Financiers Have Learned Nothing In 250 Years

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We are coming up next year on the quarter-millenary of the Ayr Bank crash of 1772 and last year we had the 300th anniversary of the 1720 South Sea Bubble. When looking at these 18th Century disasters I am reminded again and again that the financiers’ failures were very similar to those of 2007-08, or those that are being perpetrated now. Given the advances of human civilization since the 18th Century, financiers’ inability to learn from history, find better techniques, or maintain competent risk management is truly remarkable.

The Ayr Bank crash had a simple cause: excessive trading in East India Company put options. Sound familiar? Ayr Bank, founded only in 1769, had by 1772 grown to one of the largest banks in Scotland, with a balance sheet of £1.2 million, which does not sound much but was about 10% of Scotland’s GDP, and two-thirds of Scotland’s currency stock. It lent money to favored customers without much in the way of credit checks and funded itself through short-term bills of exchange sold through the London market, using a London broker Neale, James, Fordyce, and Down. Being so new, the bank had not accumulated much in the way of consumer deposits. Buyers of the bills of exchange on the London market felt secure; after all, the bank had £150,000 of capital (mostly not paid in) and no fewer than 131 partners, several of whom were Scottish Dukes. With so much Scottish wealth behind it, committed through unlimited liability to bailing out the bank’s liabilities, nothing could go wrong, it was thought.

Alas, the optimism of human financial dealings was as misguided in 1772 as it is today. Alexander Fordyce, the managing partner of the broker, had become convinced that the East India Company was doomed to fail. That company had taken on new responsibilities in 1765, through Robert Clive’s acquisition from the Moghul ruler of the “firman” giving it responsibility for the lives of 20 million Bengalis, and the ability to collect taxes from them. Alas, being a commercial operation with limited staffing, it had proved lamentably incompetent at managing its new empire. Tragically, in 1770 Bengal suffered one of the worst Indian famines in history, with millions of people dying. The EIC consequently made large losses, since it was unable to collect taxes from a starving populace, and was coming up on a re-chartering in 1773, due every 20 years.

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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of "sell" recommendations put ...

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