Panic Series (Pt. V) - 1857 — Investor Amnesia

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“Imperial Finance: A History of Empires”

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It’s hard to believe that we’ve made it this far into the Panic Series without discussing railroads, but that all changes today with the Panic of 1857.

Railroads & Western Expansion

Charleston-Hamburg Railroad, the first American line providing regular service, opened its doors on Christmas Day in 1830. That winter morning, 140 lucky passengers experienced a new form of transportation that forever altered America’s economic trajectory. After completing the 136-mile line in 1833, the company’s directors stated:

“Our citizens wisely determined that railroads would be eminently beneficial to the State; that they would revive the diminished commerce of our city and tend to bring back the depreciated value of property… Real estate in and near Charleston had sunk to half its former value … industry and talent had lost encouragement and not met their merited awards…

Stockholders of the ‘South Carolina Canal and Railroad Company’… must feel that delight in a very eminent degree, when they reflect on the public good they have rendered to this State… by constructing a railroad…”

This sentiment and excitement for railroads quickly reverberated around the country, and by 1840 America had more miles of track than Europe. However, this just the beginning of America’s railway boom.

The California Gold Rush

In 1849 there was an explosion in economic growth and westward expansion after gold was discovered at Sutter’s Mill, triggering the California Gold Rush. The scale of this expansion is underscored by the fact that over the next decade California’s population grew from 93,000 to 380,000.

A seemingly endless number of railway lines and companies were launched in this period to meet the transportation demand stemming from westward expansion. According to historian Robert C. Kennedy, more than 20,000 miles of railroad track were laid during the 1850s.

Federal Land Grants & Railway Mania

Another driver of westward expansion and railway growth in the 1850s stemmed from government land grants. In 1851, an ambitious young attorney from Springfield helped Illinois Central Railroad obtain a grant of 2.6 million acres, marking the first federal land grant ever given directly to a corporation. (A decade later that same Springfield attorney would grant 5.5 million acres of federal land to railroads as America’s 16th President, Abraham Lincoln.)

These may seem like trivial details of government bureaucracy, but these land grants were crucial to the growth of railways since they acted as federal subsidies for railroad companies. The growth of federal land granted to railroads between 1850 – 1857 is displayed below, and by 1857 the government had granted over 24 million acres of land to railroads.

An 1857 newspaper highlighted the role of government land grants to fueling this westward expansion and railway fever:

“They invited capital to carry out plans for railways over the uninhabited prairie and between unbuilt cities. The market was flooded with railroad schemes; stock was issued, money raised, and the West was tapped at every point…

Congress made extravagant grants of their only tangible resources, real estate, to excite speculation, and thus the railway mania reached its climax…” (The New York Herald, December 3, 1857)

As a result of this conviction, speculators were all too happy to invest in this exciting new railway industry, and bankers/financiers were excited to help facilitate these investments for clients (and speculate in railways themselves!). As we know with hindsight, however, the success of these railways was highly contingent upon investor’s continued enthusiasm and opportunities on the western frontier:

“Their fortunes depended on a continuing inflow of settlers and the growth of commerce on the frontier, which required confidence in the viability of expansion westward.” (Calomiris & Schweikart, 1991)

Land Speculation

The excitement around “westward expansion” was not unlike the modern enthusiasm for space exploration. In an era of canals and horses, railways unlocked a “new frontier” out West that captured the imagination of all Americans (particularly investors!). The excitement around railways and this exciting new chapter for America as a nation are illustrated in this 1857 newspaper excerpt:

Railway stocks were not the only asset to benefit from this national excitement, however. Speculators were also enthusiastically purchasing plots of land and real estate during this period of westward expansion.

“Land speculators were especially eager to purchase land they thought would be used for railroad construction. If they could predict where Americans would settle and where a railroad would be constructed, they could purchase the land cheap and resell it at a much higher price after there was a rail line going through their land, or plans for constructing one.

Land speculation accompanied the expansion of western railroads. The greater the expectation of settlers and commerce in these regions, the greater the investment in land and railroads, which often involved speculative financing.

There was a perceived relationship between the value of land and the number of settlers in any given territory, and expectations of settlement was central. Investors who believed that settlement would continue to rise would be likely to invest, which would increase land prices in these regions.” (Economic Historian)

Again, the key point here is that prices were closely tied to the expectation of future settlement and continued expansion. If investors lost their confidence and enthusiasm for westward expansion, the prices for land and railroad stocks that were pushed higher by speculation would suddenly feel very fragile and unstable. Can you guess where this is heading…?

Kansas is the most important case study on land speculation fueled by “railroad fever” as it was in Kansas that everything went wrong.

“Historian Allan Nevins described ‘a fever of speculation in Kansas lands was raging, men selling homes, giving up well paid positions, and even borrowing money at 10% to purchase farms‘… [there were] some speculators expecting Kansas lands to ‘increase by 70,000 people’ in 1857 alone. By April, a thousand settlers per day were arriving in the Kansas Territory…

Town [land] lots could pass through ‘two dozen hands within 60 days’ as speculators beamed at the relentless flow of settlers to their lands. By the time Governor Robert Walker arrived in May, he found the best Kansas lands, ‘especially along projected railroad routes,’ had already been snapped up by speculators.” (Larry Schweikart)

The Banking System

Before exploring how things went wrong, we need to discuss Wall Street and other institutions’ role in financing this boom. Up to 1850, there had been $372 million ($50 billion) invested in American railroads. From 1850 to 1857, however, an additional $600 million ($80 billion) was invested into this burgeoning new industry.

Even the number of banks roughly doubled between 1850-1857. However, as the chart below highlights, this explosion of banks coincided with increasingly risky lending practices (exhibited by the notably higher Liabilities-to-Specie Ratio in 1856). While banks helped produce and (temporarily) sustain the railroad boom, the banking system was fragile and increasingly susceptible to declines in land and railroad securities prices. This susceptibility stemmed from a few sources.

First, many speculators had made their railroad investments with loans provided by banks and brokerage firms. This was fine as long as the railway industry continued to perform well and attract further investments. If, however, the industry suffered and railroad stock/bond prices tanked, investors that borrowed money to invest in railway stocks/bonds would probably be unable to pay back their debts to the bank.

Second, this problem was exacerbated further in instances where the banks had accepted railroad stocks and bonds as collateral from speculator’s seeking additional loans to fund their investment operations. When the values of this collateral declined alongside the falling prices of railroad stocks and bonds, borrowers became unable to obtain new loans to pay off old loans. As a result, the stocks and bonds that borrowers unable to repay their debts had used as collateral were sold on the market at fire-sale prices in order to at least partially offset the losses on such loans.

“the large amount of loans made upon the pledge of stocks and bonds as security, payable on demand; by reason of which, when the embarrassments commenced, and the borrowers could not obtain new loans to pay the old ones, large amounts of stocks were thrown upon the market and sold at such prices as they would bring, to raise the moneys for which they were pledged. This caused a great and rapid depreciation in stocks and securities of all kinds, and increased the embarrassments and panic.” (Hunt’s Merchants’ Magazine, December 1857)

The Collapse of Ohio Life Insurance & Trust Company

This brings us to the event that historians argue ultimately triggered the Panic of 1857: the announcement on August 24th that the New York branch of Ohio Life Insurance & Trust Company was suspending specie (gold & silver) payments to depositors. Like many other banks, the financial institution ran into difficulties because of risky loans and investments it had made that eventually turned sour. These issues were exacerbated by the bank’s concentrated exposure to the railway industry in general.

Calomiris and Schweikart note:

“Its assets consisted mainly of securities and loans to railroads. Gripped by “railroad fever” that swept the state, Ohio Life had a special connection to the Cincinnati, Hamilton, and Dayton Railroad whose dividends were payable at Ohio Life… To facilitate involvement in the securities market, Ohio Life had opened a New York office, under the direction of Edward Ludlow…

Ludlow had loaned an amount equal to the company’s capital – $2 million – to various railroads… of its roughly $4.8 million in assets, the bank invested $3 million in the railroad industry.” (Calomiris & Schweikart, 1991)

This concentrated exposure was a huge issue when railroad stocks began to decline in the summer of 1857. (Calomiris & Schweikart, 1991)

Why did railroad stocks begin to fall? Some historians argue that the answer lies within the Dred Scott decision of 1857, which slowed the flow of settlers into western territories and depressed land/railroad prices:

“the decision put the brakes on westward migration as free-soilers feared the spread of slavery throughout the territories. The South could not provide the numbers of bodies to replace the would-be Northern migrants…

The slowing of the flow of people westward had an impact on land markets, dragging prices downward. In turn, uncertainty about the future profitability of westward expansion affected the value of railroad investments. The downward spiral in stock prices for western railroads led to heightened risk in capital markets and ultimately financial panic.” (Jenny B. Wahl)

As railroad stocks fell, Ohio Life’s portfolio became increasingly shaky, ultimately leading to their decision to suspend specie payments. News of this suspension caused a crisis of confidence nationwide, and Ohio Life’s stock fell off a cliff in just a matter of days:

Conclusion: Banking Failures & “Defensive Suspension”

So far, all of the panics we’ve covered transpired in a period when the speed of communication was incredibly slow and inefficient. During the 18th century it could take 14 days for a letter to travel from New York to Philadelphia. This meant that investors in Philadelphia might not hear about news of a panic in New York for over a week! That said, the Panic of 1857 is unique because it was the first widespread American panic communicated by telegraph, an 1844 invention.

“the more immediate cause of the panic, and which tended to aggravate the evils more than tenfold, is the operation of the electro telegraph, by means of which bad news, such as the failure or embarrassment of a bank, of a merchant or manufacturer, was immediately communicated to all the cities and large towns of the United States; and information of all such misfortunes was immediately concentrated in all the cities, and worked up the minds of the laboring classes, as well as those of the business men, to a fever of excitement, causing fearful apprehensions among them in every city, that their banks also would fail, and inducing many, out of prudence, to withdraw their deposits, and to convert their bank notes into coin.” (Hunt’s Merchants’ Magazine, December 1857)

As the excerpt above from 1857 states, the panic quickly spread from Ohio Life’s New York branch to the rest of the country and triggered bank runs as investors feared they would not be able to access their money.

In the same vein, banks became fearful of running out of specie and called in their loans from other brokers / commercial firms to bulk up their specie reserves. Banks also sold off their railroad stocks and bonds at fire sale prices to raise much needed funds, which tanked stock prices further.

“By September 26th, banks in Philadelphia suspended the right to withdraw gold. New York banks held on until October 13th, when a large run that day caused all but one bank to suspend. Most other banks in the country soon followed. Countrywide suspension would last two months, with New York City banks not resuming payment in gold until December 14th…” (New York Fed)

The bank runs grew so bad that eventually there federal troops were sent to protect the U.S. Customs House in New York (which held $20 million in specie reserves) from rioters outside.

The Panic of 1857 was the first of many 19th century railroad panics, and also the first American panic to be quickly and easily transmitted nationally by telegraph. This increased communications efficiency had a negative impact on markets as investors rushed to withdraw their money from the bank after hearing word of Ohio Life’s collapse in New York.

Tune back in next week!