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Wall Street History
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01/26/2001
The Collapse of Penn Central
In June 1970, the failure of Penn Central represented the largest
bankruptcy in America. And in the retelling of this story, you
may notice an interesting parallel or two regarding our current
economic environment.
This is a tale about the railroads and mismanagement in the
1960s. But to set the stage, going back to the late 1800s, recall
that the railroads were the first national business, frequently
dominating the geographic regions through which they passed.
Everyone was beholden to them; the farmers had to accept their
terms, the coal mines, travelers, and on and on.
Meanwhile, as the railroads became some of the giants of
American commerce, the Pennsylvania and New York Central
were two of the major players. Pennsylvania had no real
competition in the Pittsburgh market, and the New York Central
was the dominant force from New York to Chicago.
But many of the railroads had gone through very difficult
stretches, with the chief cause being the regulatory climate
overseen by the Interstate Commerce Commission (ICC). The
ICC established rates and as the costs soared for the railroads
(the cost of maintaining track and the burgeoning salaries for
workers, for example), an investment in one of these companies
wasn''t as lucrative as it had once been. [Echoes of today''s
California?]
By November 1957, the Pennsylvania and New York Central
announced that they were contemplating a merger. The industry
was losing both freight and passenger traffic to the new
superhighways as well as the airline industry. But financially,
Penn and NYC were in decent financial condition.
Unfortunately, talks were put on hold the following January
when the CEO of NYC committed suicide.
A few years went by and in the early 1960s, Stuart Saunders
became the CEO of Penn while Alfred Perlman held the reins at
NYC. The two began to hold discussions again on a merger,
while at the same time Saunders was launching a massive
acquisition and diversification campaign. But to paraphrase
Cornelius Vanderbilt (and market historian Charles Geisst),
building a monopoly requires that you extend your empire into
areas you understand, not those you don''t.
Saunders razed Pennsylvania Station in New York and created
the new Madison Square Garden, along with two office towers.
[In return for the property, Penn retained a quarter interest in the
complex.] And then Saunders went after the Great Southwest
Corp. (whose prime property was Six Flags over Texas), Arvida
(a Florida land company), a mobile home company, and
Executive Jet Aviation (from which Saunders sought to start a
major charter service), along with others. Finally, Pennsylvania
sold the Long Island Railroad to New York State for $65 million.
It''s pretty clear that the shift was away from railroads. So why
would Saunders seek to merge with New York Central? Simply
to gain additional publicity and borrowing power.
By 1965, the merger of the two creating Penn Central was
approved by the ICC; however, it wasn''t until January 15, 1968
that the move was formally approved by the U.S. Supreme Court.
Saunders became chairman / CEO, Perlman was president /
COO. And lurking in the weeds was a shady character, David
Bevan, who ran the books.
The new Penn Central was a mess. Chairman Saunders was
clearly more interested in his non-railroad activities and, anyway,
the railroad operations were steeply in the red.
Pennsylvania politician Milton Shapp (who would later become
governor) once said of Saunders:
"I''ve been to several parties with him where he had a few drinks,
and he was always talking about Litton Industries and how Litton
and other conglomerates had cash coming in and were putting it
to good use.He said he wanted to keep the money for real
estate investments instead of putting it in the f------ railroad.
That''s what he said." [Source: Robert Sobel]
Yes, part of the problem was that this was the era of the
conglomerates; Litton, LTV, Gulf & Western, ITT.to name a
few. But PC was acquiring companies that reportedly never
really made money. The investment landscape of the time,
however, allowed PC''s share price to rise and the acquisition
binge continued, as well as the accumulation of massive amounts
of debt.
And economist Henry Kaufman says of this period in the late
1960s, "I watched with growing alarm as sources of corporate
borrowers - in an effort to circumvent regulatory lending
constraints - piled into the commercial market as issuers. The
trend continued, and culminated in the collapse of the Penn
Central Railroad."
The U.S. financial system was flailing badly. It was a period of
rising inflation, Vietnam (with ever increasing military spending)
and a tight Federal Reserve. The banks began to feel a squeeze,
while corporations issued massive amounts of commercial paper
through their holding companies.
[Today, the energy problems in California and the potential
bankruptcy of two major utilities are causing a crunch in the
commercial paper market itself. Banks are afraid to lend to
certain risks, even if for very short periods of time.]
Kaufman blamed regulators for the atmosphere in the 60s, many
of whom were simply out of touch with evolving technologies
and markets.
Back at Penn Central, the Penn and New York Central cultures
were clashing badly. There was confusion among the crews and
PC had problems with the unions, even though it was forced to
guarantee employment to all existing workers as a condition for
the merger.
The end result was that some trains were misplaced for days, while
corporations like Eastman Kodak saw their piggyback vans miss
connections; in the case of St. Louis, three quarters of the time.
So it was no surprise when the freight business began to go
elsewhere, like to the trucking companies. Major industrial
customers such as Allied Chemical abandoned PC.
All the while, David Bevan was playing with the corporate
books. Penn Central''s subsidiaries were stripped of their
treasuries in order to prop up PC''s own earnings. For example,
New York Central Transport, a trucking subsidiary, had profits
of only $4.2 million and yet paid $14.5 million in dividends to
the parent. Despite this kind of maneuvering, the dividend on
Penn Central common was slashed from $2.40 to $1.80 in 1969.
Chairman Saunders vowed to hike it back up, soon. [It was later
learned, however, that insiders at PC were unloading their
company stock and bonds while all of this was going on.]
At this point, Saunders, recognizing the coming disaster, thought
he could pull a fast one. He proposed a new Penn Central Co., a
holding company that was to be formed through the acquisition
of Penn Central Transportation, on a one-to-one share basis, as a
way of recognizing a new company. This way if the
Transportation Company went into bankruptcy, Penn Central
might survive.
[To digress just a bit, at this time Henry Kaufman saw a huge
problem on the horizon. Commercial paper borrowing had
climbed from $10 billion in mid-1965, to $32 billion by the end
of 1969 (and it would further increase to $40 billion by May
1970).]
So in early 1970, PC''s Transportation Co. had $100 million due
to mature in a matter of months, and, not having the cash, CFO
David Bevan thought he could float some bonds. Well, the
market was not too fired up about buying more PC paper and,
while the company waited, they had to report a first quarter loss
from railroad operations of some $102 million. Now no one
wanted to touch the bonds and the offering had to be withdrawn.
Penn Central had one last chance, its lead bank First National
City. Well, couple the commercial paper environment described
above with PC''s balance sheet and you can see why the bank
would say no.
It was now May and news stories had been floating around
describing Penn Central''s problems for weeks. Just two years
earlier, in 1968, PC stock was trading at $86. On May 11 it hit
$18, then traded at $15 the next day.
The company had one last shot at staving off bankruptcy, a
government bailout. Bernard "Bunny" Lasker, Chairman of the
New York Stock Exchange, went to President Nixon to see if a
package could be put together. Penn Central wasn''t the only
railroad having problems, of course, and an agreement was
reached for $750 million in aid, of which $300 million would go
to PC. Saunders, Perlman, and Bevan were dismissed.
On Sunday, June 21, Penn Central declared bankruptcy. And, as
it turned out, Congress failed to approve the aid. The federal
government thus had to step in to preserve needed rail service.
The result? Conrail for freight service, Amtrak for the
passengers. And you all know how that has turned out.
Sources:
Henry Kaufman, "On Money and Markets"
Charles Geisst, "Monopolies in America"
Robert Sobel, "When Giants Stumble"
Floyd Norris and Christine Bockelmann, "The New York Times
Century of Business"
Brian Trumbore
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