Published by EH.NET (February 2002)

Richard Saunders, Jr., Merging Lines: American Railroads, 1900-1970. DeKalb, IL: Northern Illinois University Press, 2001. xix + 486 pp. $49.95 (hardback), ISBN: 0-87580-265-6.

Reviewed for EH.NET by William Huneke, Economist, Surface Transportation Board and University of Maryland.

Before Enron, There Was Penn Central

Management moving money into subsidiaries. Accounting gimmickry, which brings press calls for auditing reform. White House questioned about its ties to a big failing company. Sounds like Enron? This describes events surrounding the Penn Central’s collapse more than thirty years ago. Stuart Saunders, CEO of pre-merger Pennsylvania Railroad and then the merged Penn Central, believed that the railroad was a poor stand-alone investment, so he led a diversification effort. Unfortunately for Penn Central, diversification into real estate and private jet ventures was not successful. “The spectacle of the hidebound Pennsylvania Railroad wheeling and dealing with flashy real estate developers from the Sunbelt was either amusing or pathetic, depending on one’s point of view. In addition, diversification brought executive suite intrigue, unaccounted funds, posh clubs, beautiful women, saunas, money laundered in Liechtenstein banks, and a lot of very bad judgement” (p. 400).

One example of Penn Central’s aggressive accounting regarded the lease on Washington’s Union Station, which Penn Central co-owned with the Baltimore & Ohio Railroad (B&O). “In 1969 the station was leased to the Department of the Interior. … This had to show on the railroad’s books as something, even though it represented no immediate cash income. The B&O chose to represent its share of the station at the conservative book value, derived from the original cost of construction, $3.1 million. The Penn Central represented it at its appraised value, a sum that would not be realized for many years, if ever, under the lease agreement — $13.7 million. It was a lowly stockholder, who happened to own shares of [both companies] who saw this … and blew the whistle.” These accounting techniques ensnared Penn Central’s auditor, Peat Marwick & Mitchell, in public ridicule. The auditor openly sparred with Fortune over auditing issues and the firm’s professionalism. The auditor stood by its work, pointed out that it had warned Penn Central’s management and called for auditing reform.

Bad investments and accounting woes were not the end of the story. Penn Central also sought White House help to stave off bankruptcy. The Nixon administration wanted to help but the size of the bailout kept growing. The Penn Central also enlisted as a client of Nixon and John Mitchell’s former law firm. Nixon, Mitchell and others in the administration had investments tied to the Penn Central or its bankers. The press outcry was so enormous that finally Richard Nixon backed away from the bailout.

The Penn Central story and other great railroad stories are the subject of Merging Lines. Author Richard Saunders tells these stories wonderfully. For anyone who thought the great railroad characters are confined to the nineteenth century, this book will be a revelation. The book opens with James J. Hill, Northern Securities, and the antitrust duel with Teddy Roosevelt. Saunders also covers Edward Harriman and his resurrection of the Union Pacific. This book is just packed with absorbing stories and colorful characters.

One such character is Robert Young. Young led the proxy fight that forced the Vanderbilts out of the New York Central (NYC). In this battle he enlisted every ally he could find, especially small stockholders whom Young called his “Aunt Jane” supporters. Young declared that he was going to force the bankers out of the railroad and put an employee and a woman on the board of directors. He won the proxy fight and brought innovative Alfred Perlman in to run the railroad. However, Young’s overinvestment in passenger services compromised the railroad’s finances and NYC stock dived. Many of Young’s more prominent friends lost huge sums, and his “Aunt Jane” supporters were also hurt. Depression overcame him and he shot himself on January 26, 1958.

While this book’s strength is the narrative, its most prominent weakness is its sometime casual analysis. Saunders stresses management’s failings as the cause of Penn Central’s demise while failing to consider whether labor issues played a role in the collapse. On the one hand he points to the declining employment levels and concludes that this means there was not an inflated workforce on Penn Central. However, he also notes that Penn Central’s labor costs were fifty-nine percent of revenue compared to the contemporary industry average of forty-four percent. A more rigorous analysis could lead one to conclude that labor costs played a role.

Another example of Saunders’ faulty analysis occurs when he criticizes Albro Martin’s thesis about early twentieth-century rail regulation. Martin posited that Progressive Era regulation, by holding rates down, constrained railroads’ ability to earn adequate revenues and pushed the industry into a long-term decline. Saunders argues there’s a “major glitch [in Martin’s theory that prices were too low because] ton miles fell in 1913-1915. This is hard to explain if the ICC were forcing the railroads to charge rates that were too low — perhaps explaining why the railroads were caught short of equipment when traffic began to surge in 1916” (p. 33). Saunders misses basic economics here. He must be assuming low rates mean a lot of demand, but there’s a supply problem. If regulation were keeping railroad rates so low that they are below a market clearing level, an economist would expect to find insufficient profits. Low profits push firms to reduce supply, with deferred investment in equipment and infrastructure leading to eventual shortages, such as he cites taking place in 1916. Thus, the evidence that Saunders cites to contradict Martin actually supports Martin’s thesis.

These analytical failings do not stop me from recommending this book to anyone interested in American railroad history or twentieth-century business history. In fact I would even suggest the author revisit the earlier time periods of this work because the book only spends a quarter of its pages on the pre-1940 period. There may be more stories to tell in the earlier period.