The more you think times have changed, the more they remain the same. Amazing econ history is..
I came across this paper by Atlanta Fed econs – Stephen Quinn and William Roberds. It is just amazing to note how similar things were way back in 1763. One had pretty similar financial instruments in 1763 whose drying up led to the crisis. And yes you had pretty similar instis like Lehman Brothers which did not have access to retail deposits but relied on a form of wholesale financing.
The extraordinary nature of the Lehman crisis naturally leads to a number of questions. Would a different pre-crisis regulatory environment have increased market resiliency (e.g., Acharya et al. 2010, Gorton and Metrick 2010)? What if governments and central banks had displayed a lesser response to the Lehman failure (e.g. McAndrews et al. 2008, Adrian et al. 2010, Fleming et al. 2010)? To help answer these “what ifs,” this paper goes to the Amsterdam Crisis of 1763 to find a shadow banking precedent. In doing so, we follow Schnabel and Shin (2004) by drawing parallels between pre-Napoleonic Continental banking institutions, and the financial market structures of today.
Why late eighteenth-century Amsterdam? It was replete with merchant banks offering securitization. To enhance the credit and liquidity of debt instruments, the Dutch substituted a borrower’s obligation with a debt guaranteed by a merchant bank. The borrowers were located all over the European trading world, but the credit hub was Amsterdam, so credit risk was concentrated there. The typical Dutch merchant bank financed itself by issuing debt before the original borrowers were paid, following a business model comparable to modern asset-backed commercial paper (ABCP) conduits. Merchant banks’ dependence on debt rollover made Amsterdam in 1763 as vulnerable to aggregate shocks as New York was in 2008.
Today’s Lehman was Gebroeders de Neufville then. GDN failure led to failure of other firms. The response of Bank of Amsterdam (kind of central bank then) was also similar:
The spark for the 1763 crisis was the Lehman-like failure of the banking house Gebroeders de Neufville. As occurred in 2008, de Neufville’s failure made creditors reluctant to purchase new debt from surviving banks that were thought to be following a similar market strategy. Our investigations indicate that the resulting shadow run may have been greater (relative to the size of the market) than that experienced in 2008.
A second parallel is in the Bank of Amsterdam’s response to the crisis. As in 2008, access to central bank liquidity was expanded in an unprecedented and ad hoc basis. Differently, this expansion was relatively narrow in scope. The policy intervention worked through the Bank’s repo facilities to broaden the set of assets eligible for repo to include silver bullion. Liquidity also expanded via the traditional channel of repo transactions with trade coins.
Read the paper for further details. There are amazing parallels.
The authors explain the similarities between Asset Backed Commercial Paper (ABCP) and Acceptance loan (similar to ABCP really well.
The Panic of 1763 records a distressingly familiar recipe for financial conflagration. Flammable ingredients include a system of securitization with numerous cross exposures (acceptance loans), an aggregate shock to collateral values (the end of the Seven Years’ War), and erratic policy decisions (on the part of the Prussian monetary authorities). The spark is provided by the collapse of a single participant (de Neufville) who is “too interconnected to fail” (in the view of Hamburg petitioners), but who fails nonetheless. Missing from the mix are the too-big-to-fail distortions of modern financial environments, but these seem not to have been necessary in the lightly regulated world of eighteenth-century finance.
The Bank of Amsterdam’s firefighting efforts also displayed a light touch—by the standards of 2008—but our evidence shows that they were effective within the confines of the Amsterdam market. Unlimited amounts of liquidity were made available, on fixed terms, through the Bank’s traditional (coin) repo window, a type of policy that would be repeated 245 years later. A second window was opened for less conventional assets (bullion). This window was lightly used, yet it was well designed for its limited purpose. It assisted a central niche of market participants, and did not disrupt adjustment processes occurring outside the Bank.
The place BoA failed was in providing liquidity to adjoining regions:
Within the narrow theater of the Amsterdam market, the Bank’s response to the crisis can thus be judged a success. But the Bank could not route liquidity to where it was needed most—to satellite markets such as Hamburg and Berlin, where the flow of trade depended on unimpeded access to the Amsterdam bill market. Nor could the Bank prevent the mass unwinding of bill transactions through protests, which may have preserved the liquidity of the Amsterdam bankers, but which also led to a collapse of some outlying credit markets. Seen from Amsterdam, this may have seemed a fair outcome, since the underlying shocks had originated on the periphery.
To people in the periphery, however, the punishment must have seemed disproportionate to the crime. The Bank’s mixed record leads to the following inference for the post-Lehman policy interventions. That is, that two key elements underlying the effectiveness of these interventions may have been those that were lacking in 1763: robust settlement institutions and the free flow of liquidity across national borders.
Fascinating from the first word…