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Tag: Financial Crisis

Alexander Hamilton’s markets, bubble, and fear realized

by on Oct.18, 2010, under History


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I am often struck by the parallels in the issues faced and foresight displayed by the founders as they attempted to build the new system of government and provide guards for the safety and liberty of its people as well as their prosperity. One might be forgiven mistaking the date by a few hundred years when reading about this particular market bubble bursting; in the lead-up and the fallout.

Ron Chernow, Alexander Hamilton’s biographer, defends his subject from charges frequently levied upon him: “He was never a hireling of monied interests; rather, he wanted to attach them to the new country’s interests. Like many thinkers of his day, he thought that property conferred independent judgment on people and hoped that creditors would bring an enlightened, disinterest point of view to government. But what if they succumbed to speculation and disrupted the system they were supposed to stabilize? What if they engaged in destructive short-term behavior instead of being long-term custodians of the nation’s interest? If that happened, it might undermine his whole political program.”

Well, lets see how that turned out… (my primary source is Ron Chernow’s book linked above)

On July 4, 1791, during George Washington’s first term as the new nation’s first president, stock in Hamilton’s Bank of the United States, a kind of precursor to the Federal Reserve, went on sale. Interestingly, the shares where sold in the form of a scrip. As Chernow describes it; an investor would make a down-payment of $25 to receive a contract which entitled them to buy some number of shares at par and then pay off the balance due over the next eighteen months. So the activity centered around the buying of something that wasn’t actually a security… not a direct line to the crash of 2007, but surely an echo.

Some might argue that what happened next should have set off bi-partisan alarms and been the source for productive work by the new Congress. Instead, it just played a part in the bitter partisan divide that was forming in the young nation.

What we would term today, irrational exuberance, took hold as the price doubled and tripled sometimes on the same day. People newly turned speculator rushed in to the cities with carts full of gold in the hopes of getting in on the easy money. Through the following month the price of the scrip would grow to over $300. There was frenzy in the major cities of the north. Chernow quotes Benjamin Rush, John Adams personal physician and major medical mind of his time, as writing “The city of Philadelphia for several days has exhibited the marks of a great gaming house… Never did I see so universal a frenzy. Nothing else was spoken of but scrip in all companies, even by those who were not interested in it.” He then quotes Senator Rufus King as telling Hamilton; “The business was going on in a most alarming manner, mechanics deserting their shops, shopkeepers sending their goods to auction, and not a few of our merchants neglecting the regular and profitable commerce of the city”.

This might sound a bit familiar to those who just experienced the real estate market crash in the United States. But also those who experienced on in Florida in the 1920s. Andrew Bettie writing on Investopedia reports that prices in the Florida real estate market in the 20’s doubled and tripled… “soon everyone in Florida was either a real estate investor or a real estate agent”. This sentiment could be said to apply to the entire U.S. in the years leading up to the recent crash.

During the rise in bank scrip in 1791, Jefferson commented on the impact on the moral character of the nation; Chernow quotes him: “The spirit of gaming, once it has seized a subject, is incurable. The tailor who has made thousands in one day, though he has lost them the next, can never again be content with the slow and moderate earnings of his needle”. Also, Jefferson wrote to Washington, “It remains in a country whose capital is too small to carry its own commerce, to establish manufactures, erect buildings, etc., such sums should have been withdrawn from these useful pursuits to be employed in gambling”.

It seems that Hamilton’s fears of people “engaged in destructive short-term behavior” were realized on the very first event of his building of a market economy in the country. The interesting note here is Hamilton’s foresight, but also his lack of action. Today, the real estate rooted crash which almost took down the world economy was the result of the same “destructive short-term behavior”.

In the end, to this particular chapter anyway, the bubble burst. Just one month after the initial offering. What happened in the aftermath borders on eerie in the parallels to today. The first event, according to Chernow, almost made me drop my ebook reader when I read it; “The bubble was pricked when bankers refused to extend more credit to leading speculators”. In 2008, Bear Stearns and Lehman Brothers essentially collapsed because they ran on credit and banks refused to lend to them. Here are two “leading speculators” which bankers refused to lend to. Further, in September 2008, the Telegraph (UK) reported “A lack of lending in the bank market has led to governments in the US and Europe rescuing five financial institutions in the past two days. Yesterday the US Federal Reserve sought to avoid further banking failures by doubling the amount of dollars available to foreign central banks through swap lines to $620 [billion]”.

Chernow then writes “As a rule, he [Hamilton] tried not to interfere with markets… But he also believed he had an obligation to protect the financial systems”. So he decided to “‘talk down’ the market to avert a worse tumble later on”, and he then proceeded to “buy up $150,000 in government securities”. Although there were further fluctuations, the strategy worked, setting a precedent for market regulation through government action, including the very first bailout.

In another parallel, Jefferson wrote a letter to Edward Rutledge in which he complained “Ships are lying idle in the wharfs buildings are stopped, capitals withdrawn from commerce, manufactures, arts, and agricultures, to be employed in gambling”. Bill Gates, in 2010, gave a lecture to MIT students on the problem of many bright students going into less impactful areas and the financial sectors in the hopes of big earnings rather than into the sciences where they can make positive impacts on human lives.

So why didn’t the founders act?

In 1791, the nation was young and very vulnerable. Fighting between France and England was threatening U.S. commerce on the high seas and possibly the nation itself. Native American attacks, political infighting, and a popular uprising or two were just some of the issues threatening it on land. Still, perhaps they could have acted to stop the cracks before the dam broke.

From the prescient mind of the man who said “If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy “, we get “The stock-jobbers will become the praetorian head of the Government, at once its tool and its tyrant, bribed by its largesse and overawing it by clamors and combinations.”, from a letter he wrote to Jefferson during in August 1791. Perhaps it was, and still is, the realization of this prediction that was responsible for the lack of meaningful action.

What if Jefferson and Hamilton sat down, put aside their anger, and worked together for the good of the nation as Washington pleaded with them to do in letters sent as the bedlam in the papers was intensifying. What if we all sit down together today as the bedlam in the media is now doing the same?

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