A Brief History of Doom

by Richard Vague

  The Crisis of 1825

  Americans were not the only ones with difficulty in assessing risk. In Britain, during its lending boom in the early 1820s, investors bought dozens of parcels of land and £200,000 worth of government bonds, all from the Latin American country of Poyais. Aspiring settlers filled four ships bound for Poyais. Unfortunately, Poyais never existed. It was a lucrative fiction, conjured by Scottish mercenary Gregor MacGregor, who had set up an office in London to “sell” dozens of parcels of land in a Honduran swamp and fill ships with settlers to Poyais, before he was forced to flee England in 1823.3 He took the speculation in debt that was at the heart of the United Kingdom’s 1825 financial crisis to a remarkable new level—fictitiously conjuring not only investment value but a country as well.

  His scheme was part of a British financial crisis in 1825 that brought the nation’s entire banking system to the verge of collapse and remains one of history’s worst crises. The president of the Board of Trade at the time gravely declared that the country was “within twenty-four hours of a state of barter.” About 10 percent of all British banks—73 out of 770—failed within a few months; a “massive wave of bankruptcies” peaked in April 1826; and, in the aftermath, Britain’s Parliament was compelled to try and reform the financial system by creating new regulations.4

  By 1822, British investors had lived through years of economic stagnation and contraction. The economy struggled through its long nineteenth-century deleveraging from government debt amassed during the Napoleonic Wars—debt that had reached 260 percent of GDP. They wanted higher yields than what they could get from traditional British sources. At the same time, the newly independent Spanish colonies in the Americas were turning to London for desperately needed capital for infrastructure, operations, and other purposes. The foreign bond market took off. Between 1822 and 1825 nine Latin American nations floated bonds of over £22 million. These new economies were fragile, investments were ill conceived, and, by 1827, every issuing Latin American nation would default.5

  Latin American bonds were significant but were overshadowed by a far larger bubble created by newly formed “joint stock” companies. These companies, most unrelated to any Latin American activity, were financed by selling shares to an eager and unsophisticated public as the Latin American debt fever grew. A share with a par or face value of £100 could be purchased for as little as £5 down. The investor agreed to pay an additional sum—usually equal to the initial deposit—whenever the company’s agent placed a call notice in the London newspapers. In other words, a stock subscription was an ancestor to today’s margin loan.

  Table 4.1. Latin American Debt Sold on the London Market, 1822–1825

  Table 4.2. U.K. Crisis Matrix: 1820s

  *Limited data points.

  Private lending totals are impossible to reconstruct given the absence of data on city banks and other types of debt. However, Bills of Exchange (an indicator of overall trends) increased £47 million from 1820 to 1825, and foreign debt increased twentyfold.

  In February 1824, after the success of the Baring and Rothschild banking families with a joint stock venture called the Alliance British and Foreign Life and Fire Insurance Company, these joint stock companies moved from quiet obscurity to center stage.6 Suddenly investors seemed willing to put money into almost any newly announced joint stock company with a prospectus and a sales agent. The fascination with joint stock companies converged with Latin American investments to create an irresistible overlapping opportunity: twenty-nine companies formed by 1826 to conduct Latin American mining operations.7

  Besieged by bills seeking authorization for new joint stock companies, Parliament repealed the Bubble Act of 1720—enacted to curb certain joint stock activity in the throes of the notorious South Sea Bubble—that had been limiting the creation of these new companies. An assiduous observer, Henry English, kept track of all the new companies organizing and selling shares by scouring newspapers for announcements and prospectuses. He would find that in 1824 and 1825, some 624 companies had announced their intention to go into business and sell shares. Of these, over half apparently existed only on paper.8

  In similar fashion to twentieth-century financial crises, growth in private debt and rampant speculation, including through the emergence of new instruments in the “joint stock company,” laid the groundwork for financial crisis in the 1820s. Of the £102,781,600 worth of shares sold by the 245 companies that English identified as having actually started business operations, only £17,645,625 had actually been paid in—leaving investors potentially on the hook for £85,135,975, subject to call at any time.9

  The actions and policies of British banks, ranging from the smallest country bank to the Bank of England itself, ultimately facilitated this unchecked speculation and the ensuing crisis. England’s country banks, modest and localized, issued their own notes, which was a means by which they extended loans. As the economy grew after 1822, they flooded loans to district farmers and businessmen. Between 1822 and 1825, the value of country bank notes in circulation more than doubled, even as the number of banks remained relatively constant at around eight hundred.10 This new infusion of cash from country banks, the continued expansion of city banks, and the Bank of England’s own currency expansion, along with a sharp fall in interest rates, stoked the speculative fires.

  But the expansion in sectors across the economy had been too great and credit quality became an issue. By the end of the summer of 1825, falling reserves at the country banks and the deflation of the speculative stock bubble were indicators of trouble and worried bankers at small regional banks and London private institutions. Stock prices were down 54 percent from their highs. The Bank of England directors, either unaware of or unconcerned about signs of impending crisis, did not expand credit to support the lending institutions that were beginning to suffer.11

  In November, there were runs on dozens of country banks, whose bankers now faced a liquidity crunch and turned to their corresponding private banks in London to plead for specie. Private banks, following the financial food chain, turned to the Bank of England for funds, further depleting the bank’s already shrinking reserves of coin and bullion. The venerable London bank Pole, Thornton & Company closed its doors five days later, which crippled its thirty-four correspondent country banks.12 The crisis became a full-on panic the following week, as five more London banks failed.

  The Bank of England abruptly reversed its policy in a last-ditch effort to avoid a complete meltdown of the financial markets. Halting the contraction of bank loans is key to forestalling a panic and initiating a recovery. This was as true in the 1800s as the 2000s. The bank raised the discount rate to 5 percent and immediately began making advances to almost any banker who could elbow his way to its discount window. The amount of notes under discount, which had remained fairly steady around £2.5 million since 1823, shot up to £9.6 million by early 1826.13 All of this activity allowed the Bank of England to increase its notes in circulation by £8 million in just five weeks by the end of December. And on December 17, when the bank’s reserves of gold coin were within a few days of running out entirely, a deal with Nathan and James Rothschild brought £300,000 in gold sovereigns from Paris to London.14 The worst of the crisis was over.

  Rampant lending had brought bad debt and failed banks. The key elements that would prefigure two centuries of financial crises were already well in place. France, too, saw an extended financial crisis from 1827 to 1831, culminating in the failure of 252 banks in the years 1830 to 1831.15 Land, construction, agriculture, and even the silk industry were part of the downturn, and business bankruptcies almost doubled during this period. The Communist philosopher Friedrich Engels described a silk workers’ revolt in Lyon in 1831 as the “first working class rising” of the new industrial age.16

  The Crisis of 1837

  Just a few short years later, both Britain and the United States embarked on new and greater runaway lending in the first transatlantic financial crisis. The U.S. expansion
of the 1830s played out over several years and featured high-profile characters, such as President Andrew Jackson and Second Bank of the United States president Nicholas Biddle, but it also ensnared hundreds of anonymous bankers, merchants, planters, financiers, investors, and government employees.

  During his trip to the United States in 1831, French author and critic Alexis de Tocqueville described Americans as in pursuit of the answer to one question: how much money will it bring in?17 By the early to mid-1830s, the economy of the United States was in the midst of an enormous credit-fueled frenzy dominated by loans to purchase land, loans for real estate construction, and loans to finance large-scale cotton plantations. This frenzy drove up prices. From 1830 to 1837, U.S. GDP grew by $632 million, or 51 percent, to $1.9 billion, riding on a 22 percent surge in population. Across the Atlantic, the United Kingdom was in a credit boom as well, although it was only half as large, and much of the credit was to finance the burgeoning British textile industry that was a voracious customer for America’s cotton.

  Upon encountering Chicago for the first time in 1836, British writer and social theorist Harriet Martineau noted, “It seemed as if some prevalent mania infected the whole people. Storekeepers hailed [passersby] from their doors, with offers of farms, and all manner of land-lots, advising them to speculate before the price of land rose higher. . . . Of course, this rapid money-making is a merely temporary evil. A bursting of the bubble must come soon.”18

  The U.S. population was not only growing fast in the 1830s, through both increased birth rates and large-scale immigration; it was also moving west. From 1830 and 1840, the U.S. population grew from 12.9 to 17.1 million. But the population in the West grew faster. Missouri, including the gateway city of St. Louis, nearly tripled to 383,700. Ohio’s population grew by 62 percent.19 By 1836, observer James Buck noted that building lots in Milwaukee were already selling “for prices that made those who bought or sold them feel like a Vanderbilt.”20

  It spurred a nationwide eruption in construction, funded by loans from wealthy individuals, savings banks, private banks, states, and even insurance companies. It was during this decade that institutions first began to provide a significant portion of real estate loans. The construction frenzy went hand in hand with land sales. Between 1830 and 1836, the federal government alone disposed of 75,505 square miles of land. Most of this—50,999 square miles, an expanse equal to the whole of England—was sold between January 1835 and December 1836. Sales peaked at $25,167,833 in 1836 (Figure 4.3).

  Prices for acreage in Chicago’s Loop rivaled those in New York, rising a dazzling 41,275 percent, from $32 in 1830 to $13,240 in 1836.21 Writer and attorney Joseph Baldwin later satirized the general chaos of the boom years as “a riotous carnival,” unorganized and chaotic, a state “standing on its head with its heels in the air.”22 Meanwhile, in the West, new villages sprang up, existing villages became towns, and towns became cities. Many a young person could make a fortune simply by moving west, buying land on credit in a small town, and then waiting for the westward flow of settlers to drive up the price of that land. John Gordon reported on land sales in southern Michigan: “Everyone with whom I converse, talks of 100 percent as the lowest return on investment.”23 No one thought they could lose money on real estate.

  Table 4.3. U.S. Crisis Matrix: 1830s

  aFor 1836.

  In the five years leading to 1837, we estimate that U.S. private debt grew by 91 percent—primarily in state banks. Sector debt data is unavailable, but the sector with the greatest increase in spending was construction, which more than doubled. Other sectors with notable increases were cotton, canals, and public land.

  Figure 4.1. United States: Private and Public Debt as a Percentage of GDP, 1827–1843

  We estimate that in the United States private debt increased by $379 million (or 91 percent) between 1832 and 1837.

  Figure 4.2. United States: Total Value of Building Permits, 1830–1840

  Figure 4.3. United States: Federal Land Sales, 1831–1837

  The cotton boom developed apace with construction and land sales. In 1830, over two million acres were under cultivation for cotton; by 1840, the number was almost five million.24 As a tragic corollary, the slave population grew by almost one million between 1820 and 1840, and the price of slaves doubled between 1827 and 1836. Yet more tragically, during the runaway lending period of the 1830s and then again in the 1850s, Southern households and plantation owners engaged in the huge business of buying slaves with debt—and then mortgaging slaves for loans to use for other purposes.25

  In fact, in the antebellum South, using land and slaves as collateral to acquire a plantation was not a way to finance plantation acquisitions but one of the primary ways. In one Louisiana county, 88 percent of the mortgages were collateralized by slaves.26 Of course, slave values went the way of all booms. In the 1830s, the male field-hand price went from $580 to as much as $1,200. Those that lent at that high precrash value saw their loans go bad when values collapsed.

  The facts are tragic, appalling, and shameful. According to “Banking on Slavery in the Antebellum South” by Sharon Ann Murphy, “Commercial banks were willing to accept slaves as collateral for loans and as a part of loans assigned over to them from a third party.” Many helped finance the “sale of slaves, using them as collateral. They were willing to sell slaves as part of foreclosure proceedings.”27 Murphy continues, “Commercial bank involvement with slave property occurred throughout the antebellum period and across the South. Some of the most prominent southern banks as well as the Second Bank of the United States directly issued loans using” the enslaved as collateral, and the practice was so extensive that over time it implicated other Northern banks as well. Slaves’ value could decline over time, but they were valued as collateral because they were easier to sell than land and more mobile. The enslaved were thus often offered as collateral in large groups, as was the case with the Bank of Kentucky, to reduce the risk of any individual slave losing value because of age, illness, poor health, or death.

  Given the dearth of lending institutions in the South, slaves were used to capitalize new banks in highly circular and risky transactions to create the so-called property banks and plantation or planters’ banks: plantation bank charters required no paid-in capital to begin operations; the reserves of the bank were based entirely on borrowed money whereby investors mortgaged a portion of their land and slaves in return for bank shares.

  For example, in 1836 Bernard Marigny and his wife, Anne Mathilde Morales, mortgaged their sugar plantation in Plaquemines Parish—including the house, sugar mill, hospital, kitchens, slave cabins, warehouse, barn, stable, carts, plowing equipment, animals, and seventy enslaved humans—in return for 490 shares of stock in the bank.28 The entirety of the bank’s capital stock was based on these mortgages of plantations and slaves. But this still left the bank with no specie reserves for the issuance of bank notes or loans, so these plantation banks were further financed through the sale of bonds—typically at high yields and guaranteed by the respective state—which was used to gain specie.

  American plantations were established and then expanded by owners who borrowed against their slaves, land, and future crops, all without a clear sense of how many other farmers were doing the same. This brought overcapacity to the industry. “Buying a plantation,” one grower later told Frederick Law Olmsted, “is essentially a gambling operation.”29

  The high yields on property and plantation bank bonds made them particularly attractive for British investors eager for yields higher than the paltry 3.4 percent or so offered by British government bonds.30 New York brokerage firms with connections in Britain made sure the debt of these property banks was easily available for purchase on London exchanges.31 These bond sales contributed to a surge in American foreign debt, which increased from $110 million in 1832 to $220 million by 1836.32

  British investors tended to overlook the very real fact that Southern planters could mortgage personal property in addit
ion to land, meaning that these bonds often made investors complicit in the African slave trade, even though Britain had abolished slavery in most of its empire in 1833. Imagine the cotton boom of the 1830s as the Gold Rush of the South. Any nimble, ambitious soul with a small loan could grab a plot of land and try to spin it into cotton cash. Every cycle like this attracts masses of ordinary people who throw their hats into the ring to get rich, and is a core feature of a financial crisis in its boom phase and not a quirk. It was evident in the 1830s, in the early decades of the industrial economy. The rapid growth of the cotton market, a cornerstone export with ostensibly insatiable demand and soaring prices, lured novice farmers, shysters, pros, and mid-nineteenth-century “flippers.” Mississippi cotton production increased eightfold between 1819 and 1834, when the state yielded 85 million pounds. Two years later, in 1836, a year before the bust, they had 125 million pounds to sell. Wholesale prices on the commodities market increased from an index level of 84 in 1833 to 131 in 1836.33

  Cotton and land sales tracked each other. In 1833 the United States sold one million acres of public land in Mississippi. In 1835, it sold three million acres.34 No other state came close to that bonanza. Joseph Baldwin, the Virginia lawyer, moved to Mississippi in 1836. He muses in his memoir about “the wild spendthriftism, the impetuous rush and the magnificent scale of operations.” While the price of cotton kissed the sky and real estate followed suit, “money, or what passed for money was the only cheap thing to be had.”35 In 1830, the United States produced one million bales of cotton, priced at 10 cents per pound. In 1834–35, the price peaked at 17 cents per pound. Precrash cotton production peaked at 1.8 million bales.36