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Wednesday, January 06, 2010

A (VERY) SHORT HISTORY OF FRAUD IN AMERICA


I have come to the conclusion that no one should be handed a masters or Phd in economics or business from any American university without an intimate understanding of the history of fraud in America. We have buried this knowledge, as if afraid of teaching our best and brightest how to cheat, despite there being clear evidence that no such primer is required. The energetic, the ambitious and the greedy have always found a way to cheat the public. And the mantra of deregulation is another proof that a good education in cheating might at least warn the suckers. For example, did you know that one of the men who did the most to advance the greatest fraud upon the American people in the 19th Century was “Honest” Abe Lincoln?

Lincoln’s break through case as a lawyer involved the May 6, 1856 destruction of the “Government Bridge”, the first bridge over the Mississippi River, between Rock Island, Illinois and Davenport, Iowa. Just two weeks after the bridge was opened to trains a steamboat, the “Effie Afton”, ran into one of the bridge piers which caused a fire that destroyed the boat and one span of the bridge. The owners of the Effie sued the owners of the bridge, The Mississippi and Missouri Railroad, claiming that bridges were a navigational hazard to river commerce.

The mercurial Charles Durant, one of the railroad’s officers, hired Lincoln to defend the bridge. In lieu of payment, Lincoln accepted $3,000 in railroad stock (the equivalent of about $66,000 today). After winning the case (he got a hung jury) Lincoln traveled all the way to Kansas to inspect the intended route of the future transcontinental railroad, which would be built by corporations that Durant ran and manipulated. And then, one of the first bills signed into law by President Lincoln was “The Pacific Railroad Act of 1862” which officially authorized the Central Pacific railroad to build east from California and the Union Pacific (whose vice president was Charles Durant) to build west from Council Bluffs, Iowa. This meant that Lincoln now owned some very valuable stock.

To pay for the construction across all those hundreds of empty miles, the railroad company was to be re-reimbursed for the total cost of building the line. That was intended to allow the railroads to break even. They were expected to make their profits from the grants of land they were awarded on either side of the rails. The completed rail line would make the land accessible, which would make it valuable. But the fact that Lincoln traveled all the way to Kansas to see the route and the property with his own eyes, showed that Lincoln knew enough not to trust the word of Charles Durant. And yet he had just turned this rapacious wolf loose upon the American taxpayers. Well, Lincoln had an excuse; he was a little distracted by the outbreak of the Civil War.

Doctor Charles Durant (Medicine had been his formal training), immediately showed his true genius by first buying out Union Pacific stockholder Herbert Hoxie for $10,000. This, in addition to stock he had already owned, gave Durant majority control of the railroad, even though the “Railroad Act” had limited individual stock ownership to avoid just the kind of manipulation Durant had in mind. Then Durant bought stock in competing railroads (on margin, of course), and spread rumors that they would soon be joined to the Union Pacific line, thus giving them a piece of the projected profits from the transcontinental trade.

When those railroad stocks then went up, Durant sold them out. Eventually the suckers realized there would be no joining, and the stocks fell to below their original value. With the Civil War raging Durant had just cleared $5 million from those scams (the equivalent of about $100 million today), and he had yet to lay an inch of rail.

Durant was hot tempered, erratic and prone to manic depression. But he had a genius at making money this way. And what he had done so far was just the prologue. Doctor Durant now came up with an idea he had learned from the French construction of the Seuz Canal.


In early 1864 the good Doctor Durant sent his director of publicity, George Francis Train, on a search for just the right corporate vehicle. Train found what he was looking for in the Pennsylvania Fiscal Agency, one of the innumerable stock schemes chartered by the states to fund "The American people’s railroad to the Western Sea.” None of these shell companies ever laid a single length of rail, but this one still had an effective charter and it was cheap. Train bought the company and renamed it Credit Mobilier, a name vague enough to leave you unsure just what they did. Then he sold shares in this new company for nominal amounts (often even on credit) to the principle stockholders of the Union Pacific Railroad - the majority going, of course, to Doctor Durant.

As the completion in this little of slight-of-hand, the Union Pacific signed an exclusive “no bid” contract with Credit Moblier (meaning themselves) to supply the Union Pacific with all labor, grading, rails, ties, spikes, bridges, abutments, rolling stock and engines needed to actually build and run the railroad; let the fleecing begin

The original engineer of the Union Pacific had calculated that the first 100 miles of track would cost $30,000 per mile to build. But Credit Moblier billed the railroad $60,000 per mile, which was taken directly from the pocket of the federal government. The route also began to meander across the landscape, like a druken sparrow in flight. Each twist and turn added miles to the bill presented to the Federal government. By the end of construction in 1869, the profit from this padding of the construction bills produced a profit for the stockholders of Credit Mobilier of $50 million (equal to about $800 million today). Remember this was not the side of the equation that was supposed to provide a profit for the builders.

Better yet, for the principle investors, the Union Pacific Railroad was something new on the American scene, a “limited liability corporation”. Under the old rules stockholders were liable for any debts the company ran up. A bankrupt company meant bankrupt investors. But investors in the Union Pacific Railroad Limited, including Doctor Durant, Mr. Train and several members of Congress who had been given Union Pacific stock (because they would control any investigations into Credit Moblier) were liable only for the amount they had invested in the U.P. And in many cases that was nothing.  And what little they did have invested, they sold out before the public found out what shoddy work had been done.

By 1869 when the “the people’s railroad to the western Sea”, was completed, it was also bankrupt. It had been looted by Credit Mobilier. The U.P. stock wasn’t worth the paper it was printed on. And, of course, by then, the principle investors in Credit Mobilier were off looking for other railroads to loot.

Only after literally thousands of more scams just like this one would congress close the loophole in this particular invitation to fraud, making shell companies like Credit Mobilier illegal, allowing for the seizure of all profits made from them, and assessing fines for even setting them up. This is called regulation. And by regulating the stock market the government atttempts to limit the profits made on Wall Street to the actual profits from the real companies the suckers think they are investing in.

It’s enough to make you realize that if Lincoln had not been murdered in 1865, his reputation might have been more closely tied to that of Doctor Durant. But it is not as if any of the truly powerful in this nation have ever been caught red handed; otherwise the bank executives called before Congress in 2008 to explain the mortgage bubble, would never have had the guts to blame working class citizens for taking on home loans they could not afford after the bubble burst. In the area of economic crime, experience and history makes me want to blame the people with college degrees in finance and business who drew up thousands of those contracts, long before I blame the high school graduates who signed just one of them. And if you don’t agree, you just don’t know your American history like you should.

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1 comment:

  1. Oh, how true. I took Acctg in college - 1979. Our instructor, on the first day of class, said that if we plan on embezzling, set a goal then get out. Those who reach their goal but become "greedy" and stay for more, are the ones caught. We thought he was joking! I also read that our revered wife of Gen Grenville Dodge, came out with $70,000 with this Credit Mobilier scam. Her final resting place in Council Bluffs has a "Black Angel" Statue erected in her memory because of a dream she had of a Black Angel. I think it was the Angel of Death she dreamt.

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