The Construction Companies

Both the Union Pacific and the Central Pacific met the same basic financial difficulty. Government bonds provided only half the necessary capital, and the land grants, potentially of enormous value, supplied no ready cash. Thus construction depended heavily upon private investment. But there was no incentive to investors. A railroad through virtually uninhabited country could not be expected to return a dividend for many years. And Congress required railroad securities to be sold at par for cash. Both companies therefore resorted to a favorite device of 19th-century railroad builders—a construction company with interlocking directorate free of Government regulation.

The Union Pacific's construction company was the Crédit Mobilier of America. In 1864 Durant bought the Pennsylvania Fiscal Agency, a corporation loosely chartered by the Pennsylvania Legislature to engage in practically any kind of business, and renamed it the Crédit Mobilier. The directors and principal stockholders of this company were virtually the same as those of the Union Pacific. Greatly simplified, the process worked like this: The Union Pacific awarded construction contracts to dummy individuals, who in turn assigned them to the Crédit Mobilier. The Union Pacific paid the Crédit Mobilier by check (i.e., cash, for the benefit of Congress), with which the Crédit Mobilier purchased from the Union Pacific, at par, U.P. stocks and bonds, which it then sold on the open market for what they would bring. The construction contracts were written to cover the Crédit Mobilier's loss on the securities and to return generous profits. In this manner the directors and principal stockholders of the Union Pacific, in their opposite role as directors and stockholders of the Crédit Mobilier, reaped large profits as the rails advanced.

The Big Four used an almost identical device to build the Central Pacific. Although in practice continuing to share in the management of the Central Pacific, Crocker resigned from the directorate and formed the construction firm of Charles Crocker and Company, in which Stanford, Hopkins, and Huntington were the only stockholders. The connection between the two companies was too obvious, and in 1867 the Big Four organized the Contract and Finance Company, with Crocker as president. Acting for the Central Pacific, they awarded to this company the contract for building the road from the California line to the junction with the Union Pacific, as well as for supplying all materials, equipment, rolling stock, and buildings. The chief advantage of the Contract and Finance Company over the Crédit Mobilier, as railroad historian Robert E. Riegel pointed out, "was that it was able to get its accounts into such shape that no one has ever been quite able to disentangle them."

Such techniques not only pushed the railroad to completion in record time, but also made its financiers extremely wealthy men. The Union Pacific cost about $63.5 million to build, of which about half represented the Government s loan. The best estimate of profits gained is about $16.5 million, although the enormity of this figure emerges only when it is understood that at no one time did invested capital exceed $10 million. Profits thus amounted, not to 27-1/2 percent, but to more than 200 percent. The Central Pacific's figures are more difficult to arrive at, mainly because many of its books were "accidentally" destroyed by fire during the Congressional investigation of the Crédit Mobilier, The best authority, however, places the cost of construction at $36 million. The company received land grants and Government bonds valued at $38.5 million, while Stanford admitted that $54 million in Central Pacific stock transferred to the Contract and Finance Company in payment of construction contracts represented virtually net profit.

There was an inevitable reckoning. Both railroads were burdened with inflated capitalization that meant decades of high rates and operating losses. The Crédit Mobilier investigation in 1872, moreover, brought the railroads bad publicity that strained relations with the public and the Government for many years and produced hostile legislation. Nevertheless, almost all railroad historians, while deploring the financial buccaneering of the Pacific Railroad builders, agree that only through such methods could the railroad have been built without far more liberal Government aid.