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Train Wreck

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Train Wreck

The Penn Central’s failure resonates today. January 22, 2021
Infrastructure and energy
Economy, finance, and budgets

More than 50 years on now, the spectacular collapse of the Penn Central railroad in 1970 is little remembered today, but its legacy is still with us—not so much as a warning, but as a prelude: to New York City’s own near-bankruptcy in the 1970s; to four decades of financial engineering, beginning in the 1980s; to the 2001 Enron downfall; to the 2008 financial crisis and its “too big to fail” bailouts—and yes, even to the public discontent that elected President Donald Trump.

As America emerged from World War II, most people would have laughed at the idea of the nation’s two premier freight and passenger railroads, the Pennsylvania and the New York Central, going broke in a quarter-century’s time. By design, the Pennsy and the Central were not fierce competitors but complementary “frenemies” that had long agreed not to undercut one another’s monopoly profits. From Massachusetts to Missouri, the two railroads dominated freight and passenger travel in the northeast quarter of the United States, with nearly 21,000 miles of track between them.

Yet even as America built its powerhouse postwar economy, the railroads struggled. As Joseph R. Daughen and Peter Binzen write in The Wreck of the Penn Central, their cult-classic chronicle of the Penn Central’s demise, during the war the then-separate railroads had been running their equipment 24 hours a day to transport troops and supplies, leaving them with “worn-out” equipment.

In the fifties and sixties, moreover, new competitive pressures prevented them from catching their breath. Trucks competed with the railroads for freight hauling via the new, free highways the nation was building. Commuter-rail passengers moved to the highways as well, while long-haul rail passengers took to the skies. The railroads’ decline accelerated in the sixties, partly because of the collapse of northeast manufacturing.

In 1962, the two companies decided to merge. But railroading was one of the most heavily regulated industries in the United States, so the merger took six years, as it wound its way through multiple levels of public approval for the creation of the 100,000-worker, 100,000-shareholder, 100,000-creditor behemoth. Meantime, government-set rates already fell short of the railroads’ long-term costs.

The combined entity that would become the Penn Central made significant concessions to win political support for the merger, including no-layoff pledges that would hamper its ability to cut spending and a promise to take on the independent (and chronically insolvent) New York, New Haven, and Hartford passenger railroad.

After the merger, the railroads discovered that they had incompatible computer systems, which threw railyards into chaos and angered customers. The Penn Central’s three top officials, too, were incompatible. They “scarcely spoke to one another,” write Daughen and Binzen. Stuart Saunders, the board chairman, was a political guy. Alfred Perlman, the president, was a trains guy. These different outlooks could have complemented each other, but personalities got in the way. Rounding out this dysfunctional triumvirate was Penn vet David Bevan, the top financial official, perpetually “angry and humiliated” at not being picked for the top job.

Bevan had two ideas for keeping the cash-bleeding Penn Central alive: corporate diversification and financial trickery. If a railroad couldn’t make money, he thought, perhaps it could invest its cash in entities that could make money. The Penn had a head start in this; it already owned vast swathes of real estate around Grand Central Terminal and Penn Station, including five hotels and a share in Madison Square Garden, as well as the New York Rangers and Knicks.

Bevan added to this conservative legacy portfolio a bizarre array of new business interests, from an executive-jet company (he was its best customer) to pipelines, speculative land tracts in the southern U.S., and a travel agency. “Nobody . . . could name the 186 different companies . . . under the Penn Central’s umbrella,” Daughen and Binzen write. Under Bevan’s stewardship, these companies often sold stakes of themselves to one another, generating illusory paper profits. The Penn also had touchingly optimistic views about the future, booking years’ worth of profits, for example, when a third party agreed to buy a tract of real estate for which it wouldn’t actually be able to pay for years. Bevan was also determined to take some of the supposed profits of these deals for himself, setting up an “investment club” with several associates to buy and sell shares in these side companies before the much bigger Penn Central did, thus benefiting from the subsequent price changes.

These innovative methods didn’t generate the money that the Penn Central needed to balance the books, however. So Bevan turned to straightforward borrowing. With $1.5 billion in annual revenue, the Penn borrowed hundreds of millions of dollars from the nation’s largest banks, including more than $100 million in the nascent “commercial paper” market. This market of short-term loans was meant not for permanent operating deficits but to cover temporary shortfalls like meeting payroll just before a customer paid for a big order. The banks didn’t ask questions, though, because Penn Central had such a solid reputation—and because it was such a good fee-payer.

This three-card monte game lasted—until it didn’t. At First National City, the predecessor of Citigroup, chief Walter Wriston was “furious at his loan officers for getting his bank so deeply involved”—$300 million in loans—“without knowing what a hole the Penn Central was in.” Members of the Penn Central’s august board were also mad—though many of them perhaps never thought to ask questions because they headed companies that were themselves customers of or vendors for the railroad.

The banks’ and the board members’ big idea was to ask the federal government for a bailout. President Richard Nixon vacillated but ultimately said no, on the basis of the now-quaint idea that Congress would have to agree, which it did not.

The railroad then declared bankruptcy in June 1970, having lasted just 871 days. “Never before had there been a cataclysm as stunning as this,” write Daughen and Binzen. “What had been conceived of as the most awesome transportation machine in the world had ended as the most monumental business failure in United States history . . . How the mighty fell: Stuart Saunders, businessman of the year in 1968, business bankrupt of the year in 1970.” Saunders had a rejoinder: “I didn’t have anything to do with the concept of the Penn Central.”

Daughen and Binzen wrote quickly; their Wreck book is 50 years old itself this year. They were scathing: “So here was the record-sized merger bringing together two badly disorganized, unprofitable companies in a discredited industry regulated by an unsympathetic federal agency, denounced by public and politicians for its poor performance record, and hemmed in by powerful unions clinging to archaic work rules. . . . add management blundering, corporate disloyalty, executive-suite bickering [and] boardroom slumbering.”

In their concluding paragraphs, Daughen and Binzen expressed hope that the business and investment world would heed the lessons of the Penn Central’s collapse. “It does seem clear that certain lessons have already been learned,” they note, including the truth that bigger doesn’t mean better, that “somnolent” boards of directors need reform, and that “corporate financial statements often conceal more than they tell.”

Instead, the wreck of the Penn Central foretold more than it averted. The same banks that were shocked at Penn’s dire fiscal state pronounced themselves equally stunned in 1975 at New York City’s fiscal mess, which they had similarly helped prolong. Penn Central’s pioneering practices in debt-based financial engineering became the new standard in the eighties: cheap debt, both government and household, was now the solution to everything, from the growing trade deficit to working-class wage stagnation. Enron’s 2001 demise eerily echoes Penn Central’s accounting shenanigans and self-dealing CFO. Too big to manage? Look to massive entities like General Electric. And the “too big to fail” argument that Penn Central’s banks and board tried on President Nixon worked much better on President George W. Bush.

Anger at the Penn Central collapse even generated a mini-boom in populism. Milton Shapp, a successful investor, won election as Pennsylvania governor on his second try in 1970, largely by running against the railroad’s abysmal Philadelphia commuter service. Philly’s media—the Annenberg press—was on the side of the railroad, but Shapp needed only public discontent to coast to victory.

Finally, there are the passenger trains. New York’s Metropolitan Transportation Authority is the inheritor of much of the Penn Central’s money-losing passenger service in the New York region. Though Metro-North suffered a strike nearly 40 years ago to address the worst of its union featherbedding, the Long Island Rail Road still bases labor practices on the contracts signed decades ago by railroads whose successor company later went bankrupt. That heritage, barely tenable pre-Covid, could now thwart a robust recovery, as high fixed costs contribute to severe service cuts.

Half a century after it met its ignominious end, the Penn Central still looms large—not as a byword for failure, but as a model for imitation. As a train conductor told Daughen and Binzen decades ago, “the tragedy is that nobody seems to give a damn.”

Photo: BobEdmonson/iStock

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