January 23, 2021

TRAIN WRECK: The Penn Central’s failure resonates today.

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.”

Read the whole thing. Railfans and those with an interest in spectacular business failures will also enjoy this 20 minute industrial film Penn Central released in 1968 to celebrate their new merger. It’s the equivalent of an infomercial promoting a luxury cruise on the Titanic, or a no-money-down real estate scheme in beautiful downtown Pompeii:

 

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