by James Grant
The Bank’s charter was no help; in its vagueness, it was as thoroughly English as the English Constitution. Joseph Pease, a northeast England manufacturer and mine operator and the first Quaker to sit in the House of Commons,5 remarked on this problem to a parliamentary committee in 1848: “[The Bank] frequently appears to me to act as a private individual would act, and then at other times it appears to act as having certain national objects to sustain or difficulties to meet; so that a country tradesman, like myself, has no idea what the policy of the Bank is.”6
In hearings that followed the 1847 maelstrom, neither of the Bank’s two senior officers acknowledged that the institution they led owed the public so much as a penny. The public, testified another long-serving director, George Warde Norman, grandfather of the future governor Montagu Norman, must be disabused of the notion that an institution such as a Bank of Recourse existed or ought to exist.7 On this critical question Norman was as one with Lord Overstone, the prophet who marked the Bank’s unstinting assistance to Overend Gurney during the Panic of 1857 as the precursor to bigger troubles. The entitled recipient, he had predicted, would take still greater risks if the government deemed it too big to fail.8
Hankey was on Overstone’s side, Bagehot on the other.
AS A RULE, the semiannual meetings of the stockholders of the Bank of England were dull and peremptory, but on September 13, 1866, governor Lancelot Holland, a linen manufacturer, enlivened the proceedings by recalling the stirring days of May. Not only “this house,” he said, but also the rest of the London financial community, had acquitted themselves ably and honorably. “Banking is a very peculiar business,” Holland went on,
and it depends so much upon credit that the least blast of suspicion is sufficient to sweep away, as it were, the harvest of a whole year.
This house exerted itself to the utmost—and exerted itself most successfully—to meet the crisis. We did not flinch from our post. When the storm came upon us, on the morning on which it became known that the house of Overend Gurney and Co. had failed, we were in as sound and healthy a position as any banking establishment could hold; and on that day, and throughout the succeeding week we made advances which would hardly be credited.
Holland said he wasn’t surprised that “a certain degree of alarm should have taken possession of the public mind”—a magnificent understatement—or that representatives of needy institutions should have besieged the chancellor to allow the temporary issuance of Bank notes beyond the limit established by the 1844 Act. There was no time to wait for official clearance, the governor continued, because
we had to act before we could receive any such power, and before the Chancellor of the Exchequer was perhaps out of his bed we had advanced one-half of our reserves, which were certainly thus reduced to an amount which we could not witness without regret. But we would not flinch from the duty which we conceived was imposed upon us of supporting the banking community, and I am not aware that any legitimate application for assistance to this house was refused.9
Bagehot seized on Holland’s words; in the Economist, he almost audibly cheered (writing under the almost inaudible headline, “The Great Importance of the Late Meeting of the Proprietors of the Bank of England”). At long last the Bank had acknowledged its responsibility to hold the banking reserve of England.
The truth was, Bagehot went on, that the Bank did hold the greater part of that reserve. It was a fact. More important than even the fact was that the Bank had admitted it. “Now,” wrote Bagehot,
this is distinctly saying that the other banks of the country need not keep any such banking reserve—any such sum of actual cash—of real sovereigns and [B]ank notes, as will help them through a sudden panic. It acknowledges a “duty” on the part of the Bank of England to “support the banking community,” to make the reserve of the Bank of England do for them as well as for itself.
Bagehot wrote with a depth of knowledge that few journalists have ever possessed. He also wrote as an interested party.§ In 1865, Stuckey’s returned no less than 48 percent on stockholders’ equity, but it would earn a good deal less if the monetary rules required it to stockpile its share of non-interest-bearing cash that the Bank of England now husbanded for the banking community as a whole. Gold might have been the bedrock of English credit, but that did not mean that the banks wanted it taking up valuable space on their balance sheets.
So it was decided, Bagehot declared. The Bank would bear the cost of prudence, and it would lend and discount in the hour of need: “[It] agrees in fact, if not in name, to make unlimited advances on proper security to anyone who applies for it. And the Bank do not say to the mercantile community or to the bankers, ‘Do not come to us again. We helped you once. But do not look upon it as a precedent. We will not help you again.’ On the contrary, the evident and intended implication is that under like circumstances the Bank would act again as it has now acted.”
THE EDITOR OF THE Economist was either a fool or a knave. So Lord Overstone asserted to George Norman, who, besides his service as a Bank director, was a sometime contributor to the Economist, an acquaintance of Bagehot’s, and a bosom friend of Overstone’s. Long before Bagehot arrived at the Economist, James Wilson had led the journalistic attack on what became the Act of 1844. It could not have pleased Overstone, as the intellectual father of that key legislation, that Bagehot had perpetuated Wilson’s editorial line. Even so, his animus toward Bagehot was extreme. “The muddy slime of Bagehot’s crotchets and heresies” was one of the nobleman’s harsher turns of phrase, though it was not his most damning. Overstone cut deeper in contending to Norman that Bagehot was only a country banker and the editor of a weekly paper “which must produce some exciting topic in each succeeding publication—and also a man of vanity and crotchets.”10
Bagehot was neither fool nor knave, but he was, indeed, a country banker whose earnings were a tiny morsel of Overstone’s 1866 income of £96,000.11 And he was very much a weekly journalist whose first obligation was, in fact, to engage his readers and not to weary them. His playful turn of mind was more likely to puzzle than to bore. Such was the case with the Economist’s changeable editorial line on the critical matter of the stewardship of the English bank reserve: the paper’s opinion seemed to shift before the readers’ eyes.
The issue of the Economist just sampled—that of September 22, 1866—was clear enough in commending the Bank of England for coming around to admit its duty to keep the English treasure and serve as lender of last resort. But less than a month before, the same paper and the identical editor had made a persuasive case for a decentralized reserve. The system in which a privileged, monopolistic, government-chartered bank holds the gold for all the other banks—i.e., the system in place—was not one that any thoughtful person would have invented, Bagehot had written then. It was “not a natural, an expedient, or an universal system, or one which we should prescribe where a country has its banking system to choose, and is not controlled by an imperious history.”12
Was there a contradiction? If so, it was up to the reader to resolve it. The clue was “imperious history.” Habits were adamantine and unchangeable, and half of the bankers in England, Bagehot asserted, wouldn’t know “what was meant by ‘keeping their own reserve.’”13 So English finance was unreformable; there was no turning away from the doctrine that Holland described and that Bagehot, in the September 22 Economist, so heartily endorsed.
As Bagehot delighted in paradox, it pleased him to stand with Holland in support of a system that he himself had just poked holes in. Thomson Hankey, an official personage—he was still a director of the Bank of England—took no such pleasure in intellectual gymnastics. Bagehot’s September 22 essay offended him just as it did Overstone. Some weeks later Hankey’s lecture series appeared between hard covers with a new preface that took aim at Bagehot’s doctrine of the lender of last resort.
“The ‘Economist’ newspaper,” Hankey charged,
has put forth what, in my opinion, is the most
mischievous doctrine ever broached in the monetary or banking world in this country; viz., that it is one of the proper functions of the Bank of England to keep money available at all times to supply the demands of bankers who have rendered their own assets unavailable. Until such a doctrine is repudiated by the banking interest, the difficulty of pursuing any sound principle of banking in London will always be very great.14
It surprised him, Hankey went on, that a paper as respectable as the Economist should fall for such nonsense. Did Bagehot really mean that the Bank should ride to the rescue whenever bankers cried for help? That it should forever stand ready to exchange commercial bills for cash? That it should perform this benefaction because bankers were uniquely deserving of it? Well, if bankers were deserving, so were railroad contractors, public works engineers, dock builders, shipbuilders and house builders. Yet the Bank of England made them no gifts. It was a rank injustice: “what is really asked for by the advocates of the right of the holders of bills of exchange at all times discounted by the Bank of England is, that one class in the country shall be benefited at the expense of the rest of the community.”15
Nor did Hankey accept that the banking industry, uniquely among industries, needed special assistance. He quoted his famous relative, C. Poulett Thomson, a member of Parliament and the first governor general of Canada: “nothing was easier to conduct than the business of a banker, if he would only learn the difference between a mortgage and a bill of exchange.”16
A mortgage was illiquid; that was its nature. A commercial bill was liquid; that was its nature. A mortgage didn’t turn itself into cash, as a commercial bill did. The mortgagor—the borrower—had to refinance it or sell the collateral. Real estate takes time to sell, and in a financial panic there is no time.
Compare and contrast a short-dated bill of exchange. It was an asset that almost transmuted itself. On the due date, money and merchandise changed hands. Bills, though not cash, were first cousins to cash, while mortgages bore no known familial relation to cash, or, as Hankey called it, “ready money.”
Ready money was the nub of the matter. A tillful would suffice on most occasions, a vaultful on others, but vaults filled with gold contributed nothing to a banker’s income, nor even, in boom times, to his well-being, when an excess of prudence is seen not as strength of character but as weakness of mind.
“[It] is a most valuable thing,” Hankey observed of gold and the notes of the Bank of England, “and cannot from its very essence bear interest; everyone is therefore constantly endeavoring to make it profitable and at the same time to retain its use as ready money, which is simply impossible.” The remote cause of every crisis was “the constant attempt to perform this miracle which leads to all sorts of confusion with respect to credit.” To prosper through the business cycle, a banker must husband cash even when it seemed undesirable. There was no telling when it would become precious.17
THAT BAGEHOT’S IDEAS WOULD prove more durable than Hankey’s was anything but obvious in the months following Black Friday. A flurry of pamphlets appeared in support of the ex-governor’s position. In his 1866 Inquiry into the Causes of Money Panics, John Benjamin Smith, the first president of the Anti-Corn Law League and a lifetime adherent of liberal causes, staked out the position on the gold reserve that Bagehot himself had espoused, before espousing its opposite. John P. Gassiot, a founding member both of the Chemical Society and the London Electrical Society and a fellow of the Royal Society, approvingly quoted Hankey in his 1867 Monetary Panics and their Remedy. That same year, the Lombard Street banker William Fowler, who had been two years ahead of Bagehot at University College London, wrote in defense of the 1844 Act in The Crisis of 1866.
In the autumn of 1866, Bagehot’s erstwhile West Country banking clients issued a “Memorial” to the chancellor of the day, Benjamin Disraeli. Over the signature of the Bristol Chamber of Commerce, the petitioners urged a line of monetary policy in keeping with Hankey’s ideas. Bagehot was all for the unrestricted issue of Bank notes in times of peril, but the men of Bristol rejected “[the] delusive belief that an unrestrained issue of notes by the Bank of England would restore the confidence lost through over-trading or injudicious lending.” As for the supposed impossibility of charging each banker with the duty of maintaining his own reserve, the memorialists advocated exactly that—it was a far better thing, they held, than vesting their hopes in the Bank and on the “vague reliance of a permission” to break the law, i.e., the Act of 1844, in times of distress. To Bagehot’s credit, the Economist printed this Hankeyesque document in its edition of October 20.
But that did not mean the editor had changed his mind. He led off a December 8 article—“A Bank Director On Banking And The Currency”—with a nod to his sparring partner: Hankey’s book was the one to read to understand the inner workings of the Bank of England, Bagehot allowed. What it was not was a guide to wise policy. It was foolish to believe that the English banking community could, or would, line its vaults with gold; there was no idle cash for such a purpose. The Bank kept a reserve equivalent to 40 percent of its liabilities. A dead weight of that size in the world of private banking would collapse the dividend income on which the shareholders depended (or, perhaps, to which they felt entitled).
Lombard Street relied on the Bank for the single reserve and as the ultimate lender; it was the constitution of the money market. If Hankey wanted to amend that constitution, Bagehot taunted him, he should rise in Parliament—of which he was a member—to form a committee to propose a new way of doing things. The committee might examine the Bank directors, perhaps extracting from them a pledge to resettle the burden of holding a reserve on individual bankers. “But until that warning is given,” Bagehot concluded, “the history of the recent past will be the inevitable guide of the future, and the doctrine Mr. Hankey thinks so mischievous—the doctrine of Mr. Norman—will be the ruling principle of Lombard Street.”
In citing the views of George Norman in support of his argument, Bagehot erred, as Norman was, in fact, an out-and-out Hankey man. Bagehot’s mistake inflamed Overstone, who prodded Norman, who duly wrote to correct the record.18
Norman’s letter, which appeared on December 22, politely exposed the error while raising a useful question: concerning the maintenance of the single reserve, “How is it possible that the directors [of the Bank] should know at any given time, the aggregate demand that may be made upon their resources, and provide accordingly?” Norman next declared that the system in place—in which inadequate bankers’ reserves supported “immense amounts” of callable deposits—was inherently unsafe. The danger was “obvious and inevitable, and I fully expect that younger men than myself will witness such a financial catastrophe as we have never yet seen nor can now imagine.”
ON BOXING DAY, December 26, 1866, The Times paid Hankey the compliment of publishing a long essay on his book. The unsigned critic, evidently a member of the editorial staff of The Times, was erudite, and the essay began at the beginning. “What is money?” it asked—gold, or proper receipts for gold, is money, it replied—and “What is a banker?”—a dealer in borrowed money.
Hankey and The Times’s author were birds of a feather, though they did not agree on every point. For instance, the critic would not go so far as Hankey did in excluding any illiquid asset from a banker’s investment portfolio. Some mortgage-like assets there may be—probably must be, inasmuch as they yield more than high-grade, short-dated bills, and a banker must make a living. The acid test was not the purity of the assets, as defined in Hankey’s text, but a banker’s ability to meet his every obligation.
The critic was a man after the heart of old James Wilson, but though he deprecated governmental interference with money and banking, he was under no illusion about the nature of the human beings who exercise their right to lend and borrow. Some people would abuse it:
A banker’s profit arises from the difference between what he gets from those who borrow from him and what he pays to those from whom he borrow
s. He is therefore constantly tempted to lend to the uttermost verge of prudence, both as to the quality and amount of his loans. High interest tempts him to lend on bad security; the desire to lend as much as possible tempts him to abridge his reserve.
In a bull market, no one need be the wiser, but the upswing always ends, punctuated by a bankruptcy. Perhaps the bankrupt is he who has lent the most, or paid the highest deposit rates, in the just-concluded boom. Few have ever matched the clarity of the Times’s anonymous critic in the description of what inevitably follows:
It is remembered that bankers have struggled as to which should be foremost in the race. They have vied with one another in offers to induce the owners of money to lend it to them; they have been compelled to adventure in all directions to keep their position. Under such circumstances the failure of one of their number begets a distrust of all. Men in general, and capitalists in particular, are very like sheep passing through alternate fits of unreasoning confidence and unreasoning suspicion. The deposits made with bankers are withdrawn; the bankers, acting on the commonest dictates of prudence, attempt to diminish the advances they have made and to lessen the demands made on them for loans by advancing the rate of interest. The merchants who have maintained themselves by the help of the loans they have been able to obtain succumb, the distrust increases and becomes a panic, and for a season commerce is paralyzed.
Even for a season, paralysis was undesirable, but was it unavoidable? The critic suggested that it was. Certainly, he contended, there were worse things than a slump, and relaxing the Act of 1844 in a time of panic was one of them. He doubted it was ever justified,