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Requiem for a Railroad. The Collapse of the Rock Island Gregory L. Schneider [email protected] Why Did the Rock Island Fail?. --Conventional Wisdom: Rock Island management was incompetent and allowed the railroad to decline;

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requiem for a railroad

Requiem for a Railroad

The Collapse of the Rock Island

Gregory L. Schneider

[email protected]

why did the rock island fail
Why Did the Rock Island Fail?
  • --Conventional Wisdom:
    • Rock Island management was incompetent and allowed the railroad to decline;
    • Selfish Rock Island bondholders (Henry Crown) refused to reinvest in the property once merger was under way with UP;
    • Rock Island looked to UP and SP to save the property;
    • Interstate Commerce Commission (ICC) killed the railroad;
    • Judge Frank McGarr killed the railroad in 1980 by his decision to liquidate the property (Fred Frailey in Trains magazine this year)
    • Rock Island could have been saved—some 5,000 miles of system still in use;
    • Labor Unions helped kill the Rock Island—strike in 1979 was death knell
challenges to conventional wisdom
Challenges to Conventional Wisdom
  • --Rock Island story should be seen as a part of railroad problem:
    • Regulation was a serious issue and impacted what management could do (or not do) and issues regarding wages and rates
    • Merger was opportunity for corporate diplomacy and UP was isolationist
    • Could the Rock Island survive a changed transportation economy (highways, barges, airlines)?
    • Government failure to bring prosperity to passenger system and to northeastern railroads leads to only solution: deregulation and rationalization of system
act one

ACT ONE:

Merger

success story
Success Story

Source: Classic Trains Magazine, Spring 2011; personal collection of author

postwar success
Postwar Success
  • 1. Rock Island came out of 15 year reorganization in 1948
  • 2. Railroad had been rebuilt, was in good physical shape with new streamliners and dieselization (by 1954)
  • 3. President John Dow Farrington was a good railroad man and a builder (Armourdale Yard, KC; Silvis, Il.; Samson of the Cimarron)
  • 4. Revenues in 1949 were $197 million with low operating expense ratio
one decade later
One Decade Later
  • 1. By 1959 railroads were suffering from competition from trucking (LCL freight), interstate highways hurt passenger trains, continued regulation by ICC, low capital investment
  • 2. Rock Island was still profitable, with peak of revenues ($219 million) against expenses of $172 million—net income of only $8 million
  • 3. problems on horizon: territory heavily dependent on agriculture; increasing wages; little industry online; regulation
siding one what s the matter with regulation
Siding One: What’s the Matter with Regulation?
  • 1. Interstate Commerce Commission created in 1887—railroads had monopoly on transportation—powerless until:
  • 2. Hepburn Act (1906)—expanded power of ICC to set maximum rates on railroads

3. Mann-Elkins Act (1910)—expanded rate powers of ICC and created Commerce Court

4. WWI—railroads controlled by federal government (USRA)—returned to private control following the war

transportation act of 1920
Transportation Act of 1920
  • 1. greatly expanded powers of ICC—how?
    • Given power to set minimum rates through valuation of railroad assets (allow a fair return on investment)—who says what that is? ICC
    • ICC given power to determine whether railroads can abandon service, track
    • Empowered ICC to regulate railroad securities
    • Also created Railway Labor Board for labor issues

2. Authorized reduction in number of railroads and money from rich to poor railroads—never enacted—still being discussed into 1970s

merge or die
Merge or Die
  • 1. Railroads were hamstrung by regulations and inability to attract enough capital investment—average rate of return of around 4% in 1950s; 2% in 1970s
  • 2. merger was one solution and beginning in 1959 the merger era begins
  • 3. Rock Island’s board seeks merger and studies begin to merge with Milwaukee Road—rejected after several studies
  • 4. In 1963 the Union Pacific becomes the partner—Southern Pacific joins—roads file necessary paperwork with ICC in 1963—stock buyout of RI by UP
bleak house
Bleak House
  • 1. Intervention by other railroads—7 railroads initially oppose merger, joined by 5 others—why?
  • 2. hearings delayed until 1965—finish in 1968—then . . . A waiting game (48,000 pages of testimony, 200,000 pages of evidence, 247 days of hearings in total)—longest and biggest case in ICC history
  • 3. CNW tries takeover of Rock Island by offering stock swap—Ben Heineman—further delays hearings
  • 4. use of Rock Island to remake western railroad map—Nathan Klitenac—report released in 3 volumes (final volume in 1974 recommends merger with conditions)
one man wrecking crew
One Man Wrecking Crew
  • --Heineman’s strategy:
    • Ruin the Rock Island merger with UP by offering stock swap and exchange offer—more attractive than UP offer initially and UP had to renegotiate terms of the deal
    • Once in ICC’s hands, show how RI-UP merger would alter regional rail map and propose instead a “merge a trois” between RI, CNW and Milwaukee Road
    • Delay, delay, delay—keep the merger before ICC and prevent collapse of CNW in process—”one railroad would survive and it would be the CNW”
    • Diversification—Heineman diversifies into Northwest Corporation and sells railroad to employees—Larry Provo continues as intervener in Rock Island merger
impact rock island s worsening condition
Impact--Rock Island’s Worsening Condition
  • 1964—last profitable year--$3.8 million net income
  • 1965—(1.4 million)--loss
  • 1966—(2.6 million)
  • 1967—(18 million)
  • 1968—(9.8 million)
  • 1969—(11.3 million)
  • 1971—(6.7 million)
  • 1972—(6.1 million)
  • 1973—(14.9 million)
  • 1974—(23 million)
impact rock island s working capital
Impact—Rock Island’s Working Capital
  • 1961--$37 million
  • 1962--$16 million—funded improvements & paid debt
  • 1963--$14 million
  • 1964--$9 million
  • 1965--$6 million
  • 1966--$2.8 million
  • 1967—($4.6 million)
  • 1970—($15.7 million)
  • 1971—($15.2 million)
  • 1973—($27 million)
what were the problems
What were the Problems?
  • 1. declining traffic base—loss of some agriculture to trucks who could offer lower shipping rates
  • 2. passenger trains are expensive and operate at loss—Rock can’t afford Amtrak entry fee ($4.8 million) and operate two intercity trains from 1971-1978 (both lose $1 million per year even with subsidy)—Rock also has Chicago commuter service as cash drain (RTA created in 1976)
  • 3. little industry on line
  • 4. not enough cars and locomotives
  • 5. declining maintenance (no money for track repair)—who is to blame?
act two

ACT TWO:

Bankruptcy

no one likes john ingram
No One Likes John Ingram
  • FRA Administrator who was named RI President in October 1974 (a sort of coup)—Henry Crown was not present at meeting
  • Why was he a choice of some board members?
    • Thought he could supervise the government loan—in February 1975 Rock is granted $9 million, rather than $100 million requested
    • Problem was that he was hated in Washington—brash and acerbic figure, he had antagonized many of the people who could have helped the railroad—he himself thought Rock Island should wither and die (1972)
    • Penn Central kept tabs on his remarks and stalked him during early 1970s
bankruptcy key issues
Bankruptcy—Key Issues
  • 1. Rock files for bankruptcy (cashless) on March 17, 1975—Ford administration refuses to bailout RI—notes of phone call to Crown in Ford Library
  • 2. Judge Frank McGarr appoints William Gibbons as Trustee pursuant to Section 77 reorganization—Gibbons and Rock President John Ingram decide to reorganize the railroad
  • 3. No help from federal government to repair track (request for $100 million loan in 1974 from FRA—Rock gets $9 million)
  • 4. Intervention against reorganization by Henry Crown
crown intervention
Crown Intervention
  • 1. Henry Crown was rags to riches tale—started aggregate business in Chicago with his brothers—became Material Services Corp., largest in Midwest
  • 2. smart investor in railroads (Frisco, BN, Rock Island) and in real estate (original investor in Hilton Hotel Corp., owned the Empire State Building in 1950s)
  • 3. majority owner of General Dynamics in 1950s, 1970s
  • 4. majority owner of RI stock (150,000 shares) and of first mortgage bonds
  • 5. served on RI Board from 1948-1975 (headed up Finance and Executive Committees)
what crown wanted
What Crown Wanted
  • 1. After 1974 Crown believed RI should be liquidated
  • 2. Fought against the Trustee’s efforts to save RI in Court
  • 3. Retained the Chicago firm of Jenner and Block
  • 4. Argued that the Trustee was using assets of road and hurting bondholders (Continental Bank, First National Bank of Chicago both agreed)
  • 5. after liquidation supported Trustee’s efforts to reorganize—Jenner and Block worked with Trustee after 1980
major problems with reorganization
Major Problems with Reorganization
  • 1. Bad weather—historically bad Midwestern winters in 1978 and 1979
  • 2. inflation—interest rates of 18% by 1980
  • 3. diesel fuel shortages—another result of government regulation (Rock Island down to 6 day supply by 1979)
  • 4. continuing record losses (between 1975-1980 RI accumulates an additional $100 million in losses)
  • 5. labor issues—no willingness to negotiate to save railroad by BRAC and UTU--strike on Aug. 28, 1979 ends in ICC directed service
  • 6. reorganization plan submitted to court in Dec. 1979—rejected and railroad order liquidated in Jan. 1980
improvements by trustee
Improvements by Trustee
  • 1. Acquisition of motive power through lease arrangements (EMD GP-38, SD 40-2)
  • 2. Rebuild program for older GP-7s
  • 3. Car acquisition program—jumbo hoppers
  • 4. Unit grain trains from Iowa to Houston
  • 5. Track maintenance program with states and shippers (Iowa branchlines)
  • 6. Problems: slow orders (over 5,000 miles of system plagued by slow orders increasing operating costs substantially); delay of plan of reorganization—why?
siding two federal response
Siding Two—Federal Response
  • 1. BIG EVENT—Bankruptcy of Penn Central Transportation Co. in June 1970—formed in Feb. 1968, merger between Pennsylvania and New York Central
  • 2. PC losses are staggering—over $1 billion per year—threatens entire economy (threat of liquidation)—PC carries 1/3 of passengers; 1/8 of freight
  • 3. Nixon admin. And Congress react—form Amtrak (1971) to remove passenger train burden from RRs
  • 4. passage of 3R Act (Regional Rail Reorganization Act) in Jan. 1974 to study plan for NE railroads—created FRA and led towards Conrail in 1976
ford and choo choos
Ford and Choo-Choos
  • 1. 4R Act (1976)—creates Conrail and offers financial assistance to struggling RRs
  • 2. No aid to Rock Island from federal govt.
  • 3. Discussions of regulatory reform
  • 4. differences between WH and Dept. of Transportation
carter deregulator
Carter—Deregulator
  • 1. Push towards deregulation of transportation
  • 2. Airlines and trucking deregulated first—RRs take longer—what about privatization of Conrail? Not time. Amtrak? No support
  • 3. Congress acts with WH to secure Staggers Act (1980) which deregulates RRs and frees them from rate control by ICC; designed to speed up mergers and process of track abandonments
act three

ACT THREE:

Liquidation

reorganization and rebirth
Reorganization and Rebirth
  • 1. Rock Island is liquidated—Trustee Gibbons sells estate (5,000 of 7,500 miles is still in use today; remainder abandoned and sold for scrap)
  • 2. assets of railroads—real estate, locomotives, etc. all sold or scrapped
  • 3. Trustee secures major Supreme Court victory (Railway Labor Executives vs. Gibbons, 1982), freeing Rock from paying labor unions $75 million in vacation pay from estate (argued by Jenner and Block, firm used to argue against reorganization)
  • 4. Successful reorganization plan filed with Court in 1982
reorganization and rebirth1
Reorganization and Rebirth
  • 5. Rock emerges from reorganization in 1984 as Chicago Pacific Corp.—Trustee had paid all debts (which amounted to $250 million in 1980) with interest; repaid stock and bondholders and taxes
  • 6. Chicago Pacific is capitalized with $400 million from liquidation of railroad—board includes Thomas Ayers, Bill Ayer’s father
  • 7. investment company led by Harvey Kapnick—acquires Hoover Vacuum Cleaners; fights attempts at hostile takeovers
  • 8. Bought out by Maytag (Newton, Iowa) in 1989—end of Rock Island RR
major changes in lines
Major Changes in Lines
  • 1. Southern Pacific buys Golden State Route from NM to SL in 1979 ($58 million)
  • 2. bidding war for Spine Line between Minneapolis and KC (won by CNW)
  • 3. Branch lines in Iowa spun off to shortlines, CNW
  • 4. Iowa Interstate created (1985) to takeover Chicago to Omaha traffic—CSX buys main from Chicago to Bureau, Il. and Peoria
  • 5. RTA (later Metra) buys Rock Island main in Chicago and controls commuter service
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