Topic 1. Part 5.
The Political-Economy of Financial
Panics and Bankruptcy 1789-1819
Financial Panics or Crises -- Include a variety
of situations in which some financial assets
suddenly lose a large part of their nominal
value. Main Types:
1)Banking Crisis
2)Speculative Bubbles
3)International Crises
Bank Run
With Fractional Reserve Banking in the 18th and 19th
Centuries, if too many depositors showed up and
demanded their deposits back in specie, then banks with
insufficient reserves and few liquid assets could not
pay all their depositors and they collapsed.
Banking panic
A banking panic is a financial crisis that occurs
when many banks suffer runs at the same time, as
a cascading failure (USA 1933).
Speculative Bubbles
A speculative bubble exists in the event of large,
sustained overpricing of some class of assets.
One
factor that frequently contributes to a bubble is
the presence of buyers who purchase an asset based
solely on the expectation that they can later resell it
at a higher price, rather than calculating its Expected
Value (the income it will generate in the future) (USA
Stock market 1927-29; Housing 2001-2007).
International Crises
Examples: A country that maintains a
fixed exchange rate is forced to devalue
its currency due to a speculative attack
(this is how George Soros made a lot of
money when he shorted the English Pound –
That is, Soros bet that the £ would fall
in value against other currencies.)
A country fails to pay back its sovereign
debt and defaults (this is pretty common –
Argentina is in default now).
The Panic of 1791-1792
Hamilton’s debt securities were so successful that the
market price for the bonds kept going up.
In late 1791
William Duer (a friend of Hamilton’s) raised large sums of
money from friends and investors to buy up as many of the
6% Government Bonds as possible and also to start new
banks.
By late January of 1792 the US Government and Private Bank
securities peaked and began to fall precipitately.
This
bankrupted Duer and he ended up in Prison.
Hamilton shrewdly had brokers quietly buy up the
Government Securities at reasonable prices and thereby
stopped the panic and stabilized the markets.
For his trouble Hamilton was relentlessly attacked by
Madison and Jefferson.
The Panic of 1797 and The Bankruptcy Act of 1800
USA:
Land Speculation Schemes.
Investors would issue Private
Securities based on Western Land Claims (the Land was the
collateral). They sold the securities for specie.
The idea was
to sell the land at a price high enough to pay off the securities
and make a profit.
Britain:
Specie Outflow due to endless Wars.
Result was the
Bank Restriction Act of 1797 that halted specie payments.
This
caused a severe commercial downturn in the port cities of the USA
and bankrupted most of the Land Speculators.
The Bankruptcy Act of 1800 was the first federal
legislation governing bankruptcy procedures. A result of
the depression of 1797, the act provided only for
1) creditor-initiated proceedings and
2) applied only to traders, merchants, and brokers.
3) After receiving petitions from two creditors
concerning debts of $1,000, a district court judge
could appoint a commission to decide the case.
4) The main provisions of the act allowed the sale of the
bankrupt's assets to satisfy creditors, permitted the
bankrupt to keep a percentage of his assets, and
established that the consent of two-thirds of the
creditors could discharge the bankrupt from any
unsatisfied indebtedness.
Though enacted as a 5-year measure, prosperity
and public dissatisfaction with the act prompted
its repeal in 1803.
The Panic of 1819
A Land Bubble and Bank Runs
William Jones, First President of
the Second Bank of the United
States, 1816-1819
The first major American depression, the Panic of 1819 was
rooted to some extent in economic problems reaching back
to the war of 1812.
1) The Demise of the First Bank of the United States
caused an explosion of State Banks many of whom engaged
in uncontrolled land speculation.
2) During the War of 1812 the Federal Government was
forced to turn to these banks for loans.
This had the
effect of adding to the proliferation of paper money
(State Bank notes).
3) This practice tended to shift specie into the more
conservative New England banks, depleting the newer
“Wildcat” State banks of their hard money reserves.
4) The Federal government had to agree to a suspension of
specie payments from state banks in order to prolong the
wartime lending.
5) Politically, it was simply not possible to resume
specie payments in the war’s aftermath, allowing old and
new banks to profitably lend without regard to their
metallic currency reserves.
The economy was booming with
large increases in the population of the “Western” States.
6) Because of the economic difficulties revealed by the
War of 1812 – lack of transportation infrastructure,
manufacturing, uncontrolled banking – leading merchants
and financiers, Stephen Girard, John Jacob Astor, David
Parish – along with major Jeffersonian political leaders
John C. Calhoun, Henry Clay, and James Monroe advocated
re-establishing the Bank of the United States.
A bill was
proposed in January 1816 and signed by President Madison
in April 1816.
7) Under its charter guidelines, the BUS was expected to
acquire species totaling $28 million by the time it opened
for business; but with only $2 million secured when it
commenced operations, the Bank was compelled to purchase
species at usurious rates from the London financial
markets in 1817 and 1818, overburdening BUS credit.
In
addition by 20 February 1817 the Bank was supposed to
resume Convertibility – that is a return to specie banking
of BUS notes.
This was delayed for political reasons.
8) The 18 branch offices of the BUS in 1817 operated with
little oversight from the Philadelphia headquarters, nor
from the US Treasury.
Indeed, they poured gasoline on the
fire by flooding the West with BUS issued notes.
This had
the effect of draining even more specie from the well run
State Banks and some of the BUS branches in the Northeast.
By July 1818, the Second Bank of the United States had
demand liabilities exceeding $22.4 million, whereas its
species fund stood at $2.4 million.
unsustainable.
This was simply
9) The Dam broke in August 1818 when William Jones ordered
BUS branch offices to reject all state-chartered bank
notes, with the exception of those used as revenue
payments to the US Treasury. In October 1818, The US
Treasury demanded a transfer of $2 million in species from
the BUS to redeem bonds on the Louisiana Purchase.
10) State banks in the West and South, unable to provide
the required specie, began to call in their loans on the
heavily mortgaged lands they had financed. Cash poor
farmers and speculators found their land values dropping
50% to 75%. Banks began foreclosing on the properties and
transferring them to their creditor: the Second Bank of
the United States. Adding to the problem was the fall in
the price of Cotton on the London exchanges. The
combination of these events produced the Panic of 1819 and
plunged the USA into a Depression.
11) In 1819 Langdon Cheves was elected President of the
BUS, and during the next three years succeeded in
restoring its credit through a rigorous tight money
policy.
The problem is that it deepened the Depression.
Through public land debt relief legislation, Cheves
managed to reduce the Bank’s land debt by $6 million
within a year of assuming his position as BUS President.
By 1821 specie reserves had risen to $8 million by 1821
and bank notes in circulation were reduced by about $23
million within a span of four years from 1816 – 1820.
Langdon Cheves: President of the
Second Bank of the United States from
1819-1822
Table 1a.
The Inclusion of New States
State
Admitted
Original 13
1787-1790
Vermont
Kentucky
Tennessee
Ohio
Louisiana
Indiana
Mississippi
Illinois
Alabama
Maine
Missouri
1791
1792
1796
1803
1812
1816
1817
1818
1819
1820
1821
Slavery
Status
See
Notes
Free
Slave
Slave
Free
Slave
Free
Slave
Free
Slave
Free
Slave
Total
Free
States
Total
Slave
States
Population
at Entry
7
6
3-4,000,000
8
8
8
9
9
10
10
11
11
12
12
6
7
8
8
9
9
10
10
11
11
12
92,329
103,133
77,638
100,984
91,926
98,115
62,205
46,625
116,016
298,335
73,973
US
Population
at Previous
Census
3,929,214
3,929,214
3,929,214
5,308,483
7,239,881
7,239,881
7,239,881
7,239,881
7,239,881
9,638,459
9,638,459
Arkansas
Michigan
Florida
Texas
Iowa
Wisconsin
California
Minnesota
Oregon
Kansas
West Virginia
Nevada
Nebraska
Colorado
North Dakota
South Dakota
Montana
Washington
Idaho
Wyoming
Utah
Oklahoma
Arizona
New Mexico
Alaska
Hawaii
1836
1837
1845
1845
1846
1848
1850
1858
1859
1861
1863
1864
1867
1876
1889
1889
1889
1889
1890
1890
1896
1907
1912
1912
1960
1960
Slave
Free
Slave
Slave
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
Free
12
13
13
13
14
15
16
17
18
19
20
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
13
13
14
15
15
15
15
15
15
15
15
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
70,700
158,079
70,961
212,592
132,573
360,577
92,597
138,834
48,428
132,925
296,286
21,111
94,747
132,542
175,576
323,567
132,548
329,020
88,548
62,555
250,361
1,396,900
230,000
333,600
226,000
633,000
12,886,020
12,886,020
17,069,453
17,069,453
17,069,453
17,069,453
23,191,876
23,191,876
23,191,876
31,443,321
31,443,321
31,443,321
31,443,321
39,818,449
50,155,783
50,155,783
50,155,783
50,155,783
62,947,714
62,947,714
62,947,714
75,994,575
91,972,266
91,972,266
178,464,236
178,464,236
Notes: In 1776, slavery had been abolished in only 2 of the original 13 states. By 1849, it had been abolished in all of the 7
“free” states among the original 13. However, abolition was often restricted only to those born after a certain date. In 1860,
18 slaves remained in New Jersey, a “free” state. (Freehling, 1990, pp. 133, 480). Slavery also existed in the form of “black
apprentices” in the “free” states. Apprentices continued in Illinois until 1824 (Freehling, 1990, p. 149). President Lincoln’s
Emancipation Proclamation of 1863 freed slaves only in Confederate states but, for simplicity, all states are treated as “Free”
beginning in 1864. Slavery was ended in all of the United States by the 13th amendment, ratified 18 December 1865. Source
for population figures, Stewart and Weingast, 1992, p. 256, Morison and Commager, 1950, p. 790.