I bet you have never heard of Walter
Bagehot (above) - rhymes with gadget. He was a melancholy 19th
century economist who often did not sound like an economist -
“Nothing is more unpleasant than a virtuous person with a mean
mind”, and “The reason...so few good books are written is that
so few people who can write know anything.” But my favorite quote
is from Bagehot's 1873 book, “Lombard Street”, which tells the
story of the billion dollar (at the time 11 million pounds) collapse
of Overend, Gurney & Company in London. Originally it was a
private bankers' bank, then it went public as a brokerage house. And
on “Black Friday”, 10 May 1866, it collapsed, releasing a “mania
of terror” across England and annihilating 200 other banks and
companies. From this disaster Badget drew a fundamental economic
truth. “Every banker knows that if he has to prove that he is
worthy of credit, however good may be his arguments, in fact his
credit is gone.” Every arrogant egomaniac on Wall Street and K
Street should have that little phrase tattooed on the back of their
writing hand.
Which brings me to the central
character of this essay, who had the honor of being the first
American banker who faced that problem. His name was Andrew Dexter (above),
and like the tens of thousands of American bankers who followed the
path he blazed, he was above all else, a salesman, disarming and
relentless. The pale blue eyed Andrew with boyish tousled hair
graduated from Rhode Island College in 1799, at the head of his
class. He had only 17 competitors, but one of them was Daniel
Webster. After a brief stint working for his uncle in President
John Adam's administration, he moved to Boston. And it was there, in
1804, the young lawyer joined a group of “second tier”
financiers in forming a brokerage house they called “The Exchange”.
The business model Andrew proposed was brilliant in a country with
almost no regulation of financial institutions.
In the United States at the time, both
charted state banks and private banks issued their own currency,
redeemable at face value at the issuing bank in gold or silver coins,
aka “hard currency”. But when those same notes appeared at banks
in neighboring counties or states, where the credit of the original
bank was unfamiliar, they were exchanged at a reduced level, or a
discount. Every transaction required a series of equations to
determine the value of the various forms of paper offered as payment
for a debt or purchase. Every newspaper contained lists of the
shifting discount rates for various currencies, much like modern
baseball box scores.
Of course most customers used the notes
issued by their local bank to pay for local goods and services at
face value, and they rarely demanded the “hard currency”.that
backed them up And some notes which managed to migrate to
neighboring cities or states, might spend years in discounted
circulation before being returned to the issuing bank. Relying on
this, it was standard practice for bankers to have less “hard
currency” on hand than the value of the notes they had in
circulation. Large banks could even afford the small loss incurred by
holding heavily discounted notes issued by distant banks, before
periodically returning them for hard currency, if the issuing bank
was still solvent. And it was this very complication that Andrew
Dexter saw as an opportunity.
He began in 1805, out in western
Massachusetts, when his agents showed up in Pittsfield, a village of
just 2,300 people. With a couple of hundred notes (above) issued by the
Berkshire Bank as a negotiating point, a deal was quickly reached
with the stock holders of the Berkshire, exchanging their paper for
that issued by “The Exchange.” Under Berkshire's good name,
which looked better 100 miles away in Boston, the new management
issued a hundred thousand dollars in new new notes, each signed by
the old head cashier. Then in Boston, brokers for “The Exchange”
sold the new notes at a slight discount. It was like conjuring money
out of thin air, economic legerdemain, voodoo economics. In Andrew
Dexter's brave new world, image was every thing.
“The Exchange” repeated this same
trick at the Farmers Exchange Bank in Gloucester, Rhode Island (above) the
Hallowell and Augusta Bank, the Kennebec and Penobscot Bank and the
Lincoln Bank in what would become Maine, the Woodstock, Concord and
Coose banks in New Hampshire, and the Vermont State Bank with four
branches around that state.
Typical of the institutions chosen, The
Detroit Bank in far off Michigan territory, had been capitalized with
just $28,000 in hard currency, $8,000 of which had been used to build
the main branch. In late 1806 “The Exchange” bought The Detroit
Bank and printed up $163,000 in soft currency under its name, and
then offered that for sale to unsuspecting Boston investors..
In the spring of 1807 Andrew broke
ground for an edifice to his business acumen. It would be called the
Exchange Coffee House, and at seven stories, it would be one of the
tallest structures in North America. The masonry walls had to be five
feet thick to support the height.
Like its builder, the Exchange
would not be on the square, but a blunted triangle, covering a full
acre, 94 feet of granite and brick by 97 feet by 132 feet. And also
like its builder, its face depended upon your approach, presenting an
exterior spiral staircase for the second floor restaurant, or the
foundational stone steps for the businessman. Trading floor and
coffee house, office spaces, a ball room, a library, a lecture hall,
and tucked away in every nook and cranny, were 210 small dark
sleeping rooms: the Exchange Coffee House was a paean to Andew
Dexter's psyche. It would take two years to complete, and the final
cost would be $500,000 - more than double the original estimate.
The construction overruns drove Andrew to order up another $200,000 of currency from the
Farmers Exchange Bank, in Rhode Island. Anyone asking for hard
currency were being “plagued as much as possible...in the most
deliberate manner.” The customers responded with a lawsuit. And
then, on March 24th , the state of Rhode Island seized the
bank and closed the doors. Officials discovered the $750,000 in
currency issued was backed by only $86.48 in the vault. It was the
first failure of an American bank. The Providence Gazette wrote that
Andrew had “practiced a system of fraud beyond which the ingenuity
and dishonesty of man cannot go.” Obviously the writer had never
before met an American banker.
And now the capitalist dog Andrew
Dexter was chased by a competing pack, lead by the 30 year old
Nathan Appleton. First, Appleton's gang publicized “The
Exchange's” methods. That drove up the discounts required to sell
their currencies, which Appleton's group then bought up cheaply. The
Appleton gang would then present that paper at the issuing bank and
demand hard currency. Even if the bank could only pay a fraction of
the total, Appleton made such a profit he was able to invest in the
power loom factories that were about to kick start the American
industrial revolution. Just as the Boston Exchange Coffee House was
nearing completion, Andrew Dexter's empire was collapsing. .
In the spring of 1808 Andrew and his
pregnant wife Charlotte slipped out of Boston, reappearing beyond the
reach of his creditors, at the head of the Bay of Fundy, in Windsor,
Nova Scotia, Canada. He was to remain in this fishing village for
four years, while his victims went to debtors prison, including most
of the workers who had built The Exchange Coffee House, and who had
been paid in now worthless paper. The economic theory of capitalism
works, but it chews up most who live under its capricious rule.
When the Exchange
Coffee House opened in 1809, only 11 of its 36 offices were rented.
Two years later the occupancy had risen to 22, but quickly fell back.
The building never showed a profit. Then just about seven in the
evening, on Tuesday, November 3, 1818, the thing burned down. The
fire started in a chimney on the seventh floor, and the flames were
visible as far away as New Hampshire. By nine the entire structure had collapsed
into the basement. The pit of rubble lay vacant for another three
years, scavengers picking at the rubble for stones.
By then, Andrew
Dexter was back in the United States. He settled first in New York
state, then in 1816, when his father died and left him some money, Andrew moved to Alabama.
He laid out the capital city of Montgomery. But when he died during a
Yellow Fever epidemic in 1837, he was in debtors prison, flat broke
again.
Years later, when
the city of Montgomery searched for his grave “to raise a monument
to its benighted founder,” his poverty had swallowed the memory of
its location. He has no statue in the city. The best the city could
do was to name the broad avenue, running six blocks down from the
State Capital to Courthouse Circle, in his honor.
But thinking about
the man so obsessed with wealth that he destroyed the lives and
futures of thousands of his fellows, I am reminded of something else
that Walter Bagehot said, in his work on the English Constitution -
“The cure for admiring the House of Lords”, he wrote, “is to go
and look at it.”
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