HOISTED FROM THE ARCHIVES: The Panic of 1825. From 2009

The weekend back in the 1820s that I see as the origins of “modern” central banking as we have known & still know it: the moment when the pattern was set for the central bank to do things that the...

The weekend back in the 1820s that I see as the origins of “modern” central banking as we have known & still know it: the moment when the pattern was set for the central bank to do things that the general government wants done, but does not think it can accomplish by itself with sufficient speed and sufficient expertise—hence it declares that what are political actions—very political actions—centered around the exorbitant privileges of bankers in the capitalist modern economic system are, instead, mere technical matters of financial management, and hands off the baton…

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Written in April 2009: If you’re not satisfied with Paul Krugman or Nouriel Roubini as your guide to the current turmoil, you can always rely on E.M. Forster. It was Forster who grasped the essential drawback of the Internet long before anyone else, depicting, in his 1909 story "The Machine Stops" a world in which individuals communicate in isolation via machine. It turns out he’s pretty good on 21st-century financial crises, too, mostly because the underlying processes remain so similar to those of a financial crisis he studied. Only the scale has changed.

Forster’s great-aunt Marianne Thornton helped raise him after his father's death, leaving him 8,000 pounds upon her death, when Forster was 8. That legacy gave him the financial cushion to become a writer. So he wrote Marianne Thornton: A Domestic Biography 1797-1887, stringing her voluminous letters together with scene-setting prose. As it happens, the fortunes of the Thornton family turn on history’s first episode of successful central banking: the Bank of England's intervention in the 1825 financial crisis.

Marianne’s younger brother, Henry Thornton, was 25 in 1825. Though the Thornton ancestors had built a successful bank, it had passed out of family control a decade earlier. But in the middle of 1825 young Henry was invited to join it as the most junior of six partners. Marianne writes of profits of £40,000 a year, which is quite a lot when you reflect that Jane Austen's creation, Fitzwilliam Darcy, the richest commoner in early 19th-century England—other than Nathan Meyer Rothschild—receives (I refuse to write "earns") only £20,000 a year from his estate of Pemberly.

Forty thousand pounds a year in income corresponds to a market capital value of 1 million pounds, which bears the same proportion to the size of the British economy then as $10 billion would bear today.

The bank—renamed Pole, Thornton upon Henry's joining—was not small change.

To join it as one of the profit-splitting partners was one hell of a 25th birthday present. But, then, these were the kind of people whose house had not an address but a name: "Battersea Rise."

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And now let me turn the microphone over to 28-year-old Marianne Thornton. Writing in December 1825 to her friend Hannah More, she wrote:

There is just now a great pressure in the mercantile world, in the consequence of the breaking of so many of these scheming stock company bubbles…

Sound familiar? These were not bubbles in high-tech stocks or in mortgage lending and house prices, however, but bubbles in shipping lines, canals, and textile-spinning factories. And, of course, the bank of which young Henry had been a partner for only four months had gotten itself badly undercapitalized. The managing partner:

had been inexcusably imprudent in not keeping more cash in the House, but relying on [the bank's] credit ... which would enable them to borrow whenever they pleased…

Except, of course, that in 1825 just as in 2009, no bank can borrow cash on the one day it really needs to, for every other bank really needs that very same on that very same day. Which is why there came for Marianne’s brother Henry and for her a “dreadful Saturday I shall never forget,” when a run on the bank was made, with “one old steady customer” withdrawing, without warning, his entire £30,000, leaving the bank vault “literally empty."

According to Marianne, the other bank partners fell apart:

• The managing partner "insisted on proclaiming themselves bankrupts at once, and raved and self-accused himself."

• Senior partner Scott "cried like a child of 5 years old."

• Partner Pole was away at his country estate.

• Another partner was off on a business trip.

It fell to 25-year-old Henry to deal with the fact that in the last business hour of Saturday:

they would have to pay 33,000 [pounds], and they should receive only 12,000 [pounds]. This was certain destruction….

Henry Thornton frantically searched the City of London looking to borrow money. He found banker John Smith, who always has been “particularly kind to Henry”. He told Smith he could hardly expect him to lend the bank funds, but asked if Smith could at least tide them over until the 5 p.m. closing time. Smith asked if the bank was solvent and Henry gave his word. Well, then, Smith said, Pole, Thornton would have all he could spare.

Never, [Henry] says, shall he forget watching the clock to see when 5 would strike, and end their immediate terror.... The clock did strike... as Henry heard the door locked, and the shutters put up, he felt [Pole, Thornton] would not open again but would be forcibly liquidated Monday morning…

There were, however, other characters in motion. Robert Banks Jenkinson, Second Earl of Liverpool, First Lord of the Treasury and Prime Minister of His Majesty George IV, had been having whispered conversations with Bank of England Governor Cornelius Buller and his deputy John Baker Richards. Liverpool said that it was of vital importance that the banking system of London not collapse under the weight of speculation and the popping of all those stock company bubbles.

Liverpool claimed he could not get Parliament to appropriate money to save the banks or to prop up asset prices: Parliament was populated by tax-paying landlords who did not especially trust the stock-jobbing financiers of London. Moreover, Liverpool and his cabinet had spent much of the past year warning bankers that if their "overtrading" were followed by "revulsion" and "discredit," that he would not spend Treasury money to rescue them.

However, Liverpool told Buller, the Bank of England might.

The Bank of England had a peculiar semi-private status with enormous autonomy. And everyone knew it was too big to fail—it was, after all, the bank for the entire British Empire, and the empire would stand behind it. So the Bank of England could save the situation even if the government felt politically that it could not. It seems Lord Liverpool said to Buller: if it becomes necessary, I want you to print up banknotes in excess of the legal limit, and to lend out your gold reserves even though the bank’s charter requires you to keep them in your vaults.

Banker John Smith had gotten wind of these conversations between Liverpool and Buller. And that Saturday evening, after the banks had closed, John Smith told Henry Thornton that if Henry truly believed that Pole, Thornton was solvent he, John Smith, would undertake to get it cash from the Bank of England. This was quite a shock. "The Bank [of England]," Marianne Thornton wrote, "had never been known to do such a thing in the annals of banking," and so "Henry had little hope from this."

Nevertheless, the following morning, Sunday, at 8 o'clock, Bank of England Gov. Buller and Deputy Gov. John Baker Richards, along with every member of the Court of the Bank of England who was in London, were assembled to meet John Smith and Henry Thornton.

Marianne Thornton picks up the story:

John Smith began by saying that the failure of [Pole, Thornton] would occasion so much ruin that he should really regard it as a national misfortune," and he also praised Henry Thornton beyond all reason, saying "what he had seen of the conduct of one of the partners... had convinced him that could [the bank] be saved for the moment," the crisis would pass. Smith "then turned to Henry and said, 'I think you give your word the House is solvent?' Henry said he could... [and] had brought the books.

“Well then”, said the Governor and the Deputy Governor of the Bank,”'you shall have £400,000 by 8 tomorrow morning, which will I think float you”. Henry said he could scarcely believe what he had heard…

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I can scarcely believe it myself, even now.

Blowing that number up to account for the difference between the British economy then and the British economy now, that's a $4 billion commitment secured on the word of a 25-year-old. Amazing—although there was a joke making the rounds last April [2008] that J.P. Morgan-Chase CEO Jamie Dimon could have borrowed an extra $2 billion from the Federal Reserve if he had been willing to pledge his dog as collateral.

Monday morning, in the pre-dawn dark, Henry Thornton was at the Bank of England with Gov. Buller and Deputy Gov. Richards. For security reasons, they were alone. Buller and Richards counted out 400,000 pounds in bank notes. "I hope this won't overset you, my young man," Marianne Thornton claims one of the two said to Henry, “to see the governor and deputy governor of the Bank [of England] acting as your two clerks."

Henry Thornton arrived at his own bank before opening with £400,000 in cash. The run on bank funds then recommenced. But:

rumors that the Bank of England had taken them under its wing soon spread, and people brought back money [on Monday] as fast as they had taken it out on Saturday…

This was the birth of central banking as we have since known it.

The Bank of England had accepted the role of maintaining orderly markets and financial stability in a crisis. Why? Because the prices of financial assets are too important to be left to the market when it is panicked and when letting prices reach market levels will mean unemployment for hundreds of thousands in 1825, or tens of millions today.

Ben Bernanke's Public Private Investment Partnerships—the vehicles for purchasing banks’ toxic assets—are a natural development, even a Burkean development, of policy that has been pursued for 184 years now. When politicians wash their hands of a financial system in crisis and fail to intervene on a large scale, things do not turn out well. The most notable example was 1929–1933, when, at least according to Herbert Hoover, Treasury Secretary Andrew Mellon persuaded Hoover that "even a panic is not altogether a bad thing” because "it will purge the rottenness out of the system.”

Did 1825 turn out better? We think so. George IV was not executed on Tower Green. Lord Liverpool's head was not carried about London on a pike. The spinning of cotton into thread in Britain in 1826 was 11 percent lower than in 1825—the first serious industrial recession—but it bounced back and grew 30 percent from 1826 to 1827.

From the standpoint of Mill’s theory of how the flip side of deficient general demand for currently-produced commodities is an excess demand for safe and liquid financial assets, it is straightforward to understand how the Bank of England’s 1825-6 interventions would have boosted the economy. That the Bank of England was willing to guarantee the liabilities of Pole, Thornton turned them from shaky, risky assets back into “inside money”—safe, liquid assets that would satisfy the unusual demand at that moment for near-riskless stores of value and sources of liquidity. That the Bank of England was itself printing up extra banknotes—expanding its balance sheet—raised the supply of “outside money” that the government was providing to the banking system. That the Bank of England was taking action to deal with the crisis may have restored that elusive “confidence” which diminishes desired portfolio demand for an unusually-high amount of safe, liquid assets. And when banks, businesses, and households no longer wish to cut their planned expenditure below their expected income, the economic downturn is over. As A.C. Pigou quotes Alfred Marshall, the industrial depression

could be removed almost in an instant if confidence could return, touch all industries with her magic wand, and make them continue their production and their demand for the wares of others...

And what happened to the bank of Pole, Thornton?

Alas, Henry Thornton was irrationally exuberant—or lying—when he swore that the bank was ultimately solvent.

The bank was eventually closed. The partners lost their capital shares. The Bank of England had to wait years before getting its emergency loan back. (They did not care much; they were too big to fail, and Lord Liverpool thought they had done well.)

Henry Thornton’s career, however, prospered thereafter. Even though the financial ship that he had seized command of as a junior partner foundered, the consensus was that he had displayed great energy, good judgment, a cool head, and a facility with figures that made him worth backing in the future.

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References:

• DeLong, J. Bradford. 2009. "The Panic of 1825." The Week. April 15. <https://web.archive.org/web/20090418165647/http://www.theweek.com/article/index/95385/The_Panic_of_1825>.

• Forster, E.M. 1956. Marianne Thornton: A Domestic Biography. London: Arnold. <https://archive.org/details/mariannethornton0000fors_r8a2>.

• Forster, E.M. 1909. "The Machine Stops." The Oxford & Cambridge Review. 1(2): pp. 83-122. November. <https://web.archive.org/web/20200418165647/https://web.cs.ucdavis.edu/~rogaway/classes/188/materials/the%20machine%20stops.pdf>.

• Marshall, Alfred. 1890. Principles of Economics. London: MacMillan. <https://archive.org/details/principlesecono00marsgoog>.

• Mill, John Stuart. 1829 [1844]. “Of the Influence of Consumption on Production.” Essays on Some Unsettled Questions of Political Economy. London: John W. Parker. <https://oll.libertyfund.org/titles/mill-the-collected-works-of-john-stuart-mill-volume-iv-essays-on-economics-and-society-part-i>.

• Pigou, A.C. 1925. Memorials of Alfred Marshall. London: MacMillan. <https://archive.org/details/in.ernet.dli.2015.46531>.

• Say, Jean-Baptiste. 1828-29. Cours Complet d'Economie Politique Pratique. Paris: Rapilly. <https://archive.org/details/courscompletdco00saygoog>.