Scrippomania: When the stock market crashed
THEY called it Scrippomania, the first stock market crash in the United States. It involved the Initial Public Offering (IPO) of the Bank of United States shares in July 1791.
In the run up to “floatation” as finance people call such a sale of shares, hundreds had flocked to the capital city (then Philadelphia) laden with silver and gold to pounce on the prey.
Lust for instant riches littered their conversations and only superlatives could be heard of the shares. One such superlative was that the Bank was going to pay a dividend of at least 12 percent each year, a huge return by whatever standards.
Most, however, didn’t care about the dividend, but the likely capital gains once the shares were listed. Those that could borrow did so to the hilt to be make the most of the seemingly once-in-a-lifetime opportunity.
But, founding fathers such as Thomas Jefferson and James Madison were irritated by the excitement on financial and manufacturing sectors.
They wanted good old farming to remain the bedrock of the economy anchored of course in slavery. They thus mounted strong opposition to Treasury Secretary Alexander Hamilton’s application for the Bank charter.
A charter then was equivalent to a certificate of incorporation. A charter was such an abstract concept so difficult for many to understand. Here, for instance, is how some of them reasoned on incorporation: Human beings die, but chartered companies don’t die meaning a time will come when everything would belong to chartered companies.
It explains why charters were granted with a life span stipulation, mostly twenty years in the US.
Getting the charter approved was an edgeof-the-seat drama from January to early March when all paperwork was finalised. The drama foreshadowed the frenzy that would erupt from
July 4 when the IPO opened.
“He made your bank;” recalled an old lady to the attentive researcher some fifty years later.
“I sat up all night with him to help him do it. Jefferson thought we ought not have a bank and President Washington thought so. But my husband said, ‘We must have a Bank’. I sat up all night, copied out his handwriting, and the next morning, he carried it to President Washington, and we had a bank.”
Now the bank was going public, and Hamilton the old lady’s husband, was in the driving seat heading straight ahead to unchartered and treacherous waters. He was nonetheless confident the IPO would be fully subscribed within a week. Oh, how he was wrong!
Let us step back a bit for some background information on the IPO. The Bank of the United States was not a typical bank. It was a central bank with government as anchor shareholder.
To raise more capital, it was selling shares to the public. In a bid to broaden shareholder base, shares were to be paid for in instalments over 18 months with an upfront payment of US$25 being effectively the IPO price.
In other words, the US$25 was like a lay-by deposit. After 18 months an investor would get their share certificate if all instalments had been paid. All the investors got on paying the deposit was a script entitling them to buy a certain number of shares in 18 months — kind of like a “call option” in finance parlance. Enough on the background info. Let us go back to July 4, 1791.
The IPO opens. Within an hour it is oversubscribed. There is chaos as speculators jostle to get served, angry at missing this life-changing deal. Hamilton is shocked at how quickly the shares have been snapped while thrilled to know that cash is pouring into Treasury coffers.
The shares went crazy straight from first trades. By August 11, the shares hit US$300. Remember many had borrowed to buy the shares and more kept borrowing pushing the share price higher and higher.
Finance people call such style of trading in which investors borrow “trading on margin” or “margin trading”.
But with the share price touching US$300, bankers got nervous. They stopped lending to speculators. Shares went down almost as vertically as they had climbed. Speculators were squeezed because banks wanted them to pay back the loans, but as speculators tried to liquidate the shares, share prices crashed further. The shares were nose-diving back to double digits where they had started trading in July.
On August 15, a rumour spread in the market that Hamilton believed the shares were overvalued. That must have sent chills down the speculators’ spines. But of course, Hamilton did not want this mayhem to continue though, for some shrewd reason, he had planted the rumour himself (and here I will leave the reader to ponder on why he would plant such a rumour).
Indeed, the mayhem was not good for him. It was already being used as proof that financial markets were bad for the economy because they diverted people from working on the land to gambling. So, what did he do?
On August 16, he sent a secret letter to the CEO of the Bank of New York. He asked the bank to buy US$150 000 worth of government securities (only bonds not the just listed bank shares).
His strategy was that in buying the bonds, other securities’ prices including the just listed bank shares, would go up thus stabilising the market. Finance people now call this strategy “open market operation” but back then it had no such name, it was all unchartered waters and young Hamilton was figuring it all out by himself with no playscript.
Then on August 17, he sent a letter to a wellknown speculator, William Duer.
Duer had been, for a few months, his deputy at Treasury. Effectively, the letter advised Duer (hence market players) to exercise due care in their transactions.
He mentioned in the letter that Treasury was aware that some trades in bank shares were “fictitious purchases” meant to mislead the market into believing there were lots of buyers thus sustaining high share price for architects of fictitious trades to cash out.
Could his friend Duer be part of such a devious syndicate, asked the Secretary? If he was, that would be unfortunate and disturbing for a man of his social standing, the Secretary cautioned.
He went on to give an opinion on the share price to Duer: “I should rather call it about US$190 to be within bounds with hopes of better thing and I sincerely wish you may be able to support it at what you mention.”
In our times, finance people would call this letter (and perhaps the rumour he planted) “moral suasion.” It is when financial authorities threaten participants to behave without really sounding threatening or dictatorial.
By early September the share price was US$110. It recovered further in the month to US$145. He had stabilised the share price of the country’s first central bank and played the role of central banker so well with neither a playscript nor a central bank. But the share price gyrations vindicated the opposition.
It was not over. This was just the beginning. (For this article, I am indebted to the work of Ron Chernow, especially his biographies of Alexander Hamilton and of George Washington
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