POZNAŃ UNIVERSITY OF ECONOMICS REVIEW Volume 11 Number 1 2011 Yochanan SHACHMUROVE Department of Economics, Th e City College of New York A historical overview of fi nancial crises in the United States Abstract: One of the few constants since the United States declared its independence is the presence of frequent fi nancial crises with similar causes. In the nineteenth century, these panics were frequent with eight occurring over the century. However, following the Second World War there was a period of relative calm, which may have led to complacency. Th e Savings and Loans and the current fi nancial crises have shown that these events remain a very real threat to economic stability. I have greatly benefi tted from research assistance by Zach Winston from Pennsylvania State University and Gregory Kauff man from the University of Pennsylvania. Keywords: fi nancial crises, economic booms and busts, housing prices, banking panics, bank runs, panic of 1857, panic of 1873, panic of 1893, banking regulations, government debt, fi scal and monetary policies, bankruptcy, fi nancial institutions, gold standard, gold- silver bi-metallic standard, the Great Depression, Dow Jones industrial average, Glass- Steagall Act, Bear Stearns, Lehman Brothers, J.P. Morgan, Dodd-Frank Wall Street Reform and Consumer Protection Act: Volcker Rule, United States, United Kingdom, Poland. JEL codes: B0, E0, E3, E4, E5, E6, F0, F3, F4, G01, G1, G2, H5, H6, N1, N2, P1. Introduction Critics have long maintained that fi nancial crises, booms and busts are an inher- ent part of the capitalist system. Th e current fi nancial crisis that began in 2007 has reignited the debate about the causes and consequences of previous economic downturns. While some look at the diff erences among crises, both historical (e.g., Bordo 2008; Bordo & Haubrich 2010; Klomp 2010), and as related to the specifi c mechanics of the shock triggering a crisis (e.g., Gorton 2008), others emphasize their similarities across countries and historical episodes (e.g., Reinhart & Rogoff 2008a, 2008b, 2009a, 2009b, 2010). Th is paper presents an overview of the history of fi nancial crises, primarily in the United States. Th e conclusion is similar to that by Reinhart and Rogoff (2009a, 2009b), namely, these crises are similar. 28 Review 20.indd 28 2011-06-21 09:54:44 According to Reinhart and Rogoff (2009b), severe fi nancial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing prices decline an average of 35 percent over six years, while equity prices collapse an average of 55 percent over a downturn of about three and a half years. Second, the aft ermath of banking crises is associated with profound declines in output and employment. Th e unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts, on average, over four years. In addition, output falls, from peak to trough, an average of over 9 percent, although the dura- tion of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Th ird, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes. As they point out, the main cause of debt explosions is not the costs of bailing out and recapitalizing the banking system. Th e main cause of debt increases are the inevitable collapse in tax revenues that governments incur as a result of deep and prolonged output con- tractions, and the countercyclical fi scal policies in advanced economies aimed at counteracting the downturn. Th e remainder of the paper is organized as follows. Section II presents a narra- tive of three major nineteenth century American fi nancial crises. Section III details the fi nancial crises in the twentieth-century. Section IV describes the current crisis from an American perspective, and the responses of the U.S. and the U.K. Section V summarizes fi nancial crises in Poland. Section VI concludes. 1. Nineteenth century fi nancial crises in the United States As a newly developed country, the United States experienced a period of frequent banking panics in the nineteenth century with eight major crises. Th ese eight ep- isodes include the Panics of 1819, 1837, 1839, 1857, 1873, 1884, 1893 and 1896. Details of the three major crises of that century that occurred in the years 1857, 1873, and 1893 are described below. 1.1. Th e panic of 1857 Th e panic of 1857 is characterized by the closure of the Ohio Life and Trust Company, a collapse of the stock and bond markets, and a sharp recession. Figure 1 shows the collapse of the stock market, which fell 36 percent from August to October, 1857. Th is crisis began with an unprecedented discovery of gold. To illustrate the magni- tude of the gold discovery, note that from the year 1492 until 1850, the annual value of gold mined averaged $9 million, whereas the corresponding value for the years 1851 until 1860 averaged $133 million (Conant 1915, p. 637). 29 Review 20.indd 29 2011-06-21 09:54:44 Since the United States was on a bi-metallic, gold and silver, standard at the time, the discovery of gold eff ectively doubled the money supply. Consequently, a spec- ulative bubble emerged, mainly in railroads and the land required to build them with nearly $700 million spent over nine years accounting for seven-ninths of all railroads in the United States (Conant 1915, p. 637). 3 2,5 2 1,5 1 S&P 500 Monthly Closing Price Closing S&P 500 Monthly 0,5 0 12/31/1854 03/31/1855 06/30/1855 09/30/1855 12/31/1855 03/31/1856 06/30/1856 09/30/1856 12/31/1856 03/31/1857 06/30/1857 09/30/1857 12/31/1857 03/31/1858 06/30/1858 09/30/1858 12/31/1858 03/31/1859 06/30/1859 09/30/1859 12/31/1859 03/31/1860 06/30/1860 09/30/1860 12/31/1860 03/31/1861 06/30/1861 09/30/1861 12/31/1861 Date Figure 1. Th e panic of 1857 Source: www.globalfi nancialdata.com As the bubble burst, speculators were unable to repay their debts causing some banks to fail. Th is increased the likelihood of further bankruptcies of fi nancial in- stitutions. Following these bank runs, the stock and bond markets collapsed exacer- bating the problem. As banks failed, many cities and states suspended the convert- ibility of bank deposits into gold. However, lacking a central monetary authority, nation-wide coordination among banks was impossible. Th us, when Philadelphia suspended convertibility and New York City did not, bank runs induced by fear occurred in New York City. Eventually, on October 13, 1857, New York suspended convertibility (Calomiris & Schweikart 1991, p. 822). As the crisis continued, some regional coordination of banks emerged. Institutions, such as the New York Clearing House, coinsured coalitions in Indiana and Ohio, 30 Review 20.indd 30 2011-06-21 09:54:44 and branch banking in the South. Th e United States was relatively successful in re- sponding to this panic limiting further bank failures. However, more isolated banks were unsuccessful during this crisis. For example, 14 of Indiana’s 32 free banks failed during the crisis. On November 20, New York resumed partial convertibility and a major crisis was fi nally averted (Calomiris & Schweikart 1991, p. 828). 1.2. Th e classical gold standard Following the Panic of 1857, there was a shift from the bimetallic, silver and gold, standard towards the classical gold standard. Th e passage of the Coinage Act of 1873 ended the legal status of bimetallism in the United States and created a pure gold standard regime (Friedman 1990, p. 1165). Since many countries already adopted the gold standard, it allowed for relatively free capital fl ows among them. Th e gold standard in the United States led to a period of frequent crises, defl ation, and con- centrated reserves in New York (Bordo & Haubrich 2010, p. 6). 1.3. Th e panic of 1873 Th e fi rst major United States crisis under the classical gold standard occurred on the same year as the passage of the Coinage Act of 1873. Similar to the Panic of 1857, the Panic of 1873 was preceded by a railroad boom leading to a sharp stock market decline. In this case, the decline was less severe than the panic of 1857, dropping 15.7 percent from August to October as illustrated in Figure 2. It became apparent that railroads corporations were unable to cover their debt obligations, and the bub- ble burst. Th is burst led to the failure of trust companies in New York and Brooklyn in early September and the failure of a bank, Jay Cooke & Co, on September 18, which precipitated a banking panic. Runs occurred in nineteen Washington, New York and Philadelphia banks and trust companies on September 19. Th e stock ex- change closed for ten days and the United States was in crisis. Consequently, more banks failed, production decreased and for six years “the pall of depressed industry lay over the United States” (Conant 1915, p. 655–656). Simultaneously, the adoption of the gold standard in the United States caused a period of severe defl ation, further hindering the repayment of debts. Figure 3 il- lustrates the defl ation in this period, for both the United States and the United Kingdom. Prices in the United States fell from a high of nearly 200 to a low of 90 between late 1860s and end of the 1870s.