American Railroad Economic History

Over on another thread with an unrelated topic, an economist, possibly homemade, has started harping about how railroads never made any money, the shareholders sucked all the money out as dividends, the government subsidized them, etc. He will blast me for mischaracterizing his argument, but I started this thread for both the past and present financial operation of American Railroads.

Before I start with my brief knowledge of a few New England lines, I want to add a disclaimer that economics is not a science. An economist comes up with a theory that works in a few situations, ignores the evidence that doesn't fit, and abandons the theory for another when it leads to a crash. We're only supposed to remember the first part.

Boston & Lowell, & Providence, & Worcester. Started with local capital- some from international shipping, some from manufacturing, some paid in by municipalities along the route. Financial successes in that they paid dividends, paid back loans, boosted trade and manufacturing by making transport cheaper, faster, and more reliable, And spawned rivals because they were so successful. Whether they were able to upgrade their lines and equipment out of operating revenue alone, or borrowed and repaid I do not know. Also paid property tax on their facilities.

I'll let someone else start in on the duds- BH&E, the original incarnation of the Erie, the Rutland.

Here's what got us started:

Arlington wrote:

winsurfer wrote:Six years four months for the transcontinental railroad to get from groundbreaking to the Golden Spike. We have already spent almost half that just to get to this study, and that's just in this thread.

Please don't assume from this that rail investments are easy or obvious. Please also do not assume that all rail projects have good payback. As much as we complain about today's consultant-heavy planning process, it is actually there for a good reason: railroads were a corrupt and profitless business for their first 150 years. The transcontinental UP/CP was the source of huge financial losses (going bankrupt 4 years *and* 24 years after completion), huge political corruption (the Credit Mobilier scandal).

I think we too often forget that 60% of all rail mileage was badly planned, and nearly 100% was badly financed, and repeatedly wiped out their investors. Today, there's survivorship bias--the 100k miles of track that are still in service look like the work of fast, efficient geniuses, but are really represent 40% of the mileage (and a teeny % of the money spent) of more than 250k miles of track that were built.

On the Transcontinental Railroad:
1863: Construction Start
1869: Golden Spike Driven
1872: Credit Mobilier scandal reveals $72m spent on a railroad worth $53m (30% lost or paid out in bribes to gov't officials and corrupt contracts)
1873: Union Pacific declares bankruptcy
1885: Central Pacific is leased to Union Pacific
1893: Union Pacific declares bankruptcy again

An engineering and construction marvel, yes. A good model for how to build / invest in lines? no.

MBTA3247 wrote:

Arlington wrote:railroads were a... profitless business for their first 150 years.

They were? So where'd all those millions of $$$ paid out in dividends every year come from?

They were. Large dividends are a sign of "disinvestment" not profits. (you can't/won't re-invest the money on the railroad, so you pay it out) Counting depreciation and bankruptcy wipe-outs (across the industry) they were not profitable, but since they got the stuff "free" from wiped-out pre-bankruptcy shareholders, bondholders or the gov't, nobody cared, as long as the cash kept being paid out.

The cash millions came straight from operations and was sent out the door immediately, lest some manager carelessly invest it in track, structures or equipment. (see also, Guilford Rail System).

Like a kid's lemonade stand that only has to pay for lemons, sugar, and water (because somebody else paid for the house, chair, sidewalk, pitcher, cups, table and signs), they had cash to pay out but were not profitable. Inflation of the 1970s helped by raising the value of land under the assets, and degregulation helped by permitting RRs to strip the tracks off and sell them for cash to pay dividends.

New locomotives and railcars were leased, because all excess cash was being paid out--not held for actually buying things.
Limited spending on new tracks and signals on a profitable mainline were OK, but only if you could show that you were wearing out or pulling up branch lines even faster, or were buying a competitor and wearing out and pulling up *their* tracks. (UP, BNSF, NS, and CSX and their mainlines are the survivors, with everything else worn out, pulled up, or sold off to short lines that mostly continue the process of wearing out their stick track until it stabilizes at <10mph or is abandoned).

Dividends were also paid for by selling off great piles of old land-grant land, or the land that had been under that competitor you just bought and pulled up.

The yard sale process slowed in the 1980s as Conrail settled down. But railroads didn't/couldn't/wouldn't be net-investors in themselves until about 1996 (when Santa Fe finished its yard sale by merging itself with Burlington Northern) or 1998 (when CSX & NS split up Conrail). Only since then have the railroads actually been profitable enough to be permitted to keep their cash and actually invest it in railroading.

MBTA3247 wrote:That is an incredibly cynical view of history that doesn't match up with anything I've ever read, except perhaps for a handful of isolated cases.

I had the romantic view until 1993, when I went to a university presentation by Robert Krebs--a guy who *loved* railroads and was CEO at 3 of them (SP, Santa Fe, and BNSF). He was very clear that the industry was living off its ancient, robber-baron and land-grant wealth and being forced to pay out its cash because it couldn't convince anyone that, if given new money it would be able to pay it back.

He was hopeful that having gotten the fireman and boiler tenders off his diesel locomotives (from a crew of 4 to 2), and sold off Catellus, that he'd finally be allowed to keep his operating cash and actually invest it in railroading. And it basically worked OK since.

Just some impressionistic points to get us going:

1) The Airlines are net money-losers across their history, destroying more capital (in investor losses) than they have ever made. Railroads escape this easy analysis mostly because there were too many railroads doing too many back room deals and wiping out too many bubble/mania investors for too long in the 1840 - 1910 era to be easily valued. Airlines' data was clean: publicly-audited, CAB-regulated from its start, and so the math was easy.

2) Railroads are like airlines:
- a competitive business
- was regulated until 1980 ish
- competes with other modes
- competition within and between modes tends to drive returns on capital to zero (or negative)

3) Railroads are better investments than airlines
- having physically captive customers protects you from competitors (which helps profits)
- having physically captive customers invites you to gouge customers like farmers and mines (which is very profitable)
- But the ICC was created precisely to stop railroads from exactly this gouging (farmers outvoted RR shareholders at the ballot box)

4) Railroads were worse than airlines
- unlike airlines, railroads had a "bubble"--a .com like mania for building railroads that sucked in a lot of capital and free land, then wiped out its book value
- unlike airlines, railroads had self-dealing "robber barons" who (before the SEC and ICC) could rip investors off
- Robber barons made their money by buying land cheap and selling it to the railroad dear.
- Robber barons made their money by selling the RR expensive steel and bridges (from companies they also owned)
- Most railroad fortunes were made either in stock manipulation or self-dealing (see above) not in actually owning a railroad

This is all too vague. I tried to answer each "charge". Air travel is only one competitor. Trolleys started the ball rolling, cars and trucks picked it up, and the decline of American industry was the wall pre deregulation hit.

Today I was thinking of two common business models that might apply.

A- running a business into the ground, as in not reinvesting to keep the company going, or worse borrowing to keep it going but still sucking out a heavy cut as profits and/or compensation then filing for the company's bankruptcy, leaving the creditors holding the bag.

B- stripping assets, which the New Haven, B&M, and as mentioned, Guilford, did so well.

I have a few books on the subject beyond nostalgia and foamy fun, and I need to do some research, but-

from section 1- no argument there, except inasmuch as backroom deals were not entirely to blame for each railroads' collapse. An unwillingness to face a changed business environment by management, unions, and government is my culprit.

2- If you wait long enough, everything zeroes out at best. All modes of transportation require continued investment because the vehicles used, and (for lack of a better term) fixed physical plant wear out- roads, rails, dock, runways, cars, bicycles, horses- you name it. With the possible exception of walking barefoot and swimming across rivers, because bridges wear out, too. That's a bit esoteric, because I haven't done the research on specific examples.

3- better investments over what time periods? Road haulage and changes in fuel sources (coal to gas + oil in pipelines) ate away at the physical captivity of customers. I don't know how well shareholders in American Airlines did between 1950 and 60, nor can I add the costs of publicly owned air traffic control and airports (pilot training, too). But I bet they did better than the New Haven's at the same time and worse than the New Haven between 1880 and 90.

4- I wander a bit here, but-
airlines were regulated from the start, largely because of the bubbles and manias driven by boosters and investors trying to get rich quick. Not every railroad got land grants- that was an inducement to cross the prairie and for development. Parcels here and there may have been bought by governments and given to RRs in New England, but most RRs had buy the land for their fixed plant, or buy rights of way, sharing title with abutters.

Not everyone involved in railroad management were robber barons- that's a broad brush. Make as much money as possible, yes, it's the American way. But if one can do it while building a stronger company and providing better service, I don't see that as a bad thing. Railroads still made millionaires richer after the ICC reigned in the worst excesses. The SEC came in a bit late. RRs problems with Washington were the ICC preventing abandonment of money losing service, and the Justice Dep't preventing mergers that would have eliminated surplus lines.

Railroads tried to improve customer service in the face of competition- airlines threw it out the window in endless efforts to cut costs.

One point I couldn't fit in elsewhere. Deep in US Code on railroad accounting was a rule that said in effect, "you have to pay for the fixed plant out of operating revenue, but you can finance engines and cars." During the Depression and after the war, what railroads needed most was renewed right of way, but they didn't have the money to do it. So they borrowed for and/or leased new engines and new cars for declining traffic. The engines could go faster in theory, but the tracks couldn't keep them upright. I need to note that the changeover from steam to diesel would have happened anyway as diesels were an enormous cost saver.

Remember, we are talking about the industry in the aggregate here. Yes, it will be in generalities. Guilford is so clear an example mostly because they didn't have much in the way of a "core" business to "hide" the disinvestment in the branches. At other places with strong mainlines (eg N&W hauling coal) you didn't see it as much, but then you have even the Southern being created as a post-bankruptcy mashup which included many branches left to rot)

If you mush all railroads together, you'll find:

In the aggregate, where did the money come from?
1) Shareholders (proceeds from the sale of stock to equity shareholders)
2) Bond holders (proceeds from the sale of debt to lenders)
3) The government (usually in the form of free land

In the aggregate, where did those investors lose money?
1) During startup, when company directors directed the company to buy from the director-owend suppliers at inflated prices (rail, bridges, and land) (The robber baron era)
2) During operations, when not enough business showed up
3) During regulation, when they weren't permitted to gouge their captives
4) When a manipulator/competitor forced them to sell out for low prices after market crashes
5) During bankruptcy, when equity was completely wiped out and bondholders recovered only part of their principal

Who made money?
1) Self-dealing robber barons
2) Stock manipulators (forcing share prices up, selling, forcing crashes, buying)
3) Owners who bought in bankruptcy
4) Dividend seekers (similar to 3...bought cheap stocks made cheap by someone else's even-bigger losses

Who lost money
1) Shareholders, on average
2) Bonholders, on average
3) The Gov't (intentionally giving away land, to encourage line-construction)

I had a longer presentation but my browser froze and I decided there was no point trying to argue that the world is in color to someone who only sees black and white. I can't lump all American railroads of all time together. That's the lazy point-scoring debate club thinking that makes Congress so vile. I remember high school history with robber barons, Grangers, then- yaayy!- the ICC, strikes and unions, trust busting. In the last 22 years I discovered nuance- that everything does not fit into nice categories.

Here are three links to text and a map I scanned, dispelling the notion that land grants to RRs were an enormous giveaway or subsidy. I freely admit I did not go to the original sources.
http://www.flickr.com/photos/newmundane/9002080378
http://www.flickr.com/photos/newmundane/9000898245
http://www.flickr.com/photos/newmundane/9002081414

Without piles of financial documents, I can't disprove every shareholder was a villain in a black hat and twirly mustache. Railroads made modest sums for millions of shareholders the world over. The best evidence I can give are all of the grand Victorian institutions, particularly churches, schools and hospitals, scattered about the country, paid for not by stock manipulators, but by the donations of people enriched by their investment in well run, service oriented, forward looking organizations.

Personally, I believe regulation to be an essential part of any organization, even individual. I heartily endorse state ownership of utilities as a means of keeping costs down. I do not, however, think the sun shines from the ICC. I can't figure you out. At first I thought angry libertarian, now maybe frustrated socialist.

joshg1 wrote:I had a longer presentation but my browser froze and I decided there was no point trying to argue that the world is in color to someone who only sees black and white. I can't lump all American railroads of all time together. That's the lazy point-scoring debate club thinking that makes Congress so vile. I remember high school history with robber barons, Grangers, then- yaayy!- the ICC, strikes and unions, trust busting. In the last 22 years I discovered nuance- that everything does not fit into nice categories.

I don't feel that any of this is "good" or "bad" (or black or white) and don't ask that other people attach any sort of moral judgment to these things.

It is more the economic point that there are a lot of biases at work in the way people frame these things. In particular, There are a couple of biases that railfans don't realize are at work:

1) Survivorship bias...the "typical" railroad today is well run, but that's because they are the survivors of a 150 year process that killed off and tore up many thousands of un-economical railroads, and left us with UP, BNSF, CN, NS, CSX and a few others (all well run). At the root of this process is thousands of railroads all of which were *not* built to survive--The typical railroad was unprofitable (where "typical" or "the median" is measured by dollars in or track-miles or company-by-company)

2) Roadbed bias...if the line is still in use, we assume it was profitable for its builders. Case in point: The UP/CP Transcon railroad was cited (by a fan) of how quickly it was built, but everyone forgets that the UP and CP went bankrupt *twice* Other favorites are the Southern (famous for being well run in its day (up to and through into the NS era, really)...but everyone forgets it was created as a bankruptcy mashup.

3) Bankruptcy blindness...If the name is still in still in use (like Union Pacific) we forget that it got its start by wiping out the people who paid to build it.

4) Golden Age bias...If a road had a golden age and "headliner" trains we forget that all those eras (usually 1900 to 1960, let's say) were sandwiched between a mania/bubble start (usually cleaned up by bankruptcy) and a 1970ish Conrail bankruptcy (or perilous re-org, as with the Santa Fe ~1990). And those that didn't have a Conrail-era bankruptcy are the exceptional few "name" survivors.

5) Museum bias...You've given a good example: the gilded age mansions, churches, and universities (e.g. Stanford) founded with "Railroad Money". Well, these are again, the survivors. All the stuff built cheap and all the stuff not built (because money was "stolen" by railroad barons)...well none of the "casualties" of the age are around to look at anymore.

joshg1 wrote:Personally, I believe regulation to be an essential part of any organization, even individual. I heartily endorse state ownership of utilities as a means of keeping costs down. I do not, however, think the sun shines from the ICC. I can't figure you out. At first I thought angry libertarian, now maybe frustrated socialist.

I suspect that's because there isn't a political ax being ground here. I don't claim any special insight into how it could have been done better. People forget how badly done it was--people's history of rails tends to focus on the shiny, museum pieces it has left us, and it all looks nice and in good order and profitable.

Further, people here tend to believe that today's railroad managers are slow and stingy, and that the government's planning and capital-allocation process is slower and stingier still in giving us the new iron we crave. Well, they're right, really, because the railroads that were smart enough to survive and the government now both know that their capital investments have knowable paybacks and that they should look to maximize them.

Which means that we can't throw down iron the way they did back when railroads had lots and lots and lots of dumb money at their disposal, as in the dot-com boom, when you got paid to throw up a website as fast as possible (GeoCities? pets.com? Kozmo? WebVan?). (A good example: Mark Cuban sold Broadcast.com for $5.9Billion at a time when it had 330 employees and $13m in revenue).

As with the dot.com boom, most shareholders were "innocent" investors chasing "sure thing" returns, with money being made by a very few founders, and a very few more stock-manipulators. Old websites, however, make really crappy bike paths.

We can go back and sort through the good and the bad- I have plenty of "bad" examples- but I think you're talking about opportunity cost. I claim to distrust economics, but opportunity cost is one of my favorite subjects because it's a simple concept, we use it every day, and no one seems to consider it. For me, the opportunity cost of buying bland supermarket meat would be not buying fresh fruit and veg and the odd bottle of champagne. Cottage cheese and lentils equals a nice bottle of rosé twice a year- I can do without burgers.

Two contemporary rail examples- the Plaistow extension. Simple and relatively cheap. What else could be done with the money projected to be spent? Nothing grand- rebuild some intersections, maybe start up money for a road transit project that won't get additional funding, or not spend it. How much is it worth for commuters to not have to drive to Haverhill or elsewhere to get on a Boston bound train? This project gives us a chance to find out -if- they build a parking lot and -if- they allocate enough of that revenue towards paying off the project (I'm thinking bonded debt instead of grants). My gut feeling is that is a wise project.

On the other hand, a few years ago a proposal was made that the state of NH fund a study for a Concord to Boston CR route that projected the state's cost to implement at $285 million (I think). The study died. That proposal has an enormous opportunity cost beyond not spending anything. Two down trains in the morning, two up trains about 5, for 4 trains I'll never take. They would make numerous stops and take an hour longer than the bus. For less money we could run minibuses to more destinations more frequently. They won't have the appeal of rail travel, but they'd provide an alternative to driving to people who don't take the existing bus services. To the old coot who never goes past WalMart transit means nothing. The tax he has to pay is his opportunity cost. If the rail scheme goes through instead of my bus idea, my cost is not taking evening classes in Manchester (can't drive for several years, can't afford to move), and having to leave Boston by 10, plus the taxes. Of course when the CR scheme comes back it will be framed solely in a cars+roads vs. trains+sunshiney specialness.

As far as the first transcontinental goes, the opportunity cost of taking longer to build it right would be nothing. It's easy to say in hindsight, but I don't see the need to hurry.

I figure the financial shenanigans of the railroads to be a wash on an individual level. Put the fleeced investors, shippers, customers, consumers on one side of the scale, and the robber barons, politicians, manipulators, deadbeat relatives, and monuments to their egos on the other, and I say they balance. Having thought about it for a few days, I'm inclined to think that the costs of building and operating most of the surplus lines outweighs their benefit beyond the balance sheet. That's a close one because the decline of industry made "good" lines surplus.

What is the opportunity cost of Victorian and Edwardian railroad excesses? Fewer manufacturing bubbles, investment scams in other fields, examples of architectural mania, masterpieces from Europe, missionaries to bother foreigners, fewer knick knacks on mantlepieces, and a lot less alcohol. A lot of remote, rural/small town places wouldn't have been settled only to die later. And I think we would have been a more urban country earlier, with fewer towns strung along second rate rail lines. I don't think for a minute that the lives of the poor would have been better. I've found a rising tide swamps boats with holes. Not an optimist.

May I suggest reading the following book on Railroad Economics.

"The North American Railroad - Its Origin, Evolution, and Geography" by James E. Vance Jr.

ISBN 0-8018-4573-4

Published by the Johns Hopkins University Press.

Best to try and get it from a Library.

JayBee wrote:May I suggest reading the following book on Railroad Economics.
"The North American Railroad - Its Origin, Evolution, and Geography" by James E. Vance Jr.
ISBN 0-8018-4573-4
Published by the Johns Hopkins University Press.
Best to try and get it from a Library.

Sure, but for the record here, what is the gist of the book?

From the Amazon review it seems to be about the geography behind the engineering behind the routes chosen. Scanning the free preview reminded me of a book our library discarded, "The Wreck of the Penn Central" which might too specific and cover too short a time frame.

And I am reminded of a series of optimistic moves by the Canadian government in the early 20th C. backing additional transcontinental lines. The companies building them were buoyed by high agricultural prices and a boom in wartime exports, only to crash when WWI ended, bringing otherwise healthy companies with them. The remains were nationalized into CN. Crooked booster politicians didn't help. It's a cautionary tale about infrastructure projects that will/would never bring the desired results.

Ok, I got off to a bad start by just posting a book title. Let me restart by clearing up a few errors in earlier postings. In Arlington's posting concerning the Union Pacific, the Central Pacific was leased to the Southern Pacific in 1885, not the Union Pacific. This was important as the Southern Pacific as a transcontinental railroad had an incentive to route as little traffic as it could over the Central Pacific for furtherance east beyond the requirements of its original incorporation. Let me concentrate on the Union Pacific; The first big problem and the one that lead to both of its bankruptcies was the decision by the the government to allow the Central Pacific to own the West End. This deficiency showed up when the "Big Three"(Mark Hopkins Jr. died in 1878) who controlled the Central Pacific started to build their own Transcontinental rail line without authorization and presented the US government with a fait d'acommpli getting the Southern Pacific built from San Francisco to El Paso via Los Angeles before the government could consider whether they had the right or not to build it. Once they completed the Southern Pacific to a connection with other railroads in Texas they had no incentive to route anything other than passengers and mail via the UP. This meant that the UP had little traffic west of Cheyenne, WY and guaranteed its second bankruptcy with the onset of the Panic of 1893. Once Edward H. Harriman bought control, he invested large sums of money rebuilding the track west of Cheyenne, including several complete realignments reducing grades and curvature. He bought control of the Oregon Short Line and the Oregon-Washington Railway & Navigation Co. securing an owned route to the Pacific at Portland along with the traffic from southern Idaho. Finally he secured western traffic sources by buying stock control of the Los Angeles & Salt Lake RR. and even the mighty Southern Pacific. Eventually the government forced the divestiture of control of the Southern Pacific, but they also put in place regulations preventing traffic from former Central Pacific lines from being diverted away for the UP.