In the early 1790s, the United States was still in the midst of its first presidential administration and still establishing new governing institutions. This process was interrupted briefly by a financial panic in 1792. In a country then just a few years old, expectations for a strong response might not have been high. However, the panic subsided quickly and no economic recession resulted from trouble in the country’s nascent financial markets. This was partially the result of the efforts of Alexander Hamilton, America’s first Secretary of the Treasury.
Alexander Hamilton was deeply involved in addressing the first financial panic in the independent United States. He had been serving as the country’s first Secretary of the Treasury since 1789. He took charge of a government in default on its debt, which stood at a total of $75 million compared to revenues of about $4 million. It was also a government still developing the means to repay that debt; the federal government had only been given the power of taxation in 1787 and would continue to run deficits until 1793.
Central to Hamilton’s fiscal plans were developing the means to service this debt and building out the basic infrastructure of a new financial system. While in default, American government bonds were trading at 25% of face value; following a restructuring in 1790, the bonds recovered all the way back to face value. With faith in the public finances restored, Hamilton shifted his attention to developing a central bank for the new country. In his second Report on Public Credit, he laid out his vision for a national bank akin to what the Bank of England was for Britain; it would become the Bank of the United States.
The Bank of the United States was hastily organized and it began to sell stock to investors in 1791. It offered 20,000 shares at $400 each to private investors, raising $8 million in capital; the federal government would provide another $2 million. The combined $10 million in equity capital would make the Bank of the United States larger than all other early American banks and insurance companies combined. Even still, the order book for the new shares was oversubscribed.
Like many share offerings of the time, it was arranged to allow investors to pay in their capital over time. Investors only had to give up $25 to reserve the option to purchase a full share by making further payments of $375 spread out over installments. The options acquired for $25 were called ‘scrip’ and they began to be traded amongst investors. The public was also given the right to pay with funds other than cash. In fact, only one-fourth of the share price needed to be paid in gold but up to three-fourths of the price could be paid by exchanging government bonds for shares.
In the summer of 1791, there was a bubble in the price of Bank of the United States scrip. The options purchased for $25 quickly doubled in value and kept rising. They were traded actively in New York though the New York Stock Exchange would only be formed a year later. In the end, prices for the scrip came crashing down and the government, at Hamilton’s direction, chose to purchase government bonds to prevent the crash from affecting the prices of other securities. In all, about 2% of the total government debt, or over $560,000, was repurchased, providing liquidity to those needing to sell assets during the bust.
With this crisis averted, the Bank of the United States launched late in 1791 and almost immediately began to add meaningfully to the money supply of the country. The bank issued banknotes and raised deposits to discount commercial paper, that is, to advance funds against short-term bills and receivables as a form of financing. Some were skeptical of the bank’s prudence as its banknotes began to proliferate as far away as Boston while the bank was headquartered in Philadelphia. This prompted many to redeem their banknotes and deposits in exchange for precious metal specie reserves kept at the bank.
Reserves at the Bank of the United States fell from over $700,000 in December 1791 to $244,000 in March the following year. Seeing that it had expanded too rapidly, this caused the bank to begin restricting credit. The volume of short-term bills on the bank’s balance sheet fell from almost $2.7 million in January 1792 to under $2.1 million two months later. From the Treasury, Hamilton urged a slower contraction, but the bank, along with others, began restricting credit quickly. It would help trigger yet another panic.
The expansion and contraction of the balance sheet of the Bank of the United States affected speculation in its own shares and other securities. At the heart of this frenzy was William Duer, an English-born New York based speculator. Duer was Hamilton’s friend and a member of the Continental Congress, the Americans’ governing body during the War of Independence. He became governor of Hamilton’s recent creation, the ‘Society for Establishing Useful Manufactures’ and raised $500,000 for that new company. Duer also served as Hamilton’s undersecretary at the Treasury.
Very late in 1791, speculators attempted to corner the market in the 6% government bonds available as a means of payment for Bank of the United States shares. The speculators were led by William Duer himself who bought large volumes of the 6% bonds, lifting prices from 110 to 125 between December 1791 and the following month. Shares in the Bank of the United States also rose from $528 to $712 over that same period as it prepared to open branches in Boston, New York, and Charleston, with other cities to follow.
Duer bought the bonds using funds borrowed at high interest from whatever source he could find. The liberal lending by the Bank of the United States likely made Duer’s scheme possible. He even lent himself money from the Society for Establishing Useful Manufactures. The goal was to acquire enough of the publicly traded bonds so to control their price and sell them off at high prices to investors needing them to make payments under their Bank of the United States share subscriptions. Seeing the credit-fueled bubble from Philadelphia, Hamilton again advised bankers to gradually contract credit.
“The state of things however requires unusual circumspection. Every existing bank ought within prudent limits to abrige its operations. The superstructure of Credit is now too vast for the foundation. It must be gradually brought within more reasonable dimensions or it will tumble”Letter from Hamilton to William Seton, cashier at the Bank of New York, February 10, 1792
As a result of Duer’s buying, the price of the 6% bonds hit a peak of 129 on March 5, 1792. From here though, the scheme began to unravel. The comptroller of the Society for Establishing Useful Manufactures discovered Duer’s loan from the company and demanded its repayment. By now, the banks were withdrawing credit and Duer could borrow no more. With his debts being called in and finding no more lenders, the well-connected speculator was forced to abandon his scheme.
In addition to the reduction in lending by the Bank of the United States, Duer’s inability to borrow may have also resulted from normal contractions in credit at that time of year when farmers withdrew funds to purchase seed for the spring. In any case, Duer was unable to repay his lenders, defaulting on his debts totaling perhaps $500,0000, on March 9. He was imprisoned two weeks later.
The evaporating credit availability and Duer’s bankruptcy triggered a financial panic, the first in the nation’s history. Liquidations drove the price of the 6% bonds down by a quarter, from over 125 to 95. Bank shares also fell, with stock in the Bank of the United States falling by 30% and that of the Bank of New York, which Hamilton had founded, by 20%. Shares in the Society for Establishing Useful Manufactures fell by even more than either of these banks.
Bankruptcies rose but some nonetheless profited through the collapse. Short sellers, those betting that stocks would fall, captured riches and these included some of Hamilton and Duer’s political foes, like New York governor George Clinton. The collapse of Duer’s scheme helped Hamilton’s opponents, who believed his financial policies allowed such a panic, both politically and in some cases financially.
Like in 1791, Hamilton had the government purchase government bonds through its sinking fund, this time to the tune of $250,000. He also had his own Bank of New York lend to merchants and securities dealers against their bond holdings, albeit at a higher interest rate, so to avoid liquidation of these holdings from further depressing prices. To encourage the bank along, he promised that the government would repurchase up to $500,000 in securities should the Bank of New York be stuck with unwanted collateral.
With these measures, a recovery was accelerated and financial conditions quickly picked up from their April nadir. Stock prices also began to rise again. However, activity in the government bond markets fell and would not return to their speculation-induced levels for years. Trading volume in bonds fell from over $7.8 million in 1791 to $2.6 million in 1793 and wouldn’t reach a low of $1 million until 1799. Despite all this, economic effects were minimal and optimism soon returned.
“… our prospects began to brighten up… there can be no doubt of a speedy return to confidence and credit, and that business will reassume its natural course.”Gazette of the United States, May 2, 1792
The actions taken by the young government in 1791-92 look surprisingly similar to those implemented amidst financial crises, or in anticipation of such crises, today. Under Alexander Hamilton, the government purchased securities to restore liquidity in financial markets. He also organized an effort to absorb unwanted securities at banks to avoid their liquidation in the open market. Perhaps Hamilton’s actions even directly influenced future government interventions in crises. This was not the crisis’s only legacy. The increased coordination amongst securities dealers during the crisis is said to have led to the establishment of the New York Stock Exchange in May 1792.
Alexander Hamilton’s response to the Panic of 1792 was not just timely and effective but also surprisingly similar to what is considered best practice today. Even though some of his policies may have contributed to causing the panic, namely the restoration of public credit and efforts to create a large banking system, these were not bad ideas and his response to the panic certainly helped arrest it. The Panic of 1792 was, in a sense, a product of the country’s early financial success and the aptitude of its first Secretary of the Treasury.
More from the Tontine Coffee-House
Learn about Hamilton’s role in creating the Bank of New York and his management of the public debt. Also read about the establishment of the Tontine Coffee-House, the first location of the New York Stock Exchange.
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