Alexander Hamilton Central Banker and Financial Crisis Manager

ALEXANDER HAMILTONCentralBankerandFinancialCrisisManagerBy Richard SyllaWall Street suffered its firstcrash in March, 1792. In a matter ofweeks, U.S. government securitiescomprising the national debt lost aquarter of their value. Shares of theBank of the United States, founded in1791, fell 30 percent. Shares of thenew Society for Establishing UsefulManufactures fell 45 percent. A moreseasoned issue, Bank of New Yorkshares, declined just under 20 percent.Defaults and bankruptcies werenumerous. As confidence and trustcollapsed, a pall fell over New Yorkand, to a lesser extent, the Philadelphiaand Boston securities markets.Apart from financial historyspecialists, few are aware of thismajor crash and panic that cameduring the birth of U.S. capital markets.Our history books far moreoften mention similar events in theyears 1819, 1837, 1857, 1873, 1884,1893, 1907, 1929, 1987, and, morerecently, the major market decline from2000 to 2002. One reason for thedifference is that the key dimensions ofthe 1792 crash have only recentlyFinancial History ~ Winter 200720www.financialhistory.org

Collection of the Museum of American FinanceCertificate for stock in the Bank of the U.S., January 20, 1792.been recovered. The price changesmentioned in the previous paragraphare part of a new securities pricedatabase compiled, mostly from oldnewspapers, by Jack W. Wilson,Robert E. Wright, and me.A more important reason why1792 is less than memorable is thatit had no discernable economic consequences.There was no recession,much less a depression. Prices stoppedfalling by mid-April, the U.S. economycontinued to grow vigorously as it hadsince 1789, and the events of Marchwere soon forgotten. But why? Wasthis just an early example of thatDivine Providence that is said to lookafter fools, drunks, and the UnitedStates of America?No. Potentially damaging economicconsequences of the panic wereavoided, it is now quite clear, by verymodern central-bank-like interventionsorchestrated by Alexander Hamilton.Hamilton, Secretary of the Treasury,at the time was executing his grandplan to give the country a modern,state-of-the-art financial system.Hamilton, who knew his financialhistory, was well aware that a disastrouspanic could defeat the plan.He had studied the 1720 collapseof John Law’s Mississippi Bubble inFrance, which weakened Francefor decades, and the related collapsethat same year of the South SeaBubble, which had somewhat lessdamaging consequences for England’sfinancial system.Trial Run: The 1791Bank Script BubbleIn 1791, during the crash of a bubbleconnected with scripts — rights tobuy full shares — issued in the IPO ofthe Bank of the United States (BUS),Hamilton wrote Senator Rufus Kingthat “a bubble connected with myoperations is of all the enemies Ihave to fear, in my judgment themost formidable.” So Hamilton thendirected open market purchases ofgovernment debt to inject liquidityinto panicky markets. It proved tobe a test run for a wider range ofinterventions in the more seriouscrash of 1792.Bank scripts were issued on July 4,1791. For a $25 down-payment, aninvestor received a script entitling theholder to purchase of a full BUS shareafter a series of further payments of$375. Scripts doubled in price in July,and then really took off, reachingprices of $264 (New York) to $300(Philadelphia) on August 11. Thewww.financialhistory.org 21 Financial History ~ Winter 2007

Three checks from the Bank of the U.S. dated the year of the panic, 1792.dotcom bubble of recent memorywas hardly new or unique.In the following days and weeksscripts lost more than half of theirpeak valuations — the bid price was110 in New York on September 9 —dragging down with them prices ofU.S. debt securities. Sensing trouble,Hamilton on August 15 sprang intoaction. He convened a meeting of thecommissioners of the Sinking Fund(himself and four other top officialsof the federal government) and persuadedthem to authorize open marketpurchases of $300–400 thousand ofU.S. debt at Philadelphia and NewYork. The Sinking Fund was a featureHamilton had included in his 1790national debt restructuring plan,ostensibly to assure investors that theU.S. government was committed topaying down its debt, but really —since it would be some time beforefederal revenues would allow anypay-down — to allow just such shorttermopen-market interventions. TheCollection of the Museum of American Financepurchases were financed by loansfrom banks.Over the next month, mid-Augustto mid-September, Sinking Fundrecords show the Treasury purchasing$150 thousand of U.S. debt inPhiladelphia and $200 thousand inNew York, where the money was borrowedfrom the Bank of New Yorkand the purchases were executed bythe bank’s cashier, William Seton. TheBUS, the national bank, had just hadits IPO and would not open for businessin Philadelphia until December, andwould not have a New York branchuntil April 1792. Hamilton thereforehad to work through the one bankthen in New York, and it probablyhelped that he had been one of itsfounders in 1784.By having the Sinking Fund purchaseabout two percent of the debtoutstanding in 1791, Hamilton hadnipped in the bud an incipient marketcrash. The liquidity injection calmedthe markets. From New York, Setonin September wrote Hamilton inPhiladelphia, saying, “You have theblessings of thousands here, and I feelgratified more than I can express, atbeing the dispenser of your benevolence.”Markets are grateful to centralbankers who intervene to prevent pricesfrom collapsing by buying wheneveryone else wants to sell.Causes of the 1792 PanicTraditional accounts of rapid run upof securities prices in the first twomonths of 1792, followed by thecrash of prices in March and April,blame it on an ill-fated plan of acabal of New York speculators led byWilliam Duer to corner the marketfor U.S. six percent bonds (6s). UnderHamilton’s plan for capitalizing theBUS, investors holding Bank scriptscould pay three-fourths of the fullshare price, $400, by tendering 6s.Duer and his associates plotted toborrow whatever money they could,often by offering very high rates ofFinancial History ~ Winter 200722www.financialhistory.org

$50 promissory note from the Bank of the U.S. issued August 1, 1792.interest, to buy up most of the 6s, andthen sell at high prices to those whoneeded 6s to purchase Bank shares in1792 and 1793. As the plot wasimplemented, 6s rose from 110 (percentof par) in late December 1791 to125 by mid January 1792, to a peakof 126.25 in early March. But onMarch 9 Duer defaulted on his debts,triggering a chain of further defaultsand liquidations that drove 6s downto a low of 95 on March 20. Governmentsecurities had lost a quarter oftheir value in about two weeks.More recent research confirmsthat another factor besides the Duercabal was at work in early 1792 todrive up prices and then drive themdown. Price bubbles are almost alwaysfueled by newly-created credit, and ithappened that a new and large sourceof such credit became available at theend of 1791, namely the Bank of theUnited States. The Bank opened inPhiladelphia in December 1791, and bythe end of January 1792 it had issued$2.2 million of notes and deposits(monetary liabilities) while discountingloan paper of $2.7 million. Some ofthose loans found their way to Duerand other speculators.The new central bank had beencareless with its credit creation inits first weeks and months. By earlyFebruary, holders of BUS notes anddeposits were redeeming them forspecie reserves, which fell from $706thousand on December 29, to $510thousand on January, to $244 thousandon March 9. It was a classic drainof reserves from a bank that hadexpanded credit too fast and too far.In February, Hamilton had to informthe Bank of New York, which itselfwas stressed, that the Treasury wouldhave to draw funds from it to propup the BUS in Philadelphia. At thesame time he urged all banks to reducetheir lending “gradually.” Instead, thebanks stepped hard on the brakes;BUS discounts, for example, declinednearly 25 percent from January 31 toMarch 9, the very day William Duerdefaulted on his debts. Duer nodoubt was a reckless speculator andplunger. But in the end he and otherslike him were done in by an abrupttightening up of bank credit.Hamilton Manages the CrisisOn March 19, the day before U.S. 6sreached their panic low of 95 in NewYork, Hamilton initiated a numberof actions to alleviate the financialdistress. First, he asked the nation’sbanks, still few in number, to lendmoney to merchants who owed customsduties to the Treasury. Hepromised the banks that the Treasurywould not draw the money fromthem for three months.Second, Hamilton reminded theTreasury’s collectors of customs inthe nation’s port cities that they wereauthorized to receive post-notes ofthe BUS maturing in 30 days or less“upon equal terms with cash,” andhe encouraged the BUS to issue suchMuseum of American Financepost-notes as a way of temporarilyconserving its specie reserves.Third, Hamilton had the Treasurymake open market purchases atPhiladelphia, using the funds authorizedto be spent by the Sinking Fundin 1791 that had not been expendedthen. And he called the Sinking Fundcommissioners to meet on March 21to authorize more open market purchasesof U.S. debt. There were somedelays in getting the authorizations,but over the next month Hamiltondirected agents in Philadelphia andNew York to purchase on the openmarket nearly $250 thousand worthof U.S. debt to inject liquidity to thepanicked securities markets.Fourth, Hamilton learned in Marchthat the U.S. minister in Amsterdamhad arranged a loan to the Treasuryfrom Dutch bankers of three millionflorins ($1.2 million) at four percentinterest. He directed his agents inU.S. markets to publicize news of theloan, to assure panicky investors thatU.S. finances were in strong shape.Fifth, Hamilton initiated a planamong the banks, merchants, andsecurities dealers in New York tocooperate in stemming the crisis. In aletter of March 22 (which becamepublic only in 2005), Hamilton suggestedto Seton at the Bank of NewYork that rather than dump theirholdings on the market to meet liquidityneeds, which would only exacerbatethe crisis, the merchants anddealers instead use up to $1 million ofU.S. securities at values specified byHamilton as collateral for credits atthe bank. The dealers and merchantscould then write checks against thesecredits to settle their accounts withone another, avoiding panic liquidation.Anticipating what decades laterwould be called Bagehot’s rules forproper central bank behavior in acrisis, Hamilton directed that theloans be made at the high discountrate of seven percent instead of theusual six percent. Walter Bagehot, awww.financialhistory.org 23 Financial History ~ Winter 2007

U.S. Sixes, Philadelphia Price130120110Bi d P r i ce ( P e rcent o f Pa r )100908070601790.10301790.11241790.12151791.01051791.0129179. 0Date1 2191791.03231791.04131791.05071791.06011791.06251791.07161791.08101791.09031791.09281791.10221791.11121791.12071791.12311792.01211792.02151792.03141792.04071792.05051792.06021792.06271792.07211792.08111792.08291792.09291792.10241792.11171792.1208student of English central banking,publicized his rules in his book LombardStreet in 1873. The rules in essencesaid that a central bank in a crisisshould lend freely on good collateral,such as government securities, but ata high rate of interest so borrowerswould have an incentive to repay theloans as soon as the crisis had passed.Hamilton’s creative financial mindhad come up with Bagehot’s rulesnine decades before Bagehot.But what if the crisis did not endand the Bank of New York got stuckwith collateral that had fallen in value.Hamilton deemed that possibility“not supposeable,” but to alleviateconcerns on the part of the bank, heoffered to repurchase from it up to$500 thousand, again at the valuesHamilton had specified. In other words,Hamilton combined a repurchaseagreement with Bagehot’s rules.The plan was implemented. Fivedays later, an agent of Hamilton’s inNew York wrote to him to report,“The dealers last night had a meeting& appointed a committee, to conferwith the directors of the two banks[Bank of New York, and the BUSNew York branch about to open inApril]. The propositions they are tohold out I hear in general is to offer,funded debt, at your price [emphasisadded] as pledges for their discounts– & they are to sign an agreement tobind themselves not to draw anyspecie from the banks, on account ofthe discounts they shall obtain andgiving checks to each other…”Together the combined effect ofHamilton’s crisis management measuresworked. By mid-April, the Panicof 1792, Wall Street’s first crash, wasover and the securities marketsreturned to routine trading activities.Despite many bankruptcies, therewere virtually no negative effects onthe U.S. economy. It continued to growat higher rates than were commonbefore the financial reforms that beganin 1789.In the aftermath of the panic, 24brokers and dealers met in Mayunder a buttonwood tree on Wall Street,and subscribed to an agreement thatis regarded as the origin of the NewYork Stock Exchange. Ten of the 24had sold securities to the Treasury inthe open market purchases of Marchand April. So it is possible that thespirit of cooperation in the financialcommunity Hamilton encouraged duringthe panic carried over when WallStreet moved toward an improvedtrading system in May.There was political fallout fromthe 1792 panic. The crisis appearedto confirm in the minds of leaderssuch as Jefferson and Madison thatHamilton’s financial program wasturning the United States into anation of paper speculators andstockjobbers rather like England,instead of the nation of virtuousFinancial History ~ Winter 200724www.financialhistory.org

Dr. Richard Sylla is Henry KaufmanProfessor of the History of FinancialInstitutions and Markets at NewYork University’s Stern School ofBusiness, and a trustee of theMuseum of American Finance.SourcesCowen, David J. The Origins and EconomicImpact of the First Bank of theUnited States, 1791-1797. New York& London: Garland, 2000.Alexander Hamilton, first Secretary of the Treasury,also acted as the nation’s first central banker during the Crash of 1792.Republican farmers they hoped for.Jefferson and Madison redoubled theirefforts in opposition to Hamilton’smeasures. Thus, the panic encouragedthe formation of a two-party systemof politics and government that wasemerging in those early years, largelyas a consequence of Hamilton’sfinancial program.Hamilton as Central BankerWe usually think of Alexander Hamiltonas the country’s first Secretary ofthe Treasury who successfully stabilizedthe new federal government’s initiallyshaky finances. We also know that hewas quite a soldier, lawyer, constitutionalist,and political essayist —among other things, he conceived ofthe Federalist Papers project andwrote three-fifths of the 85 Federalistessays. We know that he conceivedand founded the BUS, the nation’sfirst central bank, but that he left themanagement of it to others. In 1791and 1792, however, when the BUS —and indeed, the entire U.S. financialsystem — was new and inexperienced,it is clear that Hamilton acted as acentral banker and crisis manager.Thus, as we approach the 250th(or some say, 252nd) anniversary ofHamilton’s birth on January 11, 2007,we can add another feather to Hamilton’scap. He was one of the very firstcentral-bank-like managers of afinancial crisis. As in so many otherareas of his endeavors, despite havingfew precedents to guide him, as acentral banker Hamilton acquittedhimself quite well. FHCollection of the Museum of American FinanceCowen, David J., Richard Sylla, andRobert E. Wright. “The U.S. Panicof 1792: Financial Crisis Managementand the Lender of LastResort.” Working Paper, SternSchool of Business, New York University,October 2006.Davis, Joseph S. “William Duer, Entrepreneur,1747-99.” In Davis, Essayson the Earlier History of AmericanCorporations. Cambridge: HarvardUniversity Press, 1917, pp. 111-348.Downing, Ned W. “Transatlantic Paperand the Emergence of the AmericanCapital Market.” In The Origins ofValue: The Financial Innovations thatCreated Modern Capital Markets, W.N. Goetzmann and K.G. Rouwenhorst,eds. Oxford and New York:Oxford University Press, 2005, chap.16, pp. 271-98.Hamilton, Alexander. The Papers ofAlexander Hamilton, Harold Syrett,ed. New York: Columbia UniversityPress, 1961-87. Vols. IX-XI.Sylla, Richard. “The Origins of the NewYork Stock Exchange.” In The Originsof Value: The Financial Innovationsthat Created Modern CapitalMarkets, W. N. Goetzmann and K.G.Rouwenhorst, eds. Oxford and NewYork: Oxford University Press, 2005,chap. 17, pp. 299-312.Wright, Robert E., and David J. Cowen.Financial Founding Fathers: The MenWho Made America Rich. Chicago:University of Chicago Press, 2006.www.financialhistory.org 25 Financial History ~ Winter 2007