Notes: Items that Lowenthal Left Out of His Book

The speaker: Walter Colpitts, the legendary senior author of the Coverdale & Colpitts study. The notes: Max Lowenthal's personal notes of the ICC Hearings, July 6-7, 1927.

Commentators had been running down the Puget Sound Extension based on a division of revenues analysis of its contribution to the St. Paul system, which consistently overlooked its importance as a revenue contributor to the system as a whole. It had been proposed that, if the Puget Sound Extension was the burden that some had argued, why not save the "St. Paul" and cut the PCE loose?

Colpitts: "It will be disastrous to the Lines East if the Puget Sound were separated. [There are] possible connections for the Puget Sound [to receive and deliver traffic] ... [but there are] no likely
connections for the Lines East." [Vol 2, page 292, Colpitts testimony, Lowenthal notes].

Milwaukee Road's chief financial officer, W.W.K. Sparrow, had independently analyzed the question. "Any breakup in the St. Paul system would be very bad for both east and west" [although] "there
are several lines with which the Puget Sound Lines could make connections ..." and do good business.

Sparrow pointed out that if the PCE were separated, it would continue to "trade on an equal basis with the Lines East" but could by connecting with the North Western "use the excess [of its trade with
Lines East] for diversion to the Northwestern in exchange for business which the Northwestern would route via the Puget Sound Lines."

"It would be a disastrous thing for the eastern lines to lose that much business." [Vol. 1, p. 78-80].

Already by 1927, knowledgeable insiders predicted that Lines West could survive, but Lines East, on its own, could not. This was testimony presented to the ICC in 1927, which, in the relevant post
above, the ICC seems to have forgotten.

Just as a for-instance. And this "for-instance" has some resonance with the Milwaukee Road in the 1970s. You can read Lowenthal's "The Investor Pays," and not be informed anywhere in it that between 1913 and 1925, the Milwaukee was, after the Santa Fe, the fastest growing railroad in America.

That receivership cannot be explained on the basis of the failure of the PCE to generate a return. Lowenthal ignored that portion of the Engineer's Report, for instance, that showed that the Milwaukee had
generated a better than average rate of return for its investment post-1905 when compared to the average of the peer railroads, NP, GN, CNW, CBQ, MILW, notwithstanding the fact that Milwaukee had made a substantially larger investment than any of its peers.

Well, this cost overrun business on the PCE is my pet peeve.

And it hghlights the problem of historical works that rely on secondary sources. Like the rumor that floats around high school, by the time its done, it barely resembles the original.

A 1901 survey was sent to determine the cost, using "modern technology" and mutliple railheads, and 1901 prices, of duplicating the Northern Pacific Railroad. The 1890s had been a period of
deflation, and so 1901 prices looked pretty good by comparison with what came before, or came after. However, the 1901 estimate was only what it was: the prospective cost of duplicating the NP in that year. It was not the construction estimate used for the Pacific Extension Construction developed in 1905-1906 based on final route selection and the costs of construction of that later time period. The NP
figure was never used as a basis for estimating the costs of the actual PCE construction, nor did Milwaukee Road contemplate building a line as poorly built and located as the NP. It was a hypothetical
exercise. The $45 million is what the surveyor reported. There is no record of what D.J. Whittemore, Milwaukee's Chief Engineer, and one of the most experienced railroad engineers in the country, thought of the estimate since the estimate was not adopted by the Company for any purpose.

The $234 million figure was generated by a lawyer writing an expose about bankers and how they take over valuable properties. That was The Investor Pays by Max Lowenthal (Knopf, 1933).

Lowenthal took the figure from an engineering study done on the Milwaukee in 1925. In that study, a short reference was made to the running investment in Lines West, including costs of construction,
costs of equipment, annual maintenance, additions and betterments, without any deductions for depreciation, scrap, retirements, etc. as of May 1, 1925. It was a different figure on May 1, 1924. and was a
different figure at any given point in time as the bulk of it represented maintenance and equipment acquisition costs, and more so as time passed. By 1925, the PCE was a long ways from the
construction era.

The engineers who prepared the study did not represent the $234 million as a cost of construction.

Nowhere do they even remotely suggest such a thing, and no Milwaukee Road record supports that assessment. It is simply wrong. Lowenthal not only took the number out of context in his book, he
misrepresented its meaning entirely. Whether it was because he didn't understand it, not having anything resembling an engineering background, or purposely mis-stated it is an interesting question.

It would be as though you suggested that the Great Northern Railway cost $1.5 Billion to build and represented this far and wide as Jim Hill's hugely expensive blunder that could never be paid off. because
you would lead everyone to believe that this was the cost of construction of the Great Northern mainline completed in 1893.

You would do that without disclosing that this was a 1970 "figure" and obtained only by adding in 80 years of maintenance, replacement, additions, betterments, all boxcars and equipment ever purchased,
total cost of dieselization, and so forth, without any depreciation or other adjustments.

Did it really cost $1.5 Billion to build the Great Northern Railway? No, at least not in the context implied here. That method of assigning a "cost of construction" is as misleading as can possibly
be because it represents everything under the sun besides the original cost of construction. "Total investment" is a constantly increasing figure with the passage of time and with the passage of
time bears less and less relevance to the actual cost of construction. It is a peculiarly engineering concept that has no basis in accounting.

Lowenthal's use of a 1925 number was odd since the same engineering study that he relied on did, in fact, clearly show that the actual cost of construction through August 1, 1909 was $99 million. The last
spikes were driven in April and May, 1909. The $234 million figure is probably the single most repeated falsehood about the Milwaukee Road, because few, if any, writers go back to the primary source material to assess accuracy once these things appear in print.

Why use the 1925 figure, or a 1917 figure, or a 1952 figure, or a 1980 figure? None of them represent the "cost of construction" as commonly understood in the discussions of the cost of building the
Milwaukee Road.

Lowenthal blundered on his interpretation of the figure and historians and politicians have relied on that blunder ever since. By now, you could cite to any of 100 or so publications all relying on
that single source for that erroneous information.

Here's my problem with most railroad histories. They are hagiographies, pure and simple. That's what readers want to read -- most readers and not looking for real-life case histories, they
simply want a good story -- and that's all that most historians are capable of writing.

And my perspective on that has surely changed since I graduated with a degree in History, and spent my first years in a real job as a professional Historian. The reasons for that change are purely
experience-based. Indeed, it started with a railroad history, "The Investor Pays" by Max Lowenthal, about the Milwaukee Road's first receivership, in 1925.

Starting from a position of admiration for the detail, coherence, and outstanding writing -- purportedly evidencing from a financial perspective, the history of the Milwaukee leading to its first
receivership -- I thought of it as a model of of outstanding historical writing. And it really is a good read.

So much so that I was apparently talking about it one day, and Marc Green, Milwaukee Road's director of publicity, said that he believed Lowenthal was still alive, why didn't I go talk to him, it might be
interesting. The book had been written in 1933, and it didn't dawn on me that Lowenthal might still be around in 1971, but typically, Marc Green seemed to know everybody that ever had anything to do with the Milwaukee, especially in the literary area and sure enough, Max Lowenthal was still alive.

I found a phone number in New York City, and called him up. He was cordial, and said he didn't remember too much about the whole affair but that it had been an exciting project for him. He had kept
voluminous files which he had stored in a barn in Connecticut and ifI wanted to fly out, he would arrange for me to get access to his files.

Well, he died just a few months later and naturally I hadn't had the opportunity to take him up on it. Thought to myself, "oh well," the book was pretty detailed, and I naturally assumed the best stuff was
in the book anyway. Isn't that the point of going to the trouble of writing a book?

Years later, I was on my way to visit Judge McMillen on some Milwaukee Road matters, and someone had mentioned that Lowenthal's papers had made their way to the University of Minnesota. So, on my way, I stopped by in St. Paul to visit the papers. Yes, they had obviously been stored in a barn, and had not been processed yet. Dust, straw, and pigeon poop.

There were several boxes related to his 1933 book, and I waded into them. There I found pages and pages of testimony and exhibits that directly contradicted what Lowenthal had said in his book.
Engineering studies that he had intentionally misrepresented as to their content and meaning. Letters to New Deal politicians/friends discussing the right "spin" for the book. As a trained historian, I
was frankly shocked, stunned, at discovering what Lowenthal had done with the evidentiary record in the case -- which was to distort it completely in the pursuit of a partisan political agenda.

But it had made Lowenthal a hero among certain New Dealers -- William O. Douglas, Roosevelt, Senator Burton K. Wheeler, Harrry Truman. Wheeler made him Counsel to the Senate ICC Committee. He helped draft the Transportation Act of 1940. He was Douglas' "campaign manager" for the vice presidential slot that ultimately went to Truman. He engineered Douglas' appointment to the SEC, then to the US Supreme Court. He was instrumental in Truman's early recognition of the State of Israel. He had frequent dinners at the Felix Frankfurter household. Mrs. Frankfurter had typed the manuscript of "The Investor Pays." He was at the center of a very politically active world.

Looking in on that world was J. Edgar Hoover. For years, ever since the mid-1920's, New York field agents kept reporting that, on their surveillance of known Soviet agents, Max Lowenthal was "visited" on a regular basis. Prominent persons reported to the FBI their own personal belief that Lowenthal was a Soviet agent. Protected by powerful politicians, Lowenthal was appointed to successive positions
of increasing influence. After WWII, he secured an appointment to the sensitive Allied Occupation Authority in Berlin in 1948, just as the Soviet Union was beginning a showdown over Berlin.

Suddenly, he was sent home on orders of General Clay himself, and barred from any further activity on the part of the U.S. Government. As rumors swirled, he fled across the country to a hotel room at the
Shattuck Hotel in Berkeley, California, where he wrote pleading letters to Burton K. Wheeler about what to do if he were subpoenaed before the Dies Committee -- implicitly asking Wheeler to intercede
for him with Martin Dies. I guess he thought he was hiding out. The FBI was right next door.

I stay at the Shattuck from time to time, and was intrigued on one of my visits a few years ago to be assigned to the room Lowenthal had stayed in.

"The Investor Pays" is probably the most influential railroad history book of all time.

It provided a useful impetus for the passage of the Securities and Exchange Acts of 1933 and 1934; it provided the historical and financial "proof" that the capitalists were fundamentally incompetent
or corrupt, or both, and that only a highly regulated government supervision could restrain such excesses as the Milwaukee's Pacific Coast Extension. It also colored the history of the Milwaukee in
perhaps a fatal way, as the PCE was forever assessed in the light of Lowenthal's ringing phrase: "To a quarter of a billion dollar, long- established and profitable railway was added a quarter of a billion
dollar, newly-constructed and unprofitable railway."

As I came to realize that the factual premise of the book was almost entirely an illusion concocted by Lowenthal for political purposes, I also came to realize the damage that "history" books can do.
Lowenthal has been cited uncritically innumerable times. Yet, anyone who actually went back and did a financial study of that era would have seen instantly that what Lowenthal claimed was false.

In general, I don't think historians typically have those kinds of personal agendas -- but they cite Lowenthal nonetheless. Increasingly, I am convinced that historians -- trained in the
traditional fashion that I was -- lack the analytical skills and tools necessary to examine the context of the times -- and with railroading that is primarily an economic and business context for
which the typical academic writer has few qualifications and even less actual experience.

The general railroad history that I see these days, academic or otherwise, is simply not in the same class as genuinely notable works, such as William Cronon's "Nature's Metropolis," Ron
Chernow's "The House of Morgan," "Morgan" by Jean Strouse, "John D. Rockefeller" by Allan Nevins or "Titan" by Ron Chernow.

The "total cost of the PCE" is a phrase that is misunderstood and is one of those unintended consequences of an engineering study attempting to do one thing, an official hearing on the matter stumbling over it, a popular book completely misconstruing the idea, possibly on purpose, and finally, 75 years later, a Trustee citing the misconception as a reason for abandonment.

An analogy might be apropos. If you build your house for $100,000 and then, in 20 years, replace the roof, the siding and the carpeting for $25,000, plus you had it repainted twice in the interim for $1,000 each time. What did it cost to build your house? $100,000 or $127,000? Well it depends on whether you were looking to finance the original cost of construction, or looking to get that home equity loan to finance improvements 20 years down the road. Two different things entirely.

I have not, in 33 years of reading railroad financial literature, ever come across the notion that the "cost to build" something included all of the subsequent "additions and betterments" accrued for all time to

Upon that theory, the Great Northern Railway, by now, ought to have cost a couple of trillion to build west. Well, no, it didn't, but that is the idea if you refer to $253 million as the cost of construction of the
PCE. In any case, Milwaukee is the only railroad I have ever looked at for which the "cost of construction" somehow became, in the public mind, " the cost of construction plus all additions and betterments for the next 20 years, including accelerated additions and betterments because of heavy use due to a world war."

This idea, that the Pacific Coast Extension cost $253 million, however, came out of this process. The source of the figure was Coverdale & Colpitts, Consulting Engineers, attempting to add up "total
expenditures" on the line through December 31, 1924. Did that date have anything to do with the termination of "construction" of the PCE? No. Did it have anything to do with an attempt to create a book value through an accounting methodology? No, depreciation and scrap value are not deducted or accounted for.

What was so magical about $253 million as of December 31, 1924?

The Engineering Report was finished March 16, 1925. That's all.

The numbers have no other significance other than an engineering exercise that had little to do with the construction cost of the Pacific Coast Extension.

The Coverdale & Colpitts figure was 1) not intended to show the costs of construction of the Pacific Extension and 2) was not an accounting exercise intended to show the value of the Pacific Extension on December 31, 1924. C&C generated a number against which they intended to offset total earnings and total capital raised during that time. From this, they intended to create a snapshot of the Milwaukee Road's financial condition at the end of 1924. It was not intended in any way to show the cost of construction of the PCE. Far from it.

However, the number was picked up the ICC during hearings in which none of the original managers of the Milwaukee were around to testify. The attorney examining the engineers did not understand the numbers, and wasn't interested in them anyway except as their use, and not their purpose, seemed to him to underscore his theory that the managers of the Milwaukee did not properly estimate the construction costs, and so shows up in a 1928 "Investigation" report by the ICC.

This in turn enabled Max Lowenthal to report these figures in his 1933 book, "The Investor Pays" as "the cost" of the Pacific Coast Extension.

But, by 1933, it wasn't "the cost" as Lowenthal was using it, not by the methodology used by the engineers for a specific purpose in their study. Rather, by 1933, the figure would have been approximately $309 million. Well, why didn't Lowenthal use THAT figure? Because he didn't understand the purpose of the number in the first place.

Or why didn't Stanley Hillman in 1978 use an estimated "cost" of the PCE, at that time, using that methodology, of $746 million? Why did he, instead, use a valuation of $96 million for Lines West? Well, because Hillman did understand those numbers, and properly offset the use of assets by allocating the expense incurred against the earnings generated by those assets, on an annual basis, through depreciation. Hillman did, however, reflect on the "immense cost" of the original Pacific Extension and proclaimed to a reporter that "the damned thing should have never been built." A historical misunderstanding came to haunt the final years of the Milwaukee Road.

Coming to the Milwaukee with that historical misconception, I think it colored his thinking to the extent that he subsequently misread, or ignored, his own internal studies which showed the PCE as the existing profitable component of the system, and that a reorganized Milwaukee could attain long term profitability only by including the PCE in the reorganization. Hillman's consultants concluded very much the same thing for the same reasons as the Coverdale & Colpitts engineers as summarized by Lucien.

Coverdale & Colpitts generated a number in 1925, a date nearly 20 years after the start of construction of the Pacific Coast Extension. That number, through not deducting deprecation, included substantial annual operating expenses for that 20 year period. By simply adding all the numbers up, without deprecation, the final number included nearly 20 years worth of these "operating expenses," that is, the cost of the use of assets ordinarily deducted as an expense in the year in which they earned a portion of the revenues earned over their service life. On top of that, the C&C number of $253 million included general railroad improvements in track and equipment that was unrelated to the cost of the PCE, except that it was, by then, an operational part of the railroad and incurred those costs. Again, they had nothing to do with the construction cost of the Pacific Extension, absolutely nothing. However, their effect on the general public by this mishandling of the figure in the public record was to overstate the construction cost of
the Pacific Extension by more than double.

What slipped under Lowenthal's radar in the C&C report, maybe accidentally, maybe on purpose [it's tough to write an expose' if there isn't a scandal to expose] was the very positive results of the PCE,
that the company as a whole earned net operating income of $224,876,000 between 1909 and the end of 1917, and that funded debt swallowed only $104,298,000, leaving a net income of $120,578,000 for that 8 year period. This compared with $137,507,000 in net operating income, interest of $49,196,000, or a net income of $88,311,000 net income, in the 8 years 1900 through 1907.

Clearly, the PCE greatly increased the Milwaukee Road's net earning capacity.

"Additions and betterments" are not part of the original cost. Hence their names. As with my house example above, careless reference and use of the figures can result in charging for the same thing -- for instance the roof -- two or more times, as you replace capital assets over time. It is far, far from the original "cost."

That is the source of the historical misunderstanding of the so-called "cost" of the Pacific Extension of the Milwaukee Road.

Final excerpts from the Interstate Commission Report No. 17021, > investigation of the Bankruptcy of 1925.

> 1. The Puget Sound extension.--The construction of this extension > was, perhaps, the chief of the causes which finally culminated in the receivership of the St. Paul.

The bizarre part of this opinion is this conclusion, which was contrary to the expert testimony that the commission received. It was as though "this is our story and we are going to stick with it" no
matter what the evidence. In addition to Walter Colpitts and W.k.K. Sparrow's opinions that, if separated, the Puget Sound extension would do just fine -- it was the Eastern part that was in trouble --
Donald Geddes also testified to that effect.

The Geddes family had a long history with the Milwaukee. Peter Geddes represented the George B. Smith holdings, one of the earliest large ownerships of the Milwaukee Road. Peter Geddes was on the Milwaukee Road board of directors from the early 1870's, and when he retired, his son Donald replaced him on the Milwaukee Board in 1909. For over 50 years, a Geddes was present at nearly every board meeting, and nearly every executive committee meeting. They also sat as active directors on the Union Pacific and other railroad boards.

The Geddes family were private investment bankers, and operated through their firm, Clark, Dodge & Co., 51 Wall Street. The represented George Smith's huge holdings in the Milwaukee. Because of
the long history and intimate knowledge of the Milwaukee's affairs, Geddes was appointed to a special committee in June, 1924, to look into the Milwaukee's financial condition and ability to meet certain
1925 bond maturities. Unlike most of the witnesses during the ICC investigation into the Milwaukee, Geddes had conducted specialized research into the problem based on an extensive and intimate
background and understanding of those problems.

"Geddes ... testified that the chief difficulty in the financial management of the railroad was due to conditions on the eastern end of the line. There, he said, expensive terminals, high operating costs
and short haul business, coupled with freight rates too low to meet these conditions had been chiefly responsible for the financial collapse." New York Times, April 30, 1926.

Now, you will see from the next newspaper dispatch, the ICC's counsel already had a theory and was pushing to prove it, attempting to lead Geddes in a different direction. You might gather that the ICC
opinion on the Milwaukee had been written before the investigation had even commenced and that lawyer Fisher was only interested in supporting a clearly pre-arranged narrative.

"Walter L. Fisher, special counsel for the Commission, made repeated attempts to have Geddes admit the financial structure of the road had been planned unwisely and with lack of reasonable foresight. The
witness, however, refused to agree on this opinion or that it could have been responsible for the present financial condition of the road." New York Herald Tribune, April 30, 1926.

Donald Geddes was one of the most knowledgeable witnesses testifying to the ICC on the Milwaukee's 1925 receivership, and it is interesting how his observations in 1926 were completely excised from
any mention in the ICC report, but it is interesting also how that testimony might have well described the Milwaukee Road in 1977.

Senator Frank Gooding, from Idaho, pointed out during Senate testimony taken at the same time that Milwaukee, after the opening of the Pacific Extension, had become the fastest growing railroad in the
country, eclipsed only by the Santa Fe. He wondered why, if the Extension was not successful, how the Milwaukee managed to obtain such extraordinary growth? You can read the ICC report until you are
blue and not find that fairly significant observation.

Neither the question ... nor the answer.


William O. Douglas is quite a story; from humble beginnings in Yakima, his story reads a little like Wallace Stegner's "The Big Rock Candy Mountain." Douglas always returned every summer to Yakima, to hike and, above all, to fish. His love of nature was so abiding that he was the author of the Supreme Court opinion, involving the Sierra Club, holding that trees have constitutional rights, too.

Early in his career, he worked for Robert Swaine and Donald Swatland at the Law Firm of Cravath, Henderson and DeGersdorf. This is the firm whose main client was Kuhn, Loeb & Company. There, Douglas drafted the Reorganization Plan for the 1925 receivership, the one that Max Lowenthal thought was about as readable to the average investor as Sanskrit. It was there that he spent all night with John J. McCloy drafting the plan and getting it to the printer's, on a deadline, only to be screamed at at 5 a.m. that morning, by Donald Swatland, when Swatland discovered that a portion of the brief referred to his majesty merely as "Donald Swatland." "IT'S DONALD "C." SWATLAND!!!!!" and Douglas was not only not permitted to interlineate the "D." on the offending pages, he had to run it back to the printers to be reprinted with the correct biographical reference. The final copy made to the court appearance on time. Douglas went home exhausted and angry.

His reward was sit in briefly as a Vice President of the Chicago, Milwaukee & Pacific after its organization, and after its name was changed to add "St. Paul" after hollering by the chamber of commerce

Robert Swaine pretty much ran the Milwaukee after the reorganization, until 1935 when the Depression sent many railroads knocking on the doors of the Chicago Federal Courthouse, among them the Milwaukee Road.

The Cravath Law Firm fought tooth and nail to keep control of the Milwaukee, but met on this occasion with an unsympathetic judge, Michael Igoe, (Wilkerson had retired) and an unsympathetic Trustee,
Walter Cummings.

The ICC had been presented with separate plans for reorganization of the Milwaukee and selected a modified bond-holder's plan over a plan submitted by Robert T. Swaine and Donald Swatland. The latter two appealed to the United States Court of Appeals, where Circuit Judge Evans offered his own insights into the Milwaukee Road's recent history.

On the 1928 reorganization, he observed:

"The creditors there took a position which ignored the long view future
of the Debtor, ignored its public obligation character and sought a
reorganization which served only the demands of the
hour, which were met at the sacrifice of the future."

"The Court, unfortunately, was helpless. So was the I.C.C. ... the
present proceedings are the direct result of the ill-advised 1928 plan."

In commenting on the proposed Swaine-Swatland plan, he remarked that "there is neither justification for, nor satisfaction in, a plan which tomorrow brings only a harvest of barren regrets." In re the Reorg.
Chicago, M.St.P.&P.R. Reorganization of the Co. (1942) 124 F.2nd, 754, 757.

I thought that was a great line. If all judges could write like that I'd probably read more of their opinions. However, read the lines, all of them, and compare their applicability to the 1977 receivership ....

Swaine and Swatland immediately appealed to the United States Supreme Court, where the opinion on the appeal was ultimately delivered by Justice William O. Douglas. Now, this is a little strange. Douglas had been a former employee of the law firm of Swaine and Swatland's. He had worked on Milwaukee Road issues while at the firm. Indeed, he had served as vice-president of the newly-organized Chicago, Milwaukee, St. Paul & Pacific Railroad Company when it was still just a corporate shell.

In one of the most unusual cases in the history of the US Supreme Court, a justice was sitting and hearing a case in which he personally knew the parties, had worked for them, and had been an officer of the
very corporation that was subject of the litigation. He had drafted the Plan that had CREATED the corporation that was the subject of the litigation before the Supreme Court.

Douglas apparently actively sought the position of writing the unanimous opinion of the Court. Thomas Ploss, in his The Nation Pays Again thought that it might have been to expiate old sins of having helped to craft Kuhn Loeb's takeover of the Milwaukee in 1926.

Douglas's opinion showed no sympathy for his former employers. A former vice-president of the Milwaukee Road authored the opinion that at last took the Milwaukee Road from the hands that had manipulated the Company into catastrophe. Group of Institutional Investors v. Chicago, M.St.P.&P. R. Co., 318 US 523 (1943). I am sure that Justice Douglas carefully called upon Donald "C." Swatland during oral argument.

Now, I don't detect any reluctance on the part of Douglas to get involved in Milwaukee issues, so I can't see why he would recuse himself from the BN merger case. He was the business expert on the court, and so it would be odd. I can't for the life of me recall why he didn't sit on that case.