When the BNSF derailment at Raymond, Minn., last month came across the news, it was ironically appropriate that I was reading Gillian Tett’s book, “Fools Gold.” It is a superb account of the development of credit default swaps, derivative financial instruments designed to reduce risk, that instead ended up amplifying it, leading to the financial meltdown of 2007-09.
What’s the link? Well, the derivatives that brought our economy to its knees and devastated millions of innocent-bystander households were invented by a team at JPMorgan headed by an intense libertarian who believed that economies performed optimally with little, if any, government regulation. Today, the same is true of the founders of Silicon Valley Bank and of cryptocurrencies. Credit default swaps and SVB ended in debacles; cryptocurrencies eventually will as well.
The cult of this form of economic libertarianism rests on assumptions that several conditions necessary for optimal markets always exist. They seldom fully do. Yes, markets can be productive running largely on their own. These can foster great prosperity. But they can also fail badly.
Now the link: U.S. railroading today is an example of failure. Extreme, but often short-term, efforts to control costs, including reduced maintenance of tracks and of rolling stock, unprecedentedly long trains and pressure for one-person crews, are driving major railroad business to trucking that could otherwise increase the railroads’ own long-term profits. This includes adopting “precision scheduling railroading” that often enrages customers with poor service. Cutting long-term investment in infrastructure and equipment reduces future profitability.
Why do all this? Well, for decades I, like all econ profs, have taught students that when a business can take an action in which the addition to revenues is greater than the addition to costs, it should go ahead as that will increase profits.
But the institutional investors, especially hedge funds, that dominate railroad ownership are more interested in a different metric than total profits. They obsess on “operating ratios.” Yes, this simple measure of operating costs as a fraction of revenues is one useful indicator of a company’s financial health. But in no other industry has an analogous ratio become such a dominant driver of the price of a corporation’s stock.
There is irony in that a half-century ago, institutional investors such as mutual funds or public and private pension plans, were hailed. They promised the pursuit of longer-term goals than did the myriad fickle individual shareholders. This hope has proved vain. Short-termism dominated and the subsequent emergence of hedge funds worsened the problem.
Yes, early railroad barons, including “Commodore” Cornelius Vanderbilt, owner of the New York Central; Edward H. Harriman of the Union Pacific and Southern Pacific, and St. Paul’s own James J. Hill, of the Northern Pacific, are reviled in popular history as rapacious plutocrats obeying Vanderbilt’s famous edict that “the public be damned!” They squeezed their employees brutally, used cut-throat tactics in vying for control of other roads and charged customers monopolistic freight rates and ticket prices however they could.
Yet ironically, as controlling owners for life, they also took long-term views and plowed large fractions of profits into new physical investment to grow capacity and long-term value. Today’s institutional investors, themselves often in fierce competition, spurn that. The libertarian assumption that necessary institutions always exist for markets to efficiently allocate resources is false.
So should all that thinking be tossed aside? No, and that is where we get to recent derailments right here in Raymond or East Palestine, Ohio, and elsewhere.
Libertarian scholars, especially University of Chicago Nobelist Ronald Coase, focused on market-based measures as alternatives to minute command-and-control rules to minimize external costs harming society. Clouds of burning vinyl chloride fumes or caustic anhydrous ammonia leaking from derailed train cars are classic external costs.
The 1980 Staggers Act was one of three major bills in the Carter administration’s deregulation of rates and fees charged in public transportation. Its results have been very positive. But, contrary to some popular opinion, the Carter administration did not reduce government regulation of safety. The Federal Railroad Administration still enforces safety rules and has the power to tighten them.
So, we could reduce derailments and external costs with more minute regulations on inspection of car bearings, numbers of trackside heat detectors, inspections of ties and rails and other risks. We could hire more civil servants to enforce these rules.
Or, following Coase, we could change incentives incorporated in tort liability law. From the English Middle Ages, those harmed by the actions of others bear the burden of proof. They must sue in court for payment of damages. This can be a long and expensive process that can force little people to simply eat their losses.
How about changing the process? A law could require the immediate posting of a $1 million damages reimbursement fund anytime equipment goes off the rails. This could be refunded, in part, but only after the railroad proves that all damage has been fully paid for.
States could have agencies to administer quick payouts. If toxic substances are released or contents burn, make the initial bond $10 million. If some chemicals get in streams or groundwater, put up $50 million.
If told to evacuate your house, you immediately get a minimum $5,000 indemnity check you never have to refund. The village fire department gets called out? $50,000! Go to the ER after inhaling harmful vapors? Collect $10,000 for that visit and more for every night if hospitalized. Actual medical bills get charged to the overall pot. If an initial fund gets depleted, the railroad must top it up immediately.
Yes, let the railroad get money back if the damages are less than the initial fund. But have an independent public commission certify that all damages have been fully compensated before a cent is returned. Let the commission deter unmerited claims, such as mayors from ordering everyone within five miles of one spilled car of corn out of their houses so all can get checks. Just keep the burden of proof on the railroads. Fund the commission with a surcharge on required bonds.
This approach mimics Coase’s classic example of alternate ways of reducing fires caused by cinders from steam locomotives. Locomotive owners or adjacent landowners? Just make it very clear on whom the burden rests. Then they figure out the best way to reduce possible losses.
If railroads faced immediate, up-front penalties for derailments, they would have a financial incentive to reduce the problem. More hot bearing or dragging equipment detectors? More frequent inspection and maintenance of bearings and brakes? Tighten criteria on when to replace rotting ties? Decrease intervals between inspections of rails for breaks or cracks using sophisticated detector cars? Leave all these decisions to the profit-maximizing managers that know their business best.
Yes, there will be “acts of God,” and accidents that pop up even when best practices are followed. Tough, life is unfair. But until now the unfairness has been borne by innocent bystanders rather than the owner of the property causing harm. Simple justice and economic efficiency would both be improved by reversing that default responsibility.
St. Paul economist and writer Edward Lotterman can be reached at [email protected].
