Adverse effect of increased costs on income.—The fact that net railway operating income for the 12 months ended June 30, 1937, was 23 percent greater than for the calendar year 1937 indicates the highly adverse effect on railroad income of the increases in operating costs and the decline of traffic which made themselves felt in the last six months of 1937. Significantly net railway operating income for the 12 months of 1936-37 was nearly 9 percent greater than that for the calendar year 1936. Hence, at the time of the expiration of the emergency charges there was ample ground for the expectation that expanding traffic and seeming stability of operating costs would enhance railroad income, and this was the actual result for the first six months after the emergency charges expired. But, although operating revenues for 1937 were only about 2.5 percent below the 1936-37 twelvemonth, net railway operating income was 19 percent less. This shows the highly adverse effect on operating income of the sharp rise in operating cost which came in the latter part of the year 1937. It has been pointed out that the adjustment in net railway operating income on the basis of changes in rates and costs reduces the figure for the 1936-37 period to $515,694,125, only about 7 percent higher than the average for the three years 1933 to 1935, when we undertook to improve railroad earnings through authorization of emergency charges. Total operating revenues in the 1936-37 period, on the other hand, were 30 percent higher than the average for the three years 1933 to 1935, inclusive.

Lowering of general level of rates and fares since 1929.-Applicants stress the fact that the rise in operating costs has also been accompanied by a lowering of the general level of freight rates and passenger fares since 1929, as measured by average revenues per ton-mile and per passenger-mile. In 1929 the average freight revenue per tonmile for the class I carriers was 1.076 cents. The figure has declined steadily except for a small rise in 1935. In 1936 the average was 0.974 cent, approximately the same as in 1934, 9.48 percent lower than in 1929. Due to the removal of emergency charges and other causes there was a further decline in 1937, and the average for the first eight months of that year was 0.939 cent. The reduction in average revenue per ton-mile is due in some degree to changes in the relative amounts of the various kinds of traffic and to an increase in the average haul resultant from the loss of short-haul traffic; but making allowance for these elements, the freight-rate level averaged 10 percent lower in 1937 than in 1929. The average revenue per passenger-mile declined 36.4 percent from 2.808 cents in 1929 to 1.785 cents in the first eight months of 1937. For all steam roads the average revenue per ton and per passenger-mile would be somewhat greater than for class I roads alone.

Impairment of credit.-Much of applicants' evidence relates to their impaired financial credit and their consequent inability to finance improvements in their facilities to keep pace with the changing character of the service which they are called upon to furnish. Such improvements are also represented as necessary to lower the cost of transportation to the shipper as well as to the carrier, and to increase the productivity of the railroad worker. They may be made only if applicants are able to attract adequate supplies of new money at low cost, and sound credit conditions demand that such financing be not merely by the sale of bonds. The evidence includes an exhaustive statistical survey of railroad capitalization, indebtedness, operating expense, net railway operating income, and other items from 1890 to date. In 1890 the class I railroads operated 156,404 miles of road, compared with 236,878 miles in 1936. Book investment in road and equipment in 1890 was $8,134,000,000 and of class I roads $24,971,000,000 in 1936, which would be stated as $22,212,000,000 if depreciation reserves be deducted. From 1890 to 1930 the investment carried on carriers' books increased at an average rate of 2.37 percent per year. The unreliability of the early investment accounts has been lessened in importance as our work of verification and correction has proceeded and as proportionately large additional amounts have been expended and accounted for under our regulations. Since 1931 there has been a small but steady decline in the aggregate recorded investment. The net capitalization of all steam railroads in 1935 was but 71.9 percent of the recorded investment in road and equipment before depreciation and 80.6 percent after deducting depreciation reserves. There has been a steadily declining trend in this percentage. For 1911 after deducting depreciation the figure was 97.6 percent.

Effect of fixed charges.-For many years net funded debt has constituted about 60 percent of the net capitalization of all steam railroads. Accordingly, as the ratio of net capitalization to recorded investment in road and equipment has declined, the percentage relation of net funded debt to that investment has been lowered. As of December 31, 1935, this percentage was 49.9 percent after depreciation, compared with 59.6 percent in 1911. Likewise there has been a gradual decline in the ratio of fixed charges to investment in road and equipment. Applicants therefore deny that the decline in railroad credit has been due to a weakening of capital structures in relation to investment, and they insist that there has been an improvement in this respect. They also assert that railroad capitalization, particularly that portion consisting of funded debt, is not unduly high in relation to gross revenue, as shown by the fact that, in general, the ratio of operating revenue to net capitalization has shown a rising trend since

1890, although there was a sharp reversal of the trend from 1929 to 1934. This reflects the fact that most of the increase in net capitalization since 1890 occurred prior to 1915, but average annual gross revenue has been much higher since that year than prior thereto.

This evidence tends strongly to show that the major cause of unsatisfactory financial condition of the applicants as a whole is not to be found in excessive fixed charges. As density of traffic has increased, the proportion of operating revenues required for fixed charges has fallen since 1890. The large increases in rates, fares, and volume of traffic following the World War were not accompanied by a corresponding increase in fixed charges, and the ratio of fixed charges to revenues of operating roads fell from 18.2 percent in 1910 to 10.4 in 1920. In 1929 the ratio was 11.4 percent. The extreme drop in revenues in the subsequent depression raised the ratio to 22.3 in 1933, but in 1936 it was 16.9 percent, only slightly less than in 1916, a year generally considered as one of prosperity for the railways. From 1916 to 1936 for all classes of roads the increase in operating revenues was 11.31 percent, in pay rolls chargeable to operating expenses 24.34 percent, in other operating expenses 20.03 percent, in taxes 100.37 percent, and in miscellaneous fixed and contingent charges 8.69 percent. Thus, the pay rolls, other expenses, and notably taxes, increased much more rapidly than the revenues, and the increase in fixed charges showed the least percentage of increase of all these items.

Narrowing of spread between operating revenues and costs.-Concluding from the foregoing facts that the present lack of financial credit of the railways as a whole cannot justly be attributed to an unsound capital structure, applicants contend that it is due to such a narrowing of the spread between operating expenses, including taxes, and gross revenues, as to leave an insufficient margin of safety represented by net railway operating income. This spread determines the proportion of the operating revenue which is available for payment of fixed charges and other deductions after taxes. It is equivalent to the difference between 100 and the operating ratio broadened to include taxes and equipment and joint-facility rents. For individual railroads or particular years this spread is not a safe test of adequacy of earnings, since in times of depression the operating ratio may be kept down by severe curtailment of maintenance, but significantly the spread has been lessening over a long period of years as shown below.

226 I. C. C.

When revenues and expenses are swollen by heavy rate increases compensating for increased operating costs, as happened during 1919, without corresponding reduction in fixed charges, the spread to cover the latter will inevitably decrease.

Although the year 1920, which marked the end of Federal control and the resumption of private operation, was abnormal, the ratio of net earnings to gross was much higher before that year than since. If current cost and rate levels had existed in 1936, the showing in 1936 would have been the most unfavorable of any year since 1920, not excepting 1932. When the volume of traffic is large, as from 1925 to 1929, a decline in the percentage of net railway operating income to gross revenue is not incompatible with railroad prosperity; but if the margin of net earnings is narrow (after taking into consideration the factors mentioned) in average or good years, a protracted period of reduced traffic can hardly fail to produce financial distress.

Because of the combination of circumstances outlined since 1929 railroad bankruptcy has risen to a point never before reached in this country. On October 1, 1937, 96 railroads were in the hands of receivers or trustees. Their operated mileage totaled 71,386, which was 28 percent of the total for the entire country. The inclusion of the Erie Railroad Company and the Minneapolis, St. Paul & Sault Ste. Marie Railway Company, which have since gone into bankruptcy, raises the total mileage to 77,149, and the percentage to 30, certain minor changes included.

Attitude of institutional investors.-Applicants' evidence concerning loss of financial credit was supplemented by testimony on behalf of the Railroad Security Owners Associations, representing the principal investors in railroad securities. Of the total net railroad funded debt of $11,834,000,000 at the end of the year 1936, nearly 56 percent, or $6,617,000,000, was held by insurance companies, banks, endowed educational institutions, and foundations. The holdings of the lifeinsurance companies amounted to $3,267,000,000. In 1931 the life

insurance companies, mutual savings banks, and national banks owned railroad bonds which were about 28.7 percent of their aggregate bond investments, but at the end of 1936 this percentage had fallen to 16.3. These institutional investors, which in the past have been a large source of railroad capital, now regard the railroads (with few exceptions) as devoid of credit. Although eager to secure sound investments for an increasing supply of idle funds, they have been withdrawing from investment in the railroads and declare that they will not resume their investments in railroad securities unless there is a reasonable prospect of adequate and stable earnings.

Market value of securities and stocks.-As further evidence of the low state of railroad credit, it is shown that the average price of railroad bonds listed on the New York Stock Exchange was about 95 early in 1930. It declined to 46 in 1932, recovered to 85.5 in January 1937, and fell to 69, November 1, 1937. On the other hand, the average price of bonds of operating gas and electric companies on the lastmentioned date was 101.68, approximately the same as it was early in 1930. It is true that certain exceptionally well-secured railroad bonds have advanced in price contrary to the general trend, because of declining interest rates. The securities of 20 roads in receivership or bankruptcy dropped from a total value of $3,738,000,000 June 30, 1929, to $630,000,000 November 18, 1937, causing an actual or potential loss to investors of $3,108,000,000. The market for railroad stocks has been more inactive, and their market values have declined in even greater proportion.

Value of the carrier property employed.-Consideration of the need of the applicants for sufficient revenues to enable them to provide such transportation service as is contemplated in section 15a of the act necessarily requires that the fair value of their property be taken into account. Even though the applicants are not here asserting a constitutional right to a fair return of any definite amount, it is necessary for us to inquire into the question of the value of the property employed in performing the service, both because of its bearing upon the economic cost of performing the service, and because of the duty we are under to avoid putting rates upon a basis which would compel the use of the property without just compensation, although the Constitution does not protect against all business hazards, Montana Public Service Comm. v. Great Northern Utilities Co., 289 U. S. 130

There have been submitted and received in evidence, without objection, data prepared by our Bureau of Valuation as to the usually recognized elements of value of railway property, under the usual processes employed. These data have not been questioned by anyone in this proceeding. The estimates covered the original cost of the properties, other than lands and rights; the costs of reproduction new