THE ART OF BANKING

I bet you have never heard of Walter Bagehot (above) - rhymes with gadget. He was a melancholy 19^th 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 24^th , 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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