Penn Central

When Penn Central failed in June of 1970, the result was the largest bankruptcy in America, up to that time. There are usually good reasons why a corporation fails - internal reasons largely - usually because the company gets into other activities it does not understand or ignores the one it is presently in, and this failure was no exception. And when the company is a large listed corporation, insiders usually know well before the public that something is amiss and bail out. Again, the case of Penn Central was no exception.

Penn Central came about as a result of a merger between two other rail lines, the Pennsylvania line, and the New York Central line. Talks for merging had been going on for years, well before the merger actually occurred in 1965. The CEO of the Pennsylvania line, Stuart Saunders, took charge of the merged entity.

In describing Saunders, Sobel, in his book When Giants Stumble, noted a conversation that once took place between Saunders and a Pennsylvanian politician, Milton Shapp: "I've been to several parties with him where he had a few drinks, and he was always talking about Litton Industries and how Litton and other conglomerates had cash coming in and were putting it to good use…He said he wanted to keep the money for real estate investments instead of putting it in the f------ railroad." Saunders lived up to his statement.

"Saunders razed Pennsylvania station in New York and created the Madison Square Garden, along with two office towers. In return for the property, Penn retained a quarter interest in the complex. And then Saunders went after the Great Southwest Corp…(with interests in property)…Arviva, a Florida land company, a mobile home company, and Executive Jet Aviation from which Saunders sought to start a major charter service, along with others." (Trumbore, The merging of the Pennsylvania with the New York central would give Saunders additional publicity and extra borrowing power.

The evolving financial techniques of the time made Saunders quest for more and more acquisitions that much easier too. Listed companies simply issued debt for each acquisition in the commercial debt markets of the time. All to push the share price along of course.

But with such debt outstanding, a tightening of the credit cycle can be deadly. Added to this, rail companies were seeing their market for freight haulage and distribution eroded as shippers took advantage of the growing road networks. So in late 1969 and early 1970, when Penn Central had $100 million in debt maturing, realizing it did not have the cash to meet it, sought to float some bonds to cover the debt. Meantime, the company reported a loss and the market then of course began to doubt the worth of the bond issue. Penn Central stock fell to $15 from about $85 a year earlier.

A government bail out was sought for the ailing Penn Central (and other rail lines also having trouble). The president approved an overall $750 million package, though Congress did not eventually authorize payment. The government did step in to preserve the rail service however, and split Penn Central into Conrail for freight service and Amtrak for passengers.

It was subsequently found that the earnings of Penn Central associated corporations had in prior years been manipulated to prop up the share price of Penn Central itself. Alan Lechner, in the book Street Games noted:

"The Penn Central wasn't exactly the SEC's shining hour. Penn Central Transportation Company, the world's largest privately owned railroad company, with assets of over $6 billion, was an American institution ranking just behind hot dogs. On June 21, 1970, it collapsed. Businesses had gone bankrupt before. But Penn Central stands as a glaring example of how the great institutions, the financial institutions on which we place our reliance, will get out whilst the going is good and leave investors, even or especially those institution's own clients, to get skewered…
A lot of banks had lent money to Penn Central. A lot of banks had trust departments that were heavily invested in Penn Central stock. It is illegal to trade on inside information, but when serious trouble began to show at the railroad, you can be sure that the bankers were the first to know about it - in their role not as trust officers but as lending bankers. Ray Dirks had gotten the wind knocked out of him by the SEC when he got his customers out of Equity Funding. But what happened to Chase Manhattan Bank, Morgan Guaranty Trust, Continental Illinois National Bank and Trust, and all the others when Penn Central began to go ? You bet. Their trust departments sold massive amounts of the company's stock. Put it out on the market for us investors to buy up. There had been some talk circulating in the Street about difficulties with Penn Central. Nothing serious. But these banks unloaded. As for the SEC. Once again it studied. Its conclusions: "Although at this point serious questions exist about whether sales were made on inside information, it should be noted that proof of insider trading is always difficult. The difficulty is increased where, as here, there is some public adverse information that might explain the trade. Unless direct testimony or documents can be obtained on the use of inside information, it is difficult to sustain a charge of misuse of information." And then the SEC added: "Both the commercial lending departments of Morgan and Continental had inside information at the time the trust department was selling Penn Central stock, but the parties to the decision to sell deny under oath that the trust department had access to the information."

The public announcement of the Penn Central collapse marked the bottom of the market for 1970.

Further references:

Daughen, Joseph R., and Peter Binzen, The Wreck of the Penn Central, Beard Books, 1999.

Lechter, Alan, Street Games, Harper and Row, 1980.

Sobel, Robert, When Giants Stumble: Classic Business Blunders and How to Avoid Them, Prentice Hall Press, 1999.

Trumbore, Brian,

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