Holte's corner

Scam and SNAFU

In reading Hannah Arendt, she traces the linkage of the Panama Canal
Scandal in France to the Dreyfus affair. She also mentions the Credit
Mobilier Scandal, and other scandals of the 19th century, but since
her emphasis was elsewhere I had to do some digging. The Credit Mobilier company was named after a respected bank of France, but was a construction company in the US contracted out with the task of building part of the Central Pacific Railroad.

It turns out that scams and Snafus have been a regular way that business insiders bilk and con the rest of society on a periodical basis; have done so
throughout our history, and continue to do so. Those of us who buy the
dream that America is a land of opportunity like Beverly Hillbillies
regularly make the mistake of thinking that we are welcome in a new
land for ourselves and abilities and not solely for our money until it
is parted.

I'll start out with a classic scam. Everyone remembers that famous
scene of the Union Pacific and Central Pacific being joined in 1867? Well the
process of building the railroad bankrupted the Union Pacific, but not
the top officials of the Union Pacific. As the author of this website
says....

http://www.pbs.org/wgbh/amex/tcrr/sfeature/sf_scandals.html
http://en.wikipedia.org/wiki/Cr%C3%A9dit_Mobilier_of_America_scandal

"An Attractive Deal"

"The Crédit Mobilier scam was born out of a simple reality: in the
1860s, the U.S. government wanted a transcontinental railroad more
than investors did. While a railroad across the Rockies had a glorious
air to it, the project also carried an enormous amount of risk, and
risk is generally something investors prefer to avoid. As a result,
when Congress chartered the two companies -- the Union Pacific and the
Central Pacific -- that would build the transcontinental railroad
toward each other, it had to make the deal as attractive as possible.
(Hundreds of thousands of dollars in bribes, by all indications, also
had something to do with the legislators' largesse.) By the time
construction on the Union Pacific really got going (after an initial
attempt quickly ground to a halt), the Union Pacific had been given
huge land grants for each mile it completed, mineral rights on the
land, and hefty subsidies for construction. The result was that what
had previously looked a fool's errand suddenly became a seemingly sure
thing."

They saw that the railroads, while looking like a sure thing, were
really a risky investment, and saw this as an opportunity to make
money and bilk more gullible investors.

"Paying Themselves to Build It"

"Not sure enough for the men who controlled the Union Pacific, though.
There was still the chance, after all, that, even with the subsidies
and land grants, running the railroad might not be a profitable
endeavor. In fact, Thomas Durant, who was vice-president of the U.P.
in its early days, was convinced that all the real money to be made
was in constructing the road, not operating it. So Durant and his
fellow promoters they came up with a seemingly foolproof plan: instead
of paying outside contractors to build the railroad, the U.P.'s
biggest stockholders would just pay themselves. They took over an
ephemeral construction company, the Crédit Mobilier of America, which
just happened to win the contract to build 667 miles of Union Pacific
railroad. The Crédit Mobilier charged the railroad tens of millions of
dollars more than the actual cost of construction, all of which went
right into the pockets of the men who were supposedly running the
Union Pacific. By the time they were done, they'd cleared at least $23
million (and perhaps considerably more), and the U.P. was on the verge
of bankruptcy. Everyone who had invested in the railroad but not the
construction company found themselves with nearly worthless securities
on their hands."

http://www.columbia.edu/~rr91/1052_2002/lectures_2002/new_south2.htm

This same scenario has played out time and time again. Wall Street
Insiders have learned how to bundle worthless loans (recent real
estate fraud) and sell them as "sure" securities. How to scam public
utilities (Enron), "privatize" government owned utilities and business
out of existence, and convert publicly traded or owned value to
private property -- over and over again -- usually with the help of
people nominally in charge of protecting those assets.

"In 1867, Dr. Thomas C. Durant was replaced as head of the firm by
Congressman Oakes Ames. In that year Ames allowed members of Congress
to purchase shares at face rather than market value, the same people
who voted the government funds to cover the inflated charges of Crédit
Mobilier. Ames' actions became one of the best-known examples of graft
in American history."

Thomas C. Durant was the smart one here. He saw his mark, made his
scam, and got out, leaving others holding the bills.

http://www.pbs.org/wgbh/amex/tcrr/peopleevents/p_durant.html

"The Doctor remained ever slippery. After the lines joined at
Promontory Summit, Utah, Oliver and Oakes Ames prepared to oust Durant
once and for all. Durant beat them to the punch, however, resigning
his position, moving onto new railroad projects and new fields of
plunder."

"The story was introduced to the public arena during the Presidential
election campaign of 1872 by the newspaper New York Sun, which was
against the re-election of Ulysses S. Grant. Henry Simpson McComb, (a
future executive of the Illinois Central Railroad) an associate of
Ames, had leaked compromising letters to the newspaper following a
disagreement with Ames. It was claimed that the $47 million contracts
had given Crédit Mobilier a profit of $21 million and left Union
Pacific and other investors near bankruptcy."

http://elections.harpweek.com/1876/Events-1876.htm

The Credit Mobilier scandal burst an investment bubble (like the Enron
Scandal, the Internet Bubble, and the Housing Market bubble) and
presaged the depression of 1873, which started:

"The depression of 1873 resulted in about 15 percent unemployment
among workers; and thousands of farmers were forced to foreclose when
the Northern Pacific Railroad financier Jay Cooke filed bankruptcy.
This economic downturn would persist through the next four years."

Jay Cooke's failure was an example of SNAFU. His banking house was
built on loans to Railroads. There was overbuilding of railroads. The
Credit Mobilier Case was investors parasiting on SNAFU. His case is
more like what happened to the Panama Canal. Credit Mobilier is part
of how SNAFUS occur.

Further reading:

http://www.amazon.com/Jay-Cookes-Gamble-Northern-Railroad/dp/0806137401
http://www.uprr.com/aboutup/history/sig-indv.shtml

Posted by cholte at October 17, 2007 09:05 PM