Buy the Book: First published in 1873, Walter Bagehot describes the intricacies of the money market and, more importantly, the necessary response when managing a financial crisis.
The Notes
- “The briefest and truest way of describing Lombard Street is to say that it is by far the greatest combination of economical power and economical delicacy that the world has ever seen.”
- “In modern English business, owing to the certainty of obtaining loans on discount of bills otherwise at a moderate rate of interest, there is a steady bounty on trading with borrowed capital, and a constant discouragement to confine yourself solely or mainly to your own capital.”
- The banking system and money markets are built on promises and trust. Credit is trust given in exchange for a promise to pay. The important question: Is trust justified and wise? Will the promises be kept?
- “In opposition to what might be at first sight supposed, the best way for the bank or banks who have the custody of the bank reserve to deal with a drain arising from internal discredit, is to lend freely. The first instinct of everyone is the contrary.”
- “A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.”
- “In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them.”
- “The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harmon, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before…'”
- An alarm is a belief that some people won’t pay their credits when payment is due. An alarm becomes a panic when the belief is that most people won’t pay their creditors when payment is due.
- Managing a panic should be viewed through the lens of business. Businesses have immediate liabilities and bills to pay, they depend on borrowing money, and any sight of alarm or panic they want to borrow to meet their immediate obligations.
- “What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had.”
- “Many things which seem simple and which work well when firmly established, are very hard to establish among new people, and not very easy to explain to them.”
- “The value of money is settled, like that of all other commodities, by supply and demand, and only the form is essentially different.”
- “A stimulated market soon becomes a tight market, for so sanguine are enterprising men, that as soon as they get any unusual ease they always fancy that the relaxation is greater than it is, and speculate till they want more than they can obtain.”
- “If you hold (as in Lombard Street some persons do) millions of other people’s money at interest, arithmetic teaches that you will soon be ruined if you make nothing of it even if the interest you pay in not high.”
- “Any sudden event which creates a great demand for actual cash may cause, and will tend to cause, a panic in a country where cash is much economized, and where debts payable on demand are large.”
- “Short depressions…have scarcely any discernible consequences; they are over before we think of their effects. It is only in the case of continuous and considerable depressions that the cause is in action long enough to produce discernible effects.”
- On Speculative Bubbles: “The fact is, that the owners of savings not finding, in adequate quantities, their usual kind of investments, rush into anything that promises speciously, and when they find that these specious investments can be disposed of at a high profit, they rush into them more and more. The first taste is for high interest, but that taste soon becomes secondary. There is a second appetite for large gains to be made by selling the principal which is to yield the interest. So long as such sales can be effected the mania continues; when it ceases to be possible to effect them, ruin begins.”
- “In a year or two after a crisis, credit usually improves, as the remembrance of the disasters which at the crisis impaired credit is becoming fainter and fainter.”
- “Every great crisis reveals the excessive speculations of many houses which no one before suspected, and which commonly indeed had not begun or had not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever.”
- “The mania of 1825 and the mania of 1866 were striking examples of…the delirium of ancient gambling co-operated with the milder madness of modern overtrading. At the very beginning of adversity, the counters in the gambling mania, the shares in the companies created to feed the mania, are discovered to be worthless; down they all go, and with them much of credit.”
- “The good times too of high price almost always engender much fraud. All people are most credulous when they are most happy; and when much money has just been made, when some people are really making it, when most people think they are making it, there is a happy opportunity for ingenious mendacity. Almost everything will be believed for a little while, and long before discovery the worst and most adroit deceivers are geographically or legally beyond the reach of punishment. But the harm they have done diffuses harm, for it weakens credit still farther.”
- “When we understand that Lombard Street is subject to severe alternations of opposite causes, we should cease to be surprised at its seeming cycles. We should cease too to be surprised at the sudden panics. During the period of reaction and adversity, just even at the last instant of prosperity, the whole structure is delicate. The peculiar essence of our banking system is an unprecedented trust…and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and great accident for a moment may almost destroy it.”
- “Men of business have keen sensations but short memories…”
- “Theory suggests, and experience proves, that in a panic the holders of the ultimate Bank reverse (whether one bank or many) should lend to all that bring good securities quickly, freely, and readily. By that policy they allay panic; by every other policy they intensify it.”
- “The abstract thinking of the world is never to be expected from persons in high places…”
- “…in a panic there is no new money to be had; everybody who has it clings to it, and will not part with it.”
- “The best palliative to a panic is a confidence in the adequate amount of the Bank reverse, and in the efficient use of that reserve.”
- “A large Bank is exactly the place where a vain and shallow person in authority, if he be a man of gravity and method, as such men often are, may do infinite evil in no long time, and before he is detected. If he is lucky enough to begin at a time of expansion in trade, he is nearly sure not to be found out till the time of contraction has arrived, and then very large figures will be required to reckon the evil he has done.”
- “The business of banking ought to be simple; if it is hard it is wrong.”
- In banking, fraud is a possibility but human error and mistakes are likely to be more costly.
- “Easy misconception is far more common than long-sighted deceit.”
- “A large business may be managed tolerably by a quiet group of second-rate men if those men be always the same; but it cannot be managed at all by a fluctuating body, even of the very cleverest men.”
- Overend, Gurney, and Company
- It was a privately owned discount house, and the largest in London until it failed in 1866.
- The seeds to its demise were sown several years earlier due to bad lending practices — poor credit risk assessment that eventually led to large losses — set up by the generation of managers, once removed from the founders.
- “…in a very few years the rule in it passed to a generation whose folly surpassed the usual limit of imaginable incapacity. In a short time they substituted ruin for prosperity and changed opulence into insolvency.”
- Panic kicked in on the news of its insolvency.
- The Bank of England stepped in as the lender of last resort, staved off the panic, and set a precedent that it would continue to do so in the future.
- It’s a lesson on the dangers of hereditary management in financial businesses.
- “The father had great brains and created the business, but the son had less brains and lost or lessened it.”
- “A great private bank might easily become very rotten by a change from discretion to foolishness in those who conduct it.”
- “A system of credit which has slowly grown up as years went on, which has suited itself to the course of business, which has forced itself on the habits of men, will not be altered because theorists disapprove of it, or because books are written against it.”
