Hamiltonian Exuberance

Politicians more interested in scoring political points than solving problems. Pirates seizing American ships and holding sailors for ransom. Some of the nation’s largest financial players going bust one by one. Sound familiar? It was 1792.

The Crash of 1792 could have been a disaster for a fledgling nation divided along ethnic, religious, economic, and ideological lines, write Richard Sylla and Robert E. Wright, of New York University’s Stern School of Business, and David J. Cowen, of Quasar Capital Partners, a hedge fund. “A major early economic shock could have ended the national experiment almost before it began,” they say.

The Treasury Department was broke, the Bank of the United States was fragile, the economic system was embryonic, and Treasury secretary Alexander Hamilton had little more than his wits and his nerve at his disposal when the nation’s first financial crisis struck in March 1792. A New York socialite named William Duer who had borrowed heavily to speculate in bank stocks was caught short when credit became tight and banks were forced to call in loans. Panic ensued. Securities prices dropped nearly 25 percent in two weeks.

Hamilton stepped in, adroitly using a mixture of loans, deposits, transfers, tax delays, and public relations to restore confidence. He cajoled and improvised, interpreting his powers broadly. At the height of the crisis, he wrote Vice President John Adams and Secretary of State Thomas Jefferson that they “may have heard that the Treasurer was in the Market last night and may be at a loss concerning his authority.” Hamilton explained that he had used some money left over from the previous summer’s authorization to try to quell the panic. In a crisis, say Sylla and his coauthors, Hamilton’s rule was “Act first, explain later.”

To allay fears in the financial markets, Hamilton counseled a New York banker to continue to lend, but at a higher interest rate than normal to prevent a bank run. His advice anticipated by 81 years financial rules laid out by the Victorian Walter Bagehot for central bank crisis management. Using every tool at his disposal, Hamilton ended the Crisis of 1792 in roughly one month, the authors write.

During the past year, Federal Reserve chairman Ben Bernanke has moved aggressively to prevent the 2008–09 recession from becoming a deeper and longer lasting economic calamity. But Bernanke is drawing on a long history of central banking and crisis management theory. During the early 1790s, the federal government was able to overcome a financial panic and put in place the essential fiscal, debt, bank, currency, and chartering innovations that allowed the U.S. economy to grow at modern rates. Hamilton deserves the credit. He wrote the playbook.

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The Source: "Alexander Hamilton, Central Banker: Crisis Management During the Financial Panic of 1792" by Richard Sylla, Robert E. Wright, and David J. Cowen, in Business History Review, Spring 2009. 

Image courtesy of Wikimedia Commons