Crédit Mobilier scandal

The Crédit Mobilier scandal, which came to public attention in 1872, was a two-part fraud conducted from 1864 to 1867 by the Union Pacific Railroad and the Crédit Mobilier of America construction company in the building of the eastern portion of the First Transcontinental Railroad. The story was broken by The New York Sun during the 1872 campaign of Ulysses S. Grant.[1]

This article is about the American railroad scandal. For the unrelated French bank, see Crédit Mobilier.
Dale Creek Crossing, completed in 1868 as part of the First Transcontinental Railroad

First, a fraudulent company, Crédit Mobilier, was created by Union Pacific executives to greatly inflate construction costs. Though the railroad cost only $50 million to build, Crédit Mobilier billed $94 million and Union Pacific executives pocketed the excess $44 million. Then, part of the excess cash and $9 million in discounted stock was used to bribe several Washington politicians for laws, funding, and regulatory rulings favorable to the Union Pacific.[2]

The scandal negatively affected the careers of many politicians and nearly bankrupted Union Pacific. The scandal caused widespread public distrust of Congress and the federal government during the Gilded Age.

Background
Further information: Pacific Railroad Acts

The scandal's origins dated to 1864, when the Union Pacific Railroad was chartered by Congress and the associated corporation Crédit Mobilier was established. This company had no relation to the major French bank Crédit Mobilier.

In the Pacific Railroad Acts of 1864–68, Congress authorized and chartered the Union Pacific Railroad and provided $100 million (equivalent to over $1.6B in 2020) in capital investment to complete a transcontinental line west from the Missouri River to the Pacific coast. The federal government offered to assist the railroad with a loan of $16,000 to $48,000 per mile of track , variable according to location, for a total of more than $60 million in all, and a land grant of 20,000,000 acres (8,100,000 ha), worth $50 to $100 million.

The offer initially attracted no subscribers for additional financing, as the conditions were financially daunting.

Obstacles to investment

The railroad would have to be built for 1,750 miles (2,820 km) through desert and mountains, which would mean extremely high freight costs for supplies. In addition, there was the likely risk of armed conflict with hostile tribes of Indians, who occupied many territories in the interior, and no probable early business to pay dividends.[3]

Moreover, there was no existing demand for railroad freight or passenger traffic for virtually the entire proposed route. Since no towns or cities of any significance yet existed on the western prairies, there was no commercial activity of any kind between Nebraska and the California border. Nor were there any branch lines running either north or south of the proposed route that would have been able to expand their traffic by connection with other future transcontinental railways. As a result, private investors refused to invest.

The entire railroad scheme was proposed as a "going concern" — a financially viable idea which relied on "below-market" financing and, thereafter, could continue to function as a business enterprise, covering its operating expenses through freight and passenger rail revenues. while providing profits for investors, interest payments to the US government for its borrowed U.S. government capital (at the Federal funds rate, based upon the US government bond rates), and, ultimately, realizing the retirement of its debt to the U.S. government.

Private capital recognized that the realization of the objectives and economic projections of this proposed model were impossible. There simply was not a foreseeable demand for freight or passenger service capable of generating sufficient revenues.

Opposition

Opponents of the Pacific Railroad Acts believed the whole project was a bare-faced fraud by some capitalists to build a "railroad to nowhere" and to make tremendous profits doing so, while getting the United States government to bear the costs. The opponents of the Acts also thought the construction and its routing were being developed without regard for trying to create a viable and profitable transportation enterprise when the railroad line was completed.

Formation of Crédit Mobilier of America
Thomas Durant, one of the founders of the Credit Mobilier company

George Francis Train and Thomas C. Durant, the vice president of the Union Pacific Rail Road, formed Crédit Mobilier of America in 1864.

The creation of Crédit Mobilier of America was a deliberate façade. Train and Durant aimed to present both to the government and to the general public the appearance that an independent corporate enterprise had been impartially chosen as the principal contractor and construction management firm for the project. In fact, Crédit Mobilier was created to shield the companies's shareholders and management from the common charge that they were using the construction phase of the project, as opposed to the operating phase, to generate profit.

As the conspirators believed that traditional profits from the operation of the railroad could not be expected, they created the sham company to charge the U.S. government extortionate fees and expenses during the construction phase.

Fraud

In simplified terms, the scheme worked as follows:

  • The Union Pacific made contracts with Crédit Mobilier to build the railway at rates significantly above cost.
  • These construction contracts brought high profits to Crédit Mobilier, which was owned by Durant and the Union Pacific's other directors and principal stockholders.
  • The outsize profits were divided among the Union Pacific stockholders.

The directors of the Union Pacific also engaged in stock fraud, circumventing requirements that they receive full payment for stock issued at par by instead paying Crédit Mobilier in bank checks, which Crédit Mobilier then used to purchase Union Pacific stock.[4]

In every major construction contract drawn up between the Union Pacific and Crédit Mobilier, the contract's terms, conditions, and price had been offered and accepted through the actions of the same corporate officers and directors, operating on both sides of the contract. 9The underlying fraud of a common and unified ownership of the two companies, as regards their principal officers and directors, was not revealed for years.

Cover-up

The principal means of the fraud was the method of indirect billing.

The Union Pacific presented genuine and accurate invoices to the U.S. government, as evidence of actual construction costs billed to them by Crédit Mobilier of America for payment. Any audit of the Union Pacific invoices to the government would have revealed no evidence of fraud or profiteering, because the fraud took place one level deeper, on the invoices from Crédit Mobilier to Union Pacific. Union Pacific was accepting for payment genuine Crédit Mobilier invoices (based on fraudulent accounting) and was applying only an overhead expense for management and administration.

If the Union Pacific's corporate officers had openly undertaken the management and construction of the railroad, this scheme to make windfall profits immediately from charges made during construction would have been exposed to public scrutiny by the opponents of the railroad project from the start.

Extent

Congress paid $94,650,287 to Crédit Mobilier via the Union Pacific project, while Crédit Mobilier incurred operating costs of only $50,720,959.

Thus, the deal generated $43,929,328 in fraudulent profits (equivalent to over $724.9M in 2020) for Crédit Mobilier, counting the Union Pacific shares and bonds that Crédit Mobilier bought and paid itself.[3] The Crédit Mobilier directors reported this as a cash profit of only $23,366,319.81, a financial misrepresentation since these same directors were the recipients of the undisclosed $20,563,010 Union Pacific share of the total profits.[3][5]

Bribery
Oakes Ames

In 1867, Crédit Mobilier replaced Thomas Durant with Congressman Oakes Ames.[6]

Ames, still a member of Congress, distributed cash bribes and discounted shares of Crédit Mobilier stock to fellow congressmen and other politicians in exchange for votes and actions favorable to the Union Pacific.[7] Ames offered to members of Congress shares in Crédit Mobilier at its discounted par value rather than the market value, which was much higher due to its superb (but fraudulent) profits and exclusive contract with the Union Pacific Railroad. It also declared substantial quarterly dividends on its stock.

Those allowed to purchase shares at par value could reap enormous capital gains simply by offering these discounted shares on the market, knowing that they would be purchased at a higher price by investors desiring to own stock in such a profitable company. These same members of Congress made the company appear to be profitable by voting to appropriate additional government funds to cover Crédit Mobilier's inflated charges. Ames's actions became one of the best-known examples of graft in American history.

Revelation and political impact
A politicla cartoon depicts Uncle Sam directing Congressmen implicated in the scandal to commit hara-kiri (ritual suicide)

Following a disagreement with Ames, Henry Simpson McComb leaked compromising letters to The New York Sun, a reformist newspaper highly critical of incumbent President Ulysses S. Grant and his administration.

On September 9, 1872, Sun broke the story.[8]The Sun reported that Crédit Mobilier had received $72 million in contracts for building a railroad worth only $53 million.

After the revelations, the Union Pacific and other investors were left nearly bankrupt.[6]

Congressional investigation

In 1872, the (Republican) House of Representatives submitted the names of nine politicians to the (Republican) Senate for investigation:

All of those named were Republicans except Bayard, a Democrat who was largely dropped from the investigation after he wrote a letter disavowing any knowledge.[9] Ultimately, Congress investigated 13 of its members in a probe that led to the censure of Oakes Ames and James Brooks, a Democrat from New York.

During the 1872 campaign, Grant's running mate Henry Wilson initially denied involvement. However, in the February 1873 Senate investigation, Wilson admitted involvement and provided a complicated explanation claiming he had paid for stock in his wife's name, and with her money but had never taken possession of the shares. According to Wilson, when his wife (and later he himself) had concerns about the transaction, the transaction was reversed.[10] Wilson's wife had died in 1870, so senators had to rely on Wilson's word and that of Ames, whose account corroborated Wilson's. The Senate accepted Wilson's explanation, and took no action against him, but his reputation for integrity was somewhat damaged because of his initial denial.

Senator Henry L. Dawes of Massachusetts was also implicated. Dawes had purchased $1,000 in stock and had received a dividend. Dawes later had doubts about the propriety of the stock purchase and cancelled it. Ames returned the purchase price to Dawes with interest and Dawes returned the dividend to Ames. Dawes received $100 in interest on his returned purchase price, but he was not further implicated.[11]

Department of Justice investigation

A Department of Justice investigation was also made with Aaron F. Perry as chief counsel. During the investigation, the government found that the company had given shares to more than 30 politicians from both parties, including James A. Garfield, Colfax, Patterson, and Wilson.

James A. Garfield denied the charges and was elected President in 1880.

This scheme was dramatized in the AMC television series Hell on Wheels, beginning with the November 6, 2011 pilot episode.

The scheme and scandal was proposed as a topic for a musical cabaret in season 10 of the FXX television series Archer.

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See also

References
  1. "The Crédit Mobilier Scandal | US House of Representatives: History, Art & Archives". history.house.gov. Retrieved 2015-12-28.
  2. James Ford Rhodes, History of the United States from the Compromise of 1850 to the Final Restoration of Home Rule at the South in 1877: 1872-1877. Vol. 7, 1916, pp. 1-19.
  3. Rines, George Edwin, ed. (1920). "Crédit Mobilier of America" . Encyclopedia Americana.
  4. White, Richard (2011). Railroaded: the Transcontinentals and the Making of Modern America. New York, N.Y.: W. W. Norton & Company. p. 33. ISBN 978-0-393-34237-6.
  5. Ambrose, Stephen E. (2001). Nothing Like It in the World: The Men Who Built the Transcontinental Railroad 1863-1869. New York, N.Y.: Simon & Schuster. p. 93. ISBN 978-0-405-13762-4.
  6. Trent, Logan Douglas (1981). The Credit Mobilier. New York, New York: Arno Press Inc. p. 6. ISBN 978-0-405-13762-4.
  7. "WGBH American Experience. Transcontinental Railroad | PBS". American Experience. Retrieved 2015-12-28.
  8. "The King Of Frauds: How the Credit Mobilier Bought Its Way Through Congress". The Sun. New York. 1872-09-04.
  9. "The Expulsion Case of James W. Patterson of New Hampshire (1873) (Crédit Mobilier Scandal)". U.S. Senate Historical Office. Retrieved September 30, 2013.
  10. Crawford, The Credit Mobilier of America: Its Origin and History, p. 126
  11. Crawford, Jay Boyd (1880). The Credit Mobilier of America: Its Origin and History. Boston, MA: C. W. Calkins & Co. p. 127.

Further reading
  • Green, Fletcher M. "Origins of the Credit Mobilier of America." Mississippi Valley Historical Review 46.2 (1959): 238-251. in JSTOR
  • Kens, Paul. "The Crédit Mobilier Scandal and the Supreme Court: Corporate Power, Corporate Person, and Government Control in the Mid‐nineteenth Century." Journal of Supreme Court History (2009) 34#2 pp: 170-182.
  • Martin, Edward Winslow (1873). - "A Complete and Graphic Account of the Crédit Mobilier Investigation". - Behind the Scenes in Washington. - (c/o Central Pacific Railroad Photographic History Museum).
  • Rhodes, James Ford. History of the United States from the Compromise of 1850 to the Final Restoration of Home Rule at the South in 1877: 1872-1877. Vol. 7 (1916) online, pp 1-19, for a narrative history
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