Bagehot described the 1866 panic at the time as “a credit panic.” It was not the result of excessive drains on bullion reserves, he argued, or of national expenditures that exceeded savings. It was rather “a failure of credit by intrinsic defect”—the misuse and overextension of credit by even “the most celebrated of old houses.” And he was right. Bagehot had aptly and succinctly described the essence of all major financial crises.107
The Crisis of 1873
The 1870s boom that led to the global crisis of 1873 came from the renewed expansion of railroads. Railroad expansion this time was tied closely to the expansion of wheat production because agricultural transport was as big or a bigger source of revenue than passengers.108 Wheat production increased 89 percent between 1866 and 1873, and railroads expanded apace.109 In the United States between 1865 and 1873, the total mileage of the railroad network more than doubled, from 31,919 miles to 67,409. During that same period, the amount of bonded debt outstanding of American railroad companies more than tripled, from $539 million to $1.836 billion.110 In the same period, railroad mileage grew by 70 percent in Germany and more than doubled in Austria and Hungary.
Table 5.6. U.S. Crisis Matrix: 1860s and 1870s
In the five years leading up to 1873, U.S. private debt grew by 58 percent. Sectors with the greatest concentration of overlending were railroads and mortgages, which together comprised 69 percent of the total.
Figure 5.8. United States: Private and Public Debt as a Percentage of GDP, 1865–1885
Private debt in the United States increased by $1.8 billion (or 54.6 percent) from 1868 to 1873.
Table 5.7. Germany Crisis Matrix: 1860s and 1870s
*Limited data points.
In the five years leading up to 1874, bank loans grew by 90 percent; the value of wheat production and the number of railroad miles built both more than doubled.
The problem that should have been familiar by then was that this debt-enabled expansion had gone too far, and when the inevitable tumble occurred, those that financed it—lenders making too many bad loans—tumbled too, with colossal bank failures in the United States, Germany, Russia, and Austria.
The American Civil War had led to high wheat prices, and with that, far across the ocean, Russian nobles had bought more land and vastly expanded their production.111 Joint-stock company formation had exploded in the newly consolidated Austro-Hungarian (1867) and German (1871) Empires. The indemnity paid by France to Germany after its defeat in the Franco-Prussian War of 1871 left Germany flush with new money, and debt-financed speculation had accelerated markedly. In Prussia, 763 new businesses with a total worth of about 6 billion marks were launched in 1871 and 1872.112 The German stock exchange was 73 percent higher in 1872 than it had been two years earlier.113
In Germany, real estate investment companies called Baugesellschaften (building societies) emerged in the 1870s, more interested in “real estate speculation than in actual construction,” according to historian John Lyon.114 This foreshadows events with U.S. savings banks and real estate securities in the 1920s and 1980s. A special law in Prussian-dominated German states allowed for home purchases without down payments and, contrary to other mortgage bonds, usually went along with interest-only payments.115 Germans could thus acquire houses without equity, paying interest instead of rent, which led to excess mortgage lending and then “foreclosure rates of about one third of all housing units in the 1870s economic crisis and an ensuing 15-year interruption of building activity.”116
In France, by 1872, struggling to rebuild its battered cities, its national pride, and its economic momentum after that same Franco-Prussian War, bank loans had almost tripled in just three years, and railroad miles built had more than doubled in four years. Over the next two years, both tumbled.
In Austria-Hungary, 70 new banks formed between 1868 and 1873 in Vienna, and 928 joint-stock companies with market capital of 2.8 billion marks were formed between 1871 and 1873. In all, between 1867 and 1873, a total of 1,005 new companies were chartered. By 1874, half would fail.117
Mortgage loans in Austria-Hungary ballooned from 166 million Gulden in 1868 to 427 million Gulden in 1878,118 with speculation financed by a new genus of banks, as in Germany, called Baubanken (construction banks). Charles Kindleberger describes how the Baubanken stimulated “a class of peasants . . . that sold their farm land in the periphery of cities, especially Berlin.”119 The wealthy landowners, the Junkers, made a large profit, and expelled their tenant farmers. David C. Goodman and Colin Chant note that earlier, land prices typically correlated to agricultural use, “but as farmers came to realize the value of their land for housing, prices began to escalate.”120 This created a wandering population of displaced people. Families in search of affordable housing, wheeling carts of their belongings, clogged the city streets. A group of Schlafburschen, or “sleepers,” would rent “a patch of floor in someone’s apartment for a night or two.” Packing-carton manufacturers advertised “good and cheap boxes for habitation.”121 Beyond this, a consortium of princes and aristocratic families throughout Europe eagerly rode the coattails of the “railroad king” Bethel Henry Strousberg, legendary for his railway development in Romania.122
Given the greater railroad capital demands in the United States, Germans and Austrians bought U.S. railroad bonds as well. Traces of this transatlantic bubble can still be seen today: railroad promoters in North Dakota named a town Bismarck to “attract German capital.”123
Back in the United States, Philadelphia banker Jay Cooke, who is so central to most versions of the 1873 crisis story, typified the railroad finance excesses of the day. He made his fortune as a young man and then gained a national reputation selling U.S. war bonds during the Civil War.124 After the war, wanting to invest in a railroad but having determined that most of the important lines were already controlled by syndicates of wealthy investment banks and businessmen, he shifted his focus to the frontier and took control of 60 percent of the Northern Pacific Railroad. It had an enormous land grant but was on a sparsely populated and rugged route, so it had suffered chronic delays.125
Its losses and ongoing need for new capital were large, and so Cooke needed to quickly increase funds by selling both land and $100 million in Northern Pacific bonds. He spared neither effort nor hyperbole. Typical was one ten-column-inch ad that ran in the Times of London early in 1872, extolling the “excellent lands” available for purchase as well as the “salubrity of the climate, and diversity of natural resources.”126
The Northern Pacific turned out to be a hard sell, though, and was burning through capital far more quickly than Cooke could raise it. Almost from the start he resorted to making up the difference with funds from his Jay Cooke & Company banking firm.127 Things were dire enough that in 1871 and 1872, Cooke’s brother Henry, then the president of the recently created Freedman’s Saving and Trust Company, transferred between $500,000 and $600,000 out of the small deposit accounts of freed slaves to Jay Cooke & Company, which resulted in the loss of the meager savings of thousands of newly freed slaves.128
Wheat fortunes were lashed to railroad fortunes in the 1870s. Rapid expansion of production and technological advances in agriculture drove the price of wheat down by 56 percent, and North American farmers began to undercut the pricing of European wheat. This left Ukrainian and Russian grain producers with a glut, and they soon found themselves unable to make payments on their new mortgages, with the bitter result that Russian banks foreclosed on nearly six thousand estates in the winter of 1872–73.129
This brings us to Vienna in early May 1873. In the euphoria, Viennese stocks had risen to unsustainable levels, and on the afternoon of May 9, stocks crashed. The Maklerbanken (agency banks), with their large investments in Austro-Hungarian exports, collapsed first. Many of the building and loan societies that had financed overvalued land purchases followed.130 The collapse bruised every business sector.131
What began in Austria made its way to U.S. lenders in September 1873. Most of
the early casualties, including the New York Security & Warehouse Company and the stock brokerage Kenyon, Cox, & Company, were brought down directly or indirectly by their exposure to railroad companies, which were in worse shape than imagined.132 As we saw with the Great Depression, the first bank failures do not happen randomly. In 1873, they happened to those with exposure to railroads and its associated construction.
When Jay Cooke & Company failed on September 18, the country was uniformly shocked, though rumors had been circulating for some time.133 The failure brought on a full crisis. Soon dozens more banks, brokers, and other railroads failed.134 Mercantile failures exploded. The 5,183 failures in 1873 grew to 5,830 in 1874 and 7,740 in 1875.135 Banks called in loans as fast as they could, damaging good businesses and further damaging the bad, and loans fell from $940.2 million to just $853.4 million in a mere two months.136
When Jay Cooke and Company filed for bankruptcy, Berlin could no longer hold and collapsed the same month. That year, one-third of all Prussian banks failed,137 and 61 banks, 4 railroads, and 115 industrial companies went bankrupt.138 The Prussian Office of Statistics reported that 444 public Prussian companies lost 2 billion marks.139 Many stocks were soon worthless. In France, a number of savings banks were suspended and notaries (issuers of long term credit) failed.140
Overcapacity meant that the United States—and much of Europe—descended into a half-decade of economic depression and stagnation. From 1873 to 1875, 121 U.S. railroad companies defaulted, with a total of $552 million in outstanding debt.141 Earnings from passenger service would not fully recover until 1879. Freight traffic fell off by up to 50 percent. It took seven years to regain the 1873 level.142
With the collapse in demand from railroads, by the end of 1874, half of all U.S. foundries had closed down.143 Other firms tried to stay afloat by cutting back on the labor side, using layoffs, reduced hours, pay cuts, and the payment of wages with company IOUs to mitigate the lack of liquidity. Indeed, this crisis is also notable because it was the first financial crisis in which a large number of Americans had become wage earners, no longer able to retreat easily into subsistence life on farms. From this point onward, the prevalent condition of wage labor would fundamentally change how financial crises were experienced. Unemployment was punishing, and at one point roughly 25 percent of all workers in New York City were jobless, leading to protests, demonstrations, and violence as workers gathered to demand jobs in such places as Chicago, New York, and Boston.
The 1873 crisis also contributed to post–Civil War racism, as many whites blamed former slaves rather than railroads for their economic woes. This not only bolstered the cause of “redemption” (the return of white Democrats to political power) but also increased physical violence against African Americans. This scapegoating of minorities for economic trouble occurred in Europe, too.144
The 1873 crisis took a devastating toll, and across all of these countries, it was notable for the length, unevenness, and turbulence of the recovery. The United States did not truly regain its momentum until 1879, France not till 1880, and Germany not till the mid-1880s.
Table 5.8. France Crisis Matrix: 1870s and 1880s
*Limited data points.
In the five years leading up to 1882, France’s bank loans grew by 50 percent. Railroad miles built increased by 66 percent.
The Crises of the 1880s
In 1882, France once again touched the hot flame of financial crisis. From very low levels in the late 1870s, railroad miles built had exploded by 1881, and in the three years leading to 1882, banks loans had grown by a startling 85 percent. The period saw the spectacular rise of the banking industry, with such notable events as the doubling of the capital of Crédit Lyonnais, the 1881 founding of the Bank of Lyon, and especially the 1878 founding by Paul Eugène Bontoux of the Société de l’Union Générale.145 Bontoux’s bank lent aggressively to all sectors but especially to railroads both in France and abroad. Collectively, the industry was making an excess of ill-judged loans that would come back to haunt them.
The Paris Bourse reflected the surge in activity, with a burst of listings of construction, trade, and transport companies.146 In 1881 alone, 163 new companies entered the market to raise capital.147 It all came tumbling down in January 1882, and with it, Bontoux, whose bank among other missteps had fraudulently misrepresented its capital position. He was tried and sentenced to five years in prison but fled to Spain.148 A number of other, mainly industrial banks failed. The painter Paul Gauguin, a stockbroker at the time, had his earnings crushed in the crisis. He decided to take his brushes and devote himself to painting.149
On the other side of the globe, Japan had aggressively industrialized after the Meiji restoration of 1868, in a determined quest to catch up to the industrial powers of the West. This included the establishment of factories and banks. But Japan quickly took this to a level of overcapacity and saw resulting bank failures by 1882. China, too, suffered a banking crisis in 1883 centered in Shanghai.
In the United States, the 1884 crisis came as annual railroad miles built grew from 2,280 (1877) to 11,599 (1882)—far too much capacity at that moment—before plunging to 3,131 (1885). An adjunct was the rapidly expanding western cattle and meatpacking industry, extending from Texas cattle drives, to Chicago’s meatpacking plants, to the rail transport of the meat to the East Coast. It had its own bout with overcapacity and collapse at this time. Private debt grew by 52 percent between 1879 and 1884. U.S. GDP fell by 4.3 percent in the two-year period culminating in 1885. The crisis is best known for bankrupting former president Ulysses S. Grant and Grant & Ward, the firm he had established with his son and his son’s close friend. The crisis took down several other lending institutions and thousands of small firms.
Émile Zola’s novel L’Argent [Money], penned in serial form beginning in 1890, reflected on the decade with a searing indictment of “the evils of ‘speculation’ ” and showed that the path to financial crisis or, in his words, “the ways of the speculator, the promoter, the wrecker, the defaulter, the reptile journalist, and the victim, are much the same all the world over.”150
The Crisis of 1893
The U.S. financial crisis of the early 1890s came with the 1887 spike in railroad construction, the largest in U.S. history.151 With it, railroad miles built quadrupled. The associated upturn in locomotive and freight car production peaked in 1890, and steel production peaked in 1892. This period saw another avalanche of largely debt-financed federal land sales from 1883 to 1890, also the most in U.S. history. It was an indicator of the accompanying surge in residential and commercial construction, which peaked in 1889 and 1890, respectively, creating another layer of overcapacity.152 Production of rails, steel, locomotives, and freight cars collapsed and would not fully recover for half a decade.153 This timeline illustrates a common element of financial crises: the staggered overcapacity peaks and the protracted agony of the bust.
Figure 5.9. Distressed U.S. Railroads: Value of Stocks and Bonds, 1885–1905
Table 5.9. U.S. Crisis Matrix: 1880s and 1890s
a1886–1887 change.
b1887–1893 change.
In the five years leading up to 1891, U.S. private debt grew by 42 percent. Railroads and mortgages comprised 58 percent of that total.
Figure 5.10. United States: Private Debt as a Percentage of GDP, 1880–1900
Private debt in the United States increased by $7.6 billion (or 121 percent) from 1880 to 1893.
Railroad companies started to collapse in 1892, with a huge number placed under receivership and sold under foreclosure over the next five years, as shown in Figure 5.9. The stocks and bonds of railroads placed under receivership had been less than $200 million from 1888 to 1891, grew to $358 million in 1892, and then tripled to $1.8 billion in 1893—an amount equaling 12 percent of GDP. Bank failures rose from 17 in 1889, to 69 in 1891, to a cruel 326 in 1893. The stock market echoed the pain, with sharp reversals in 1890154 and then again in 1893.155
Fatally overextended,
the Philadelphia and Reading Railroad collapsed on February 23, 1893, just days before President Grover Cleveland’s inauguration for his second term.156 Rumors of financial problems at the National Cordage Company also drove it to receivership on May 4,157 as banks called in its loans, and the New York stock market crashed the following day. Other railroads fell in succession, including the Erie Railroad in July, the Northern Pacific again in August, the Union Pacific in October, and the Atchison, Topeka, and Santa Fe Railroad in December.158 The bill for railroad overcapacity was coming due—again.
Businesses were overextended as well. The number of commercial failures grew each year, starting in 1887 with 9,634, but reaching 15,242 companies, with liabilities of $346 million, in 1893. The companies that failed in that year were on average double the size of those that failed the previous year.159 The agriculture sector had expanded in the upturn, but farmers suffered when wheat prices crashed in the crisis.160
A Brief History of Doom Page 17