New York Times, March 16, 2009, Monday

New York Times

March 16, 2009, Monday

New York Times

Railroad Bailout May Offer a Model for Detroit


As General Motors and Chrysler struggle to remain solvent, the railroad bailout of a generation ago could offer a template to the Obama administration — one in which the federal government would run the auto companies until they are back on their feet.

That was a different age, of course. Congress was very much on board, supervising the reorganization of the bankrupt Northeastern railroads and then forming Conrail, in 1976, to run them. The auto companies, in contrast, are being pushed by the White House and Congress to reorganize themselves and remain private corporations, owned by shareholders.

Conrail presided over huge cutbacks in rail operations, leaving the railroad system with much less track and roughly half the number of employees. By 1981, it was turning a profit hauling freight, and eventually its operations were sold back to privately operated lines.

Five years after Conrail’s creation, Ronald Reagan became president and gave government takeovers a bad name by popularizing the view that government was inept in the marketplace. The Obama administration, respectful of this continuing view, wants the automakers to stand on their own, with only temporary federal loans to get them through the hard times.

“The ideological debate already in progress,” said Peter Cappelli, a management professor at the University of Pennsylvania’s Wharton School of Business, “is whether government should actually direct the auto companies, stepping into management, or passively give them more loans, and then get out of the way.”

The railroad failures in the Northeast, vividly evident in the 1970 bankruptcy of the Penn Central network, endangered an industry that President Gerald Ford and Congress considered vital to the nation’s well-being. The American-owned automakers are similarly regarded as vital; if not all three, then at least General Motors and Ford. Automaking in this country might not survive, this argument goes, without American companies at its core.

Their footprint in manufacturing is huge. Even now, no other industrial sector, except perhaps pharmaceuticals, spends more on research than the Big Three, according to the Center for Automotive Research in Ann Arbor, Mich. The automakers are also the principal customers for the nation’s 6,000 independent auto parts makers.

“The hit to the parts makers if one or two of the Big Three disappeared would be so great that Toyota and Honda would have difficulty operating here, and they have said so publicly,” said Sean McAlinden, the center’s chief economist.

The Obama administration’s reaction, so far, has been to appoint a task force that is sorting out the viability of G.M. and Chrysler. The goal of the task force is to determine whether the automakers’ plans for survival — even the best laid plans — justify the risk of billions more in bridge loans, on top of the $17.4 billion already lent. The goal is to keep the companies alive, and out of bankruptcy, until auto sales climb back to a level that would permit them to survive on their own.

For that to happen, vehicle sales nationwide would have to reach at least 12.5 million to 13 million a year, G.M. said in the survival plan that it submitted to support its case for more federal loans. Ford and Chrysler offer similar estimates. The annualized sales rate in February, in contrast, was only nine million. And months may pass before that rate climbs back to 12.5 million or 13 million — a pace associated with upturns in the economy or milder recessions than this one.

Whatever the dangers of persistently weak sales, “the task force does not seem to be going in the direction of running the auto companies, even though that might be a fine idea,” said Dan Luria, research director for the Michigan Manufacturing Technology Center, who has spoken with some of the 21 task force members.

None has spoken publicly yet. But there are eerie similarities in the unwinding of the railroads in the 1970s and the American-owned automakers today.

Hurricane Agnes, sweeping through the Northeast in 1972, did roughly the same damage to the railroads as the devastating recession is doing today to the auto industry. The hurricane flooded hundreds of miles of track, precipitating more bankruptcies among already weakened railroad companies operating lines from Boston west to Chicago and St. Louis.

The biggest bankruptcy was in 1970, when Penn Central went under, leaving lenders, mainly banks, holding $100 million in suddenly worthless commercial paper. In what turned out to be a preview for today, the Federal Reserve pumped reserves into the damaged banks, just as it is doing now on a broader basis.

More to the point, if the auto companies declared bankruptcy, shedding their debts, then Washington would be under pressure to cover a shortfall of more than $30 billion in retiree benefits, mainly for health care.

The Obama task force itself has a rough parallel in the railroad crisis. Congress created a similar commission in 1973, on the heels of Agnes, to lay out a course of action that would make the railroads workable in their competition with truckers for freight. About 12,000 miles of underused track were abandoned, the work force was cut to 50,000 from 100,000, and unprofitable passenger services were jettisoned.

The American auto companies are similarly slimming down, but ad hoc in response to a recession that has destroyed their sales. Factories have been closed, car models dropped and 235,000 auto workers have lost their jobs in the last year, or 25 percent of those making vehicles and parts.

Pay is also shrinking. With the tacit agreement of the United Automobile Workers, wage rates are gradually being cut to the levels paid by the foreign auto companies assembling vehicles here, in nonunion plants.

“The U.A.W. realized that bailout money would not be provided unless it brought wages and even benefits into line with those of the transplants,” said Harry Katz, a labor economist and dean of Cornell’s School of Industrial and Labor Relations. “That was the standard that moderate Democrats accepted.”

Despite the cost cutting, the American auto companies may need federal loans for many months to stay afloat. Faced with that same situation in the 1970s, Congress created Conrail to run bankrupt freight lines in the Northeast and Midwest.

Five years later, the government-run company earned its first profit. In time Conrail disappeared, its operations sold to commercial railroads that dominate freight traffic today across the country and do so profitably.

But there is a difference. Railroads, regulated for decades, had come to be viewed as public utilities, and federal ownership was not unimaginable, said John McArthur, dean emeritus of the Harvard Business School and a Penn Central bankruptcy trustee.

“Discussions about the American railroad system and its shortcomings went on all through the first half of the 20th century,” he said, “and when the crisis came, there was a consensus how to proceed. Today, our society has yet to decide whether we want government-owned auto companies.”