, gone quite into the discard. Few dare now to argue for reproduction cost as a rate base for any public utility. The only theory now seriously contended for is the sound policy of endeavoring to make the honest and prudent investment in all public utilities as safe as changing conditions permit. This ideal should guide in any remedial programme for government ownership of our wastefully constructed and inefficiently operated rail transportation system. But this ideal cannot be fully attained.
It is important to observe that railroad rates are essentially taxes — something that everyone has to pay. Congress, in its recent rather bitter discussion of a sales tax, overlooked the fact that we already have, in our railroad rates, the most widely diffused sales tax imaginable. We cannot conceive of anyone who does not directly or indirectly contribute, in living expenses, to railroad rates. In these times of economic depression and chaos, when taxes are being discussed as never before, it is well to analyze the real nature and incidence of taxes.
We must distinguish prices from rates. Prices are the results of agreements between free buyers and free sellers. Rates are the charges made by monopolies, natural or artificial, for things or services that people must have or be deprived of the ordinary facilities of modern civilization. Governments are merely artificial monopolies that furnish us with a part of such facilities, like the post office, and frequently water. When we buy clothing, we may go to various merchants who compete for our trade; the payment we finally make is the price. Not so when we take telephone or electric service, from the only concern available to furnish us that service; then our payments are rates — in essence, taxes.
From the taxpayer’s point of view, payments for railroad rates, telephones, electric light, water, gas, — and shortly power, — are, as a practical matter, as identical with taxes as though the payments went into public treasuries and were disbursed by public officials. The railroad revenue from such taxes has, in recent years, amounted to over 6 billions a year — the largest tax fund anywhere, at any time, turned over to non-governmental forces for collection and administration — about 50 per cent more than the revenue of the Federal Government. The taxes by other public utilities are now amounting to a comparable sum. The aggregate of such non-governmental taxes must now exceed the amount paid into and disbursed by our public treasuries.
Moreover, our railroad rates are now unfairly high, about 50 per cent higher than in 1916 — in many cases higher than the traffic will bear. The trucks are taking from the rail lines much traffic that naturally belongs to the railroads.
In this connection, a study made by the Interstate Commerce Commission, in March 1932, of the relation between railroad rates and the value at destination of the commodities transported, is illuminating. The statement shows the total value of freight transported in 1930 to be $62,090,176,000; of which about 45.7 billions was for manufactures and miscellaneous goods, leaving about 16.3 billions for the products of agriculture, animal husbandry, mines, and forests. The revenue derived from the 45.7 billions was only 1.85 billions, while that derived from the 16.3 billions — largely agricultural products and coal — was 2.36 billions, the respective percentages being about 14.42 on the agricultural, mining, and forestry products, and 4.05 on the manufacturing and miscellaneous. If we adjust these percentages to the present greatly reduced commodity prices, the sales tax on this total would be much increased. Prices have dropped, and railroad rates have been somewhat increased. The grains, then paying about 15 per cent of their destination price, must now be paying about 25 per cent.
Consolidation, with resulting economies, will probably enable the Government to reduce these unfair taxes, now falling, with intolerable severity, on the farmers. This factor has more remedial importance than any of the futile, foolish schemes of the Farm Board or of the Farm Loan Bureau. Reduced taxes and increased income, not more debts, indicate the proper programme for saving the farmer — if he can be saved. A dollar, in the farmer’s salable products, is now worth about 50 cents for buying his farm machinery and his needed ‘store goods,’ relatively the lowest purchasing power in recorded farm economic history. This is the result of the so-called remedies thus far devised and adopted.
It is plain that there is no solution for our railroad troubles in an increase in rates. The original scheme of the railway managers in the early months of this depression, of raising railroad rates 15 per cent, was absurdly unsound. No community can stand unlimited taxation of all sorts.
IV
Of course, the railroad forces and their numerous satellites will attack government ownership as ‘lacking in individual initiative’ and as being but ‘another inefficient government bureaucracy.’ To my mind it is a sufficient answer to this criticism to say that, after many years of observation of both government and private-corporation bureaucracies, the only government bureaucracies fairly comparable in inefficiency and waste with innumerable private-corporation bureaucracies are the Farm Board and possibly the Shipping Board. In general, government business is managed, both by the Federal Government and by most state and municipal governments, on sounder and less wasteful lines than private-corporation business. There is less fraud in government administration, and fewer serious errors in the methods and in the policies adopted; private corporations, however, are more successful in concealing both their frauds and their inefficiencies than the government bureaucracies. In general, our Government functions with less disregard of essential human rights and interests.
To state adequately the grounds for these frequently disputed but maturely considered propositions would require a paper perhaps as long as the present essay. Enough, for present purposes, to note that our Federal Government has obviously great intrinsic advantages over any state-chartered corporations in the field of interstate railhighway transportation. Even if less efficiently managed, a single Federal corporation would do the job better than several state-chartered corporations. But we may fairly expect better management, dealing with a better organization.
It is also clear that government officials can hardly show less ‘individual initiative’ than have our railroad executives. Their failure seasonably to recognize and to take any intelligently devised measures to meet the new competitive transportation methods has subjected them to just criticism in quarters normally favorable to railroad and banker management.
The last three years have shown us that we have, in banking, in industry, and to a less degree in politics, no ‘great men’; that we are all, with meagre brains, groping in the mazes of the economic and political labyrinth of this machine age. Many of the idols of the recent past are now seen to be merely predatory and aleatory schemers — not a few of them of the Kreuger type. They have functioned less usefully than the earls and barons of mediæval feudalism. We are now disillusioned as to all our ‘great business leaders.’ There are none. Really great leaders would have seen that mass production, without mass purchasing power, could only give us the present ghastly contrast of ragged bread lines with unmarketable surpluses of both food and clothing — a mere economic engorgement.
The tax returns for 1929 show over 500 individual incomes exceeding a million dollars, of which 36 exceed 5 millions, with an aggregate revenue for 504 persons of over 1470 millions. This tremendous concentration of the results of our dominant American policies was a large cause contributing to our present widespread unemployment of about 10 millions, as well as the destructive drop in all commodity prices, largely brought about by the general failure in mass purchasing power. If these many hundreds of millions of current income had been fairly spread, they would have substantially increased the general purchasing power; we should have had less economic arteriosclerosis.
After the October 1929 stock-market smash, the first step taken by the Hoover-Mellon administration, as a remedy, was to reduce taxes in the higher brackets by 160 millions. Let us pass over the question of this unintelligent estimate of the prospective Treasury needs; the argument for this reduction was that thus more capital would be set free for an assumed needed increased production — that is, for more steel, automobile, and other manufacturing plants, in utter disregard of the obvious fact that there was an existing excess of production facilities in every line. American business needs nothing less than more manufacturing plants. Probably a substantial part of the existing plants will be junked within the next few years, as hundreds of expensive textile and other plants have already been junked. Our outstanding, unsolved, and perhaps insoluble problems are now those of distribution, not of production. From Adam Smith down to the present, our economists have dealt mainly with means and methods of production. Let them now teach us how fairly to distribute our excessively abundant production and thus restore their damaged prestige. Profit seeking, as a dominant economic force, clearly does not give us fair distribution.
In science, including medical science, we may have really great men. I do not know. But no other class or profession can advance any claim to having made any contribution to our present civilization.
But we still have intelligent, hardworking, and faithful men, striving to work out some solution for the present. apparently insoluble problems. A fairly careful reading of the Senate reports in the Congressional Record leads to the conclusion that we have there, in places of limited though important power, a body of harder-working men, more intelligent and far more public-spirited, than most of their shallow and abusive critics in editorial or banking service; that more than half of them are abler than all but a few of our industrial or banking leaders. In the House of Representatives also there are many high-minded, hardworking men. The recent gross and general abuse of Congress is entirely unwarranted.
It is an encouraging fact that our tendency is now toward drawing a full proportion of our ability, character, intelligent activity, and social sense into our public service. Our politicians and statesmen are the ablest of our real rulers. Their controlling motives and actions are more humane and less antisocial than those of our industrial and financial leaders. On them we must mainly ground our hopes for the radical economic and financial changes clearly needed to make our American life wholesome and tolerable. A large factor, in any tolerable future, will be a thorough reorganization and coördination of all our means and methods of transportation. This should be one of the early undertakings of our statesmen.
V
Let us go back, for a moment, to the suggestion that 15 billions is a reasonable valuation of the railroad properties. It may well be that this figure overestimates the extent to which the market depreciation is due to the utter failure, so far, both of Congress and of the railroad executives, even to broach any workable and constructive plan. It is thus quite possibly, in this implied valuation, an excessively optimistic plan. The market value may be nearer the real value. The question of what value to attach to the mixture of unusable junk and still usable transportation facilities is one of great doubt and difficulty. This warrants a few general observations.
A fundamental factor in our past American development has been the rapid increase in our population, from birth and from immigration. Immigration is now cut off; the birth rate is down.
America’s economic future must be estimated in the light of an approximately static population. No increase in any line of business, such as we are accustomed to think of as ‘American progress,’ is in reasonable prospect. The problems of a nearly static population, dwelling in a land with no more substantial areas of unsettled territory, are radically different from those contemplated by all Americans now of mature years. It is almost impossible to exaggerate the controlling importance of this factor in assessing our economic future.
Moreover, the prevailing tendencies (probably unwholesome) make against the effective use of all transportation, and particularly transportation by rail. We now have a great excess of transportation facilities of all kinds. Yet we are apparently committing ourselves to the St. Lawrence Waterway. The project may be wise (the hydroelectric power aspects are most enticing), but it will not decrease the troubles of our railroads. It requires much optimism to see a normal growth of traffic compensating the railways for diversions to the great carrier performances prophesied for this waterway. The European Old World has, in general, shown more sense and judgment in providing itself with needed (and only needed) transportation facilities, and in equipping and operating them, than we of the New World. The European rail systems involve less excess building than ours; the equipment is lighter, and far more economical, especially for passenger traffic; the development of air transport is ahead of ours.
Transportation is nothing but a means to trade, to exchange commodities. Tariff walls have destroyed a large part of our foreign trade, with its resultant movement of commodities to and from our seaports. There are marked tendencies, not only toward national self-sufficiency, but toward local self-sufficiency, in the production both of food and of manufactured products. An illustration is the manufacture of textiles in the South, in the cotton-producing section, thus greatly reducing the transportation of cotton. In spite of agricultural overproduction of food supplies, there is a slight movement back toward the farm, where people can at least escape starvation by raising their own food.
More than one third of the tonnage of the railroads of recent years has been coal. Coal is, relatively, decreasingly used. More and more it is being transmuted into power at or near the mine mouth, and thus carried by wire. Less and less will it furnish traffic for the rail carriers.
A fundamental factor affecting the value of our rail facilities is the great increase in competitive facilities. Oil goes by pipe line; so does natural gas. Their most serious competitors are the trucks and buses. The railroads have about 2,400,000 freight cars; there are some 3,500,000 trucks on our highways. The undeniable tendency is toward a diminishing traffic in coal, ores, and crude heavy stuffs generally, and thus toward lighter, short-haul traffic, in which the truck has an intrinsic competitive superiority. The competition between the rival systems of transportation is increasing, and is exceedingly difficult of regulation; but existing conditions are unfair to the railroads, which are heavily taxed and move on purchased and owned rights of way, while the trucks move on free roads, in considerable part paid for out of taxes levied on the railroads. The railroads have, since 1920, lost over 40 per cent of their passenger traffic, without taking into account the normal increase from an increasing population.
Mr. Edward A. Filene tells me that when he was asked by representative Chinese to advise them concerning the development of the essential facilities of modern civilization for that great country and great people he told them to build, not railroads, but motor roads, because motor roads are more generally adapted for human needs. Clearly, motor roads can do everything that railroads can do, except steer the vehicles and thus permit the use of long trains with but few operators — a vital difference for our present traffic needs.
In my article, ‘Roads — Motor and Rail,’ published in the Atlantic for March 1925, I wrote: ‘It always becomes “a public function” to provide essential roads and necessary public carrier service thereon, when, charging what tolls the traffic will bear, the undertaking is not money-making. If it is money-making, then the job belongs “in the field of efficient private initiative.” We may be nearing that stage in dealing with our railroad problems.’ We have now reached it. On that theory the Government took over the Cape Cod Canal, and Massachusetts has gone far toward taking over the unprofitable Boston trolley system.
The railroad problem is far more difficult, but it must be solved in the same way. Government ownership is inevitable. The important question now is: Will it be adopted promptly, and on a sound plan? An affirmative answer requires an optimistic disregard of the forces of blind greed and unenlightened selfishness that have generally dictated our American policies, at least in recent years.