Price Goeth Before a Fall

Today, banks are a part of everyday life.  Our money is deposited there (usually via electronic transfer), we draw on it to buy stuff (usually via electronic transfer), and if there’s enough in our accounts, we might even draw a bit of income in the form of interest paid.  But unless there’s a discrepancy or our identity is stolen or we lose our cash card, we really don’t give banks a second thought.

Back in 1790, however, banks were not a part of everyday life.  Many people in the infantile United States looked on banks with intense suspicion.  And when Alexander Hamilton, the 30-something Treasury Secretary, proposed a government-run “central bank”, one didn’t have to go to the woods to see the fur fly.  As a leading Federalist, the bank was one of many ideas that Hamilton proposed to strengthen the central government, establish good credit with trading partners, pay down debts, and create a uniform U.S. currency.

Others, however, saw it as Hamilton grasping for greater and greater power and, ultimately, the return of a monarchy.  When the Bank was proposed, Secretary of State Thomas Jefferson and James Madison spoke for this group in a strongly-worded letter to President Washington, castigating the “bank” concept and warning of Hamilton’s ambitions.  Hamilton, as usual, wrote a massive response that swept opposition away.  As the primary defender of the U.S. Constitution when writing The Federalist Papers, he fully understood the importance of the existing government and had no desire to revert to a monarchy.

In February of 1791, the Bank of the United States was created with a 20-year charter.  Carpenter Hall (shown above), located in Philadelphia and meeting place for the First Continental Congress, was selected as the Bank’s location.  On July 4th of the same year, the country’s first official “IPO” (Initial Public Offering) took place, when stock in the Bank was sold to the public.  And for all their fears and concerns, the stock sale created a frenzy.  All the stock sold in an hour, and the rumor of double-digit returns in interest sparked a frenzied speculation that simply overran people’s sensibilities.

People began trading their shares, called scrip, driving the price through the roof.  They stopped working, they stopped running their businesses, and newspapers came out less frequently.  An angry Jefferson wrote, “Stock and scrip are the sole domestic subjects of conversation. . . . Ships are lying idle at the wharfs, buildings are stopped, capital withdrawn from commerce, manufacturers, arts and agriculture to be employed in gambling.”  People gave themselves over to the “baser angels of their nature” and simply went nuts.  It was “Scrippomania”.

Much of the speculation was led by Hamilton’s former Assistant Treasury Secretary, William Duer.  He conjured up all kinds of speculation schemes to drive prices up.  Many people, including Duer, completed their purchases with the help of loans from the smaller national banks, which horrified Hamilton.  On several occasions, he warned the public on the dangers of using credit to make such volatile purchases.  He warned Duer specifically about this, adding that his former position in the Treasury Department made him susceptible to charges of “insider trading”.  On almost all counts, Hamilton was ignored.

Within weeks, stock prices had climbed from $25 to more than $300 per share.  It was not sustainable, and the Treasury Secretary knew it.  On August 11, 1791, the runup ended in dramatic fashion.  Smaller banks refused to extend any more credit to people wanting to trade the scrip.  This frightened investors, who now realized that the stock they held was valued at far more than it was worth.  A frantic sell-off ensued, the price plummeted, and people lost their fortunes.  A good number of people were poorer now than they were when the Bank of the United States stock was first issued back in July.

The United States, just a few years old, had experienced its first Stock Market crash.

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