The Crash of 2008: It's the Panic of 1825 all over again (also 1837, 1847, 1866 ... )
Filed under: Economy
A freeze in lending triggers a panic in a Western financial capital which then spreads around the globe, eventually tipping several South American countries into default. In a desperate attempt to stem the panic, the central bank steps in as "the lender of last resort" and unleashes a flood of new money into the palpitating financial system.Gee, was that 1998, or 2008? Neither -- try 1825 London.
You might think an era of gas lighting, slow sailing ships and horse-drawn carriages has little to teach us about modern finance, but much of what we consider advanced capitalism has been in place since the 1500s: stock markets, portfolio insurance, options, commercial paper and global banking.
Eerily, many of the conditions that fed the boom of the 1820s and the bust of 1825 parallel the present:
- Emerging economies were opening (South America then, China and India now);
- Expansionary monetary policy and easy credit fueled a stock market boom;
- Infrastructure projects required massive capital and equally massive borrowing;
- Risky/fraudulent "investments" were sold alongside sound ventures;
- Banks' lending discipline and oversight declined in the euphoria, creating bad debt;
- Prices rose, adding to the instability (in our era: oil jumping to $147 a barrel);
- Speculation in overseas and risky domestic ventures ran rampant;
- New financial instruments had been introduced which obscured both risks and returns.
Many analysts point to the prodigious expansion of difficult-to-assess mortgage backed securities and exotic derivatives such as CDOs (collateralized debt obligations, often backed by highly leveraged securities) as the chief source of asymmetric information flow which caused buyers around the world to purchase highly risky assets in the belief that they were high-yielding "safe" investments.
Others point to the ample opportunities for fraud and embezzlement in such cloudy situations -- another parallel with 1825 and indeed, every stock market/credit bubble and subsequent crash.
It is generally overlooked that capitalism in its natural state is highly prone to bouts of credit expansion and euphoric speculation which then lead to financial panics and crashes. The Panic of 1825, for instance, was followed by the panics of 1837, 1847 and 1857. Then next crash, in 1866, was hardly the end of volatility, as the Panic of 1873 was a real doozy, setting off a deep six-year recession in the U.S. The Panic of 1893 is generally considered to have launched a depression, while the Panic of 1907 is widely credited with sparking the creation of the Federal Reserve system six years later in 1913.
Walter Bagehot, the influential editor of The Economist in the 1860s and 70s, held the view that the first task of a central bank during a financial panic is to end the panic. In 1825, after some initial hesitancy, the Bank of England did exactly that by lending money to anyone with just about any sort of collateral -- not just sound assets but even illiquid assets.
This flood of new lending staunched the panic, but the stock market slump and recession lasted into 1826.
Central banks appear to have taken Bagehot's message to heart, as the Federal Reserve and other central banks have slashed interest rates to near-zero and eased lending to banks and financial institutions. The Fed has also taken distressed assets such as mortgage-backed securities as collateral.
The central purpose of the U.S. Treasury and the Fed's interventions has been to prop up the banking system, with the understanding that it was necessary because banks perform the essential services of processing private information (mortgage applications, for example) and monitoring borrowers.
But what the Fed and Treasury have not learned from the Panic of 1825 is that the shareholders and managers of the banks which were saved from insolvency by central bank intervention should suffer the losses which are necessary to encourage prudent lending after the panic has ended.
The Fed and indeed, all the central banks of the major global economies, also failed to understand the chief lesson of the 1825 Panic: that it was fundamentally fueled by expansionist monetary policy.
Thus we have to wonder if the current central banking "solution" -- encouraging lending, lowering interest rates and accepting any sort of distressed asset as collateral -- isn't just setting up the Panic of 2011.
Charles Hugh Smith writes the Of Two Minds blog and is the author of numerous books, most recently Survival+: Structuring Prosperity for Yourself and the Nation.
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Reader Comments (Page 1 of 1)
11-09-2009 @ 10:52AM
jesse said...
Lessons learned ? Hardly. Humans are a different breed from the rest of nature. A cat who jumps on a hot stove won't jump on a cold stove either after one bad experience. It learns stoves can cause pain.
Investors on the other hand always believe that they can out-wit the market as if it were entirely rational and the investor has out-rationaled the rest of the investing world. Millions of investors can make stupid mistakes and do so every day. Irrational investment decisions are what makes markets move. Perhaps humans can understand now that markets can freeze up really fast, too fast for anyone to get out before it falls.
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11-08-2009 @ 11:25PM
Steve said...
Is it reasonable to suggest that rather than blaming others for the economic downturn, we might hold the solution in our own actions? What if every American bought a treasury bond; bought a little stock; did something to improve their house or apartment; invested in a CD; helped a neighbor who was out of work, and so on? What if every company hired or rehired someone--or if a large company, several someones? Is this too simplistic, or could we pull ourselves up by our bootstraps?
Thanks
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11-09-2009 @ 12:02AM
Tim said...
I couldn't have said it better. All share holders and board members should have to share in the looses they created from their greed. No mortgage should ever be allowed to be bundled into securities and sold. The bank makes the loan, they keep the loan. Old fashion banking is common sense.
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11-09-2009 @ 12:07AM
AL said...
Well written! Bailing out the very institutions that helped fuel this crisis is total insanity. Those that played by the rules look at themselves as nothing more than suckers. We played by the rules and got cheated out of all that we saved and worked hard for, while those that defrauded, got bailed out and this is not sitting well with those that played by the rules. In 1929, bankers jumped from windows, and all the ceo's of today was jump from one bailout to another and suffered no consequences. How can these very same institutions ask us to invest in the markets they destroyed, and all we hear from them is, TRUST ME, TRUST ME.
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11-09-2009 @ 5:20AM
Allyn said...
As long as capitalism is allowed to go unfettered and unregulated those in the position to benefit financially will allow their individual greed to fill their pockets. IF anyone really thinks the wall street ilk really care about anyone else other than their own they are sadly mistaken. Insider trading was and still is flourishing. We have had past Presidents who have noted what needs to be done both Democrat and Republican but to get congress who can be ,and is, a boughten branch of government to do anything is fruitless.
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11-09-2009 @ 5:28AM
Dumbasdon said...
Bailing these Greedy people out of the mess THEY created was the Biggest mistake the Government has ever made!! Now THEY are all Laughing at all of US while THEY continue to live in Luxury and SUCK the living blood out of all US gullible Lemming's that allow THEM to do so and always will.You can Thank ALL the GREEDY rich CEO's in this Country for the mess WE are ALL paying for NOW!!!!!!!!!
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11-09-2009 @ 7:27AM
cabo79 said...
The only way to end this BS is to go to term limits. You cannot have a Free Society without rules, laws, a police force to catch the bad guys and prisons to put them in. The same goes for a Free Market capitalist society, you have to have rules, regulations, a police force and prisons to put the bad guys in. Our government is not maintaining a Free Market. Too many political contributions (pay-offs), it is obvious laws are bought and sold. Folks we need to correct this, it happens over and over. Our government is paralyzed by the need for pay-offs (political contributions). We need a major change to end this professional politician form of government. We need TERM LIMITS and real campaign finance reform. How about three 4 year terms for Congressmen, two 6 year terms for Senators and keep the current limit of two 4 year terms for President. The most anyone may serve in the Congress and Senate combined would be 14 years. We need an end to the professional politician form of government.
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