U.S. History/IPO of the Bank of the US - Pt. 2
QUESTION: I've read a couple of articles that mention the securities being used in this IPO as specifically being US debt securities. But it sounds like that would be an oversimplification, right? You're saying that any securities were acceptable as payment for BUS stock, not just ones that came from the federal government?
I've also read that when the price of BUS scrips fell, it nearly caused a widespread financial crisis. While the concept behind this might be Econ 101, I'm struggling to understand how this one thing could have had such huge ramifications. Especially, since as you said, the drop in prices wasn't really a full on "crash", but more of a "correction". It seems that (looking only at the price fluctuation in scrips and not getting into what happened with securities yet) the worst that would have happened is that a few personal fortunes might have been lost, in the cases of those who had bought a whole ton of scrips at peak prices and then had to sell them all off at a major discount. After all, BUS scrip was still a very valuable commodity, and as you pointed out earlier, those who held from the beginning were not adversely effected by the fluctuation in prices.
So did the fear of financial crisis have more to do with the drop in prices of securities? Or am I underestimating the impact that the drop in price of BUS scrip could have had?
ANSWER: There were financial crises in 1791 and 1792, which were both tied to speculation in the Bank of the US. Speculators of that time were basically the same as today. They gambled wildly with their investments, became fabulously rich when those gambles paid off, and cried like babies - demanding government assistance when their gamble lost. Speculator often suffered more than a little when a gamble did not pay off. If they were using borrowed money, they not only lost their own money but were still on the hook to pay off the debt. In those days, if you could not repay a debt, you went to debtors' prison and sat there until someone could repay your debt or your creditor forgave the debt.
In those days, you also have to remember that the US economy was not as tied into commerce as it is today. The vast majority of Americans were farmers who were not strongly affected by such panics. But they did have consequences beyond the investors who lost money. When lenders were not paid back money lent out to buy scrip, they had to tighten credit for other borrowers because they did not have enough money to make additional loans.
There was also some fear that the collapse could affect the bank itself. Buying a scrip is not exactly the same as buying stock. You were essentially buying a subscription to purchase stock over time. Those $25 scripts were actually a down payment on a promise to pay $400 for a share over time. So investors were on the hook for another $375, regardless of stock price. Some investors hoped to sell some of their stock (which hopefully increased in value) to cover future payments. Ordinarily, this would not affect the bank directly. If a shareholder could not make payments, he would be forced to sell his stock to someone else who could. But when so many people were unable to pay, there was a fear that no one would ever make the additional payments and the Bank not have sufficient cash reserves. I think these fears were unfounded, but it did cause a panic that make some people withdraw cash out of their accounts for fear of a bank run.
Because the Bank did not have sufficient capital, it had to refuse to renew a large number of its 30 day loans, which were typically just rolled over. This left many borrowers in the lurch, having to repay loans immediately that they did not expect to repay.
The bigger concern for Hamilton was the reputation of US commerce abroad. The Confederation Congress had already screwed foreign and domestic lenders by revaluing the Continental Dollar and failing to repay promised loans. Without a good reputation for credit, it would be impossible for the government to get further needed foreign loans. If the bank collapsed, or if repeated panics meant that the economy and commerce were too uncertain, investors would not want to get involved, or would at least charge a much higher interest rate to mitigate the risk.
I am not certain exactly what securities the BUS considered acceptable to buy scrips. There were obviously some limits as the value or risk of some securities were questionable. If payment was limited to US debt securities as some sources suggest, traders would simply need to swap other securities for US debt securities, which were available for trade on the open market, before purchasing scrip.
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QUESTION: So the biggest effects that the 1791 crisis had on the general economy were that credit became less available domestically - after loans that had been made for scrip buying went unpaid - and foreign lenders became more wary about doing business with the US, since the crisis made the nation's economy seem unstable. Is that right? One of the articles that I've read said, (quote) "the possible complete collapse of prices across the economy became increasingly a concern." Would this "collapse of prices" have been caused by the lack of credit available? Or something else?
How exactly did Hamilton's plan to buy US government securities end the 1791 crisis? It sounds like one thing that Hamilton could have done would have been to get money into the hands of the speculators, so that they could -
A. Pay back their loans
B. Finish paying off the full $400 for each share of scrip they owned
So, when Hamilton activated his "sinking fund", did he focus on buying securities from the speculators who were most directly suffering from the crisis? Or was something else going on here?
Also, when you said that people withdrew "cash out of their accounts for fear of a bank run" and that the "The Bank did not have sufficient capital, [so] it had to refuse to renew a large number of its 30 day loans, which were typically just rolled over", were you talking about the Bank of the US? And were you talking about the 1791 crisis or the 1792 crisis? Because I've read that when the 1791 crisis was occurring, the Bank of the US had not yet opened for business.
The result of the crisis beyond the individuals who lost money was primarily a credit crunch which made things difficult for all sorts of commerce, and affected foreign trade. It was similar in concept to what the US went through in 2008 when the housing bubble burst. The resulting credit crunch made life difficult across a whole range of businesses. It caused housing prices to collapse an other items as well. Similarly, in 1791, people had less money or credit to buy things so the prices on those items had to fall.
As the government did with its Fed Bailout in 2008, Hamilton created a similar bail out in 1791. He used government funds to buy falling scrips. This gave other investors confidence that the prices would not continue to fall and so the falling prices leveled off.
Yes, Bank of US withdrawals happened in the 1792 crisis as the bank did not open for business until Dec. 1791.