Post by Gary on Sept 13, 2003 4:27:03 GMT -5
An extract about the Overend Gurney failure taken from "Learning To Avoid Financial Crises: The Bank Of England" by Forrest Capie, City University Business School, Cardiff.
Incidentally, in 1858 limited liability was allowed, and in 1862 Overend Gurney the major discount house took advantage of that. Overend Gurney’s origins were Quakers. They were highly respected in the financial sector from at least as early as the late seventeenth century. Few, it was said, were as wise in the ways of the City or more judicious than Samuel Gurney.
The decade of the 1860s was the high point of the mid-Victorian boom. In 1866 the Chancellor of the Exchequer, Gladstone, was decidedly upbeat about the economy. In May Bank of England reserves were in good shape. But on the 10th of May Overend Gurney & Co failed. Overend’s was a giant financial institution dominating the discount market. It competed in the City with The Bank of England in terms of prestige. But it got involved in bad asset management and became grossly overcommited to risky enterprises; ‘the most celebrated of old houses had misused money’ as Clapham put it. Many of the booming firms of the 1860s failed and that led to Overend’s failure. Panic set in immediately. It was the worst panic since 1825, ‘this ruin of its most famous neighbourand sometime rival, “the Corner House”, the greatest private firm in England’. (Clapham p.261)
Overend’s epitaph was written by Bagehot. “In six years” from 1860 to 1866 – the immensely rich partners “lost all their own wealth, sold the business to the company, and then lost a large part of the company’s capital. And these losses were made in a manner so reckless and so foolish that one would think a child who had lent money in the City of London would have lent it better.” Samuel Gurney’s old sound business called for “great care with every bill, great knowledge of the ‘standing of parties’, and considered use of that knowledge. The younger men now in charge held bills of doubtful subordinate. Portfolios filled up with all sorts of flimsy paper, including the so-called ‘finance securities’”. (Clapham, p.261). These latter were “issued in advance by company promoters, perhaps before the public had even subscribed, to contracting firms, and by themdiscounted. And Overend had gone far beyond dealings in bills, good or bad. They were mixed up in all sorts of financing, were ‘partners in almost every kind of speculative and lock-up business”.(p.262)
On 11 May 1866 there was an unprecedented fall in Bank of England reserves. There were deputations to Gladstone to suspend the Act and Gladstone agreed. Bank Rate went to 10 per centand stayed there for 3 months; and more banks failed. The Bank of England was criticised forlending, “… hesitatingly, reluctantly, and with misgiving. In fact to make large advances in this faltering way is to incur the evil of making them without obtaining the advantage”. (Bagehot pp.64,5)
It is worth pausing here to consider the “too big to fail doctrine” as it might have applied to Overend Gurney. Overend Gurney was, as noted, a giant of a financial institution. It had become banker to the London and country banks and on the day it failed The Times said it “could rightly claim to be the greatest instrument of credit in the Kingdom”. (11/9/1866). Its balance sheet was roughly ten times the size of the Midland Bank and the Westminster Bank – two of the biggest banks in the country; and while they operated with capital/asset ratios of about 9-11 per cent, Overend was 2 per cent. (Discount houses do have lower ratios but as noted Overend was conducting banking business).
Overend appealed to the Bank for help but it was refused. “The Governor took the view that the Bank could not assist one concern unless it was prepared to assist the many others which wereknown to be in a similar plight”. (King p.242 ) There was considerable animosity between the two institutions. Nevertheless, this should surely be seen as a further step on the road to the Bank seeing its function as coming to the aid of the market and not bailing out imprudent and insolvent institutions. The panic of 1866 was huge but in spite of Overend being so large and apparently central to the system, the panic passed and the system went on to become so stable that it is worth at least considering that such a signal was an important step on the road. Too big to fail is a cost benefit concept. Generally speaking for banks of a certain size the benefits of saving them - to the rest of the system and the economy as a whole - are reckoned to outweigh the costs of them failing. The costs of failing are relatively short term and susceptible to some calculation. But the benefits to the system of the salutory lesson of allowing them to fail must be seen as very long term and almost impossible to measure. Take Overend Gurney. The cost of refusing assistance was high, but the benefit, of making it clear to all institutions that they could not count on the Bank of England saving them must run over of a very long period. When it becomes clear that the lender of last resort will not rescue an individual institution that removes moral hazard from the discussion.
The decade of the 1860s was the high point of the mid-Victorian boom. In 1866 the Chancellor of the Exchequer, Gladstone, was decidedly upbeat about the economy. In May Bank of England reserves were in good shape. But on the 10th of May Overend Gurney & Co failed. Overend’s was a giant financial institution dominating the discount market. It competed in the City with The Bank of England in terms of prestige. But it got involved in bad asset management and became grossly overcommited to risky enterprises; ‘the most celebrated of old houses had misused money’ as Clapham put it. Many of the booming firms of the 1860s failed and that led to Overend’s failure. Panic set in immediately. It was the worst panic since 1825, ‘this ruin of its most famous neighbourand sometime rival, “the Corner House”, the greatest private firm in England’. (Clapham p.261)
Overend’s epitaph was written by Bagehot. “In six years” from 1860 to 1866 – the immensely rich partners “lost all their own wealth, sold the business to the company, and then lost a large part of the company’s capital. And these losses were made in a manner so reckless and so foolish that one would think a child who had lent money in the City of London would have lent it better.” Samuel Gurney’s old sound business called for “great care with every bill, great knowledge of the ‘standing of parties’, and considered use of that knowledge. The younger men now in charge held bills of doubtful subordinate. Portfolios filled up with all sorts of flimsy paper, including the so-called ‘finance securities’”. (Clapham, p.261). These latter were “issued in advance by company promoters, perhaps before the public had even subscribed, to contracting firms, and by themdiscounted. And Overend had gone far beyond dealings in bills, good or bad. They were mixed up in all sorts of financing, were ‘partners in almost every kind of speculative and lock-up business”.(p.262)
On 11 May 1866 there was an unprecedented fall in Bank of England reserves. There were deputations to Gladstone to suspend the Act and Gladstone agreed. Bank Rate went to 10 per centand stayed there for 3 months; and more banks failed. The Bank of England was criticised forlending, “… hesitatingly, reluctantly, and with misgiving. In fact to make large advances in this faltering way is to incur the evil of making them without obtaining the advantage”. (Bagehot pp.64,5)
It is worth pausing here to consider the “too big to fail doctrine” as it might have applied to Overend Gurney. Overend Gurney was, as noted, a giant of a financial institution. It had become banker to the London and country banks and on the day it failed The Times said it “could rightly claim to be the greatest instrument of credit in the Kingdom”. (11/9/1866). Its balance sheet was roughly ten times the size of the Midland Bank and the Westminster Bank – two of the biggest banks in the country; and while they operated with capital/asset ratios of about 9-11 per cent, Overend was 2 per cent. (Discount houses do have lower ratios but as noted Overend was conducting banking business).
Overend appealed to the Bank for help but it was refused. “The Governor took the view that the Bank could not assist one concern unless it was prepared to assist the many others which wereknown to be in a similar plight”. (King p.242 ) There was considerable animosity between the two institutions. Nevertheless, this should surely be seen as a further step on the road to the Bank seeing its function as coming to the aid of the market and not bailing out imprudent and insolvent institutions. The panic of 1866 was huge but in spite of Overend being so large and apparently central to the system, the panic passed and the system went on to become so stable that it is worth at least considering that such a signal was an important step on the road. Too big to fail is a cost benefit concept. Generally speaking for banks of a certain size the benefits of saving them - to the rest of the system and the economy as a whole - are reckoned to outweigh the costs of them failing. The costs of failing are relatively short term and susceptible to some calculation. But the benefits to the system of the salutory lesson of allowing them to fail must be seen as very long term and almost impossible to measure. Take Overend Gurney. The cost of refusing assistance was high, but the benefit, of making it clear to all institutions that they could not count on the Bank of England saving them must run over of a very long period. When it becomes clear that the lender of last resort will not rescue an individual institution that removes moral hazard from the discussion.
