Solving the 'Railroad Problem'


THE problem in its simplest form is something like this: (a) Can the existing railroads be made to serve the national requirements of transportation better and still maintain their separate private identities, or will they have to be combined into either a few noncompetitive regional systems or one national system under private ownership? (b) Will the Federal Government have to own all railroads eventually? (c) In event of this last taking place, will the government lease its railroad lines to private interests, or will it operate them itself?

There is no doubt that after all of the masterly discussions of the ‘railroad problem ’ have been analyzed they may be classified into the three categories listed. The ultimate aim of any solution should be to foster and protect interstate commerce and to prevent and relieve obstructions and burdens thereon, in order to safeguard and maintain an adequate national system of transportation, as stated by Congress. When that is accomplished there should be prevalent in the rail transportation industry greater stability of employment, better security for capital, lower rates to the public, and no duplication of facilities, services, and effort. To these ends these remarks are directed.

One should approach the railroad problem with due deference. Its solution is regarded most seriously, and rightly so. In any consideration of rail transportation, the magnitude of the property involved, representing some twenty-six billion dollars of invested capital, is sufficient to attract attention even in these days. The gross operating revenues of the railroads, in normal times about six and one-quarter billions of dollars, are not approached by any single industrial activity. The revenue of the Federal Government itself is less. A million breadwinners find employment, even now, in the conduct of rail transportation, while in 1927 and 1928 there were three quarters of a million more. In other words, one out of every twelve unemployed may be an ex-railroad employee. In normal times nearly three billions of dollars went to pay wages and salaries of men and women employed in railroad operation — a sum of money almost equivalent to that which Congress appropriated in 1933 to give employment to capital and labor for the purpose of restoring normal economic conditions.

The railroad industry is one of the large taxpayers. When business is good, its annual tax bill amounts to from three to four hundred million dollars. It is the largest customer of the coal, lumber, and steel industries, as well as many others. Some industries are wholly dependent upon railroad purchases, and a tremendous field of industrial activity is seriously affected when the buying power of railroads is impaired. In normal years they spend from one and one-half to one and three-quarter billion dollars annually for materials used in operations, and six hundred millions additional for wages and materials used in construction.

Truly railroading is a colossal business. Congress has recognized that the best thought and effort should be directed to fostering and protecting such transportation. In the pioneer days of railroad construction (up to about 1900), nearly every municipality, county, and state in this country, either directly or indirectly, gave financial aid in one way or another. The aggregate land grants of the Federal Government exceeded the territory of many independent nations, and many states of the Union. In some instances financing was promoted by the public credit of the United States. From 1827 to the present time railroads have been regarded by the public as essential to the upbuilding of the nation.


The time when a railroad was owned by a single individual or corporation, in the same sense that a bank, a laundry, a barbershop, or other private business may be owned to-day, has long since passed. In a broad general use of the term ‘ownership,’ the public has been the real owner of the railroads for many years, although the responsibility for their administration and, in some respects, control rests ostensibly with private parties. Seventy-eight companies with securities totaling nearly three billions of dollars were in the hands of receivers or trustees at the end of 1934. Applications for reorganization under the bankruptcy law during 1935 added eight large systems with outstanding securities aggregating more than two billion, three hundred million dollars. The boards of directors of railroads that are not bankrupt, and thus directly controlled by the courts, are more like administrators, executors, or trustees, holding such properties largely under conditions prescribed by public authority.

There is a wide gulf between the treatment accorded railroads and that accorded other public service corporations by regulatory bodies. It is conceded by both the private operators of railroads and those responsible for regulation that there can be no thought of a ‘fair return on a fair value,’ for them, such as the courts hold to be the right of other public service corporations. Railroad transportation service is a vastly different kind of public service from that of telephone, electric power, gas, and even urban transportation companies. The revenues of the latter utilities are derived predominantly from local sources. Such institutions and their regulation should be kept local in character, so that each community would bear only such burden (rates, tolls, and charges) as its requirements make necessary. Railroad transportation, on the other hand, has national characteristics because of the services performed. Wheat, which furnishes bread for the entire country, is grown largely on the Western plains. Fir lumber of the far West and yellow pine of the far South are the principal natural structural materials of the nation. Steel, the backbone of heavy construction, is produced largely in Pennsylvania, eastern Ohio, northern Illinois, Colorado, and Alabama. Soft coal, while somewhat more widely found, is not produced in many localities. Anthracite is almost entirely a product of Pennsylvania.

In order to make all national resources available at reasonable prices, railroad rates should be adjusted on bases different from those of other public service corporations.

Neither the Interstate Commerce Commission nor the private operators of railroads can establish a system of rates which would yield net earnings sufficient to permit the payment of reasonable dividends on the securities of every railroad. There are many thousands of miles of necessary railroads which have earned no dividends for many years. In other words, the public derives the benefits of the service, but the owners (stockholders) receive no compensation (dividends) for the use of their property. These roads can do little more than pay running expenses and taxes. Only during periods of extreme national prosperity can they hope to do otherwise, and such periods are rare. On the other hand, some large railroad systems that are conservatively financed, economically managed, strategically situated, soundly constructed, and properly equipped and maintained, earn sufficient to pay dividends under all kinds of economic conditions. No system of railroad rates, uniform or otherwise, can be devised to provide a reasonable profit to every operating property.

The recapture provisions of the Act to Regulate Commerce (Section 15-a) were intended to correct these wellrecognized facts by applying a socialistic principle to railroads. ‘Share the Wealth’ was the theory underlying the recapture provisions. Unfortunately, dominant personalities within the Interstate Commerce Commission during the period that those provisions existed held views contrary to the philosophy underlying the act. Some believe that a different, or more aggressive, policy of administering the recapture provisions would have justified the hopes of the proponents of the plan. Authorities competent to pass judgment believe that the greatest blow to the future of private ownership of railroads was struck when Section 15-a was repealed at the instance of certain railroads and the Interstate Commerce Commission.

To solve the ‘railroad problem’ now, one of three alternatives will have to be resorted to: (a) consolidation of all railroads under a single private ownership and operation as a national system; (b) government ownership and private operation; (c) government ownership and operation. It is more than likely that the second or third will be the ultimate solution.

Many billions of dollars are represented by the par value of stocks and bonds of railroads which only under unusual conditions ever pay a dividend. From 1908 to 1928, only about 63 per cent, on the average, of the owners of outstanding capital stock received any dividends at all; the percentage varied from 57 per cent to 70. Naturally the owners of nonproductive securities form a tremendous spearhead favorable to government ownership, because the consummation of such an arrangement would afford an opportunity or possibility of transferring billions in par value of stocks and bonds to the Federal Government at prices not otherwise obtainable. If the government should ever purchase railroad properties by any plan (not including a resort to condemnation) except that of quiet acquisition of outstanding securities over a protracted period of time, tremendous pressure in favor of owners of securities of the least desirable properties would unquestionably occur.

In the face of almost certain government ownership, capital sits complacently twiddling its thumbs. Neither those who hold the mortgages (bondholders) nor those who own the capital stock (ostensible owners of the railroads) have any definite, tangible, workable plan to continue the railroads under private ownership and operation. It is apparent, and has been so since as early as 1885, that the poorly financed, ill-conceived, and badly managed railroads will eventually make private ownership and operation impossible unless they are absorbed by other lines. It is this sort of carrier which, in part, constitutes the so-called ’railroad problem.’

Those who are charged with the duty of managing the railroads know full well the way to avoid government ownership, yet personal interests are stronger than community interest. There is unanimity of opinion among them as to what is essential to ensure the continuation of private ownership and operation, but individual greed and selfishness outweigh other considerations. There are few among them who do not recognize the imminence of public ownership; yet none appears of sufficient influence and leadership to keep private ownership from being wrecked by its own proponents. Leadership in the railroad industry is indeed at low ebb. Thus is created an ideal field for exponents of public ownership, though responsibilities requiring vast government expenditures for the relief of distress among the unemployed so far during this depression have made government ownership financially impracticable.


What has been said concerning the inability of private operators to cooperate in a plan of private operation is not in disparagement of those engaged in railroading as a class. It is but human that a large group of railroad presidents, who receive from twelve to a hundred or more thousands of dollars per year salary, with certain perquisites such as private cars, and who in their own domains often have as great dictatorial powers as Il Duce, would not make recommendations which would deprive them of these things. There are still more vice presidents who receive salaries ranging from ten to forty thousand dollars; they too enjoy privileges and power extraordinary. Quite naturally, they would not care to join the ranks of the unemployed. Besides these, there are possibly more than a thousand general managers, general superintendents, and other generals, who, together with their satellites, desire to continue in their present lucrative positions, with the luxuries and power they enjoy.

Over and above all these individuals there are powerful interests which have their own particular fish to fry. These are banker influences which batten on the carcasses of many railroads, and which, as shown in cases of record before the Interstate Commerce Commission, profit from the financial misfortunes of necessary transportation agencies.

When government ownership comes, it will be because private owners are unwilling to submerge their personal ambitions for the good of either the nation or the industry. It will come when public opinion reaches the conclusion that there is no other way out.

While government ownership may be necessary eventually as a measure of protection to the public, this need not be a matter of concern. Probably it would be better if private ownership and operation could be continued. The conditions governing public ownership and operation would have to be known before anyone could express an intelligent opinion of its possible success or failure.

The intelligence of the present operating managements of the railroads is of as high degree as that obtaining in any other industry. This is reflected in the incomparable service which the railroads are rendering after five of the leanest years in their history, years which required that literally every cent spent in operation had to do the work of two. If those who determine financial policies for railroads were as conscientious and resourceful as the operators, the railroad problem might be solved.

The future of railroad transportation eventually may have to be determined by the Interstate Commerce Commission. That body is and always has been composed of competent, faithful, efficient, and intelligent men who generally have avoided political angles and kept the public interest foremost. The acts of the Commission must, however, be confined to the delegation of power entrusted to it by Congress. It is possible that, with broad powers to solve the eternal railroad problem, with ample discretionary power, and with present limitations removed, these men could find a solution acceptable alike to the private owners and the public. However, only dictatorial powers administered by two-fisted men will avoid government ownership, if at all.

At this time the outstanding railroad securities have a market value of about eleven and one-half billion dollars, while the recorded cost of the property to which they are attached is about twenty-six billion dollars. If the Federal Government should buy the railroads through the acquisition of their outstanding stocks and bonds aggregating eighteen and one-half billion dollars par value and should issue eighteen and one-half billions of its 3 per cent bonds in payment therefor,1 the maximum interest charges to be met at the end of the first year of operation would be five hundred and fifty-five million dollars. On the basis of the market value of the securities, — that is, eleven and one-half billion dollars, — the interest charges at the end of the first year of operation would be three hundred and forty-five million dollars, the probable minimum annual charge which would have to be met out of earnings. Somewhere between that figure and the maximum of five hundred and fifty-five millions would be the interest requirements of the Federal Government — say four hundred and seventy-five millions. According to the Interstate Commerce Commission the average normal rate of interest on the funded debt of the railroads at the close of 1933 was 4.60 per cent and the interest charges paid amounted to six hundred and thirteen million dollars on funded and unfunded debt.


Suppose the Federal Government would pursue such a policy as outlined — that is, actually purchase the railroads, lock, stock, and barrel, and then lease them to a private operating company for fifty years on a basis which would impose no additional tax burden on the people, and which would contemplate the amortization of the purchase price (bonds) during the period of the lease. The only unusual feature of such a plan would lie in the departure from the present practice of permitting common carriers to use the public highways and inland waterways free of charge. In other words, there is no plan to amortize the billions of dollars representing the investments by Federal, state, and county governments in hard-surfaced roads or inland waterways, daily used by common carriers in competition with rail transportation operating over private right of ways.

The ownership of the rail highways by the government would not be a departure from past policies of Federal, state, county, and municipal governments, as will be shown more fully later. The operation of such rail highways by the government would be a new adventure. That, however, is not suggested.

The Emergency Railroad Transportation Act of 1933 contained the following provision: —

Section 2. In order to foster and protect interstate commerce in relation to railroad transportation by preventing and relieving obstructions and burdens thereon resulting from the present acute economic emergency, and in order to safeguard and maintain an adequate national system of transportation, there is hereby created the office of Federal Coördinator of Transportation. . . .

To ‘safeguard and maintain an adequate national system of transportation ’ was regarded by Congress as necessary, and that commerce between the states should be fostered and protected was considered imperative. There can be little doubt that Congress thus reflected concisely and accurately the feelings of the nation. In the following discussion a plan to accomplish those aims is outlined.

According to figures in the 1934 edition of the Yearbook of Railroad Information published by the Committee on Public Relations of the Eastern Railroads, the average annual net earnings, after operating expenses and taxes, of all the railroads were: —

For 5-year period ending 1933. . .$ 645,000,000
For 5-year period ending 1929. . . 1,165,000,000
For 13-year period ending 1933. . . 871,000,000

The first five-year period includes at least three years of the lowest net earnings in railroad history (1931, 1932, and 1933). The second period probably represents the best five-year period ever experienced. It is not unreasonable to assume that the thirteenyear period ending with 1933 would represent a fair annual average of future railroad net earnings over a period of twenty-five years.

To each of the averages should be added one hundred and twenty-five million dollars paid annually for rent of cars and common facilities, such as union stations, yards, and so forth. That charge would not be present under a consolidation plan by private or government ownership. The expectancy is that over a period of years the railroads, under one management, could earn at least nine hundred and ninety-six million dollars net per year.

It is assumed that the four hundred and seventy-five million dollars heretofore referred to would be a minimum annual rental to be paid by the operators, and that all net above that sum would be divided between the operators and the government on a basis which would encourage the operators to exert their maximum efforts to increase efficiency and economy and to improve constantly the condition of the property and equipment, to the end that rates would come down, net earnings go up, and labor conditions improve. Such a profit-sharing plan might be based on the government taking 50 per cent of the first two hundred millions in excess of four hundred and seventyfive millions, 40 per cent of the next one hundred millions, 30 per cent of the next one hundred millions, and 25 per cent of all above four hundred million dollars.

That kind of plan would have left the private operators an average of fortytwo and one-half millions net income during the three worst years in railroad history which the Year Book records, instead of more than a six-milliondollar average deficit (1931, 1932, and 1933). At the same time the interest charges on the government bonds would have been met, with forty-two and one-half millions to spare for debt amortization. On the basis of the best year on record (1929), the private operators would have received five hundred and ninety-nine millions, while the government would have got two hundred and ninety-three millions for the purpose of debt reduction, in addition to the minimum of four hundred and seventy-five million dollars which would have gone to pay interest in the first year.

Of course, government interest requirements would diminish annually by reason of the retirement of outstanding bonds. The rate of such diminution would increase rapidly during periods of prosperity and would slow up with cessations of industrial activity. A rather careful study of this problem indicates that it is probable that the entire purchase price represented by bonds issued by the government would be redeemed in slightly more than forty years, and that, under conditions somewhat less favorable than those expected, fifty years would elapse before all debt would be extinguished. After forty or fifty years the rental in its entirety could be used to reduce the national debt at the rate of nearly a billion dollars annually. This is on the basis of an average (1921-1933) net of nine hundred and ninety-six millions annually. However, the history of railroad earnings indicates an upward trend.


So far nothing has been said about the source of funds needed for improvements and extensions and other capital purposes. Except for the one hundred and twenty-five millions now paid annually for use of such facilities as cars, union stations, yards, and so forth, savings from unified operations have not been included in the probable earnings so far estimated. Such savings have been estimated by various authorities from about two hundred million to as high as eight hundred million or more dollars. No one could accurately estimate or know what savings would result from unified operations until several years had elapsed. It is reasonably certain that they would run into several hundred millions annually.

Dividend payments averaged about four hundred and twenty-five million dollars annually during the six-year period ending with 1930. The capital stock outstanding aggregated on the average about seven billion dollars. For the fourteen-year period ending with 1933, the stockholders received about three hundred and twenty-five million dollars annually. During the last three years dividends averaged less than one hundred millions and were paid largely from previous surplus accruals.

One billion dollars would be considerably in excess of the capital necessary to finance a company for the purpose of operating the railroads. One hundred million dollars available for dividends would give a return of 10 per cent on the capital employed, so that net earnings of seven hundred and fifty millions annually would ensure a ready market for all common stock in the project, in view of the fact that the thirteen-year average was nine hundred and ninety-six million dollars. All additions and betterments to the property paid for out of earnings would become the property of the United States Government. Any earnings above one hundred millions, after deducting the amount represented by the percentages which would belong to the Federal Government, would be divided, 75 per cent to be spent in improving the property and 25 per cent to be additional compensation to the operators as an encouragement to greater economy, efficiency, and the promotion of the very best interest of national transportation.

Added to all of the net figures given would be an unknown amount, running into many millions of dollars annually, derived from rent paid by private parties holding concessions, such as lunchrooms, barbershops, and so forth, in stations, and from other and varied sources. These sources of income, together with others which would not obtain in a government-owned property, aggregate about one hundred and thirty-five millions annually at present.

There need be no lessening of taxes collected by state, county, and municipal governments because the property is owned by the Federal Government. States have a right to tax railways and utilities on the basis of gross earnings, and some states do. At present the railroads pay taxes equivalent to about 8 per cent of their gross revenues. Railroad taxes rose from about 4.4 per cent of gross revenues in 1920 to a high of 8.8 per cent in 1932.

For the twelve-year period ending with 1933 the carriers spent about six hundred million dollars annually for capital purposes. Economies equivalent to about five hundred million dollars would result from unified operation of all railroads. Furthermore, with all the railroads operated as one system, no capital expenditures would be required to meet competitive conditions. It is a known fact that railroads during the twelve-year period ending with 1933 spent money extravagantly to gain advantages over competitors. Rail of a section as heavy as that in use on the main line of the Pennsylvania Railroad was made the standard on railroads having not more than 10 per cent of the volume of tonnage passing over similar rail on the Pennsylvania. Tremendous sums are spent on unproductive passenger equipment largely for advertising purposes to meet competitive conditions.

If the government should follow such a plan as suggested and lease its transportation system on the best terms obtainable, there would be little doubt that the results would be far more favorable than there outlined. Any terms should, however, provide a liberal incentive to the operators and their employees to earn more than a fixed amount.

Lower freight and passenger rates and greater stability of employment would be possible from such an arrangement. The savings resulting from unified operations that would not be needed to meet capital expenditures, compensation to operators, and payment to the Federal Government for bond interest and amortization of debt would be divided on equitable terms between the operators, the employees, and the public (through decreased freight and passenger rates). Additional opportunity in the way of beneficial results would be provided if a lower rate of interest on bonds issued by the government were practicable.

The payment of nearly three hundred million dollars annually for rent of leased roads and for rent of cars and common facilities would be eliminated by this plan. Existing assets other than fixed physical property and equipment would be transferred to the operating company as working capital, fuel, and materials and supplies. The value of these assets would be returned to the government upon the termination of the term of any lease.


As a matter of fact, the combination of government ownership and private operation in the railroad world is not new. The Nashville, Chattanooga and St. Louis Railway has operated its main line from Chattanooga, Tennessee, to Atlanta, Georgia, for about seventy years under such a plan. That line was built from 1845 to 1849 by the State of Georgia and is owned by it. The lease has been an important source of revenue for the state ever since the Civil War.

Similarly, the City of Cincinnati, Ohio, owns the principal trunk line from that city to Chattanooga, Tennessee. The property is leased to and operated by the Cincinnati, New Orleans and Texas Pacific, a double-track railroad. This company has for a half century paid Cincinnati about a million dollars annually for the use of its property.

The main line of the Southern Railway from Goldsboro to Charlotte, North Carolina, has been owned since 1855 by the State of North Carolina, which receives a substantial annual income from the lease.

The City of Baltimore and the State of Maryland furnished the capital for the construction (1827) of the Baltimore and Ohio, the first American railroad, after private bankers and financiers refused to do so. That city and state were the principal stockholders (owners) of that company for nearly seventy years, during which they had twelve members on the board of directors.

The State of Virginia was at one time a dominant stockholder in all its privately owned railroads, and still is in some. The state aided the financing of all its early railroads by lending them credit.

The State of Massachusetts furnished the capital to build many of its lines of railroad, outstanding among which is the present main line of the New York Central from Albany to Boston, of which Massachusetts and the City of Albany were the principal owners for nearly half a century. Other New England states similarly acted as stockholders and bondholders, bankers, financiers, underwriters, and syndicate managers for most of the railroads in that section of the country. When private capital failed, public funds were used to build some of the existing transportation lines.

New York and Pennsylvania, similarly, had no qualms about participating in the ownership and, at times, operation of railroads. The Pennsylvania, the Erie, the New York Central, and many other railroads relied to some extent upon the credit of those two states, which issued bonds and otherwise extended credit. The Commonwealth of Pennsylvania (1827) began the construction of its first railroad after private interests failed to raise the money.

Similar treatment was accorded to railroads in all Southern states and many other states of the Union, in that public participation in the ownership and management of railroads was prevalent.

In conclusion, it is obvious that there is no tangible plan for removing the railroad problem from its age-old place in our economic life. There is little or no hope that jealousies prevalent in the industry will be submerged in either the public interest or the interest of private operation. The financial structures of too many roads are utterly at variance with sane financing based on earning power. Only one solution, other than the one described in this article, remains, and that is government ownership and operation. No one can intelligently appraise this alternative without a detailed knowledge of the legislation through which it would be accomplished. Neither can any man predict with assurance its ramifications.

  1. Quoting from a speech by R. V. Fletcher, General Counsel of the Association of American Railroads, September 28, 1935. — AUTHOR