The hammer rail cloth serves at least two purposes that I can think of. First the elastic properties of the felt help to keep the shanks from getting loose due to wood movement from season to season. When the flanges shrink in the dry seasons (this can be more than 1% in height) the felt acts like a lock washer keeping pressure on the screw. During periods of high humidity the felt compresses allowing the flanges to expand without becoming damaged. Examining flanges screwed to rails without felt liners will show the extent of damage that can happen. The screw heads deeply indent the tops of the flanges, the screws strip out their threads and the flanges become distorted (what does this do to regulation?). As most of us know, in many cases cracks develop. A second more obvious reason is that if and when a flange becomes loose the felt will be there to dampen the noise. I have in the past tried leaving the felt off and using sand paper instead. Returning to the piano after six months or so I usually found the shanks rattling on the rail with nothing left of my careful spacing job. I have since gone back to the traditional felt. The advantages are more stable shank spacing and less damage to the flanges over the long haul. I seam to be in the minority on this subject but I cant help thinking that, in this case, tradition could teach us something. After all what possible reason can there be for leaving this felt off except perhaps to save $10 or to show how clever we are?
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