(FORTUNE Magazine) – WHEN the U.S. government sold Conrail in March, records fell right and left. At a price of more than $1.6 billion, it was the largest initial public offering in U.S. history. With railroads, investment banks, and other companies spending hundreds of thousands in Washington to press their views, the deal was also one of the most expensive lobbying efforts ever. The Conrail sale signaled the dramatic start of the Reagan Administration's move toward privatizing big federal projects. It may also have heralded the end of that effort (see box). The six-year ride from when the Administration first looked into selling Conrail until the CRR symbol lit up on the New York Stock Exchange was tiring and bumpy, and demonstrated how painfully difficult it is to unite government and Wall Street even behind such an eminently reasonable idea as placing a once bankrupt federal operation in private hands. Although Ronald Reagan campaigned in 1980 on a pledge to sell to the private sector businesses that government should not be in, the President stayed above the Conrail fray, partly because the details were tedious. ''When you talk about housing and transportation, the President's eyes glaze over,'' says a former White House aide. His Department of Transportation, under the leadership of Secretary Elizabeth Hanford Dole, resisted selling stock in Conrail to the public, the freest of free-market solutions, until the end. The unlikely savior of the public offering was a Democrat, Representative John Dingell from industrial Dearborn, Michigan, the chairman of the Energy and Commerce Committee. His ally: Morgan Stanley, a big, aristocratic New York investment bank. Says one of the participants: ''It was wild. All of the roles were reversed.'' To fully savor this tale of a world turned upside down, it may help to have a precis at the outset. In 1976 the government assembled Consolidated Rail Corp. out of the financial wreckage of Penn Central Railroad and five other bankrupt Northeast lines. As soon as Reagan came to Washington in 1981, Transportation Secretary Drew Lewis started looking for a way to get rid of Conrail. Dole inherited the project from Lewis when she became Secretary in 1983 and by February 1985, after lengthy study, decided to sell Conrail to Norfolk Southern Corp., in the process rejecting the alternative of a public offering. The Senate, no doubt at least somewhat influenced by her husband, Bob Dole, then majority leader, approved her plan 54 to 39 the following February. Several months later, however, Congressman Dingell declared he could not support the Norfolk Southern sale. Mrs. Dole capitulated. In retrospect, Dole, 50, and Deputy Transportation Secretary James Burnley, 38, on whom she relied heavily, were wrong for the job of selling Conrail. Not that they lacked integrity, dedication, or intellect. Both Liddy Dole, a Phi Beta Kappa from Duke, and Jim Burnley, a magna cum laude from Yale, are Harvard Law School graduates. But they thought too much like lawyers; they were cautious and legalistic to the point of rigidity. Twice Dole asked Goldman Sachs, the DOT's financial adviser on Conrail, to look into a public offering that would have preserved the railroad as an independent company. Twice she rejected such a scheme because of the twin risks it carried: In a bear market Conrail might not be able to sell all its shares; in a bull market the issue might be underpriced, leaving too much money -- taxpayers' money -- on the table. ''I had to think of the public interest,'' says Dole, holding her hands around her eyes like blinders to emphasize the narrowness of her focus. ''We were lucky the market was so good on March 26 when we sold Conrail. A week later the market had dropped almost 100 points.'' She neglects to mention that Conrail shares did not suffer (see Personal Investing). Burnley is a conservative Republican who, according to those who have worked with him, has a phobia about Democrats that goes beyond the requirements of his political persuasion. His feelings about the party in control of the House made him just as fearful of a public offering as his boss. Suppose the market wouldn't take Conrail in a single bite and the railroad had to be sold off in pieces over a long time. As long as the government owned even just a piece of Conrail, Burnley worried, Congress would treat it like a cow, milking it for cash when the railway business was good and feeding it subsidies when times were bad. Above all, Dole and Burnley did not want Conrail, which had already taken $7 billion in federal handouts, coming to the Treasury for more. They reckoned that the safest thing to do with this cripple was put it in a stable, supportive home through a private sale. After looking at 15 bids, they accepted the one that seemed to offer the sturdiest shelter, Norfolk Southern, one of the best-managed railroads in the country. What brought Dole and Burnley to this pass was their unshakable assumption that Conrail was a loser, an attitude established at DOT before they arrived. Because freight revenues in the slow-growing Northeast were not likely to rise, Dole felt duty-bound to advertise the product she was selling as a lemon -- not a technique that Lee Iacocca would use. Stephen Berger, a former investment banker who from 1980 to early this year headed the U.S. Railway Association, an agency created by Congress to oversee Conrail, says: ''I've bought and I've sold, but when I've been selling I've never made it a point to knock the product.'' THE IRONY IS that even though Dole and Burnley genuinely believed they were peddling a clunker, this was no longer the case. In 1981 Conrail got an inspiring new chief executive, Stanley Crane, a sort of Sugar Ray Leonard of the railway industry: small, smart, scrappy, and bored in retirement. The year before, at age 65, Crane had been forced to step down as chairman of Southern Railway Co., shortly before it merged with the Norfolk & Western Railway to become Norfolk Southern. Conrail hired Crane as chairman. After studying the situation, he concluded that the railroad could be run for profit, and launched an effort to win Congress and the workers to his view. Crane acknowledged that revenues were not likely to highball, but he knew as well as any railway man the other way to skin the cat. He cut costs, with enormous help from federal legislation that allowed him to abandon some freight routes, turn over commuter operations to local governments, and lay off excess workers with settlements of up to $25,000 each. In 1981 Conrail made a small profit. Dole's decision to sell the newly profitable Conrail to Norfolk Southern did not please some of her supporters. The Heritage Foundation, a Washington think tank that serves as a sort of theological seminary for Reagan Administration clerics, favored a public offering that could work as a model for future privatizations. Daniel Burke, the president of Capital Cities/ABC and a Reagan-appointed member of the Conrail board, let it be known that he was willing to consider a public offering. The Thatcher government had impressed him with its public sale of British Telecom. Burke says: ''The American taxpayers had put a lot into Conrail, and I thought they were entitled to buy in if they wanted to.'' In response, Burnley told Burke he would not be reappointed to the board. Determined and inflexible, the Department of Transportation isolated itself in its Seventh Street fortress. Proponents of the public offering made their case to Joseph R. Wright, deputy director of the White House's Office of Management and Budget. When Burnley found out the antimerger forces had taken a back door to the White House, he told Wright to mind his own business: The Conrail sale was a DOT matter. Much to the anger of Dole and Burnley, Crane fought the proposed sale like any chairman threatened with a hostile takeover. Crane's most important ally was Thomas A. Saunders III, 50, an intense and ferociously competitive managing director of Morgan Stanley. Crane had hired Saunders to see how Conrail could become independent. The investment banker came up with a plan in which a syndicate of big investors, including Harvard, Princeton, and Stanford universities, the CSX railroad, and Morgan Stanley itself, would buy Conrail. The government would get a guaranteed $1.4 billion up front, eliminating the uncertainties of a public offering. The investors would later sell shares to the public. Dole told Saunders, in effect, to get lost. ''There were too many ways for the investors to get out at the last minute,'' she says. ''Norfolk Southern was cash on the barrelhead.'' Saunders, a relentless salesman whose aggressiveness would be insufferable if it were not softened by a Virginia gentleman's manner, declined to give up. Morgan Stanley let him gamble what may have been as much as $5 million on efforts to secure an independent Conrail. And so the great lobbying war began. On one side were Conrail, Morgan Stanley, and CSX; on the other the Department of Transportation and Norfolk Southern. Each competitor hired K Street lawyers and lobbyists by the dozens. ''If you laid the lobbyists out like ties, you could have built another railroad,'' quips Berger. The pro-public-offering forces pointed out that at the $1.2-billion figure proposed by Norfolk Southern, Conrail was a bargain. The railroad had over $800 million in cash and another $300 million in securities above what it needed to fund its pension plan. Also, Norfolk Southern would have been able to reduce its taxes by using Conrail's depreciation and investment tax credits. That could have cost the Treasury $400 million or more. By selling Conrail to another railroad the government would be taking a big hand in consolidating the railroad industry. Such a move represented a significant departure from the policy that railroads should initiate mergers and government should decide whether the proposed combinations violate antitrust laws. Besides, the anti-Dole forces argued, the merger threatened to reduce competition in another way. Even though trucks fight penny for penny with the railroads to haul cargo everywhere in the East, some commodities, such as coal and bulk chemicals, move almost exclusively by rail. The Conrail- Norfolk Southern merger would have put CSX at a considerable disadvantage. Norfolk Southern would be able to ship paper from Georgia mills to New England over its own track, for example, while CSX would have to hand that load over to the merged Conrail to reach the same market. THE SENATE WAS the first to judge between Crane's arguments for an independent Conrail and Secretary Dole's push for cash. The two antagonists went to extraordinary lengths to get regional politicians, shippers, and voters to pressure Washington. Morgan Stanley staked out governors' conferences and sponsored symposiums where state transportation officials were briefed on Conrail's prospects. The firm dispatched a managing director to alert city fathers in Seattle and Tacoma and Portland, Oregon, that if Norfolk Southern were to take over Conrail, traffic patterns in the Northwest would suffer. Rubber from Singapore that now disembarks at Northwestern ports, for example, might be unloaded in New Orleans. Meanwhile, Dole spent days in the halls of Congress and hours on the telephone seeking support. Norfolk Southern and its staff of four professional lobbyists, including Edward T. Breathitt, a former governor of Kentucky, spent at least $3 million to promote the sale. Mrs. Dole's powerful husband did not buttonhole his Senate colleagues for votes; since his sentiments were obvious, he did not have to. Saunders, the outsider, didn't seem to stand much of a chance in the Senate. He kept roaming the corridors of power, though, pushing open the great mahogany doors. Behind them he discovered Senators like Russell Long, who was thoroughly familiar with the pros and cons of public offerings, and Sam Nunn, who invited the combatants to debate in his office so that he could master the issues. But Saunders also found many other lawmakers who were poorly informed and preferred to stay that way. One elderly Senator, after years of hearing about Conrail, did not realize the government still owned it. ''Senators kept asking things like, 'What does Morgan Stanley know about running a railroad?' '' says Saunders. He pointed out to them that under the American system those who buy and sell the stock do not necessarily run the company. When the Senate finally voted to go along with the sale to Norfolk Southern, the battle shifted to the House, where the Democrats were in control. As Burnley feared, the Democrats were less enthusiastic about privatization than the Republicans. But on the subject of a Conrail public offering, the Democrats were open-minded. For one thing, labor was not opposed. In the end, Conrail's future rested with one man, the imperious Congressman Dingell. The Conrail bill, like more than a quarter of all legislation, had to pass Dingell's committee. Observes lobbyist Breathitt: ''There were two keys to getting the merger approved by the House -- find out what Chairman Dingell wanted and give it to him.'' What Dingell wanted was facts. ''I wasn't especially excited about doing anything with Conrail,'' he says. ''It was making money for the government. But I felt if you're going to sell a damn railroad, do it right.'' His staff surveyed several dozen shippers and discovered that many were concerned that a merger might reduce competition and drive up costs. Dingell cooled to the merger plan. TO HELP ANALYZE the public offering, Dingell turned to what might seem an improbable source -- a rare and trusted friend on Wall Street, namely Frank Zarb, senior partner of the investment company Lazard Freres. For 2 1/2 years Zarb had been energy czar in the Ford Administration, and Dingell, as head of the committee inspecting Zarb's labors, had made his life miserable. But when Zarb moved to New York, the two became friends and hunting buddies. ''The firm came to the conclusion that a public offering would work,'' says Zarb. ''And the government should get at least $1.8 billion.'' In the unlikely friendship of Dingell and Zarb, Wall Street and Washington saw eye to eye. The proposal to sell Conrail to Norfolk Southern died in Dingell's committee. Congress later voted to endorse the public offering. Ultimately Dole embraced the public offering. She graciously salutes her former adversary, Stanley Crane, with whom she had not spoken for more than two years, as ''a fine railway man.'' For the record he considers her a ''fine Southern lady.'' The taxpayers came out well. As a condition of the sale, the government was allowed to get $300 million back from Conrail before the offering. Since the issue yielded $1.65 billion, minus $70 million for underwriting fees, the government netted $1.88 billion from the sale. Before it quit the field Norfolk Southern had upped its offer to $1.9 billion, but that figure included $500 million of Conrail's assets. Dingell called the bid ''a shell game.'' At the insistence of Congressman Dan Rostenkowski, chairman of the Ways and Means Committee, Congress wrote down the value of Conrail's assets before the sale, which will lower the amount of depreciation the railroad can claim in the years to come and therefore raise its taxes. If that hadn't happened, Conrail could have been worth roughly $200 million more in the public offering. Though the free-market forces won in the end, the Conrail saga points out that Wall Street and Washington are separated by more than a few hundred miles. Representatives of the securities industry, who are likely to be before Congress testifying about insider trading or lobbying against restrictive legislation should learn from the Conrail epic that most lawmakers do not understand what investment bankers do, and most regulators, even those in a sympathetic Administration, do not care. One more lesson for Wall Street firms: Try to iron out your differences before you go looking for something on Capitol Hill. Goldman Sachs and Morgan Stanley spatted about which would be first among equals as underwriters for the initial public offering. In an unusual arrangement six main underwriters get equal fees of about $7 million each, but only one can boast that it managed the issue. Goldman had a claim to that honor because its contract with the Department of Transportation stipulated that if Conrail were sold in a public offering Goldman would be lead underwriter. Morgan Stanley insisted that its unceasing efforts for the issue entitled it to the prize. For two successive weekends, Zarb refereed a nasty argument between the two, finally deciding in Goldman's favor. He says of the squabble: ''It could have blown up the public offering.''

BOX: WHY PRIVATIZATION IS STALLED When the sale of Conrail was almost complete, some supporters of privatization gathered to celebrate, and Ronald Reagan asked: ''Okay, when do we sell the TVA?'' The faithful looked at their shoes. The President told about a tiff he had had with TVA years ago. Everyone laughed. Then someone changed the subject. TVA is not likely to go on sale. Nor are many other major federal assets the Administration would like to put on the block except perhaps for loans. Not just in the U.S., but around the world, governments are meeting resistance in trying to unload projects and properties that the private sector could run better. Of 1,000 attempts to privatize state-run operations, only 150 have been successful, says the International Monetary Fund. In the U.S. the movement has stalled for several reasons. TVA and other major agencies that produce electric power, like Bonneville in the Pacific Northwest, will not be sold because the buyers would inevitably raise rates , for local customers. ''Legislators from those regions would be nailed to a cross before they'd allow anything like that,'' says a Congressman. In fact, Congress passed legislation forbidding the Administration from even thinking about such sales last year. Amtrak, which operates passenger trains across 24,000 miles of track, might seem likely to chug off into the private sector after Conrail. Indeed, the Administration is counting on the sale of Amtrak's Northeast corridor to reduce the deficit by as much as $1 billion in the next fiscal year. But no buyers have stepped forward. Amtrak trains do not make enough to cover operating expenses, much less provide for capital improvements. The government also wants to sell off the Naval Petroleum Reserves, oil fields in California and Wyoming. But oil prices are so low that a Mobil or an Exxon might not be willing to pay more than $5 a barrel. At that price, some politicians would surely cry sellout. Stuart Butler, a Heritage Foundation scholar, thinks that if Conrail had been sold quickly and smoothly through a public offering, the deal would have served as a model for spinning off the petroleum reserves as an independent company. Since the Conrail sale was anything but smooth, the chances of selling the petroleum reserves are slim.

CHART: INVESTOR'S SNAPSHOT CONSOLIDATED RAIL

SALES (LATEST FOUR QUARTERS) $3.2 BILLION CHANGE FROM YEAR EARLIER DOWN 0.1% NET PROFIT 234.0 MILLION* CHANGE NA RETURN ON COMMON STOCKHOLDER'S EQUITY 7%* FIVE-YEAR AVERAGE NA RECENT SHARE PRICE $30.75 PRICE/EARNINGS MULTIPLE 9* TOTAL RETURN TO INVESTORS (INITIAL OFFERING TO 4/24) 0% PRINCIPAL MARKET NYSE

*Pro forma figures.