The Fine Print: How Big Companies Use "Plain English" to Rob You Blind (8 page)

This assertion is belied by Justice Department analyses, and my own, which show that railroad profits rose at an accelerating pace in the 2000s. Rail profits became so robust in the Great Recession of 2009 that the
Journal of Commerce
, the daily newspaper of the freight industry, headlined an article “US Railroads Are Holding Up as the Healthiest Segment of the North American Freight Carrying Industry.”

Buried deep in a Surface Transportation Board report is profit data that could prompt Buffett to dance a jig. In 2008 the industry’s revenue for each mile each ton of coal was shipped shot up 22.1 percent over 2007. This was the year when the Gross Domestic Product, our key measure of economic activity, was virtually flat in real terms and the Bush administration asked Congress for $700 billion to rescue Wall Street. This was the year when the worst economic meltdown since 1932 ravaged the country. But the price of shipping a ton of coal rose 22.1 percent. (That $700 billion figure, by the way, was the equivalent of all of the federal income taxes you and everyone else in America paid from New Year’s Day through Labor Day that year.)

So here we are, talking again about that black residue in the Powder River Basin. How could railroad shipping rates explode when the economy was falling apart? Economic theory says that railroads and others should have been cutting prices to keep from losing business in a recession, especially since the volume of freight being shipped fell. That they did not shows why it’s nice to own legal monopolies, especially when faux “free market” ideology spouted by politicians empowers you to extract more and more from customers instead of coping with the rigors of market competition. When it comes to hauling coal, railroads enjoy monopoly routes, which in turn means monopoly pricing.

Another example? Monopoly power has meant railroads can shortchange maintenance of the rail beds. When derailments shut down coal shipments from the Powder River Basin in 2007, the railroad blamed coal dust, saying it weakened the rail beds. Burlington Northern Santa Fe increased prices to coal shippers, charging them for measures to reduce how much coal dust flew off its trains as they moved down its tracks. What Buffett and other railroad owners really did was simply raise
prices—prices that they knew would be passed on to electricity consumers, making them pay more each month.

A little-known STB policy helps further inflate railroad prices and profits. In judging how much railroads should charge for hauling freight, the Surface Transportation Board uses a standard measure called “cost of capital.” But the cost the STB applies is a fifth higher than what Wall Street analysts use. Inflating the cost of capital distorts economic decisions. Ultimately, artificially inflated costs destroy jobs in industries that depend on goods shipped by rail, including chemicals, coal and grains.

For much of the twentieth century railroad executives complained about union work rules, which they said forced them to retain people whose jobs were no longer necessary. The railroad companies called it worker “featherbedding.” Now we have, by government policy, what might be called “capital featherbedding.” But you won’t hear the railroad executives gripe about that.

4.
In the heart
of Cajun country, Lafayette Utilities System should be able to negotiate a competitive price with the rail companies. From Kansas City on south, two railroads, the Kansas City Southern and the Union Pacific, rumble across Arkansas, delivering Wyoming coal to Louisiana. The presence of rolling stock competing for business would seem to suggest that negotiating with the two railroads would produce a good price. Unfortunately, the game of monopoly has advanced too far for that to happen.

Although both railroads trace the eastern shore of the Red River to Lafayette, the utility’s power plant is twenty miles back upstream on the west side of the river. As it happens, the west bank is Union Pacific’s exclusive province. Well, you might say, why can’t Lafayette negotiate competitive rates from Wyoming to the Lafayette rail yards, then pay Union Pacific a monopoly rate to haul its coal the last twenty miles to the parish’s Rodemacher power plant? Sadly, it doesn’t work that way, and Lafayette pays a monopoly rate for the entire 1,520-mile trip.

“We are a classic captive customer,” said Terry Huval, who runs the Lafayette Utilities System. “On ninety-nine percent of the route we have competitive rail service, so we would like to negotiate for competitive rates on that portion, but we cannot.” The reason is the “bottleneck” decision of the Surface Transportation Board.

In 1996, the STB ruled, in essence, that if any portion of a trip is on a
monopoly rail line, the monopoly rail can charge monopoly prices not just to the nearest junction with another railroad, but all the way. One implication is that bottlenecks become a good thing for railroads. In the case of coal, two-thirds of which moves under this monopoly-pricing rule, bottlenecks have become a very good, very profitable policy for the carrier, but not the customer.

As usual, the implications are broad. Across America nonprofit electric utilities like Lafayette’s, as well as corporate-owned utilities, pay higher freight charges because the government rule favors monopolies (Warren Buffett surely understood this when he willingly paid a premium price to own all of the Burlington Northern Santa Fe). And what of the customers of the utilities that burn coal? The costs get passed on to them because, under rules that apply to corporate-owned utilities, the rates customers pay may include any reasonable amount paid for fuel, making these utilities largely indifferent to how much the railroads charge to deliver coal.

You’re probably wondering what this means to your monthly electric bill. Thanks to Congress, you’re not really allowed to know that.

Recall the Staggers Rail Act, the 1980 law that was going to bring competition to the railroad industry. Under the terms of the legislation, railroads do not have to publish the prices they charge to haul freight the way that, say, Amtrak and passenger airlines do. Instead, the Staggers Act encourages railroads to negotiate individually with their customers on the theory that this will promote competition. The Staggers Act also lets the railroads
require
that the contract terms be kept confidential, even when the customer is a public entity such as the Lafayette Utilities System.

“I’d tell you the terms of our contract if I could,” Huval said. Even though he couldn’t tell me the particulars, he did describe the big picture. According to Huval, Union Pacific’s monopoly pricing costs his community about $6.5 million per year. And the figure keeps rising.

Union Pacific’s picking of Lafayette’s pockets works out to more than a dollar per week for every man, woman and child in Lafayette, more than $200 annually for a family of four. That’s more than enough to finance a 10 percent cut in Lafayette property taxes. Or it could cover free electricity to Lafayette schools and colleges, relieving taxpayers of that burden, with enough left over for a small property-tax reduction.

Looked at another way, that $6.5 million per year could be spent on local goods and services for the benefit of Lafayette’s businesses and workers. Instead, it is extracted from the wallets of local residents and
businesses and sent to Omaha, home to both Union Pacific and BNSF owner Warren Buffett.

Lafayette is far from alone in being railroaded into paying higher prices. Charging monopoly rates for an entire route, not just the small portion served by one railroad, is common. Few rail customers have direct access to two or more lines, and railroads work hard to make sure they can protect their monopoly pricing power. Since half the electricity in America comes from burning coal, we can multiply the numbers from Lafayette by all the communities whose electric power comes from burning coal and reach the unsurprising but still shocking conclusion that billions of dollars are being extracted through monopoly pricing. The total cost of monopoly pricing nationwide is easily $6 billion per year; if Lafayette’s experience is in the middle range of price gouging, the cost may exceed $8 billion per year nationwide.

In a quirky turnabout, the “bottleneck” decision from 1996 was challenged by another utility, none other than Warren Buffett’s MidAmerican Electric Holdings. In early 1999, the decision of the Eighth Circuit Court of Appeals made clear the judges did not agree with the policy; still, they upheld the bottleneck decision. The decision found that, since the rationale given for “bottleneck” pricing was neither arbitrary nor capricious, it would stand.

COUNTING CARS AND CALCULATING COMPETITION

Monopoly rates allowed by government rules are just part of the story of how monopoly railroads pollute the economy. The official data on how many freight cars the railroads own suggest a decline in the American rail system, but the actual number of railcars in use has gone up, not down. The explanation for this apparent contradiction is that railroads now demand that more customers supply their own railcars.

Let’s go back to Lafayette, a city of a little more than 120,000 people. As a railroad customer, it had to pay half the $16.5 million cost of buying 246 aluminum railcars. The railroad paid nothing, since customers of neighboring electric-utility systems paid the balance. For residents of Lafayette, the cost came to about $200 for every household for the new cars.

Big railroads also erect “paper barriers” to block competitive pricing. The big railroads go to the myriad little mom-and-pop railroads, making offers they cannot refuse: agree to an exclusive relationship—or get cut
off. As Mark Cooper, director of research at the Consumer Federation of America puts it, paper barrier contracts memorialize, in essence, the edict “Thou shalt not compete or do anything that promotes competition.”

What does the railroad industry have to say for itself? In speeches, in testimony to Congress and in disclosures to shareholders, rail industry leaders describe a tremendously competitive market, one in which the railroads are under siege by truckers, barge operators and pipelines trying to take away their business. As you would expect, each railroad has reliable expert witnesses who testify in trials and present politicians with studies that show how tough it is to make a profit running a railroad. Even more powerful than expert witnesses are the government insiders with whom the railroads have established relationships that serve their interests—often at the expense of the consumer. Two quick examples: When Linda Morgan left the Surface Transportation Board in 2002 she was its chair; she joined Union Pacific as one of its top lawyers. Less than four years later, her successor, Roger Nober, left the government board only to resurface, exactly one year and one day later, as executive vice president and chief lawyer at Buffett’s BNSF. They are just two of the many who reaped the rewards of having been reliable industry allies while in government.

The rail industry is quick to challenge anyone who questions its power, its misleading use of statistics or its stranglehold on the economy, asserting that critics really want to destroy a crucial mode of transportation. This is poppycock, of course, but given how little most journalists know about business—and especially business law—outraged railroad voices with one simple message often succeed in drowning out those that describe the complexities of a modern octopus that has businesses and communities in a stranglehold.

Lafayette’s Huval offers a fair-minded view from the middle of the fray. He reports that his nonprofit electric utility “supports a strong national coal delivery network by rail,” before adding a crucial qualification: “It is in the national interest to have a railroad system built on reasonable, not predatory, pricing and service.”

That brings us back to another common complaint concerning monopoly railroads: quality of service. In a competitive environment, there’s pressure not only to match or better a competitor’s prices but to provide reliable service so the customer will not shift allegiances. But just as the wheat farmers in Montana and Idaho sat powerless, their harvests sitting trackside while prices fell, so electric utilities suffer from sporadic coal
deliveries. In 2005 and 2006 the Union Pacific provided such atrocious service that the Lafayette Utilities System had to import coal from Venezuela (which, by the way, was shipped by barge). At times the system had to truck low-quality lignite coal from northern Louisiana to keep the lights on. Competitive businesses would pay dearly for providing such unreliable service, but government-protected monopolies can disregard customer need yet keep on making huge profits.

The so-called unit train is a transport practice that has worsened customer service in recent years. The most efficient way to run a railroad is nonstop between two points, with two or three locomotives pulling a hundred or more fully loaded railcars at slow speeds. Such unit trains are extremely efficient because once a train is moving, fuel consumption drops dramatically (as we’re reminded often by the CSX Transportation commercials boasting of moving a ton of freight more than two hundred miles on one gallon of diesel). The same principle applies to airplanes, which gulp fuel on takeoff but sip at cruising altitudes; thus, a direct flight from New York to San Francisco consumes much less fuel than connecting flights that carry the LaGuardia passenger to the same final destination but connect at St. Louis and Salt Lake City.

That said, neither passengers nor every piece of freight shares the same cost-effective destination and point of departure. When in-between and tangential destinations are factored in, a network develops. Though that’s part of the fabric of modern economic life, it runs counter to the ideal model for reducing rail operation costs by scheduling fewer trains that pull more cars with fewer stops. Increasingly, manufacturers and farmers have been pressured to alter their business to suit the railroads.

In the past, manufacturers constructed their factories near mainline railroad lines, often with a siding so they could load boxcars with their products for pickup every day or two. But in the new world in which railroads dictate to customers, the manufacturer must face added costs, cash-flow impacts, and slowed delivery times when the train stops only once a week. Such erratic rail service forces some businesses to switch to trucking, which can cost four times as much. It’s also one of the myriad reasons why 56,000 American factories have closed and jobs moved to China in recent decades. Today trains run an average of 900 miles between stops, half again as many as the 600 or so in the 1970s. More long-haul unit trains, fewer stops and inflexible rules have meant, in short, many fewer freight cars stuffed with American-made goods.