Bagehot

by James Grant

  He would soon rue it. The shares bounded to £25 from the £15 offering price, but flattened and faltered in the new year. Rumors were making the rounds that Overend Gurney partners were selling their estates to raise cash. It was later revealed that members of the Gurney family pitched in with £2,000 to persuade one of the partners, John Gurney, not to fire his servants, lest the discharged help spread worrying stories.

  At the end of January, the Joint Stock Discount Company, one of the new limited liability flotations, announced that the expected dividend would go unpaid. Worse, the directors found it necessary to issue a capital call, the second of the firm’s short public career.§ The news seemed not to tarnish Overend Gurney, though the Joint Stock Discount Company bore more than a passing resemblance to the Corner House. An old-line partnership, the Joint Stock firm had issued limited-liability shares to the public in 1863. By and by, the old management, which had made a good living in the staid business of bill brokering, had taken up riskier lines of lending. It did so out of necessity, as its own cost of funds (for deposits at fourteen days’ notice) was fully 7 percent.

  “To finance” was a new verb on Lombard Street, the one-time noun now pressed into service to describe the new array of French-imported credit operations.26 To earn a rate of return in excess of its elevated cost of borrowing, the Joint Stock Discount Company had financed, among other speculative-grade businesses, the railroad contracting firm of Overend, Watson & Co. A known heavy borrower from the new cohort of finance companies and risk-tolerant bill brokers, Overend Watson was now bankrupt.

  The Economist remained sanguine: such difficulties as these implied nothing adverse about the general state of affairs. “Ordinary credit is sound,” the paper opined. “The revelations of the Joint Stock Discount Company and other such Companies are disastrous to those concerned, but they have no diffused effect. The public at large never heard of them; their momentary success was known only within a small circle, and their present disasters will spread dismay within that circle only.”27 Still, the market’s suspicions were aroused. It did not escape public notice that the first name of the failed railroad contractor matched that of the storied bill broker (though there was no known direct connection between the two companies). Deposits began to leak from Overend, Gurney & Co.

  On one hand, Overend Gurney’s was hardly to blame for the threat of war between Prussia and Austria, falling share prices, falling commodity prices, the rash of business insolvencies, or the jump in the bank’s bill deposit rate, all of which contributed to a loss of business confidence in the early months of 1866. On the other hand, only Overend Gurney was responsible for the blunder of lending £422,565 to the Millwall Ironworks Company, resulting in the ultimate loss of precisely £422,565.

  Details of the goings-on at Overend Gurney were years in coming to light, but not so the criminal incompetence of the management of the Joint Stock Discount Company: it blazed forth in a March 16 shareholders’ meeting. A new set of directors had inspected the books (such as they were), inventoried the assets and liabilities, and, out of their own pockets, stumped up the funds with which to pay up to £50,000 in immediately maturing debt. While the balance sheet showed assets of £4,851,000 with which to cover liabilities of £3,892,000, the quality of those assets was a mystery. The new directors readily supplied their qualitative assessment: in one case, the securities were not worth “the snap of a finger,” and in another, more general case, on “a large amount of securities on which advances had been made it was found that, when the securities came to be examined, a considerable proportion were missing, and that others had been substituted which were worthless.”28

  The fall in share prices of limited-liability finance companies turned into a panic, though not a conventional one. Panics by their nature are undifferentiating, but this was a panic largely confined to financial and discount shares. Neither The Times nor the Economist had seen the likes of it before. Good luck to the burnt speculators in the formerly white-hot financial shares, the two journals agreed; they deserved everything that was coming to them.

  No “competent person” was taken unawares, Bagehot wrote. “The wonder has been how it has been postponed so long.” He had known it all along, he intimated, though “the feeling is not one which could find expression with propriety in print.”29 The Economist had been predicting a decline in interest rates, and it renewed that forecast in mid-April. It likewise repeated its conviction that no harm would come to “sound people” and that the authorities had the situation well in hand:

  The Bank of England now manage well, and they used to manage ill. The directors used to let the reserve run low, and at every period of consecutive failures there was then the probability of a panic. Now the Bank of England manage well, keep their till full, and the failure of fifty discount companies, and the depreciation of all manner of shares, produces no real effect on the world at large.

  By the time the Overend Gurney directors met in the first week of May to consider a capital call, the situation was irretrievable. Their only recourse was to their former savior, and, subsequent to 1857, their nemesis, the Bank of England. Would the Old Lady extend a helping hand to the troublesome people at 65 Lombard Street? The Bank dispatched a three-man team to inspect the supplicant’s books. The verdict was negative—the Corner House was insolvent—and the Bank declined to assist. The heretofore unimaginable occurred at 3:30 p.m. on Thursday, May 10. Overend Gurney closed its doors.

  The ensuing panic exhausted the descriptive powers of the financial press. One observer likened the crisis to an earthquake: “It is impossible to describe the terror and anxiety which took possession of men’s minds for the remainder of that and the whole of the succeeding day. No man felt safe.”30 There were exceptions, though: prospering bears who had sold short the overvalued shares of Overend Gurney and those of its major clients, some of whom had, in addition, hammered the shares of innocent financial institutions about which they had planted malicious rumors. In the best of times, not many banks and discount houses could have exchanged their liabilities for gold sovereigns if the depositors demanded their money at once. In the worst of times, such a transformative feat was impossible.

  On Friday—Black Friday, and therefore, inconveniently for the Economist, a going-to-press day—Bagehot scribbled a live report to Chancellor William Gladstone:

  A complete collapse of credit in Lombard Street and a greater amount of anxiety that I have ever seen. . . . There is much foreign money in London invested in bills, many due in May; I fear this money will be withdrawn from a general apprehension that English credit is not to be relied on.”31

  Next he wrote for the waiting presses in the basement of 340 Strand. Nine months earlier, Bagehot had stamped the going-public transaction with his paper’s seal of approval. He had not said “buy,” and he had, indeed, dropped hints of concern, but the tone of the article was largely positive. It would likely have dissuaded no one from making a costly mistake.

  But mea culpa was no part of the repertoire of Victorian financial commentators, including Bagehot. On the contrary, he acknowledged no error, and instead invited his readers to recall how right he had been. He had known, even if he had been unable to commit that knowledge to paper:

  It will be found that when that firm was converted into a private company we expressed ourselves most anxiously and guardedly as to the value of their shares. Of course we could not say what we then believed, and what was generally known, that the old firm had by most reckless management reduced one of the most profitable concerns in England to one of the most losing concerns. We can only say what we can prove, and though we thought this as much as we now think it, we could not say it in print without legal consequences. We expressed ourselves with guarded caution, and under the circumstances this is all which we could do.32

  How vast, Bagehot continues, is the gulf in knowledge between outsiders and insiders. There can be no doubt on which side of the informational divide the editor is privileged to si
t:

  We have often heard it said, and we ourselves believed that the failure of Overend, Gurney & Co. (Limited) (which we have thought possible any time this three months) would not produce at all the effect which would have been produced by the failure of the private firm some years since. But in fact, the failure of Overend’s could hardly in their most reputable days have produced a greater effect. It has been signally shown how much an old name, which all really instructed people knew to have lost its virtue, still retains its magical potency over the multitude.33

  If Bagehot had not foreseen the downfall of Overend, Gurney & Co., still he excelled at describing it. In the very fire of the panic, he produced a lengthy article on the nature of credit, the uses of bank notes in a financial system rapidly converting to checks, and the methods by which banks cleared their reciprocal debits and credits, methods that wonderfully economized on paper currency. The piece renews the Economist’s longstanding criticism of Peel’s Act: there ought to be an opt-out clause in the law, he urges, by which the chancellor and the First Lord of the Treasury could themselves issue an order allowing the Bank of England to issue enough currency to quell a panic—for, in a panic, people clamored for legal tender, the Bank’s own notes.

  That being said, Bagehot concludes, the Economist was far from advocating “laxity,” or “insolvency.” It rather supported an improvement in the machinery by which the government and the Bank could spare the community unnecessary suffering. As things stood, days dragged by before the Bank and the government could combine to suspend the strictures of the 1844 Act. Each day seemed like an eternity. “We have,” Bagehot reminds his readers,

  often before quoted a saying of Sir George Lewis. He said that Peel’s Act did so much evil in the panic week that it made one doubt if, on the whole, it were not bad rather than good, notwithstanding all the good it did at other times. Yesterday was perhaps the worst day ever known in a week of that sort, and our proposal would save at least half the agony of such days as these. If the Act of 1844 is to stand at all, it can stand only by such an alteration as this.34

  The magnificently talented Bagehot proved, at last, no more clairvoyant than are most of his journalistic descendants. With Overend Gurney, as with America’s Civil War, he did his best work after the fact.

  * As it took a director twenty years or so to succeed to the office of governor, and as the governor’s office could be physically and intellectually demanding, the court liked its new blood young. Walter Bagehot, Lombard Street: A Description of the Money Market (London: Henry S. King & Co., 1873), 209.

  † Actually, not quite 100,000 shares were on offer, as the selling partners consented to take half of the cash portion of the purchase money in the form of shares in the new company. The other half they accepted in the shape of a credit to an account in support of their guarantee. So, the selling partners received not one shilling of cash from the sale. The price of the business was determined to be £500,000—the sellers’ reckoning of goodwill, or the value in excess of assets minus liabilities. It proved a generous reckoning.

  ‡ 100,000 shares times £15 minus the £250,000 worth of stock that the selling partners accepted in lieu of cash.

  § The Joint Stock Discount Company made its public debut in February 1863 with a nominal capitalization of £2 million; 80,000 shares were issued at a par value of £25, of which £5 was paid in. Early in 1865 came a call for another £5 per share on account of a temporary setback caused by the failure of the Leeds Banking Company, among other difficulties. “One of latest inventions of modern ingenuity,” The Times, February 2, 1866.

  CHAPTER 10

  “THE MUDDY SLIME OF BAGEHOT’S CROTCHETS AND HERESIES”

  Thomson Hankey’s scraggly sideburns drew only momentary attention from his bald head, weak chin, and inexpressive eyes. His clothes hung loosely on an unathletic frame. Unprepossessing though he may have been, Hankey was a man of substance. A one-time governor of the Bank of England, he provoked Bagehot into a monetary controversy that nudged the editor of the Economist in the fruitful direction of Lombard Street—that seminal description of the workings of Victorian finance which twenty-first-century central bankers would use to justify the doctrine that Hankey most abhorred, and that, in its extreme form, Bagehot himself might have condemned.

  Born in 1805, the eldest of eight children, Hankey became the long-serving senior partner of his father’s firm, Thomson Hankey & Co., plantation owners and West Indies merchants. (His father and he were recipients of government compensation for the slaves they owned in Grenada, under the Slave Emancipation Act of 1833.) Hankey became a director of the Bank in 1835, though not because he had ever worked in a bank; merchants and businessmen, as we have seen, predominated in the Court of Directors. London bankers were barred on the grounds that the Bank, in its commercial capacity, competed against them, and they against it—never mind that a banker knew something about banking.*

  Hankey was elected governor in 1851, at the dawn of the golden ’50s. In 1853, at the end of his two-year term, he entered Parliament as the Liberal member for Peterborough. In the wake of the Panic of 1857, he favored his constituents with a series of lectures on banking; a decade later, provoked by heretical doctrine, including Bagehot’s, he turned those lectures into a book under the title The Principles of Banking, Its Utility and Economy; with Remarks on the Working and Management of the Bank of England. His stance on monetary policy boiled down to this: A good banker had no need of a central bank and a bad banker had no claim on a central bank.

  There was nothing ornamental about Hankey’s writing and speaking: the plain facts were his stock-in-trade, let those facts irk whom they might. When, for instance, the Bishop of London preached at St. George’s Church, Hanover Square, London, and The Times reported that no collection had been taken, as if that fact deserved censure. Hankey wrote to rebuke the editors that the churchwardens, of whom he was one, chose not to pass the plate for perfectly sound reasons which they had thought out well before the service. Readers of The Times came to know Hankey’s views on a variety of other topics, as well: the £20,000 estimated cost of repairing the Westminster clock was too high, he contended; the Metropolitan Visiting Association, with which he was associated, should not yield to more energetic charitable organizations; and the directors of the Great Eastern Railway Company incurred debt too casually.

  If there was a theme to Hankey’s public advocacy, it was to hold to account persons occupying offices of trust. He closed another letter concerning railway finance, this one in August 1866, with a reminder as to the moral obligations of the governing capitalists: “and above all do I hope that in future the directors of these great and most beneficial undertakings will avoid incurring responsibilities in the way of pecuniary arguments which they are clearly not able effectively to carry into question.”

  By this time, the shocking failure of Overend Gurney, three and a half months before, had become a dull, aching fact. Stockholders who had nursed the early hope that they would suffer no permanent loss were resigning themselves to a heavy assessment.† The emergency 10 percent Bank Rate, imposed on May 12 as a condition of the temporary suspension of the Act of 1844,‡ had only just been trimmed to 8 percent.1

  In Parliament, there were calls for a Royal Commission to investigate the upheaval. Though Overend Gurney’s failure approximately conformed to the decennial rhythm of nineteenth-century boom and bust, and though every crisis had as its underlying cause the overextension of credit, the 1866 affair exhibited a worrying new aspect: while the visible symptom of the 1847 panic had been railway speculation, and that of 1857 had been unsound American banking practices, Overend Gurney featured a home-grown credit disaster. The failure of a single limited-liability bill broker—albeit a most eminent one—had transformed the cool and calculating financiers of the City of London into a mob.

  Sir Edward Watkin, a gruff, public-spirited railway promoter, rose in the House of Commons at the end of July to propose a commission of inqui
ry. He demanded to know why the Bank of England had done so little—really, “nothing”—to help to subdue the panic: “They have not given the accommodation which, under the circumstances, we had a right to expect would have been rendered.”2

  In referring to the Bank, Watkins called it “the Bank of Recourse,” but John G. Hubbard, MP, a member of the Court of Directors, denied that it was any such thing. He likewise corrected Watkins’s facts. Far from doing nothing, the Bank had provided massive infusions of cash: £12,225,000 in five days in advances and discounts on commercial bills, as Gladstone, the chancellor of the exchequer, subsequently informed Parliament. Not that such openhandedness was desirable; “in no case,” Hubbard told the House, “should encouragement be given to the banking world to assume that, in any emergency, they had a right to ask the Government to supply them at any price with a reserve which they should in common prudence have secured for themselves.”3

  Hubbard and Watkins clashed on the fundamental question of the Bank’s reason for being. Whose bank was it, the stockholders’ or the public’s? What duty, if any, did the Bank owe the public? Excessive borrowing was the downfall of many a troubled business. Might not the Bank, through a too-ready willingness to help, encourage the accumulation of excessive debt, thereby causing the panics it was then expected to quell?

  Watkins’s Bank of Recourse did exist on Threadneedle Street, in practice if not in law. The Old Lady, affirmed Sir Francis Baring, founder of the great merchant banking house of Baring Brothers & Co., had been the “dernier ressort” in a crisis as long ago as 1797.4 To relieve the crisis of 1825, as Jeremiah Harman, longtime member of the Court of Directors, testified, “We lent it by every possible means and in modes that we never had adopted before. . . . and we were not upon some occasions over nice.” The question, in 1866, was whether the Bank was precommitted—duty-bound—to lend. Was it, by obligation as well as by precedent, the lender of last resort?