A transcontinental railroad across mid-19th century America was a colossal project, far larger than any American railroad built before then. While campaigned for and debated for years, work got underway while the country was in the midst of civil war. Trepidation on the part of investors meant it hardly got off the ground at all. Still, the government prioritized the project, guaranteeing it would happen. It came at tremendous cost though and this would hardly be a triumph for honest dealing as the construction of the Union Pacific Railroad was plagued by corruption resorted to by its promoters.
Envisioning a Railway
The idea of an American transcontinental railway could be said to have its origins in the efforts to find a Northwest Passage by sea through or around North America, to connect the Atlantic to the Pacific. As for a railway, while envisioned by others before him, the New York based merchant Asa Whitney was an active promoter of such a transcontinental railway in the 1840s.
Whitney was convinced a railroad would improve internal commerce and foreign trade. His advocacy for such a project began before the United States even controlled any Pacific coastline. This would be an expensive undertaking; Whitney estimated it would cost $60.6 million to build a 2,030-mile railroad. At about $30,000 per mile, this was an estimate not far off from the actual construction costs of the first transcontinental railway in North America, the Union Pacific Railroad.
In 1853, the American congress finally appropriated $150,000 for exploring possible routes for a railroad connecting the county east of the Mississippi River to the Pacific Ocean. However, further efforts to commence work on such a project in the 1850s did not find the support required. Nonetheless, the American Civil War accelerated legislation permitting such a railroad. The absence of southerners in Congress meant the debate between a southern or northern route for the railroad was resolved and many came to see such a railroad as a military necessity.
Pacific Railway Act
The legislation enabling the creation of Union Pacific, the Pacific Railway Act, became law on July 1, 1862. It set out that a new east-west railroad would run from Council Bluffs, Iowa, near Omaha, to San Francisco. At Omaha, it would connect with another railroad, Chicago and Northwestern, which would be extended to Omaha in 1867. The project would add about 2,000 miles to the nation’s railroad network, which was then 32,120 miles long. Up to then, no individual road controlled more than 700 miles of this system.
Union Pacific Railroad was incorporated in 1862. It was the first company chartered by Congress since the Second Bank of the United States in 1816. The company would control the transcontinental railroad from Omaha to the state line of California while the Central Pacific Railroad Company would control the California segment. Other railroad companies would build branches connecting the eastern parts of the Union Pacific with other eastern destinations. Union Pacific was required to complete the railroad by July 1, 1875 or it would forfeit the right to operate the line.
The Pacific Railway Act granted Union Pacific large tracts of land in exchange for laying down track. The company received ten square miles of land for each mile of track laid. More precisely, the land alongside the railroad was divided into sections alternating between government ownership and tracts twenty-miles-wide, ten on each side of the railroad, given to Union Pacific. The government would retain all the mineral rights but the railroad would control timber on the land. Union Pacific would be given twelve million acres of land in total.
Financing
The assistance to Union Pacific did not end there. The government gave the company a subsidized loan of $16,000 to $48,000 for each mile of track completed, depending on its difficulty to construct. Sections on flat plains unlocked a loan of $16,000 per mile, $32,000 per mile on the plateau between the Rocky Mountains and the Sierra Nevada, and $48,000 per mile in the mountainous regions themselves. The loan was delivered in thirty-year government bonds at 6.0% which the company could sell. Union Pacific would eventually have to repay the government at the bonds’ maturity.
Still, Union Pacific had difficulty raising private money. Ten thousand shares of $1,000 each were supposed to be issued and only 10% of this had to be paid at the time of subscription. However, only thirty-one shares were sold despite being marketed in twenty-four cities. There were many reasons for the failure; shareholders did not have limited liability and investors in railroads found the government inducements insufficient. Union Pacific also had difficulty selling bonds.
The eventual involvement of railway executive Thomas C. Durant did help in promoting the shares. Durant, a graduate of the Albany Medical College, never practiced medicine but went on to organize several railroads. He and his fellow promoters badgered acquaintances to subscribe, putting up the first installment of 10% themselves and even guaranteeing them against loss on their investment. His work promoting Union Pacific meant that 2,177 shares were sold by October 29, 1863 and he became the company’s vice president. Despite all this, Durant did not disagree with the assessment of many that more government support was needed and he worked on getting the Pacific Railway Act of 1862 amended.
Construction
Work began on both ends of the railroad in 1863 but it was clear the project needed more support. To help, the Pacific Railway Act was amended the following year. Under the new legislation, the government subordinated its loan to holders of Union Pacific bonds who could now be secured by a first lien mortgage on the company’s assets. Union Pacific’s land grant was doubled and the legislation also included many other favorable changes to the 1862 law, including giving the company some mineral rights to the land it was granted.
While the opportunity to invest in shares of Union Pacific was hardly greeted with enthusiasm, the railroad project did spur investment. In property for example, President Abraham Lincoln was himself involved in a real estate deal to have the Union Pacific Railroad locate a terminus on its property in Council Bluffs.
There would also be a lot of money made in constructing the railroad. To this end, an existing railway construction firm was acquired by Durant and renamed Crédit Mobilier of America. This Crédit Mobilier, of no relation to the contemporary French banking firm of the same name, was a construction and financial company established to build track for Union Pacific. It was also a vehicle by which to raise more capital for the project in the form of a limited liability company.
Crédit Mobilier made a fortune building the railroad. To take advantage of government financing, extra curves were added to the railroad’s route and for the work provided, Crédit Mobilier was given shares in Union Pacific at one-third of their value. By 1868, the company had paid out dividends of $3,500 for every $1,000 invested by shareholders but these dividends were corruptly earned.
Officials were bribed to record as completed sections of track still in progress so the company could be paid early with the government’s loans. To suppress the inquiries of politicians, the company offered stock at below market prices to members of Congress. All this corruption was expensive, requiring that Union Pacific be overcharged even more to cover the costs. Not all of the graft went to Durant; many benefited from the corruption. It was perhaps the largest such scandal in 19th century America, implicating the Vice President, members of Congress, and cabinet secretaries.
Still, construction of the railway was finished in 1869. Nonetheless, though just completed, already millions more needed to be spent to resolve deficiencies identified. After building the railroad, Union Pacific had $74.3 million of debt, making it likely one of the most indebted companies in America. Though the railroad had cost ‘only’ about $60.5 million to build, debt had been issued at a meaningful discount to face value, making the indebtedness higher.
Future
Still, the railroad earned a profit of $2.9 million in 1870. This rose to $4.1 million by 1872. The financier and speculator Jay Gould obtained control of the railroad after purchasing a lot of shares in the 1870s. After taking over Union Pacific, Gould got it into a financial position strong enough to begin paying regular dividends. Almost $12 million in dividends were paid in a period of less than five years. By 1880, Union Pacific was earning a profit of $11.7 million but Gould began selling shares around 1880 and gave up majority control.
Gould was selling his shares near the peak of the railroad’s profitability. Revenues would fall from $22.3 million to $17.4 million between 1880 and 1893. Meanwhile, operating expenses hardly changed so that profits fell from $11.7 million to $6.2 million over those same years. Proceeds from land sales were also falling.
Things would only get worse though. Falling commodity prices triggered a depression in 1893. In the downturn, six hundred banks and fifteen thousand businesses failed. Unemployment rose by four million. Over a quarter of American railroads were bankrupted by the Panic of 1893 and its aftermath, including Union Pacific. The railroad was reorganized in 1896 with the assistance of the bankers Kuhn, Loeb & Co., E.H. Harriman, and National City Bank of New York, today’s Citibank.
Lesson
Union Pacific was not a conventional railroad. However, this had more to do with its scale than how it was funded. Indeed, it was normal for railroad projects prior to this point in American history to receive large government support. The scale of this construction though was greater than anything before it in American history and thus so to was the scale of support and the resulting corruption and scandal. Perhaps the early trepidation of investors signaled that the project could not possibly be completed by conventional means. Of course, the project itself was anything but conventional and was forced to get underway amidst poor circumstances, a civil war. At the intersection of the civil war and the Gilded Age, this was not the right time for conventional or honest finance.
More from the Tontine Coffee-House
Read about the construction of a transcontinental railroad in Canada and how capital markets were pivotal to the 19th century railroad boom. Lastly, learn how construction of the Erie Canal was financed. Consider subscribing to this blog’s newsletter here.
Further Reading
1. Klein, Maury. Union Pacific. Vol. 1, University of Minnesota Press, 2006.
2. Markham, Jerry W. A Financial History of the United States. Vol. 1, M.E. Sharpe, 2011.
3. White, Henry Kirk. History of the Union Pacific Railway. The University of Chicago Press, 1895.
T Camuti