In 1836 Graham led a group of American and European immigrants who supported Juan Bautista Alvarado and José Castro in a coup against Mexican Governor of Northern CaliforniaNicolás Gutiérrez. In 1840 Alvarado had Graham arrested, among a group of about 100 foreigners, and sent to Tepic, Mexico for trial and imprisonment. This action led to a diplomatic crisis that became known as the "Graham Affair". With the help of a recent arrival in Monterey, Thomas J. Farnham, Graham and the others were eventually released, Graham having been imprisoned for about a year. Farnham later wrote a romanticized account of these events. Some credited the incident with assisting in the formation of an American political justification for Washington's eventual annexation of California.
In 1841, upon his return from Mexico, Graham moved north to the Santa Cruz area, where he established another distillery at Rancho Zayante, near the present-day community of Felton. With help from Danish-immigrant Peter Lassen, Graham built one of the first water-powered sawmills in California. Part of Graham Hill Road, now a major route between Felton and Santa Cruz, was built by Graham to transport his timber to the coast for shipment. Although not a Mexican citizen, Graham was able to purchase the Rancho Zayante land by proxy through his fellow frontiersman Joseph Majors, owner of the adjacent Rancho San Agustin. Other former mountain men and Graham associates were also at Zayante, including Job Francis Dye, who later dictated a memoir including some adventures he shared with Graham. Early in 1846, a U.S. Army exploring mission led by John C. Fremont stopped at Graham's Zayante community. Mexican authorities feared that Fremont's hidden purpose was to stir up anti-government sentiments among the Americans there, and Fremont was soon forced to leave California for Oregon. He returned later in the year, after the Mexican–American War began, to recruit volunteers for the California Battalion. Graham himself, at age 46, did not volunteer. In 1851, Graham purchased Rancho Punta del Año Nuevo, on the coast north of Santa Cruz. Isaac Graham died in 1863, and is buried at Evergreen Cemetery in Santa Cruz.. Part of Graham's former lands are now the community of Felton, California.