There is actually some very interesting history here. The major decisions on which line to keep and which line to shut down were made by New York State DOT. Starting in the early 1970s, NYS became very involved in these lines.
The problems with the Graham line vs. the 'Old Main' predate Metro-North. Back in the early 1970s NYSDOT agreed to fund some improvements to the EL's Southern Tier route with the stated goal of keeping it in service as a freight mainline. Erie Lackawanna had begun rerouting traffic off the old Erie main line between New Jersey and Binghamton in favor of routing traffic via the Lackawanna route via Scranton. (This was also when EL began to regret abandoning the Boonton section through Paterson; instead they used the Greenwood Lake line and it was never really suitable because of the stiff grade at Great Notch which proved to be a continuing operational headache.) Most if not all of the money spent east of Port Jervis went to the Graham Line.
When Conrail came into being the road really didn't want either route -- the passenger line via Middletown or the Graham Line -- but agreed to continue service on the Graham Line in exchange for NYS providing funds for a maintenance upgrade. In 1982 during the planning for the start of Metro-North, NYSDOT decided they did not want to be responsible for two routes between Arden NY and Port Jervis NY (Otisville). Since the Old Main was unsuitable for freight service -- and with NYS&W operating a new stack train service on a portion of the Graham Line -- the decision was made to abandon the passenger route and have Metro-North operate on the Graham Line. There was so little Conrail freight traffic on the route -- one train a day each way I think -- that interference with freight trains was not an issue.
By the time Metro-North service started on January 1, 1983 trains still operated via the old line but station construction was already underway on the Graham Line. Then the operating unions struck Metro-North in early March. When the strike was settled on April 18, 1983 (after a six-week strike) the changeover was made to the Graham Line.
It's been quite a while since I researched this, and I may have a few details wrong or mixed up, but I think this account is pretty close to accurate.
Suburbanite wrote:...And the trip to Port Jervis takes at least an hour longer via the Graham Line...
I don't know where you heard that but back in 1959 No. 59 to Port Jervis departed Hoboken at 5:42 PM for Port Jervis, arriving there via Goshen and Middletown two hours and twenty three minutes later at 8:05 PM. Today Metro-North 59 departs Hoboken at 6:11 PM and arrives at Port Jervis two hours and five minutes later at 8:16.