Crédit Mobilier of America scandal
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The Crédit Mobilier scandal of 1872 involved the Union Pacific Railroad and the Crédit Mobilier of America construction company (no relation to the French Credit Mobilier) in the building of the eastern portion of the First Transcontinental Railroad.
The scandal's origins dated back to the Abraham Lincoln presidency, when the Union Pacific Railroad was chartered in 1864 by the federal government and the associated Crédit Mobilier was established. In 1868 Congressman Oakes Ames had distributed Crédit Mobilier shares of stock to other congressmen, in addition to making cash bribes, during the Andrew Johnson presidency. The story was broken by the New York newspaper, The Sun, during the 1872 presidential campaign, when Ulysses S. Grant was running for re-election.
The federal government in 1864–1868 had authorized and chartered the “Union Pacific Railroad,” with $100,000,000 capital, 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, according to location, for a total of more than $60,000,000 in all, and a land grant of 20,000,000 acres, worth $50,000,000 to $100,000,000. The offer initially attracted no subscribers for financing, as the conditions were daunting. The railroad would have to be built for 1,750 miles through desert and mountain, 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.
George Francis Train and Thomas C. Durant, a vice president of the Union Pacific Railroad, formed the Crédit Mobilier in 1864. The original company, Pennsylvania Fiscal Agency, was a loan and contract company chartered in 1859. The creation of Crédit Mobilier of America was a deliberate attempt to falsely present to the Government of the United States and to the general public the appearance that a corporate enterprise (independent of the Union Pacific Railroad and its principal officers) had been impartially chosen by the Union Pacific Railroad’s officers and directors to be the principal construction contractor and construction management firm for the Union Pacific Railroad project. It was created by the officers of the Union Pacific to shield the companies' shareholders and management from the then common charge that they were using the construction phase of the Union Pacific project (as opposed to the operating phase of carrying passengers and freight), to line their pockets in excess profits. They believed that profits could not be generated from the operation of the railroad. So, they created a sham company to charge the U.S. Government extortionate fees and expenses during construction of the line.
In simplified terms, the Crédit Mobilier fraud worked in the following manner. The Union Pacific made contracts with Crédit Mobilier, paid by check, to build the Union Pacific railway. The Crédit Mobilier used these checks to buy stock and bonds in the Union Pacific at par value, the crux of the fraud. They sold the bonds on the open market to make huge profits. These construction contracts brought high profits to the Crédit Mobilier, which was owned by Durant and the other directors and principal stock holders of the Union Pacific. The Crédit Mobilier split the outsize profits with the UP stockholders. The net result was that the U.S. Congress paid $94,650,287 and $50,720,959, respectively, to the Union Pacific and Crédit Mobilier. The deal generated $43,929,328 in profits, counting at par value the shares and bonds that Crédit Mobilier paid itself. The Crédit Mobilier directors reported this as a cash profit of only $23,366,319.81, a financial misrepresentation.
If the Union Pacific’s corporate officers had openly undertaken the construction of the railroad, this scheme (to make windfall profits immediately through charges during construction), would have been exposed to public scrutiny. It would have provided proof to the opponents that the western transcontinental railroad plan was an unprofitable venture. The opponents believed that the whole project was an ambitious fraud by some capitalists to build a "railroad to nowhere" and to make tremendous profits doing so, all the while getting the United States Government to pay for it. They thought that the construction and its routing were being developed without regard for trying to create a valid and profitable transportation enterprise when the railroad line was completed.
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 for construction costs, which were generated by Crédit Mobilier of America and presented to the Union Pacific Railroad for payment. The railroad then prepared meticulously detailed invoices to the U.S. Government, requesting payment for these bills, accrued by the Union Pacific from Crédit Mobilier, for the construction of the line, with only a small additional fee over the cost stated on the Crédit Mobilier invoices, for the Union Pacific's overhead expenses.
Any audit of the Union Pacific and its invoices to the U.S. Government would have revealed no evidence of fraud or profiteering. Union Pacific was accepting for payment genuine Crédit Mobilier invoices and was applying an auditable overhead expense for management and administration during construction of the railroad.
The underlying fraud of a common and unified ownership of the two companies, as regards their principal officers and directors, was not revealed for years. Nor was it revealed that in every major construction contract drawn up between the Union Pacific and Crédit Mobilier, the contract’s terms, conditions and price had been offered (by Crédit Mobilier) and accepted (by the Union Pacific) through the actions of corporate officers and directors who were one and the same persons. The company sought, and was largely successful, in maintaining this fraud and its secrecy by giving discounted (well below the market value, of this highly profitable company) shares of stock (in Crédit) to those members of Congress who also agreed to support additional funding for the railroad. Because of its excessive charges for building the line, the company fully expected that the Union Pacific would have to return to Congress to gain appropriation of additional construction funds. For its time, it was a very sophisticated corporate scam, and it was, at the time, mostly legal.
In 1867, Crédit Mobilier replaced Thomas Durant as its head with the Congressman Oakes Ames. In that year Ames offered to members of Congress shares of stock in Crédit Mobilier at its discounted value rather than the market value, which was much higher. The high market value of the stock was due to the superb performance of Crédit Mobilier of America as a corporation; which was in turn due to its major contract with the Union Pacific. Crédit Mobilier was the exclusive construction and management agent for the building of the Pacific Railroad. The Union Pacific "suspected" nothing, and they "paid" Crédit Mobilier (actually themselves) whatever "they" were asked to pay. Crédit Mobilier's corporate balance sheet regularly showed high earnings in excess of its expenses, and very high net profits in every quarter that it was engaged in the construction of the railroad. It also declared substantial quarterly dividends on its stock.
The Congressmen and others allowed to purchase shares at a discount could reap enormous capital gains simply by offering their discounted shares to a grossly under-subscribed market, where demand was high for shares of such a “profitable” company. These same members of Congress voted to appropriate government funds to cover the inflated charges of Crédit Mobilier. Ames' actions became one of the best-known examples of graft in American history.
During the 1872 presidential campaign, the New York City newspaper, The Sun, broke the story. The paper opposed the re-election of Ulysses S. Grant and was regularly publishing articles critical of his administration. Following a disagreement with Ames, Henry Simpson McComb, an associate of his and a later executive of the Illinois Central Railroad, leaked compromising letters to the newspaper. 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.
Investigation and outcome
In 1872, the House of Representatives submitted the names of nine politicians to the Senate for investigation: Senators William B. Allison (R-IA), James A. Bayard, Jr. (D-DE), George S. Boutwell (R-MA), Roscoe Conkling (R-NY), James Harlan (R-IA), John Logan (R-IL), James W. Patterson (R-NH), and Henry Wilson (R-MA); and Vice President Schuyler Colfax (R-IN). Bayard wrote a letter disavowing any knowledge of the affair, and his name was generally dropped from the investigation.
Ultimately, Congress investigated 13 of its members in a probe that led to the censure of Ames and James Brooks, a Democrat from New York. A Department of Justice investigation was also made, with Aaron F. Perry serving as chief counsel. During the investigation, the government found that the company had given shares to more than thirty representatives of both parties, including James A. Garfield, Colfax, Patterson, and Wilson.
Garfield denied the charges and succeeded in gaining election as President in 1880, so the scandal did not have much effect on him. The Republicans replaced Colfax on the ticket, who was being renominated for Vice President. But they named Henry Wilson as the new candidate, who had also been implicated in the scandals.
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