Sunday, March 16, 2008

History Repeating Itself

In the aftermath of the dissolution of the First Bank of the United States the individual states continued to charter and regulate banks. Paul Johnson writes [P285]: “Each state bank was allowed by the state legislature to issue bills up to three times its capital … literally a license to print money. During the War of 1812 America was awash with suspect $2 and $5 bills … Such gold as there was flowed straight into Boston, whose state banks were the most secure … [by 1814] every bank outside New England was forced to suspend payment.”

The Federal debt incurred by the War of 1812 and the nationalism that follows war led to an abandonment of the constitutional objections to a Second Bank of the United States, which was created as a national monopoly to bring about the discipline of specie-backed bank notes. It did just the opposite.

After initially restraining the state banks, William Jones, the bank President reversed course. Sean Wilentz describes Jones’ new outlook [P206]: “The original BUS [Bank of the United States] … had been too conservative in its credit operations.” Thus, a new credit expansion was born. “Rather than force state banks to curtail their inflated emissions of notes and loans, Jones approved lavish lending, especially by its new branches on the western urban frontier. By putting so many BUS notes into circulation, Jones abdicated the leverage he had had over the state banks early in 1817—for no longer could the national bank demand specie payments without being pressed for such payments in return.”

Paul Johnson explains the effect of this policy [P285]. “Indeed, he managed to create a fragile boom which was a miniature foretaste of the Wall Street boom on the 1920s leading to the crash of 1929. Jones’ boom was in land. From 1815 the price of American cotton rose rapidly and that in turn fed the land boom. At that time public land was sold primarily to raise revenue rather than to encourage settlers, who needed no encouragement anyway. Each was charged $2 an acre in minimum blocks of 160 acres. But they only had to put 20 percent down, borrowing the rest form the banks on the security of the property. The $2 was a minimum; in the South potential cotton land was sold at $100 an acre in the boom years. The SBUS, fueling the boom by easy credit, allowed purchasers to pay even the second installment on credit, again raised on the security of the land, like a second mortgage.”

“Jones … ran this federal central bank like a bucket-shop. He actually allowed the SBUS to deal in ‘racers,’ short for Race Horse Bills. These were bills of exchange paid for by other bills of exchange, which thus raced around rapidly from one debtor to another, accumulating interest charges and yielding less and less of their face value.”

“Jones’ easy-credit policy was further undermined by the activities of the SBUS’s branch offices… In Baltimore the branch was run by two land speculators … who financed their speculations by taking out unsecured loans from their own bank… Here was a typical example of the general credit expansion Jones encouraged, raising the debt on public land from $3 million in 1814 to over five times that amount ($16.8 million) three years later. Some of this went into house purchases—it was the first urban boom in the US history too.”

Of course it was not to last. “Suddenly, the cotton bubble burst, as Liverpool cotton importers, alarmed by the high prices, started shipping in Indian raw cotton in huge quantities. In December-January 1819 the price of New Orleans cotton halved, and this in turn hit land prices, which fell from 50 to 75 percent. The banks found themselves with collateral in land worth only a fraction of their loans, which were now irrecoverable. Jones compounded his earlier errors of inflation by abruptly switching to savage deflation, ordering the branches of the SBUS to accept only its own notes …”

The result was the Panic of 1819 and following depression.

31 Comments:

Blogger Charles N. Steele said...

Excellent! You've certainly hit the nail on the head with this one!

However, when history repeats itself, it isn't ever exactly the same. Today we have Ben Bernanke, who a) apparently sees further credit expansion as the cure for everything, and b) is willing to make the Fed the lender of last resort for non-bank financial institutions that gambled and lost.

A sharp severe recession would be better than the lengthy bloodletting Bernanke & co. will bring us.

3/17/08, 11:54 AM  
Blogger Jeff Perren said...

Just so.

The Feds have recently promised $200 billion in cheap loans to financial institutions.

What accounts for the near-total collapse of common sense when it comes to finance? I suspect it's the desire to have something for nothing, or at least less than one has earned.

Mere ignorance of economics couldn't possibly explain foolishness of this magnitude.

3/17/08, 4:02 PM  
Blogger Always On Watch said...

I don't know where our economy is going right now with the bailouts and the Fed securing buyouts such as J.P. Morgan's of Bear Stearns. However, I have the sinking feeling that this fall is going to being a downturn which will propel the Dems into the White House and the Congress. GWB seems to be suffering from a disconnect when it comes to our present economic crisis.

3/18/08, 8:47 AM  
Blogger Jason_Pappas said...

Getting an A in economics from Prof Steele is gratifying. Jeff and AOW make some interesting points that explain the difference between then and now.

In the 1820s it was widely understood that the national Bank was a government granted monopoly. A skeptical population viewed the institution as inherently dishonest and unjust. There wasn’t any ‘sophisticated economic analysis’ but as Jeff suggests just plain horse sense. People saw the creation of special privileges as morally questionable. Getting something for nothing & borrowing forever would have ‘raised a flag’ to say the least.

By the 1820s Jefferson was one of the only articulate opponents of the national bank left (opposition was taken for granted in the 1770s and common among anti-federalists in the 1790s). Andrew Jackson would revive the popular animosity to this institution in the 1830s.

3/18/08, 11:50 AM  
Blogger Ducky's here said...

Sounds like a call for regulation, Jason. Here's some food for thought.

Corporate Welfare

E.J. Dionne finally says it:


Never do I want to hear again from my conservative friends about how brilliant capitalists are, how much they deserve their seven-figure salaries and how government should keep its hands off the private economy.

The Wall Street titans have turned into a bunch of welfare clients. They are desperate to be bailed out by government from their own incompetence, and from the deregulatory regime for which they lobbied so hard. They have lost "confidence" in each other, you see, because none of these oh-so-wise captains of the universe have any idea what kinds of devalued securities sit in one another's portfolios.

So they have stopped investing. The biggest, most respected investment firms threaten to come crashing down. You can't have that. It's just fine to make it harder for the average Joe to file for bankruptcy, as did that wretched bankruptcy bill passed by Congress in 2005 at the request of the credit card industry. But the big guys are "too big to fail," because they could bring us all down with them.

Enter the federal government, the institution to which the wealthy are not supposed to pay capital gains or inheritance taxes. Good God, you don't expect these people to trade in their BMWs for Saturns, do you?


This is so overdue. We've essentially in the Bush era set up a kind of corporate Marxism, where risk is socialized, but where wealth is privatized. And the middle class, in this case homeowners, are the only ones who ever feel any pain.

Ben Bernanke believes that he can save the economy by managing and financing the ultimate downfall of these financial institutions. Which is fine to a point, because the alternative is a massive meltdown of the entire system. But let's call it exactly what it is. And let's no longer allow the other side to say things like "let the market make its own decisions," because they only believe that when they're not affected. This is a selective bailout, and it's government intervention into the markets to save them. Because they currently are non-functional and unregulated. It doesn't have to be this way, but under a laissez-faire system it's inevitable.

Can't wait for some Wall Street honcho or BushCo official to go on about welfare queens or big government programs...

3/18/08, 1:34 PM  
Blogger Jason_Pappas said...

The national bank, then and now, is a government regulating institution. It’s the regulations that cause the problem.

3/18/08, 3:21 PM  
Blogger Mr. Beamish the Kakistocrat said...

America's federal government fiscal year begins in October.

Congress is the branch of government tasked with the economic controls of America's federal government budget.

Democrats took over Congress' tasks of controlling America's federal government budget in January 2007.

The first fiscal budget year of the newly elected Democrat-controlled Congress began in October 2007.

The economy of the United States began lurching towards recession in October 2007.

Coincidence?

I think not.

Democrats can't even run a decent bake sale and you want to put them in charge of the nation's economy?

3/19/08, 1:41 AM  
Blogger Mr. Beamish the Kakistocrat said...

Ducky,

E.J Dionne? People still read that crap weasel?

Bear Stearns gave loans to people who could not pay them back... welfare, if you will...

an example of capitalism run amok?

And a government bail out of these burned lenders... welfare, if you will...

..is an example of capitalism run amok?

Lay off the crayons, E.J. Your teeth are starting to look like Easter eggs.

3/19/08, 1:57 AM  
Blogger Ducky's here said...

Beamish, Bear Sterns BOUGHT securities from mortgage brokers who made money selling the junk which Standard and Poor's and Moody's had graded as investments grade and then used the junk as collateral to leverage it as much as 20 times.

It's always a treat to read you guys try to render these failures down to some individual failure rather than admitting the obvious. The free market(LMAO) is far too precarious to be left to the whims of the market place.

3/19/08, 10:30 AM  
Blogger Ducky's here said...

AOW, as far as bailouts go, we've learned something this century.
Regardless of the downside you keep the financial system functioning. Without intervention you could have seen the system completely seize up on Monday.

Bernanke has done a pretty good job and has done the best he can to clean up Greenspan's poop.

3/19/08, 10:32 AM  
Blogger Charles N. Steele said...

The Dionne piece is half right. Dionne correctly lambastes the pseudo-free marketeers who want to "privatize the profits, socialize the losses." It isn't surprising that the market doesn't work well when market discispline is replaced by allowing speculators' mistakes to be foisted on the taxpayer. Dionne correctly identifies this as welfare for well-connnected financiers. But then he unaccountably endorses it, defending everything Bernanke is doing.

Bernanke is doing a dreadful job.

1. He's destroying the dollar with continued money expansion with no end in sight. His "core inflation is low" argument is nonsense.

2. He's essentially having the taxpayer buy the Collateralized Toxic Waste. It's not the job of the Fed to bailout non-banks like Bear-Stearns at citizen expense.

3. He's not uttering a word about the misbegotten policies that got us here in the first place, and the way he's acting increases the chances nothing will change.

The misbegotten policies: i) An expanding federal deficit that put the U.S. in the red. Both parties are to blame, but of late the lion's share of blame goes to Bush and the GOP Congresses, "Free Marketers" in name only. They were enabled by

ii) Alan Greenspan's Fed, which provided loose money to help out. Thus under Bush & the GOP, a continuous combination of fiscal and monetary stimulus. Even the most die-hard Keynesians know you can't get away with this.

iii) A cheap-credit housing bubble exacerbated by explicit Fed pressure on lenders to make bad loans and call 'em good.

Add to this the moral hazard that arises when financial houses are "too big to fail" (i.e. too big to face market discipline) and you get today's terrible mess. It has nothing to do with free markets, and everything to do with a governmental fiscal irresponsibility and a central banking system manipulated by political hacks.

What we are seeing is a modern episode of the Austrian Business Cycle outlined by Mises and Hayek. What their model didn't take into account, though, was that the government would be locked-in to high spending via entitlements, that this spending would be scheduled to grow, and that the country would be utterly dependent on foreign financing at a time it was destroying its own currency.

This is a very dangerous mess, brought on by interventionism, and it won't be fixed by pontificating about the alleged evils of market discipline and calling for more of the same gov't behavior that created the problem in the first place.

3/19/08, 2:48 PM  
Blogger Ducky's here said...

Aren't you being a little sever Mr. Steele in placing so much responsibility for the dollar's slide on Bernanke?

Isn't he playing a zero sum game? At some point in the not so distant past it seems the Fed's function has become, "protect Wall St.". He didn't bring that with him.

Keep the pyramid from collapsing without causing much pain. Nasty problem, no?

3/19/08, 3:17 PM  
Blogger Mr. Beamish the Kakistocrat said...

Ducky,

It's always fun to point out how and why leftists are stupid.

Bear Stearns did in a microcosm what leftists want to do with the entire US economy, particularly the health care industry - give money to people who have no reasonable expectation to pay it back, and then treat the debts as if they were fungible collateral.

In a free market, should one ever actually spring up in America, lenders wouldn't be required by the government to piss away their capital to sub-prime and deadbeat borrowers.

Want to see "corporate welfare?" Go to a major league baseball game.

3/19/08, 3:32 PM  
Blogger Mr. Beamish the Kakistocrat said...

After all it is all these "fat cats" with no money we must tax to death to give free housing to people less efficiently than they do.

3/19/08, 3:40 PM  
Blogger Charles N. Steele said...

Ducky: Mr. Bernanke isn't singlehandedly wrecking the dollar. Greenspan and Bush have certainly been the major contributors here. But Bernanke is exacerbating the decline. Former IMF chief economist Ken Rogoff makes this clear.

Ducky, you also write:

"We've essentially in the Bush era set up a kind of corporate Marxism, where risk is socialized, but where wealth is privatized. And the middle class, in this case homeowners, are the only ones who ever feel any pain."

You then say "It doesn't have to be this way, but under a laissez-faire system it's inevitable."

You're not that far off target in the first comment -- but it completely contradicts the second. Artificially cheap credit, special protection for well-connected firms, bailouts, and "corporate Marxism" aren't laissez faire.

Beamish: this crisis was predicted long before 2007. Yale economist Robert Shiller wrote about the housing bubble in 2003. NYU's Nouriel Roubini has been saying since at least 2005 that the combination of Fed policy, US federal borrowing, and housing bubbles would generate a crash.

Much as I hate to say anything nice about the Democrats taking over Congress, it was largely irrelevant for this mess. They haven't really done anything that different from the Republicans on the budgetary side of things, which is, of course, part of the problem. But the bubble was already there when they "took charge" (joined in business as usual, a better way of saying it).

Of course, they have no idea of how to fix things, either.

3/19/08, 3:54 PM  
Blogger Charles N. Steele said...

Ducky: "Keep the pyramid from collapsing without causing much pain. Nasty problem, no?"

The problem is that the pyramid should collapse. A recession is needed to liquidate mistakes, bad investments. Trying to prolong things with more cheap credit probably will not work at this point, but if it does, it just means more bad investments piled on top of the old ones, which trades today's crisis for a bigger one tomorrow.

3/19/08, 4:05 PM  
Blogger Ducky's here said...

"Artificially cheap credit, special protection for well-connected firms, bailouts, and "corporate Marxism" aren't laissez faire."

Yes, point taken.

3/19/08, 4:11 PM  
Blogger Ducky's here said...

"The problem is that the pyramid should collapse. A recession is needed to liquidate mistakes, bad investments. Trying to prolong things with more cheap credit probably will not work at this point, but if it does, it just means more bad investments piled on top of the old ones, which trades today's crisis for a bigger one tomorrow."

Would I be amiss in stating that you would take a position much like Paul Volker (who I think did a pretty good job) and demand that we take our medicine quickly before we have to up the dosage?

3/19/08, 4:13 PM  
Blogger Mr. Beamish the Kakistocrat said...

Charles,

The asset to liability ratio of the American people is still 5 to 1.

It's all a matter of "we the people" deciding to tax our assets to pay off our liabilities, or increase our liabilities slightly less faster than our assets are growing.

3/19/08, 4:28 PM  
Blogger Ducky's here said...

This comment has been removed by the author.

3/19/08, 4:35 PM  
Blogger Ducky's here said...

What's the standard deviation, Beamish?

3/19/08, 4:53 PM  
Blogger Mr. Beamish the Kakistocrat said...

Ducky,

Assets are private, liabilities are public.

Don't tax me to pay your bills.

3/19/08, 5:52 PM  
Blogger Charles N. Steele said...

Ducky, you ask: "Would I be amiss in stating that you would take a position much like Paul Volker (who I think did a pretty good job) and demand that we take our medicine quickly before we have to up the dosage?"

No, not amiss. But we need more than just tighter monetary policy: federal fiscal responsibility would be a start.

Beamish: By "'we the people' deciding to tax our assets to pay off our liabilities" I think you mean "Congress taxes us to pay for its irresonsible spending." Regardless, while the Federal fiscal position is fixable, it's not sustainable. And neither is the endless credi expansion that the Fed continues to pursue.

As for "Assets are private, liabilities are public," you aren't endorsing the "privatize profits, socialize losses," are you?

3/19/08, 6:28 PM  
Blogger Mr. Beamish the Kakistocrat said...

Charles,

Actually I have a different position towards people who advocate socialism, and that position involves blindfolds and small arms fire.

So no, I am not an advocate of "socializing loss." Socializing loss creates more loss.

I'm an unabashedly pro-wealth creation capitalist.

Leftists believe the preamble to the Constitution reads:

"We the already born people of the United States, in order to form a more perfect government regulatory office, invalidate justice, insure domestic hostility, sabotage the common defense, provide the general welfare, and secure the blessings of socialism to ourselves on our posterity's dime, do ordain and establish this Constitution for the Federalized State of America."

This is why Ducky watching is so fun. Here's a guy that never tires of bashing laissez faire like a good little Mussolini-an, with a relentless incessancy reminiscent of Hitlerian dialectics in that ugly stain of leftism-tainted thought that begat Mein Kampf. Ducky's so illucid, so clueless, so ignorant, so leftist that he sees laissez faire everywhere, even in the clearly leftist government required sub-prime lending that created this "crisis."

So more private assets - the individually owned properties and effects of American citizens must be lost to cover an expansion of liabilities.

Or, we stop the expansion of liabilities.

The only liability the American people have is their own government.

3/19/08, 8:55 PM  
Blogger Jason_Pappas said...

I don’t have much to add to the above conversation. Instead, let me clarify what the Fed has done. The Fed hasn’t bailed out Bear Stearns. The owners of Bear lost 99% of their equity. The Fed bailed out the counter parties to Bear Stearns (and the bond holders). The market recognized this immediately. On Monday the prices of other investment banks took a hit since not only was Bear solvent but it was going to declare a profit for the first quarter! As I understand it, the Fed was being pre-emptive. At the same time, swap spreads dropped indicating the lessoning of counter party risk between banks.

Let’s remember the differences between an investment bank (like Bear) and a commercial bank (like JPMorgan). An investment bank underwrites new securities and makes a market for these securities afterwards. It is a short term holder of securities in both cases. A commercial bank makes long-term loans against depositor’s money-market accounts.

An investment bank marks-to-market its inventory of securities, hedges the inventory, and tries to move (i.e. sell) the inventory to investors. Most maintain 30 times leverage, i.e. they hold securities 30 times the value of their capital. The goal is to make money on the flow by being a middleman. Changes in the market value of the securities create profits and losses because of the imperfections of the hedge. If this mismatch is deliberate, the bank is speculating.

A commercial bank doesn’t always have to mark-to-market. It has to maintain reserves. To avoid interest rate risk, it has to immunize its portfolio against the mismatch of assets and liabilities inherent in having long-term assets and short term demand-deposit liabilities. In practice it sells long-term loans into the market or keeps them in a hold-to-maturity portfolio that doesn’t have to be marked to market. Consequently, today it has some of the middleman behavior of an investment bank although it generally has half the leverage.

The Fed, by protecting Bear’s counter parties while bankrupting its owners, has acted like the FDIC to those who have accounts, contracts, and dealings with Bear. While the moral hazard to capitalists hasn’t increased (as owners) the moral hazard of customers has. No longer does the customer have to be as concerned with the credit worthiness of its counter parties just as a savings account owner doesn’t worry about its bank. We remember what happened to the Savings and Loan banks when no one worries.

With the restrictions to oversight from owners (because of insider trading laws) and a lessoning of oversight from counter-parties (because the Fed is now an institutional FDIC), who’s watching the store? It’s clear that the void will eventually be filled by government bureaucrats and regulators. Capitalism is ending by an evolution that is bringing a corporatist structure, i.e. socialism with a capitalist façade.

The trend is worrying. I haven’t commented on the over-leverage and mal-investment, all which the Fed wants to maintain. Neither Party wants the correction to mal-investment on their watch. They both want to buy votes. There will be a housing bailout in the future and that requires propping up the mortgage industry, maintaining lending volume at low rates, etc.

What was that quote attributed to Tyler about a democracy voting itself wealth?

3/20/08, 9:37 AM  
Blogger Ducky's here said...

I'm in the unusual position of agreeing with Jason. No, it's pretty clear it wasn't a "bailout". Bernanke may have helped engineer the best deal he could get that generated some stability and hurt some of the people who deserved to be hurt.

The lawsuits are already flying from people who stand to lose plenty.

"Neither party wants the correction on their watch."

Yeah, that tells us plenty. Although I do remember that the much kicked around Jimmy Carter was the one who appointed Paul Volcker to the Fed and did generate some hard love.

3/20/08, 11:02 AM  
Blogger Beamish said...

There ain't no such thing as a free lunch.

3/21/08, 5:39 AM  
Blogger Ducky's here said...

This comment has been removed by the author.

3/24/08, 12:13 PM  
Blogger Ducky's here said...

Looks like it might have been a bailout. The Bear Stearns stock price is being bid up. Oh well, back to the old zero sum. Kapital gets the profits, citizens get the expenses.

The Fed and the Treasury Department gave Bear and JP Morgan shareholders a $30 billion gift from taxpayers. And the moment Bear Stearns realized that all the crap on its balance sheet had been transformed into a Treasury Bill, it demanded more for itself.

3/24/08, 12:15 PM  
Blogger Beamish said...

Ducky,

It's like an earned income tax credit, except it's for people that work for a living.

3/27/08, 11:36 PM  
Blogger Always On Watch said...

Jason,
From this March 28, 2008 article in the WaPo:

In the past two weeks, the Federal Reserve, long the guardian of the nation's banks, has redefined its role to also become protector and overseer of Wall Street.

With its March 14 decision to make a special loan to Bear Stearns and a decision two days later to become an emergency lender to all of the major investment firms, the central bank abandoned 75 years of precedent under which it offered direct backing only to traditional banks.

Inside the Fed and out, there is a realization that those moves amounted to crossing the Rubicon, setting the stage for deeper involvement in the little-regulated markets for capital that have come to dominate the financial world.

Leaders of the central bank had no master plan when they took those actions, no long-term strategy for taking on a more assertive role regulating Wall Street. They were focused on the immediate crisis in world financial markets. But they now recognize that a broader role may be the result of the unprecedented intervention and are being forced to consider whether it makes sense to expand the scope of their formal powers over the investment industry....


I'm not sure that I buy that part about no master strategy, however.

3/28/08, 11:33 AM  

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