A Brief History of Doom

by Richard Vague

  The same pattern would hold in subsequent crises. Substitute “office buildings” or “houses” for “railroads,” and the story reads very much the same for the 1980s or 2000s. Borrowers could not pay debts, and ruin followed for railroads, farmers, and banks.

  The first steam-powered railroad company made its appearance in England in 1825,7 and railroads there were at least a minor factor in its crisis of 1837.8 But only in 1847 did the manic expansion of railroads first become a driving and central factor in financial crises, especially in Britain and Germany. In a very real sense, financial crisis in the mid- to late 1800s followed the tracks—and overcapacity—laid by the railroads themselves.

  Figure 5.2. United States: Public Land Sales and Miles of Railroad Built, 1800–1914

  The pivotal role of railroad overexpansion and debt in the financial crises of this era has been underrecognized. Every history of the crisis of 1873 mentions the failure of Jay Cooke’s Northern Pacific Railroad, but most gloss over the massive overexpansion of scores of other railroad companies in the United States, Germany, and Austria above and beyond Cooke.

  Figures 5.2 through 5.6 provide a rough sense of the connection between railroad overexpansion and financial crisis that often occurred. Figure 5.2 shows colossal spikes in railroad miles added in the United States in 1854, 1872, 1882, 1887, and 1902 through 1906. These correlate to spikes in federal land sales. Each was followed by a collapse in railroad construction since the resulting capacity had far outstripped demand, and those spikes and collapses played a significant part in the crises of 1857, 1873, 1884, the early 1890s, and 1907, respectively.

  Most of these crises saw a delay of a year or more between the point of overcapacity and the onset of the crisis, as is often the case in financial crisis. It was that staggered sequence during which the railroads first realized this trouble but were reluctant to convey this news to their creditors, then inevitably their lenders or bondholders would become aware, and finally the broader financial markets would learn the ugly truth. As we will see, in some crises, in fits of ignorance or optimism, overcapacity actually continued to be created during and even after the moment of crisis.

  Figure 5.3. United Kingdom: Miles of Railroad Built, 1837–1914

  The staggered unfolding of a crisis also happens because it was not just the laying of railroad track that brought the overcapacity but also the manufacturing of railroad locomotives and cars, the building of depots, the purchasing of land, and the constructing of new railroad towns replete with houses and commercial buildings. For example, in the U.S. crisis of the early 1890s, railroad track construction peaked in 1887, but railroad car construction peaked in 1890. The statistic we cite, “railroad track miles added,” is thus a rough shorthand for a whole host of associated activities that collectively overwhelmed economies in a connected timeline.

  In Britain, major construction spikes in the mid-1840s and mid-1860s correlate to the crises of 1847 and 1866, while smaller bursts of railroad-track miles in the late 1830s and the mid-1850s were at least a minor factor in the crises of 1837 and 1857 (Figure 5.3).

  In Germany, major spikes in 1847 and the 1870s were central to its crises in 1847 and 1873. Smaller spikes in the late 1890s were at least a minor part of the overcapacity that led to its crises of the 1900s (Figure 5.4).

  France was different. It came somewhat later to the industrialization game, and its railroad development was more constrained by the struggle between those who wanted to nationalize its railroads and those who didn’t. Thus, as Figure 5.5 shows, France never had quite the outsized burst of railroad construction as seen in Britain in the late 1840s, Germany in the mid-1870s, and the United States in the late 1880s. And the Bank of France was often more active in intervening when the country’s banks were in trouble. France’s crises, as we will see, came as much from its agriculture and from its bank’s investments in the railroads and industrial development of other countries (especially in Eastern Europe) as from its own railroad overbuilding.

  Figure 5.4. Germany: Miles of Railroad Built, 1837–1914

  Figure 5.5 France: Miles of Railroad Built, 1837–1914

  Figure 5.6. Cumulative Railroad Miles Built, 1837–1900

  Figure 5.6 compares the miles of track added in the four countries. The importance of this chart is to show that activity in the United States in this period dwarfed that in the rest of the world, as did the U.S. appetite for capital. In fact, the need for capital was so vast that European banks and investors were routinely enticed to invest in the debt of U.S. companies and were thus vulnerable when that debt became troubled. The sheer amount of financial activity in the United States meant that its crisis would resound the most powerfully around the globe.

  Worldwide, these cataclysmic crises were intertwined with the most momentous conflagrations of the era. Examples abound: the crises of 1847 helped fuel the Revolutions of 1848; the rise in grain prices that came with the Crimean War fed the creation of overcapacity before the crisis of 1857, which itself exacerbated the tensions that brought the American Civil War; and German exuberance, fueled by reparations after their victory in the Franco-Prussian War, contributed to the crisis of 1873.

  Each of these crises could be treated in as much detail as the crises described in the earlier chapters of this book, but each followed a similar pattern, so the scope of this chapter is only to provide highlights. It is a brief tour of the financial crises of 1847, 1857, 1866, 1873, the 1880s, 1893, and 1907.

  The Crisis of 1847

  The financial crisis of 1847 was brought on by the first major railroad-building expansion in the German Confederation and France and the second such expansion in Britain, which drove up share prices in all three nations. Railroad miles tripled in Britain and France and quadrupled in Germany, though total mileage in France was still comparatively small. Records are sparse, but loans appear to have grown rapidly in all three countries. The potato famine in Ireland, which drove up wheat prices and brought debt-fueled agricultural expansion, compounded the era’s turbulence. When the shares of railroads and the price of wheat collapsed, lenders failed and economic recession enveloped Europe.

  Table 5.1. U.K. Crisis Matrix: 1840s and 1850s

  *Limited data points.

  Loan data are incomplete, but railroad miles built grew sevenfold in this period; railroad debt growth was likely commensurate.

  In October 1845, Britain had roughly 1,428 extant or proposed railway companies, which collectively could claim £113,612,018 in capital against liabilities of £590,447,490, for an aggregate net liability of £476,835,472—or about 84 percent of Great Britain’s GDP in 1845.9 Even in December 2008, the Economist called the railway mania of the 1840s “the greatest bubble in history.”10

  Beset with “railroad fever,” 33,959 individuals subscribed to at least one railway share offering during the 1845–46 parliamentary session. The Bankers’ Magazine at the time stated that the “real object of the concocters of railway schemes” was “to rob and delude the public by getting their scrip into the market at a premium, and to rob and swindle their subscribers in particular by squandering and embezzling the deposit money.”11 In July 1845 the Times reported, in language that foreshadowed the Roaring Twenties, there was not a “man in London, above the condition of a streetsweeper, who had not speculated in railways.”12

  Table 5.2. France Crisis Matrix: 1840s

  In the five years leading up to 1847, railway miles grew briskly, France’s wheat production doubled, and capital investment nearly doubled before collapsing in 1848.

  Railway stocks rose sharply, with the average railway share price increasing 73 percent from July 1843 to July 1845.13 Some accounts conclude that £500 million in railway-related securities were trading by the summer of 1845.14 GDP growth, almost certainly fueled by this loan growth, soared by 8.1 percent in 1844.15 The Bank of England was part of the lending boom, and after the Banking Charter Act of 1844, the bank reduced its rates and began a policy of aggressive lending�
��or “discounting” in the vernacular of the time.16

  But with higher costs and revenue projections that fell short, railroad shares fell into distress, and those railroads called for the additional capital committed by subscribers.17 As the situation worsened, subscribers facing these calls raised cash the only way they could: by selling railway stocks. This pushed stock prices down, and by October 1848, railway mania had morphed into panic. Investors scrambled to sell railway shares before the bubble burst completely.18

  Feared shortages and soaring prices had led farms to expand, and many prominent corn (a British term that encompassed wheat) dealers and merchants to speculate. But when news arrived in June of abundant foreign grain supplies, prices immediately plummeted. This caught speculators completely off guard, and many were forced to sell at enormous losses. Wheat and the railroad industry grew together, and interdependently, since railroads enabled western wheat to affordably reach European markets from the eastern United States and to reach more distant markets within Europe.19

  In July a group of London merchants, traders, and bankers petitioned Parliament to dismantle the 1844 Bank Act to allow it to provide lending support to troubled lenders, which would in turn provide additional lending support to distressed businesses.20 A growing number of businesses—sent reeling by a combination of losses from corn speculation and the virtual illiquidity of money markets—began suspending payment or failing outright.

  At first, most of the affected firms were involved in the “corn” trade and based in either London or Liverpool, the primary entrance point for grain shipments. By the end of August, a total of eighteen such businesses had failed, eight of them prominent London corn houses saddled with liabilities totaling over £1.5 million.21 Failures peaked in October, with eighty-two suspensions reported by companies as diverse as tea brokers and soap boilers, not only across the United Kingdom (including Manchester and Glasgow) but even in a handful of Continental cities, such as Hamburg, Leghorn (Livorno), and Lisbon.22 The nadir came after the middle of the month, as both private and joint-stock banks began to fail. The first was Knapp & Company in Abingdon on October 13, but the most significant was the Royal Bank of Liverpool. With an ownership widely considered among the wealthiest in Britain, its suspension sent shock waves across the landscape of British finance and briefly shut down virtually all private discounting (lending) in London.23

  The Bank of England finally acquiesced and came forward with a commitment to “make advances more freely than it would otherwise have done,” providing funding support for banks and thus for their customers. This assurance alone stopped the bank runs and ended Britain’s banking panic.24

  Railways in Prussia and other Germanic provinces—along with associated construction—had grown rapidly too. From Berlin’s Silesian station to Frankfurt Oder, to the Berlin-Hamburg Railway and the Frankfurt to Mannheim and Heidelberg service, a loosely connected German railway network had rapidly emerged. Prussian iron and steel production went from 58 million marks to 101 million marks, with presumed commensurate loan growth, and then back down to 57 million marks.25 In the compressed time from August 1847 to January 1848, 245 businesses and 12 banks failed.26

  In France, it was agriculture and, to a lesser extent, railroads that brought the turbulence of this period, with the failure of 829 French banks with 207 million francs in liabilities.27 Agricultural shortages and high prices first brought famine, and France saw food riots, an increased population of beggars, increased urban migration, and heightened levels of hoarding and speculation. To address this shortage, farmers borrowed to expand, bringing an overabundance of crops. Wheat prices collapsed, causing heavily indebted farms to fail and putting thousands out of work. France’s GDP tumbled by a stark 22 percent, though there is much uncertainty regarding GDP figures for this era.

  Railroads were emerging in France too, but it was a smaller effort, as industry in France lagged behind both Britain and the German Confederation. In France the passage of an 1842 law had provided the general schematics for what eventually became the six great railroad lines, envisioned as privately run but government sponsored and owned.28 The 1840s nonetheless did witness an expansion of credit, mostly in the form of “speculative investment centered in projects for railway construction.” According to one study, the “lapse in confidence occasioned by the agricultural crisis produced a liquidity crunch at just that moment when calls for the unpaid balance on railway shares found French capitalists dangerously overextended,”29 bringing three railroad failures. Runs on banks resulted in failures in the provinces. Even the Bank of France saw its deposits reduced nearly sixfold between 1845 and 1847.30

  It should be noted that although France had comparatively less industrial development, this period saw it beginning to invest disproportionately in the industrial opportunities of other countries, a trend that continued through the century. France was thus vulnerable to the financial calamities of those other countries. This financial crisis set a pattern for others in the railroad century. It was the first major railroad-driven crisis and illustrated how this large, debt-fueled sector could topple an economy.

  The Crisis of 1857

  The next railroad crisis, in 1857, is often thought of as the first truly global financial crisis.31 In the three short years from 1845 to 1848, under Presidents James Polk and John Taylor, the geographic size of the United States had doubled,32 and gold had been discovered in the newly acquired territory of California.33 A “reckless optimism” followed, fueling business expansion in the United States. Just months before the start of the 1857 crisis, the New York Herald was proclaiming the “dawning of exceedingly brisk and prosperous times” that would last at least three years before any threat of a downturn.34

  With reliable long-distance transportation now a necessity to connect the sprawling new nation, U.S. railroads added over 9,536 miles of track from 1853 to 1856, particularly along the nation’s western and northwestern frontiers. This more than doubled the total mileage of the national rail network. By 1857 the total debt of U.S. railroads was over $400 million—with much of that owned by British investors.35

  Table 5.3 shows the rapid growth in debt in this era. However, it is likely that the totals were higher and the trends worse. There was a type of debt not included in the totals shown because of the scarcity of supporting information regarding the amount involved. The net worth of all households in the South in 1860 was $6 billion,36 and $3 billion of that was the value of the slaves they owned.37 Yet more disturbing, the enslaved themselves were often encumbered with debt. Based on the scarce data available, in total that debt was perhaps $200 million or more.38 If true, that would make it one of the largest single categories of debt. And if true, and if the slaves were freed, not only would half the Southern household asset value have disappeared, but those borrowers would have been left with a very large amount of debt that they would have had few resources to repay. This presumably further entrenched the tragic Southern position on slavery.

  Table 5.3. U. S. Crisis Matrix: 1850s

  a1852–1854 change.

  In the five years leading up to 1857, U.S. private debt grew by 57 percent. Sectors with the greatest concentration of overlending were railroad debt and household mortgages, which together comprised 75 percent of the increase.

  In 1850, the United States began giving railroads free land to encourage their expansion, and between 1850 and 1857, railroad projects in eleven western and southern states received land grants totaling 22 million acres. Railroads used this land as a source for funding since they could sell it or use it as collateral for debt offerings. Farmers and investors bought land by assuming a five-year mortgage from the railroad, and speculation quickly became rampant.39 As far west as Nebraska, “lots on the best street in Omaha, which had sold for $500 in the spring of 1856, went for $5,000 a year later,” writes Kenneth Stampp.40

  Figure 5.7. United States: Private and Public Debt as a Percentage of GDP, 1845–1867

  Private debt i
n the United States increased by $1.1 billion (or 128 percent) from 1849 to 1857.

  One of the more interesting aspects of this crisis is its illustration of a recurrent feature of financial crises: the development of creative lending instruments all but predestined to fail. In this case, clever railroad executives devised a financing method known as the railroad farm mortgage.41 The La Crosse & Milwaukee Railroad owners invented this deceptively simple scheme. They would approach farmers with land near the planned rail line and entice them to purchase shares of the railroad’s stock with debt secured by a mortgage on their farms.

  For the farmer the deal seemed like a no-lose proposition. It required not a dime in downpayment and no documentation other than an appraisal by a railroad agent. It foreshadowed the no-down-payment subprime loans of the Great Recession. Dividends on the railroad’s stock the farmers bought covered the interest on the loan. The farmer could expect increased land values once the railroad was built and an appreciation in the value of his railroad shares as the company accelerated its operations. But railroads that marketed these schemes were not profitable, and the dividends they paid were unsustainable.42 It was a catastrophe waiting to happen.

  Meanwhile the British economy had soared, fueled by high demand for British manufactured goods in both Europe and America.43 Then came the discovery of significant gold deposits in Australia in May 1851, only three years after the California gold rush.44 The shipbuilding industry responded by tripling the total tonnage of ships built, and gold began “heaping up in the Bank [of England’s] vault.” This allowed the bank to drop its discount rate to just 2 percent in April 1852, the lowest ever, which facilitated a lending boom.45 The aggregate total of deposits held in London joint-stock banks grew nearly fivefold between 1847 and 1857.46