Transcript TRIUM opening lecture, New York 8 January 2006

Financial University lecture, Moscow
26.10.10
“Two centuries of US financial development in
comparative contexts: growth and crises”
Richard Sylla, New York University
A crucial US advantage: modern finance from the 1790s
• The US westward expansion depended on finance: e.g.,
the Louisiana Purchase, lands sold on credit
• The US transportation revolution depended on finance:
e.g. turnpike and bridge companies, the Erie and other
canals, the railroads
• The US industrial revolution depended on finance: e.g.,
textile manufacturers raised equity capital by selling
stock, and obtained working capital via bank loans
• Rapid industrial growth began with the establishment of
a modern financial system in the 1790s
US Expansion
• Modern finances from the 1790s promoted
territorial expansion of the USA, as well as
US economic growth.
• The USA territorially became one of the
largest of all nations. Russia, of course, is
quite a bit larger.
• In less than a century after 1790, the US
economy is the world’s largest. It remains
the world’s largest 125 years later, 2010.
Year
2006
1998
1990
1982
1974
1966
1958
1950
1942
1934
1926
1918
1910
1902
1894
1886
1878
1870
1862
1854
1846
1838
1830
1822
1814
1806
1798
1790
2000 USD
Real GDP Per Capita in the United States, 1790-2006
$100,000
$10,000
$1,000
$100
US Growth Rates per year,
1790-2009
1790-1860
1860-1920
1920-2009
Real GDP
4.40%
3.61%
3.36%
Real GDP/Capita
1.30%
1.52%
2.13%
Population
3.02%
2.05%
1.20%
Growth of US Industrial Production, 1790-1913
(percent per year in the new Davis index)
1790-1913
5.2
1790-1802
1802-1815
1815-1833
1833-1860
5.3
3.9
5.3
6.0
1860-1913
5.0
Growth of the US banking system
• The US banking system grew rapidly in
the early decades because US states,
following Hamilton’s example with the
Bank of the United States, discovered that
it was in their fiscal interest to charter
more and more banking corporations.
• The expansion from the 1790s to the
1830s was, however, just a start.
US State-Chartered Banks: Numbers and Authorized
Capital, by Region and Total, 1790-1835
(Capital in millions of dollars)
Region
New
Engl
Mid-Atl
South
West
US
Year
No.
Cap.
No.
Cap.
1790
1
0.8
2
1795
11
4.1
1800
17
1805
No.
Cap.
No.
Cap.
No.
Cap.
2.3
3
3.1
9
9.4
20
13.5
5.5
11
11.9
28
17.4
45
13.2
19
21.7
6
3.5
1
0.5
71
38.9
1810
52
15.5
32
29.4
13
9.1
5
2.2
102
56.2
1815
71
24.5
107
67.1
22
17.2
12
6.4
212
115.2
1820
97
28.3
125
74.4
25
28.6
80
28.4
327
159.6
1825
159
42.2
122
71.2
32
33.3
17
9.4
330
156.6
1830
186
48.8
140
73.8
35
37.3
20
10.5
381
170.4
1835
285
71.5
189
90.2
63
111.6
47
35.0
584
308.4
Banking growth
•
•
•
•
•
•
Year
1860
1896
1921
1970
2010
No. of banks
1,562
9,469
31,076
14,187
6,620
Bank assets
$ 0.7 billion
7.5
49.6
611.3
13,000.0
Compare and Contrast
•
•
•
•
•
Canada did not have chartered bank until 1817. It had 6 banks in 1830 and
16 in 1840.
Mexico did not have a chartered bank until 1863. It had 8 banks in 1883
and 46 in 1911.
In England, until 1825 all banks apart from the Bank of England had to be
unlimited-liability partnerships with no more than six partners. By 1825 the
US had 330 state banking corporations and a central bank with 25 branches
carrying on interstate banking.
England, France, and Germany did not offer general incorporation to banks
and other business until the latter half of the 19th century. By that time the
US had thousands of corporations.
The US had 80 banks and branches by 1805, 600 by 1835, 1,600 by 1860,
and 25,000 by 1910. In 1913, the US had at least 30% of the total bank
deposits of the entire world, and at least 36% of commercial bank deposits-far more than any other country.
Corporations
• Since 1790, the USA has led the world in developing the corporate
form of business enterprise. Corporations have a number of
advantages over other forms of business organization, as well as
some disadvantages.
• The financial revolution of the early 1790s was marked by a large
increase (about 300) in the chartering of corporations by US states,
the main chartering authorities.
• By 1830, states had chartered 9,400 corporations.
• By 1860, states had chartered 23-24,000 corporations under special
legislative acts, and another 5-6,000 under new general
incorporation laws. Total of ~ 30,000.
• By 1920, the USA had 300,000 operating corporations; by 1960,
more than one million; and by 2000, the number of corporations was
nearly 5 million.
Securities Markets
• In history, securities markets usually began with the
trading of government debt securities.
• These first securities markets then facilitated the trading
of corporate equity and debt securities, giving liquidity to
representations of fixed, long-term real investments. This
encouraged real investment and capital formation.
• Only a small number—today perhaps 10,000 of 5 million
corporations—have tradable securities. But they are the
largest corporations that produce most of the GDP.
• The following slides show the early development of US
securities markets and a 200 year-history of US stock
market returns.
Securities Markets: City Listings in 1811
Growth of the New York Securities Market, 1797-1832
Financial crises
• The 200-year history of US stock returns indicates the
volatility of financial systems despite fairly steady longterm economic growth. Is this “creative destruction”?
• Financial history is punctuated with crises. In the US
case, these occurred in 1792, 1814, 1819, 1837, 183942, 1857, 1873, 1884, 1890, 1893, 1907, 1930-33, the
1970s (inflation), 1987-89, and 2007-09.
• What follows is a discussion of several of these US
crises, and the lessons we can learn from them. First, a
“model” of a financial crisis.
Kindleberger model
Stages
•
•
•
•
Underlying process
Displacement
Boom
Speculation
Mania
• Distress
• Revulsion
• Panic/crash
Money chases assets
Assets chases money
» Depression?
» Lender of last resort?
25
1792: Alexander Hamilton saves
his financial revolution
• US is in midst of a financial revolution, 1789-92, planned
earlier and now executed by Alexander Hamilton, a founding
father of the USA and the first Secretary of the Treasury.
• Hamilton stabilizes public finances, restructures the US
national debt, founds a central bank, and defines the
convertible US dollar.
• US States respond to the plan by chartering more banks and
more business corporations.
• Private actors respond to the plan by asking the States for
banking and corporate charters, and by creating securities
markets and stock exchanges (e.g.NYSE, 1792) to give
liquidity to all the new securities that appeared in 1790-1792.
• Markets crash in the panic of March 1792.
1792: Bubble, collapse, panic
--Fueled by increases in bank credit, partly from the new
central bank, and a speculative cabal to corner a US
debt issue, securities prices rose rapidly early in 1792
[see securities price chart—slide coming].
--Prices crashed in March, after banks stepped on the
brakes and the cabal collapsed in default. Panic selling
drove US 6s in New York from 126 on March 5 to 95 on
March 20, a drop of 25% in two weeks.
--Hamilton intervened on a number of fronts in response to
the crash.
27
Bank of the United States, Dec. 1791 to
Mar. 1792
Date/BUS
data
Discounts
Notes and
deposits
Specie
reserves
Dec. 29,
1791
$0.96 mill.
$1.10 mill.
$0.706 mill.
Jan. 31,
1792
$2.68 mill.
$2.17 mill.
$0.510 mill.
Mar. 9,
1792
$2.05 mill.
$2.06 mill.
$0.244 mill.
28
Boston
New York
Date
Philadelphia
29
1792.1222
1792.1130
1792.1107
1792.1013
1792.0919
1792.0818
1792.0731
1792.0707
1792.0609
1792.0512
1792.0410
1792.0327
1792.0315
1792.0306
1792.0225
1792.0208
1792.0118
1791.1228
1791.1213
1791.1200
1791.1122
1791.1111
1791.1101
1791.1015
1791.0927
1791.0916
1791.0905
1791.0825
1791.0816
1791.0727
1791.0700
1791.0608
1791.0518
1791.0420
1791.0330
1791.0226
1791.0200
1791.0108
1790.1222
1790.1127
1790.1031
Bid Price (Percent of Par)
U.S. Sixes, Boston, New York, and Philadelphia
130.00
120.00
110.00
100.00
90.00
80.00
70.00
60.00
Hamilton’s crisis management, March and
April 1792
• Orders open market purchases of 1-2 percent of outstanding US
debt.
• Directs banks to keep lending; promises not to withdraw government
deposits in the banks.
• Orchestrates cooperative agreement whereby securities dealers
collateralize their holdings for bank loans, at a 7% penalty rate of
interest, instead of selling on the market at fire-sale prices. Names
prices at which collateral is accepted. Agrees to purchase collateral
from banks if they get stuck with it.
• Directs Treasurer of USA and Bank of United States not to draw
money from other banks without his permission.
• Publicizes new Amsterdam loan of $1.2 million at 4 % to USA for its
calming effects; later uses the Dutch money to pay for his open
market purchases.
• These actions end the panic in little more than a month. This is how
to manage a financial crisis.
1837-1842, an extended crisis
•
1832: President Jackson vetoes Congress’s bill to re-charter Bank of the United States; it
will cease to be a central bank in 1836 when the old charter expires.
•
From 1830 to 1837, number of US state-chartered banks increases from 380 to 780.
•
•
Money stock, 1830-1837, increases from $105 million to $276 million.
Rising prices and a property boom: huge land sales and speculation, 1830-1836.
•
The US government announces two policy initiatives in 1836: A “Specie Circular” decrees
that land can be purchased from the government only with gold and silver money. And a
“Surplus Distribution” act says that bulging federal surplus revenues after the national debt
is retired will be distributed to States on the basis of population. Both measures drain
Eastern money-center banks of specie reserves.
•
Panic breaks out in May 1837. Widespread bank and business failures. Van Buren,
Jackson’s successor, resists repeal of the Specie Circular. After a brief recovery, panic
and failures return in 1839. Nine US States default on their debts in 1841-1842. Credit of
States and US government is tarnished, but both recover in a few years.
•
This is how to CREATE a financial crisis, and also how NOT to manage it.
1873—an international crisis
• Was it one crisis or two?
• The pattern of events in Austria and
Germany was rather similar to the pattern
in the USA.
• The crises were connected by
international capital markets. The
continental European boom may
eventually have reduced the supply of
European capital to the USA.
• Leading nations were similar in population.
1870 Populations
• USA
• Canada
• Mexico
40 million
4
9
•
•
•
•
39
38
31
5
Germany
France
UK
Austria
The world prior to 1873: Globalizing
Capital flows to the USA:
The USA imported $1.1 billion of capital, mostly from
European investors buying US government and railway
securities, in the eight-year period 1866-1873.
US net liabilities to foreigners were $1.8 billion in 1873.
Thus, some 60% of US net liabilities to foreign investors
were incurred from 1866 to 1873.
36
Displacements in Europe promoting a boom-bust
cycle matched those of the USA
•
•
•
•
•
•
•
•
•
Prussian-Austrian war, 1866
Overend-Gurney crash, UK 1866
Transatlantic cable, 1866
Austrian Wunderharvest, 1867
Suez Canal opens, 1869
Franco-Prussian war, 1870-71,
with 5 billion franc indemnity paid
to Prussia
Thiers rentes issued to pay
indemnity, 1871 and 1872
German coin circulation triples as
gold coins are added to silver
German banking laws relaxed:
Maklerbanken, Baubanken,
Deutsche Bank
•
•
•
•
•
•
•
•
•
Civil War ends, 1865. National
banks.
France leaves Mexico, Britain
grants Canada independence, and
Russia sells Alaska to USA
Transcontinental railway
completed, 1869
Gold corner panic, 1869
US national debt restructured
Chicago fire burns 1/3 of city
Britain settles Alabama claims by
paying US $15.5 million, 1872
Granger legislation attacks
railways
Monetary tightness to promote
resumption of specie standard
37
RR Mania leads to panic
• The railroad industry, at the time the nation's largest employer
outside of agriculture, involved large amounts of money and risk.
• A large infusion of cash from speculators caused abnormal growth in
the industry. US railway network doubles in size from 1866 to 1873;
in 1873 it is the size of the entire European rail network—20
countries including Russia.
• Jay Cooke's investment banking firm, like many others, was
invested heavily in the railroads.
• Cooke and other entrepreneurs had planned to build a second
transcontinental railroad, called the Northern Pacific Railway, across
the northern USA. Cooke's firm provided the financing.
• Cooke’s bank fails in September 1873, setting off the panic.
• The US government does next to nothing to help. Its goal is to reestablish dollar convertibility to gold. The banking system and the
securities markets are left to fend for themselves.
• Financial contraction actually helps the government to re-establish
the gold standard in the USA.
38
Global speculative shocks
 A major economic reversal began in Europe that reached
the United States in the fall of 1873:
 Spring 1873 : Austria. Vienna Universal Exposition to
open in May. A speculative movement anticipating it
generates tripling of prices in a few months
 May 9 : Austria. 2 big banks fail. Stock market crash.
European contagion.
 September : German stock market in Berlin crashes
simultaneously with Jay Cooke’s failure in New York.
16
40
35
30
25
34.2
21.2
20
15
10
21
12
14.7
10.2
6.3
8.8
5
0
9/
20
/1
87
9/
3
27
/1
87
3
10
/4
/1
87
10
3
/1
1/
18
10
73
/1
8/
18
10
73
/2
5/
18
73
11
/1
/1
87
11
3
/8
/1
87
3
Millions of dollars
Legal tender currency in NY Banks
17
Wicker, E. Banking Panics of the Gilded Age
Background US:
40
35
30
25
20
15
Selected statistics for all national banks, March 1870 to October
1878
10
5
0
1870
1871
1872
1873
(feb 28)
1873
1873
1874
1874
(sept (oct 13) (feb 27) (oct 2)
12)
1875
1876
1877
Ratio of legal reserves to currency and deposits
Ratio of basic reserves to currency and deposits
Selected statistics for all national banks, March 1870 to October 1878
Source: Timberlake
41
1907: the background
• Rapid industrial and economic growth, 1897-1906, with a lot
of mergers and corporate consolidations.
• Theodore Roosevelt administration somewhat hostile to big
business and ‘malefactors of great wealth.’
• San Francisco earthquake of April 1906 leads to tightening of
Eastern US and international financial markets.
• Rapid expansion of trust companies, which are lightly
regulated banks.
• Collapse of a speculative attempt to corner the market in a
copper company’s stock in October 1907; some banks and
trust companies are implicated.
• Runs on trust companies and banks in New York City set off
the panic of 1907 in latter half of October.
1907: J. P. Morgan to the rescue
(1)
• Called back from a church convention in Virginia, Morgan arrives in
New York on October 20, and orders stress tests of trust companies.
• On October 22, the Knickerbocker Trust failed, Morgan asks the
Secretary of the Treasury to come to New York from Washington,
and when he arrives, requests the Treasury to deposit money in
New York banks. The first $25 million is deposited on October 24, to
be followed by more over the next month. At week’s end, Morgan
encourages the Secretary to return to Washington because it will
look good.
• On October 23, Morgan organizes a cooperative agreement of trust
companies to pool $10 million to support those facing runs, and
arranges for a $3 million dollar loan from National City Bank to Trust
Company of America, which faced a run.
• On October 24, when the head of the NYSE informs Morgan that he
wants to shut it down because no money is available, Morgan orders
him not to do so and arranges a $24 million dollar fund to lend to
dealers and brokers.
1907: Morgan to the rescue (2)
•
•
•
•
•
Morgan’s team requests New York clergymen to give calming sermons on the
weekend of October 26-27, and—learning of gold shipments to USA—has these
publicized in the press.
On October 28, the mayor of New York City says the City needs a loan, cannot
get one, and will have to default by the end of the week. Morgan underwrites a
$30 million loan to the City. The New York Clearing House issues $100 million
of clearing house loan certificates to help member banks economize on
reserves.
On November 2, Morgan learns that a major investment bank is about to fail
because it holds large amounts of stock in Tennessee Coal & Iron Co. (TCI)
which it had collateralized for bank loans and now could not repay the loans.
Morgan arranges to merge TCI into U.S. Steel Corp., saving the investment
bank, after gaining President Roosevelt’s approval for the deal.
The same weekend, November 2-3, Morgan invites New York bank and trust
company presidents to his library, locks the doors, and cajoles them to pool
funds and lend $25 million to Trust Co. of America to stem a run.
On November 6, Morgan arranges a further $20 million loan to trust companies
facing runs.
•
•
•
•
•
Panic of 1907 ends that year;
aftermath leads to new central
bank
J. P. Morgan’s one-man central-bank actions end the
panic.
In 1908, Congress passes Aldrich-Vreeland Act.
Act authorizes emergency currency issues in a panic;
it was used in 1914 at outbreak of World War I,
stemming a US panic.
Act also establishes a National Monetary Commission,
which leads to Federal Reserve Act of 1913 and
Federal Reserve System opening for business at end
of 1914. USA once again has a central bank.
1907 is another good example of how to manage a
financial crisis.
1930-1933 crisis and Great
Depression
• The stock market crash of October 1929 had little to do with the
financial crisis that arose a year later.
• The crisis began in the fall and winter of 1930-1931 when large
numbers of US banks failed and the Federal Reserve did nothing to
prevent the failures, which initiated a deflationary downward spiral
and deepening recession.
• In May 1931, the Austrian Creditanstalt failed. The crisis then
spread to Germany, which defaulted on its large foreign debts and
left the gold standard. Pressure then shifted to the UK, which left
the gold standard in September. Pressure then shifted to the USA,
which saw a run on its gold.
• The Federal Reserve responds by raising its discount rate from 1.5
to 3.5 %, in the midst of a deflationary downward spiral. The year
1932 becomes the worst year in US economic history.
• This is how NOT to manage a crisis.
Lessons and Grades
• Lender of last resort actions in crises are helpful. Responsible
public and private authorities can execute them. Central
banks are useful for the purpose. But central banks can also
make things worse, as they did in 1792 and 1930-1933.
• 1792 and 1907 demonstrate bold, effective leadership and
crisis management. The professor’s grade: A.
• 1837-1842 and 1930-1933 demonstrate misguided and
ineffective leadership. Grade: D.
• 1873 is an example of public authorities doing nothing and the
crisis nonetheless ending quickly. Grade: Pass
• What can be said about crisis management in 2007-2009?
The crisis was not foreseen—they seldom are. Once it broke
out, some good things were done, and some not-so-good
things. The crisis lingers. Grade: B- or C+.