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A History of Market Panics
Happy Sunday, everyone! Today’s newsletter takes a look back at the history of U.S. market panics from 1792 through 1907.
Part I: The Panic of 1792
The Panic of 1792 is a fascinating episode in America’s financial history for many reasons. Not only did this period witness the first attempted ‘corner’ in America, the creation of a quasi central bank, and an insider trading scandal involving former Treasury department officials… it also occurred at the very founding of America. This meant that unlike today, where economists can leverage prior experiences and lessons to guide their decision-making process, Alexander Hamilton and his team were navigating crises on the fly. To understand the eventual Panic in 1792, however, we must first understand the conditions that preceded it…
Part II: The Panic of 1819
The asset class at the heart of the Panic of 1819 was not equities, but real estate. The impetus for America’s first speculative real estate boom had a few culprits, some of which are familiar from the Panic of 1792. You may remember that in 1812, America waged another war with Great Britain (it was in this war that the White House was torched by British soldiers). Well, as with the Revolutionary War, America had borrowed heavily to finance the costs of this conflict, and found herself heavily indebted when the conflict drew to a close. Making matters worse, the large debts Jefferson had issued to execute his famed 1803 Louisiana Purchase from France were coming due to 1818.
In short, the American government needed a substantial revenue stream – and fast – to meet all of its payments associated with the War of 1812 & Louisiana Purchase…
Part III: The Panic of 1825
If we’ve learned one thing from financial history it is that war is expensive. Like in 1792 and 1819, background for the Panic of 1825 begins with the end of another expensive conflict: The Napoleonic Wars. These wars are not the focus of this article, so to briefly summarize… this conflict was a series of wars lasting roughly 15 years as Napoleon sought to establish French supremacy in Europe. Napoleon was opposed by shifting coalitions of other European powers that were primarily led by the United Kingdom. The Napoleonic Wars were eventually ended by Napoleon’s defeat at the Battle of Waterloo in 1815.
The excerpt and chart below from Pamfili Antipa‘s article in the Journal of Economic History highlights why these wars were relevant to the Panic of 1825:
“Between 1797 and 1821, in order to finance the Napoleonic Wars, Britain suspended convertibility of Bank of England notes into gold… in terms of monetary policy maintaining the suspension of the gold standard for such a long period of time was an innovation.
However, funding of the wars with France meant that the suspension was accompanied by inflation and public debt accumulation. By the time of Napoleon’s final defeat at Waterloo in 1815, the price level exceeded its 1797 level by 22.3 percent and the debt-to-GDP ratio climbed to 226 percent… only WWI would entail a larger increase in the debt-to-GDP ratio.”
Part IV: The Panic of 1837
“The impact of the bank runs and collapse in credit conditions triggered a brutal panic. Between 1837 and 1843, Banking & Insurance stocks fell 32% and Railroad stocks fell 63% (The Economic Historian). In 1843, 25% of US banks had closed their doors, and “overall prices had fallen by more than 40%”. Even worse, almost 10 states defaulted on their debts in the years following the Panic of 1837.
Jackson had satisfied his dream of ending the national bank, but it came at the cost of a prolonged six year depression in the United States, lasting from 1837 to 1843.”
Part V: The Panic of 1857
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.
Part VI: The Panic of 1866
“It was this note posted on Overend & Gurney’s door announcing the suspension of payments that triggered the Panic of 1866. In terms of monetary policy, this panic was pivotal in the evolution of central banking. When Overend & Gurney collapsed, depositors at other banks rushed to withdraw their funds out of fear that their funds were also in danger. In response, the banks went “to the Bank of England discount office in search of funds.”
For the first time, the Bank of England acted as a Lender of Last Resort by injecting liquidity into the system, lending out £4 Million to commercial banks in just two days. The Bank of England’s actions quelled the panic and reduced its impact on the “real” economy.”
Part VII: The Panic of 1873
One of the main drivers of railway panics in the 19th century stemmed from the nature of their financing. Constructing railway lines was a very costly endeavor, and provided no revenue in the short-term. It is expensive to build a railway, and the railway can’t make money until the railway is built. Not great. From the perspective of an equity investor, railways were not a particularly attractive business model until construction had ceased and revenue started flowing.
For this reason, many railroad companies in the 19th century relied upon loans and bonds for financing their operations. In a survey of 408 railways in 1872, The Commercial & Financial Chronicle found that only 159 of 408 (39%) railroads had issued equity. Within the 159 that had issued equity, only 6% of railways had equity that actively traded on the NYSE.
Railway financing became problematic when railroads became unable to repay their debts or defaulted on their bonds, which was all too common due to the large up-front construction costs and no revenue.
Part VIII: The Panic of 1882
The root of France’s 1882 Panic was 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.
Part IX: The Panic of 1907
What we now call the Panic of 1907 was the most brutal recession in America until the Great Depression. The Dow Jones Industrial Average fell 37.7% in 1907, and was the final straw for American regulators. This panic directly led to the creation of the Federal Reserve as U.S. leaders looked for a way to reduce the fragility of American financial markets, and frequent ‘panics’ caused by gold shortages or shocks. Again, this all traces back to the San Francisco earthquake. Remarkable, isn’t it?
Missed last week’s article? Catch up here!