The Biggest Bankruptcy Ever

THE nation's largest railroad succumbed last week to a lethal combination of politics, tight money, mismanagement and fumbled Government rescue efforts. A federal court ordered the tottering Penn Central Transportation Co. into a bankruptcy reorganization. The order prevents creditors from collecting a mountainous debt, while permitting trains to run as usual. Its impact was felt far beyond the railroad. The Penn Central's financial collapse, largest in U.S. corporate history, spread anxiety among businessmen and Government officials about the fortunes of several other large corporations--to say nothing of other railroads.

There have been widespread, but so far unconfirmed, rumors that some conglomerates, airlines and other fast-expanding companies are in money trouble. In Philadelphia, Dolly Madison Industries, an overbuilt conglomerate, last week petitioned for a bankruptcy reorganization. So did Four Seasons Nursing Centers, a large Oklahoma-based chain.

Both the Penn Central debacle and the general corporate cash bind raised concern about the precarious condition of the commercial-paper market (see following story). Like Penn Central, many companies have been using short-term borrowings in that market to finance long-term projects, a classic formula for disaster. Now corporations with anything less than top credit ratings will find increasing difficulty in selling their own notes and bonds, even to refinance existing debts.

Potential for Mischief. It was the Penn Central's liquidity crisis that forced the railroad to declare insolvency. In his petition to the court, Chairman Paul Gorman said that the line was "virtually without cash, unable to meet its debts, [and] has no means of borrowing." The petition declared only that the company could not repay $9,795,000 in commercial notes and $21,900,000 in debt and rental charges on its equipment, all due by July 1. But that is a minuscule part of the railroad's financial woes.

The transportation company lost $182 million last year, and by Government estimate is highballing toward a $150 million deficit this year. Though the railroad's parent holding company, Penn Central Co., has assets of nearly $7 billion, the bulk of its salable holdings of real estate, securities and other non-rail property is already pledged to secure some $2.6 billion of debt, including $700 million falling due this year.

Three weeks ago the Nixon Administration agreed to help the railroad by letting the Defense Department underwrite $200 million in bank loans. But that plan ran into such severe political fire from key Democrats in Congress that the Administration withdrew its offer. The critics threatened to make an election issue out of the loan by portraying it as a bailout for the Administration's friends in big business and banking. "The potential for political mischief really scared people," says a top Administration official.

Many Congressmen and Senators questioned whether the Government ought to come to the aid of any private company--large or small--with a record of sloppy management. The hardest blows were struck by Wright Patman, chairman of the House Banking Committee. A Texarkana Populist who detests both big city banks and railroads, Patman attacked the legality of the Administration's plan to guarantee the loans under the Defense Production Act.

Delaying the Debtors. With that, Penn Central executives hastily presented the bankruptcy petition. The bankruptcy covers only the Penn Central Transportation Co. (1969 assets: $4.6 billion), which operated the railroad. Neither the parent Penn Central Co. nor the several solvent subsidiaries of the railroad corporation were immediately affected. Among the latter are the Buckeye Pipe Line Co., a 7,000-mile network of petroleum lines; Arvida Corp., which is developing land and apartments on 35,000 acres in Florida; and Great Southwest Corp., which has extensive housing and other realty ventures in California, Texas, Georgia, Hawaii and Missouri. Ultimately, the courts will decide whether, as congressional critics of the Penn Central insist, the profits and property of the railroad's affiliates should be siphoned off to meet its debts.

In ordinary bankruptcy proceedings, the assets of the company are turned into cash, which is distributed among creditors. The Penn Central, however, filed under Section 77 of the federal Bankruptcy Act, which is designed to help railroads delay paying their debts while they keep running. Since the start of the Depression, some three dozen railroads have been reorganized under Section 77, and none have gone out of business. The process often requires 20 years. Last week the Philadelphia district court picked Judge John P. Fullam, 48, to handle the Penn Central case.

Fullam's first big job, after a mid-July hearing, will be to appoint one or more trustees to run the railroad. The trustees will have the power to float new loans to keep the line operating. While waiting for those loans, Transportation Secretary John A. Volpe warned last week, the railroad may have to shut down for lack of cash to meet expenses, which include the $20 million a week payroll for its 94,000 employees. Said Volpe: "I don't believe any of us can say with any degree of certainty if the payroll will be met or not."

Volpe may have been exaggerating in order to gain support for an Administration bill to aid the Penn Central and other impoverished railroads. That measure would empower the Transportation Department to underwrite up to $750 million in private loans. Volpe said that four or five more railroads might soon follow the Penn Central into bankruptcy unless federal aid is forthcoming.

Whether the Penn Central failure foreshadows further trouble for the U.S. economy remains to be seen. Most bankers and economists consider chances of a money crisis to be slight, but they add a crucial qualifier: provided there is no unexpected series of bankruptcies among big companies. When the federal financial managers last year severely restricted the money supply in order to hold back inflation, they knew that there would be some business failures--though they hardly expected the world's largest transportation company to go under. By most measures, the recession so far has been mild, and it has succeeded in breaking an inflationary psychology. In May, the wholesale price index rose at an annual rate of 1.2%, after four straight months of 3.6% gains. Profit-starved companies have been reducing their capital spending and inventories, and such moves should help relieve the squeeze on corporate cash during the next few months.

Meanwhile, consumers are accumulating a great deal of spending power, which could later help to revive the economy. The personal savings rate has rebounded. Personal income, already increased by raises in social security benefits and Government pay, will rise further with expiration of the 5% income tax surcharge this week. Most important, the Federal Reserve has been feeding money into the economy at a brisk though uneven rate since February. But since it usually takes nine months for a change in money policy to turn the economy around, business is not likely to start picking up until late this year or early in 1971.

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