Great Britain had a colossal stake in this as a trading partner. Between 1820 and 1830, according to early economic historian Leland H. Jenks, “Thirty-six per cent of the domestic exports of the United States went to the British Isles,” while “sixteen per cent of the domestic produce and manufacturers of the United Kingdom . . . were shipped to American ports; and this merchandise formed forty-three per cent in value the total imports into the United States.”37
Cotton was the raw material for Britain’s industrial revolution. It arrived in Liverpool on ships from the American South to be transformed in the mills of Lancashire into textiles and other goods. By the mid-1830s, nearly 90 percent of the cotton imported into Britain came from the United States, and the British market claimed 60 percent of all American cotton production. In 1836, the $50 million of cotton sales to Liverpool brokers represented roughly half the value of all U.S. exports, more than tobacco, manufactured goods, lumber and wood, wheat flour, and rice combined.38
The economies of the United Kingdom and the United States would rise and fall together, on cotton. Britain would later rue this concentration and diversify cotton sourcing to Egypt, India, and beyond. Debt fueled all of this—debt in land, construction, and cotton. As in most such expansions, central government debt was a benign factor. In fact, most private debt booms are good news for the government, at least over the short term, and this was true in the 1830s. Revenue from import duties, a primary form of U.S. federal income before the advent of income taxes, grew 133 percent from 1834 to 1836, rising from $21.8 million to $50.8 million. With these revenues and the sale of federal land, the U.S. government was able to fully pay off its debt—an extraordinary development. (The states’ debt, as we will see, was another matter.)
In notable contrast to government debt, which disappeared, U.S. private debt skyrocketed. It grew from an estimated $340 million in 1830 to almost $800 million by 1837. Rapid GDP expansion was fueled by the lending boom that came from such lenders as banks, cotton brokers, and bond houses. The Second Bank of the United States was at the heart of the U.S. banking system. Because the currency issued by locally chartered state banks lost value in proportion to the distance it traveled from its home city, the Second Bank—the only bank permitted to have branches across different states—helped to stabilize the values of different bank notes and effectively produce a “nationalized currency.”
Yet President Andrew Jackson hated the Second Bank, blaming it for the Panic of 1819, with some justification as we have seen, and believed that banking should be left to individual states. The Second Bank’s shareholders included not only the government but wealthy individuals—many of the elite, moneyed eastern interests that as a westerner Jackson loathed. Following Jackson’s decisive defeat of Henry Clay in the 1832 election, Jackson vetoed the bill to renew the Second Banks’ charter set to expire in 1836. Then he charged his secretary of the Treasury, Roger B. Taney, to create a separate financial apparatus that would remove federal monies from the Second Bank and send it to certain state banks, referred to as “pet banks.” In other words, Jackson intended to gut the Second Bank’s central role in U.S. banking.39
This removal cut the Second Bank’s deposits to a meager $2.3 million by 1837. Its loans quickly dropped by almost $13 million and never again reached their 1832 peak. (After it lost its federal charter in 1836, the Second Bank obtained a state charter and tried desperately to stay in business, but closed in 1840.) Freed from any federal responsibility or oversight, states embraced the establishment of new state banks. The number chartered jumped from 381 in 1830 to 703 in 1836. These were often poorly regulated, which is another core element of a financial crisis. These state banks were a prototype for the less regulated lenders who time and again would play an outsized role in precrisis lending mania. Flush with these new deposits and sensing opportunity, these state banks went on a lending spree. Jackson had curbed the Second Bank’s power but ironically contributed to the era’s profligate lending growth through his support of these state banks. Their loans, fueled by these government deposits, surged from $153 million in 1832 to $511 million in 1836.
Across the Atlantic, British lenders were financing a large portion of the U.S. cotton industry at the same time. Historian John Joseph Wallis relates that around 1836, Southern cotton owners “typically consigned their product to a business that arranged for shipment and finance, in return for which the cotton owner was able to draw on credits for a percentage of the estimated value of the cotton prior to final sale.”40 That was financed through a “bill of exchange” in Liverpool or London markets. The arrangement was typical, and the bills were viewed “good as gold.” For American importers of British goods, the same mechanics applied in the other direction. The Bank of England’s acceptance and discounting of these bills provided a giddy stream of liquidity for international trade.
By 1836, bill brokerage—the buying and selling of these bills—was a massive transatlantic enterprise in its own right. Given Britain’s financial structure, the size and liquidity of this market ultimately depended on this willingness of the Bank of England to buy good bills from brokers.
By 1835, Britain had over 1,200 integrated cotton mill factories, employing a third of a million people. This industry expansion brought a slew of new banks across Britain and Ireland. The 1833 act to renew the Bank of England’s charter also allowed for the simplified organization of joint-stock banks and permitted those outside of London to issue bank notes as a means of extending loans. With this, more than 200 new British banks and bank branches had opened for business by 1836, with roughly 75 percent issuing their own currency. These additional issuances made it difficult for the Bank of England to gauge the overall circulation of money in the country and even harder to craft appropriate responses to changing monetary conditions.
By mid-decade, a widespread and troubling excess of real estate development, cotton, and other commodities on both sides of the Atlantic imperiled the loans made to fund those activities. Overcapacity in cotton had been reached and exceeded. There was simply too much of it—more cotton than the British could use for its textile industry and more land and houses being sold than legitimate U.S. demand could support. Cotton had become the equivalent of those vaunted Manhattan skyscrapers of the 1920s or the resort hotels and office towers of 1990s Japan.
U.S. lenders grew concerned about their borrowers’ ability to repay months before this would be abundantly verified by unfinished ghost towns hard beside rivers. The Milwaukee Advertiser warned presciently in September 1836, “There is a limit to speculating on land. Before three years pass, numbers of speculators will be as anxious to sell out their lands as they have been this year to buy them.”41
President Jackson was growing more concerned about this widespread and rampant speculation. On July 11, 1836, he signed the executive order called the Specie Circular. It took effect on August 15 and required that government land be purchased with gold or silver instead of paper currency. Like a lightning bolt, it stunned and then deflated the debt frenzy by dramatically curtailing the ability of purchasers to use loans to buy federal land since many loans took the form of paper currency in this era. Land sales collapsed from $25.2 million in 1836 to $7 million in 1837, and secondary market land prices with them.
This collapse reverberated widely. It meant that a significant number of loans made at the higher prices were now inadequately collateralized and at risk. It also meant that loans where the borrowers’ only means of repayment was to sell the land were now at risk, an early example of Minsky’s Ponzi phase. Most notably, it meant that there were tens of millions of dollars in loan losses for fragile, undersupervised state banks.
The Specie Circular created an enormous demand for gold and silver in the nation’s Southern and Western states, since only those forms of currency could be used to purchase land. This further drained reserves in New York and thus curtailed the availability of credit from those institutions. Was Jackson to blame for the collapse? He faced
a classic financial boom dilemma: whether or not to intervene to cool down an overheated market.
The Specie Circular did precipitate the decline in sales and values. But if he had not issued the circular, the real estate loan problems would still have come, only later—at which point the problem would only have been larger and the damage greater. Could there have been a gentler transition than the one brought by the Specie Circular’s abrupt prohibition? Certainly—but again, not without allowing the problem to grow larger.
In 1836, we see essentially the same dynamic and false choices evident in 1929 and Japan in the 1990s: once an excess of private debt and overcapacity has occurred, there are no policy solutions to completely avoid damage, only policies to mitigate it after the fact. By 1836, far more land had been sold than could be economically employed. At some point, the overselling needed to stop and the overcapacity given time to be absorbed. It would have been better if some mechanism had been in place all along to moderate the surge in leveraged land sales.
As in the 1830s, so also in the 2000s: it would have been better to prevent runaway private debt growth than to try to fix it later.
Meanwhile, across the Atlantic, the Bank of England reported a decline in its reserves, likely owing to emerging loan problems, to withdrawals to meet loan payments, and to increased imports caused by poor harvests. Since the bank had a requirement to maintain a certain level of reserves, it did what it had to do: it raised rates to attract new reserve funds.
After nine years of rates at 4 percent, the Bank of England raised rates to 4.5 percent on July 21, 1836, and then to 5 percent on September 1, 1836. The rate stayed at 5 percent through the end of 1836 and all of 1837.42 In the following months, New York banks had to do the same to prevent an outflow of funds to Britain. These higher rates pressured borrowers on both sides of the Atlantic, who were already under strain.
Outside of London, many interpreted the Bank of England’s decision to raise rates over a short period as evidence of deeper problems in the city, and economics scholar Geoffrey Fain Williams writes that British financial institutions in the summer of 1836 were “getting very nervous about the credit that was being extended to the United States.”43
A number of British banks soon faltered. Williams writes of the textile and manufacturing center of Lancashire that “11 banks as failed or disappeared . . . while the directories suggest 19 branches closed in the same period. A number of Lancashire banks failed or endured spectacular losses between 1836 and 1837, and the Lancashire region’s banking system became somewhat infamous.” British bank failures tripled from twenty in 1835 to sixty-one in 1836.
Table 4.4. U.K. Crisis Matrix: 1830s
*Limited data points.
In the five years leading to 1837, Bills of Exchange increased 35 percent, and bank failures increased markedly.
A second problem haunted the Bank of England: it had to decide how best to handle the delicate financial condition of the merchant banks that specialized in the financing of trade with the United States. Typically referred to as the “American houses,” these were seven large and powerful firms that had become essential and integral to just about every Anglo-American commercial or financial transaction. They were the 1830s version of “too big to fail.”
Not all were in bad shape. The relatively staid Baring Brothers had backed away from many of its dealings with the United States earlier in the year. But the Bank of England had worried for months about the three American houses in the most precarious financial situations. These three houses—Wiggin & Company, Wilson & Company, and Wildes & Company—were dubbed the “Three Ws.” They had combined liabilities of £2.78 million as of June 1836, but more problematic for the Bank of England was that it held a total of £1.67 million in these companies’ acceptances, money it might never see if worrisome trends continued. The Three Ws had been suspect for some time, mostly because of their close ties to the United States. Many believed that U.S. businessmen, abetted by the Three Ws, were rolling over debts to British creditors that they couldn’t pay.
By late August, the bank finally decided to stop discounting paper from the American houses altogether. In other words, they stopped lending to these firms against the collateral of their loan contracts. This was terrible news for those firms, who had been seeking assistance from the Bank of England for months, but the decision allowed the bank to try and relieve itself of a problem that had been festering for just as long.
As soon as the policy was announced, though, an American-born director of a large Liverpool bill-broking business, William Brown, told the Bank of England that such a move could be potentially disastrous. The firms involved in the cotton trade, he explained misleadingly, were just temporary victims of the cotton growing calendar and would have the cash to repay their debts once the year’s crop was harvested. Without access to bills of exchange during this vulnerable time, he explained correctly, the American houses would surely be ruined and would take down untold numbers of British cotton merchants and American cotton factors with them. So just four days after declaring its hard line on the American houses, the Bank of England reversed its decision.
As summer turned to fall, evidence grew that a crisis might be looming. Bank of England bullion levels gradually shrank, down to a little over £5 million by September. In November a number of Irish banks failed, and the monetary “pressure” was soon felt in Britain’s manufacturing districts. Later that month Manchester’s Northern and Central Bank of England came to London, hat in hand, asking for an emergency loan of £100,000. It was becoming increasingly apparent to businesspeople and bankers on both sides of the Atlantic that a crisis was all but inevitable by the end of 1836. The only question was when it would start. Over the first few months of 1837, caution and anxiety dominated the money markets of Britain and the United States. In fact, remarkably similar stories were playing out in both nations, without the other knowing about them, since news from one side of the Atlantic to the other traveled only as fast as the packet ships that carried it.
For the American houses in Britain and the major cotton brokerages in New Orleans, the oversupply of cotton had become a matter of life and death. And so all eyes were watching these firms. Prices of the world’s biggest crop dropped as the panic and the beginnings of a depression gained hold. Prices had peaked in 1834, but production was continuing to climb and would crest in 1837, putting further downward pressure on prices.
Between January and March 1837, contradictory news from Britain caused wild fluctuations in the U.S. stock market. And the news on cotton became very bad very quickly, with an oversupply sending prices down 30 percent during that same period.44 On March 4, 1837, New Orleans’ largest and most prominent cotton broker, Hermann, Briggs & Company, failed, only hours before Martin Van Buren’s presidential inauguration, bringing down with it at least ten other major cotton brokers and dozens of smaller companies. Like so many of the major players in the cotton trade, Hermann, Briggs had been hurt by speculation, overproduction, and depressed cotton prices in Liverpool.45
Hermann, Briggs was insolvent by $6 million and had been keeping afloat over the winter by essentially passing bills of exchange back and forth between itself and a Mississippi firm also owned by its partners, using promissory notes from one business to cover the debts of the other, and vice versa.46 When news of Hermann, Briggs’s failure reached New York a week and a half later, the impact was immediate and widespread. Cotton lenders on both sides of the Atlantic were casualties. Within hours, the banking and bill-broking firm Josephs & Company announced its own suspension. Josephs, a large and well-regarded establishment, had extensive correspondent and credit relationships with Hermann, Briggs and had continued lending to the firm despite its own financial troubles. It had even ignored advice from the Rothschilds to cut their ties with the cotton broker. By at least one account, Hermann, Briggs owed Josephs $1.4 million when it suspended.
News of the Josephs failure quickly spread through Wall Street. “Yesterday wa
s the ‘beginning of the end,’ ” the New York Herald declared on March 18. As went the price of cotton, so went the price of land and slaves. A Vicksburg, Mississippi, editor in 1837 wrote that slaves “are selling under execution for a fifth of their real value.”47
In Britain, rumors swirled all winter about the great difficulties of the American houses, especially the “Three Ws.” The entire London business community well understood that these companies, the linchpin of the Anglo-American cotton trade, would take down a cascade of merchants and bankers with them if they failed. People noticed, then, when partners of five of the seven American houses sent a letter to the governor of the Bank of England in late February, explaining that they would collectively require hundreds of thousands of pounds in discounts each week of April and May if they were to survive—and perhaps in June as well.
After two days of negotiation, the Bank of England announced its bailout plan on March 4. The American houses would continue to have access to discounting, half of which would be provided by the bank and half by a group of private banks without any ties to U.S. trade. But a rising chorus of observers criticized the plan.
Back in New York on Tuesday, May 2, the New York Herald ran a story exposing a problematic credit scheme involving the Dry Dock Bank, Mechanics’ Bank, and the brokerage house Bullock, Lyman & Company. Because of the scandal, Dry Dock president John Flemming resigned his position the following day and was found dead the next morning. Mechanics’ Bank survived a run on May 4. Though Dry Dock continued to open for business, other New York City bankers met and announced they would refuse to accept any paper from or offer any assistance to Dry Dock.
A Brief History of Doom Page 13