Judgment Day

In two important railroad decisions last week the Supreme Court in effect laid down a basic principle: It is more important for bankrupt roads to drastically revise their capital structures and get in tiptop working condition than it is to protect their junior bondholders and stockholders.

The decisions came in the cases of Western Pacific Railroad and the Chicago, Milwaukee, St. Paul & Pacific. In both instances the Court approved thoroughgoing reorganizations, ignored present war-boomed earnings as the basis for capitalization, and upheld the hard hand of the Interstate Commerce Commission.

The Profits and the Losses. The court decisions raised hob. Hardest hit were junior bondholders and stockholders in receivership railroads. They have watched railroad profits soar skyward for months, had become convinced they could get the ICC-sponsored reorganization plans changed enough to make their holdings highly profitable. When the Court said no, receivership rail stocks on the New York Stock Exchange nose-dived 50 to 80%. Prices for junior bonds jumped the tracks. Western Pacific preferred stock flopped from $3 to 70-c-; Rock Island 7% preferred from $3.25 to $1.

But the decisions, hard on the little fellows, were a windfall to speculators in senior bonds (equipment trusts, underlying liens, first mortgages). For, after the Court had barred the door to junior security-holders, it then declared that senior bondholders (who get inferior securities under most reorganization plans) should get compensation for the loss of their senior rights. Said Justice William Orville Douglas, who wrote the Milwaukee decision: senior bondholders should receive "equitable compensation, qualitative or quantitative."

Result was a buying wave in senior receivership bonds at the very time prices for junior bonds and stocks were on the skids. By week's end the better-grade receivership bonds were selling at five-year highs.

Pattern for the Future. The Court's decision was of lasting significance. Despite the boom in railroad profits, some 30 major U.S. railroads are still in the courts. Together these "broke" railroads operate nearly 30% of U.S, railroad mileage. One has been in receivership for 38 years. With a clear precedent and no higher court of appeal, these railroads can now stop going to law and knuckle down to the job of reorganizing. But it will be a tough ride: before ICC and the courts get through, their combined capitalizations will be cut from the pre-depression $4,750,000,000 to $3,500,000,000 or less, and many a securityholder will suffer.

Yet this severe cut may be a blessing in disguise. The decisions may mean the difference between profits and bankruptcy for many a railroad after the war. With capitalizations cut to the ballast, fixed charges down to a minimum and strong-boxes bulging with leftover wartime cash, all well-managed roads now should not merely be alive but should also be in first-class shape to fight truckers, shippers and airline operators for postwar business. For the whole U.S. economy this was good news.

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