Alexander Hamilton, the first Secretary of the Treasury, laid the foundations of the American financial system. When Hamilton became Secretary of the Treasury on September 11, 1789, the nation’s finances were in a mess. Government 6% bonds were trading at 25 since they were in default. Hamilton planned to follow in the footsteps of John Law and reduce the amount of government debt by allowing it to be converted into equity. The President, Directors and Company, of the Bank of the United States, or the First Bank of the United States, as it is more commonly known, was chartered for a term of twenty years, by the United States Congress on February 25, 1791. The bank was part of Alexander Hamilton’s plan for stabilizing and improving the nation’s credit by establishing a central bank, a mint, and introducing excise taxes. Opposition to the bank was led by Thomas Jefferson and James Madison who thought the bank was unconstitutional and created an unnecessary centralization of power. Hamilton modeled the Bank of the United States on the Bank of England. The bank could be a depository for collected taxes, make short-term loans to the government, and could serve as a holding site for incoming and outgoing money. Nevertheless, Hamilton saw the main goal of the bank as a way of promoting commercial and private interests by making sound loans to the private sector. Most of the bank’s activities were commercial, not public. The Bank of the United States had $10 million in capital, of which $2 million was subscribed by the U.S. government. The $8 million in shares sold to the public (20,000 shares at $400) were sold in July 1791. To understand how large the Bank of the United States was, the revenues of the Federal Government were only $4.4 million in 1791, so the capitalization of the Bank of the United States was twice that of the Federal Government’s revenues.  

The Bank Scrip Bubble

Scrip on the Bank of the United States, which represented rights to buy full shares of stock, initially sold for $25 on July 1, 1791. To complete ownership, payments of $75 were due on December 31, 1791, $100 on July 1, 1791, $100 on December 31, 1792 and $100 on July 1, 1793. One-quarter of the payment had to be in gold, but the remaining three-quarters could be made in U.S. government bonds. By allowing three-fourths of the payment to be made in United States debt securities, the prices of U.S. government bonds immediately rose in price. U.S. government debt had been reorganized in October 1790 into the Sixes and Threes, at which point the Sixes traded at 70, and by July 31, 1791, the Sixes were trading at 100. Since Hamilton had taken over as Secretary of the Treasury, U.S. government bonds had risen in price from 25 back to par at 100. Fully-paid shares in the Bank of the United States were issued in August 1791, and they rose in price from 530 to 740 by the end of August, only to fall back to 524 by early October. Trading also occurred in the scrip of the Bank of the United States, which represented shares that had not been fully paid for (these later became half shares and three-quarter shares as payments became due). The scrip went on an even wilder ride, rising from 25 at the beginning of August to 249 on August 12, 1791, falling to 165, rising again to 207 on August 22, then sliding back to 121 by September 16. The speculation became known as the Bank Scrip Bubble of 1791. Within weeks of the issuance of Bank shares, the nation had gone through its first stock market bubble and crash.  

Duer and the “Six Percent Club”

The Society for Establishing Useful Manufactures (SUM) was established in 1791 to promote industrial development along the Passaic River in New Jersey, founding the city of Patterson in the process. The goal was to use the Great Falls of the Passaic River as a power source for grist mills. The company was the idea of Assistant Secretary of the Treasury Tench Coxe, and was charted in New Jersey under Hamilton’s direction as a type of public-private partnership. Hamilton asked William Duer, who had sided with Hamilton in The Federalist Papers, writing in support of the United States Constitution under the alias of “Philo-Publius,” to become governor and chief salesmen for the SUM. Duer was instrumental in helping to raise $500,000 in capital for the new company. William Duer was not only a master salesman, but a speculator as well. When Hamilton discovered that Duer had been a driving force in the “scripomania” which had driven the Bank Scrip Bubble, he sent Duer a letter admonishing him for speculating in bank scrip. Like any plunger, his failure in the Bank Scipr Bubble only motivated him to invest on a larger scale and to try and have greater control over the market to insure success. Duer organized a pool along with Alexander Macomb, a wealthy land speculator who had purchased the largest piece of property from the state of New York, and with other owners of shares in the Bank of the United States. They were known as “The Six Percent Club” since shares in the Bank of the United States paid a 6% dividend. Their goal was to try and corner the market before the next distribution of shares in July 1792 and sell the shares to European investors at a profit. Duer and the others bought the shares on time, in essence buying options, rather than buying full shares, so they could maximize their profit through leverage. The Bank of the United States finally opened in December 1791, and made use of its capital by making loans and issuing banknotes. This increased the money supply and helped to feed new speculation in bank shares and U.S. 6% bonds. The wild ride in shares of the Bank of the United States continued. Shares rose in price from 524 to 680 on October 26, 1792, fell back to 528 on December 17, 1791 and rose to 712 on January 4, 1792. Since the U.S. Government Sixes could be used to buy shares, their price rose in sympathy with the increase in the price of the Bank of the United States, rising to 129 on March 5, 1792.

The Panic of 1792

By March, the banks started to face a credit crunch. Clinton and his clique began to withdraw large amounts of money from the city’s banks to create a credit shortage. Moreover, it was springtime when farmers began withdrawing money from the banks to pay for the crops they were planting. Oliver Wolcott, the comptroller of the currency, had discovered the deficiency of $292,000 at the SUM, which Duer acknowledged, and demanded repayment. Wolcott called upon the U.S. attorney in New York to sue Duer for the long overdue debt. Duer appealed to Alexander Hamilton to intercede on his behalf, but Hamilton refused, and on March 9, 1792, Duer failed to meet payments on some of his loans and Duer’s paper pyramid collapsed. With Duer and his pool no longer able to buy shares in the Bank of the United States, the price of the stock began a precipitous decline. On March 23, Duer took refuge in the New York city jail. Duer was soon joined in jail by two other members of the “Six Percent Club,” Walter Livingston (who is buried at Trinity Churchyard near Wall Street), who had cosigned over $200,000 of notes signed by Duer, and Alexander Macomb, who defaulted on $500,000 in stock he had purchased from the bears. By mid-April, with the Six Percent Club defaulting and the price of Bank of the United States stock collapsing, the country suffered its first financial panic. This delighted Secretary of State Jefferson, Governor Clinton and his allies, who were opposed to Hamilton’s attempt to centralize the finances of the United States. They would turn the Panic into political capital which they would use to undercut Alexander Hamilton. In response to the crisis, many banks tightened their credit, and in March and April, money began flowing to farmers to provide funding for their crops. From December 29 to March 9, cash reserves for the Bank of the United States decreased by 34%, prompting the bank to not renew nearly 25% of its outstanding 30-day loans. In order to pay off these loans, many borrowers were forced to sell securities they had purchased, which caused the price of stocks to fall sharply. The price of Bank of the United States half shares collapsed from 203 on March 3 to 146 on March 21 while the price of U.S. Sixes fell from 129 to 95. The price of stock in the Society for the Establishment of Useful Manufactures fell from 136.5 on February 8 to 30 on March 13, 1792. Duer had perpetrated the young nation’s first financial Panic and stock market crash, and he paid the price. Duer spent the rest of his life in debtor’s prison where he died on May 7, 1799. Hamilton promised that the government would buy from the bank up to $500,000 of securities should the Bank of New York be stuck with excess collateral. Hamilton also supported lending by the Bank of Maryland and Hamilton authorized an additional $150,000 of open-market purchases by the Bank of New York. In essence, Hamilton followed Bagehot’s dictum, given eighty years later in his book Lombard Street to “lend freely, against good collateral, at a penalty rate,” acting as the lender of last resort for other banks. Nevertheless, in the elections in the congressional elections of 1792, Jefferson and his allies benefitted as voters expressed their disgust with Duer and his financial shenanigans. After the collapse was over, the United States began its first bull market, with stock rising in price until 1802. The outline of every financial panic that has happened over the past two hundred years occurred in the Panic of 1792: the wild speculation, the financial frenzy, the collapse that followed, and the intervention of the government to keep the rot from spreading. Despite everything the Federal Reserve, Congress, President, Stock Exchanges and other agencies may do to insure that financial panics are a thing of the past, this pattern will no doubt be repeated many times over in the century to come. Speculators as a specie will never die.

Railroads Transform the Stock Market

When Little entered the stock market in 1834, it was going through tremendous changes. Until the 1830s, most of the listed stocks were in insurance companies and banks. Most finance companies were small, had a limited number of shares outstanding, and their shares traded infrequently. Speculative activity was limited. In the 1820s and 1830s, shares in railroads began to dominate the stock market since they needed large amounts of capital to fund their operations. The first exchange-listed railroad, the Baltimore and Ohio Railroad, started trading in 1828. Whereas railroads weren’t even represented on the NYSE in 1825, by the 1840s, they represented around ninety percent of the volume of the exchange. With the growth in share size and volume, speculators like Little were able to jump into the market and seize opportunities that didn’t exist until the 1830s. Little had a fanatical obsession with the market. He would often work twelve hours at his office speculating on stocks, only to spend another six hours at night buying and selling banknotes issued by private banks. Little played both sides of the market, shorting stocks he felt were overpriced, trying to corner stocks the shorts were selling, or going long during a bull market. Little could remember every transaction he made, and attended to every detail of his transactions. He even delivered stock he sold personally to make sure there was no mistake in the transaction. Until Jacob Little arrived on the scene, most speculators used inside information to make their fortunes, but Little relied upon predicting the future direction of stocks and manipulating stocks to reap his fortune. Little was an inveterate gambler, but one who wanted the cards stacked in his favor. The spirit of Jacob Little was summed up when he said, “I don’t care what happens, so long as I am in it.” To understand Little’s involvement in the stock market, you have to understand how the stock market of the 1830s differed from the market today. Of course, there was no CNBC or ticker tape, telegraph or telephones, all trading was done on the floor of the exchange. Shares were not traded all day long as they are today. Instead there was a morning session and an afternoon session. During each session, a representative of the exchange would run through each of the listed stocks. Traders could only buy and sell when a stock was announced. When the representative of the Exchange arrived at Erie, for example, he would offer to buy or sell shares at set prices. Traders would respond by offering to buy and sell shares. Then the exchange moved on to the next stock. Continuous trading in stocks did not exist. You had two chances each day to trade a stock. That was it. Each and every transaction was written down, and published in The New York Times, The New York Herald or another newspaper the following day. If you go to a copy of The New York Times from the 1850s, you can see a record of every transaction that took place on the stock exchange. Shares were sold short either through borrowing shares directly from an owner, or more often through selling options on the stock. In the 1830s, options were not derivatives ruled by Black-Scholes mathematical formulae calculated on computers with a fixed premium. Instead, someone would offer a customer the opportunity to buy or sell the stock to them at a fixed price to be delivered at the request of the buyer at any point in the next six months. If you look at the record of transactions published in The New York Times, you can see the notation of the time period the buyer had the option to buy or sell the stock as well as the agreed upon price. Since this was how foreign exchange transactions and moving money between cities were carried out, this methodology seemed natural to people on the floor of the exchange.  

Little and Morris: The First Corner

Little’s first coup occurred in his corner of the Morris Canal and Banking Company in 1835. There had been an attempt to corner the stock of the First Bank of the United States in 1792 by William Duer and Alexander Macomb, but the attempt had failed, leading to the Panic of 1792. The Morris Canal was a 107-mile canal, established in 1822, that stretched across northern New Jersey from Phillipsburg on the Delaware River to Jersey City on the Hudson River. The canal lowered the cost of moving coal from Pennsylvania to New Jersey and iron ore from New Jersey back to Pennsylvania. It took only four days to move goods from one end of the canal to the other, but when railroads were able to move goods the same distance in five hours, the canal could no longer compete. Rather than make a tender offer for outstanding shares, as is done today, raiders had to buy up all existing shares of a company to own it. Little determined to do this for the Morris Canal and in the process, he cornered shares of the company. Little and his group of New Jersey traders ended up owning all of the outstanding shares, and shorts had to buy their stock from Little in order to cover their short positions. The price of Morris Canal stock went from $20 in February 1834 to $185 in January 1835. Little could have asked for more from the cornered shorts, but if he had, the shorts would have had to sell shares in other companies to raise the capital to cover their shorts which could have destabilized the market as a whole. The spike in price caused by the corner is visible in the graph below.   Jacob Little also participated in an attempt to corner the stock of the Norwich and Worcester Railroad in 1846. He organized a pool with several Boston operators to secure control of the railroad. Each member put up a $25,000 bond pledging not to sell stock below $90. The pool drove the stock price up, but Little thought the corner would fail. He sold his stock while it was in the 80s to cut his losses, and as promised, delivered a check for $25,000 to his co-conspirators. Little made a similar mistake in 1847 when he was given a chance to invest in the telegraph by Samuel Morse, but declined, a decision he later regretted.