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Source: The Crash of 1882, Counterparty Risk, and the Bailout of the Paris Bourse
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This week’s Panic brings us to a country not yet covered in this series: France. In 1882, the Paris Bourse (Stock Exchange) experienced its worst crisis of the entire 19th century as leading French bank Union Générale collapsed, bringing the market down with it.
Background & Context
As with most Panics, France’s 1882 crisis was preceded by a period of wild and enthusiastic speculation. A New York Times article dated January 21, 1882 offers a useful overview of events leading up to the 1882 Panic:
“The present case is a very peculiar one. The French people, since 1872, in spite of political disturbances, failures of food crops, and the apparently nearly mortal blow inflicted upon their vast vine-culture, has been steadily growing rich, because they have meanwhile been steadily laborious and saving even to parsimony. Properties which were moderately valuable before the great war with Germany have advanced almost without interruption. Industry in every branch has thriven, at first slowly, and then constantly more rapidly. The intellectual ferment produced by the political agitation connected with the republic has extended to all the varied classes of the population… Nearly all current influences have tended to stimulate the hope, the courage, and even the greed of a people little accustomed to the allurements and risks of modern speculation.
The result has been that the accumulated profits and savings of the French have been poured continually and recklessly into every channel of speculation. In the general excitement, to an extent heretofore unknown in France, the aristocracy, and particularly its younger members, have shared. Shut out by the political changes that have taken place so rapidly in the direction of republicanism from the activity in public affairs which had previously absorbed so much of their energy, they have turned to the Bourse, where they have shown all the characteristic daring, recklessness, and vanity of their class…”
During this period of economic prosperity in France, scores of new companies were formed across a range of industries. Charles Kindleberger wrote that in the late 1870s, “France was entering a boom based on the expansion of the railroads, the construction of the Suez Canal, and the growth of banks.” In 1881 alone, more than 400 joint-stock enterprises were launched in France.
“According to The Times, ‘there is not a waiter or a cabman who is not risking his little mise in some stock exchange certainty’. Another paper reported how young men were apparently having great success in wooing comely maidens by relating developments on the Bourse… placards and advertisements for new enterprises appeared everywhere and even the meanest shops were supplied with summarized prospectuses in which to wrap up customers’ parcels.” (Winton Capital)
Yes, that’s right, national excitement for market speculation grew to such heights that shops were even using prospectuses as wrapping paper! Yet, what exactly fostered these levels of market exuberance? Part of this question is answered by the structure of French markets in the 19th century, specifically their margin/call money loans named “reports”.
“Trading in securities was conducted through fortnightly settlements in both Paris and Lyon. A purchaser would pay 10 percent down, borrow 90 percent from an agent de change or broker who in turn borrowed the money in the call-money market. Money was invested in reports by banks, by special caisses (funds created especially by banks and other investors for this outlet) and by individuals. A bank and caisse moreover could favor brokers who specialized in trading in a particular stock…” (Kindleberger, ‘Manias, Panics & Crashes)
So, in summary, reports were one-day margin loans that brokers offered to clients for speculation on stocks. Brokers obtained the funds for these reports via caisse funds, which were investment funds organized by large creditors (banks) for the sole purpose of providing reports to brokers. Importantly, caisse funds often focused on a single stock, so a publicly traded bank could theoretically operate a caisse focused on providing reports to speculators buying its own stock, supporting prices. Obviously, however, this system was not free of problems. In fact, there were risks for brokers (and their associated creditors) regardless of how a stock performed. Kindleberger describes the issues for brokers when stocks went up.
“When the market was steady, speculators made gains and losses, and brokers would typically pay out or receive very little net, assuming that speculators were working on roughly the same margin, for example 10 percent. If stock prices were increasing however more funds were needed to pay off profits that would be realized and withdrawn from the market. These funds were often reinvested in the market, but if they were not reinvested, the market needed more capital.
Assume a speculator bought a share for 100 francs, paid 10 francs down and borrowed 90 francs. If the speculator sold the share at 110 francs and withdrew his 20 francs, 11 francs of the 20 francs withdrawn from the market would come from the new speculator, and 9 francs had to be new report [loan from the creditor/bank] and taken from the call market.” (Kindleberger, ‘Manias, Panics & Crashes)
When stocks went down, on the other hand…
“When the share prices declined new money was also required, this time from the speculators. If the speculator bought a share at 100 francs, again with 10 francs down and 90 francs in reports, and the share price then fell to 90 francs, the speculator had to produce 9 more francs to comply with the 10 percent requirement.
If the speculator had been fully leveraged earlier and did not have the money to meet the margin call, the broker sold the speculator’s position. If the price dropped below 90 francs, the broker, bank, or individual that had made the loan lost money.” (Kindleberger, ‘Manias, Panics & Crashes)
Union Générale Bank
This brings us to the root of France’s 1882 Panic: The Union Générale Bank. This financial institution was founded by a former Rothschild railroad engineer in 1878, Paul-Eugène Bontoux. While it is hard to imagine this being anything notable today, a defining feature of Bontoux’s bank was the fact that it was a “catholic” bank founded in a time where banking was dominated by Jewish-German banks. By heavily leaning on this Catholic affiliation, Bontoux was able to generate significant interest (and money) from the catholic establishment and France’s conservative catholic aristocracy.
The downfall of Union Générale stemmed from a few sources. First, Générale was “the bank most heavily involved with this [report] lending” (Winton Capital). As mentioned earlier, publicly traded banks like Union Générale could support their stock price by extending credit to brokers that the bank knew serviced speculators buying their stock. While this supported stock prices in the short-term, it was also incredibly risky. Second, like most financial institutions that failed in this period, the company had made some questionable investments and loans in European railways.
Lastly, and most importantly, however, was the company’s announcement on January 4, 1882 when Bontoux announced that the bank would be opening up a new bank in Trieste with the goal of taking business from its banking rival, The Banque de Lyon. The great irony of this was that Bontoux’s announcement caused the price of Banque de Lyon’s shares to plummet, and investors that owned both Générale and Lyon shares sold Générale stock to cover their losses on Banque de Lyon stock. Due to this heavy selling, Union Générale’s stock price similarly plummeted.
The final blow arrived when speculators in Union Générale stock could not pay their margin call payments and brokers were left with an enormous amount of losses on their hands. These losses meant that the Union Generale could no longer meet payments. Despite an attempt by other Paris institutions to save Union Générale, the bank eventually collapsed and shut its doors on January 30th. (Source below: Winton Capital)
The collapse of Union Générale triggered France’s worst market crash of the century. The panic also provided an example of anti-Semitism in 19th century Europe as Bontoux spread a conspiracy theory that his bank was brought down by Jewish banks working together to destroy their “Catholic” rival. While this was obviously untrue, there were many in France that began to believe this theory, and even the New York Times ran many pieces that supported this crazed theory.
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Sources & Further Reading
The Krach of 1882 and the Bailout of the Paris Bourse
The Crash of 1882, Counterparty Risk, and the Bailout of the Paris Bourse
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