Merge then Collapse
Even on Wall Street one’s memory can be short-lived. ENRON and WorldCom have been described as America’s largest bankruptcies. But few can name another, which in current dollars, was almost as large as the ENRON and WorldCom debacles.
Players of MONOPOLY will recall the value of controlling the railroads, with The Pennsylvania Railroad one of the historic four. (An interesting footnote is: in depression- ridden 1935, the firm of Parker Brothers was itself near bankruptcy, when it reluctantly acquired then marketed MONOPOLY. The board game became an instant bestseller, both in America and abroad.)
Almost four decades ago, in 1968, the management of the New York Central Railroad Company were playing real life MONOPOLY with their repeated and ultimately success- ful attempt to merge with The Pennsylvania Company. In 1971 two top-notch reporters on the editorial staff of the Philadelphia Bulletin, Joseph R. Daughen and Peter Binzen, wrote a best-seller called The Wreck of the Penn Central.
The book jacket describes it thus:
“One cold winter's day, after more than ten years of fighting, bargaining, and negotiating, the New York Central and Pennsylvania railroads merged to form the most monumental single railroad in the history of the United States: the Penn Central, a railroad worth $4.5 billion with over 20,000 miles of track, 95,000 employees, and an annual payroll of over $1 billion. The date of this merger: February 1,1968.
On June 21, 1970, only 867 days later, with a sickening crash that jarred not only Wall Street but the government and the whole national economy, the Penn Central went broke. The largest single railroad became the largest single bankruptcy in the history of the United States
The directors of Penn Central Company, after being informed there was insufficient cash to operate the railroad, chose to file a petition for reorganization under Section 77 of the Bankruptcy Act, and thereby put its wholly owned subsidiary, the Penn Central Transportation Company, into bankruptcy. Section 77 of the Bankruptcy Act permitted a railroad to suspend most of its debts. The Section, adopted by Congress in 1933, was drawn specifically to cover railroads that found themselves in bankruptcy situations. Unlike ordinary bankruptcies, Section 77 did not provide for liquidation. It was a means for railroads to reorganize while the trains kept running.
The share price of the Penn Central Company – just as in the case of ENRON - had been in free-fall, dropping from a high of $86.50 to a low of $6.50, on the day the bankruptcy was announced. The next day the stock closed at $4.50. Authors Daughen and Binzen concluded their story with the bankruptcy of the Transportation Company. Yet the holding company continued operating.
Putting its major subsidiary into bankruptcy preserved the major asset of the Penn Central, but now, working capital was needed to pay expenses in order to maintain the value of the parent company’s publicly traded shares. Through the Swiss based investment-banking firm of Pressprich & Co. the Penn Central Company sold $24,000,000 of short-term notes (12% rate) to a number of banks and individuals in Switzerland and the United States.
At the time, it looked to be a “low-risk” investment, as the holding company had a number of valuable assets, apart from the railroads, which would eventually provide more than enough cash to retire the notes.
If everything had proceeded as planned there would be little more of interest to relate. Because it didn’t evolve that way, there is another story, which begins on a Wednesday afternoon in December of 1971.