Every decade or so bank failures and the subsequent bailout response via central bank intervention appear. The latest jangling of depositor nerves involved US regional banks and a certain Swiss bank of great systemic importance. As James Grant writes in his book Bagehot: The Life and Times of the Greatest Victorian, “In economics, the most ostensibly rigorous of the social sciences, progress–and error, too–are cyclical; we keep stepping on the same rakes.” Sounding Rothbardian, Grant writes, “In banking, though, accidents came in clusters. Bank runs, unlike train wrecks, were contagious.” Nothing has changed.
Walter Bagehot famously urged the Bank of England—or “the Old Lady,” as the world’s first central bank is referred to in Grant’s elegant telling of Bagehot’s life and the economic history surrounding this great man of letters—to lend freely to stem a panic, against good collateral and at high rates. The Bank Term Funding Program (BTFP), the new facility post–Silicon Valley Bank, would not meet Bagehot’s qualifications. Banks can borrow funds equal to the par value of the collateral they pledge, which according to the Wall Street Journal is “a boon for banks, who were sitting on some $620 billion in unrealized losses on securities at the end of last year, according to the Federal Deposit Insurance Corp.”
Besides his prolific output as an author and journalist—five thousand words a week and never one out of place, according to Grant—Bagehot was a banker back when bank general partners were on the hook personally for customer deposits, “down to their last shilling and acre.” Precorporate structure without limited liability protection and government deposit insurance protection not even considered, “the depositor’s only security against loss was the prudence of his bankers and the assessable wealth of the bank’s shareholders.”
The Joint Stock Companies Act and the Bank Charter Act were enacted in 1844 in preview of the Limited Liability Act of 1855 and the subsequent passage of the Companies Act of 1867 which unleashed “a powerful stimulant to new financial enterprise,” Grant explains. To unleash the animal spirits of the hoi polloi who could never invest “when one’s entire net worth was at risk was, for many a thoughtful person, unacceptable.”
While Bagehot was in favor of limited liability, he wrote: “The system of unlimited liability is that which fosters the most speculative management.” This speculative management we’ve lived with ever since with each banking crisis is not simply a problem for the overextended individual bank to solve but becomes the public’s business. “They would look not to their own reserve but to the central bank’s.”
Robert Lowe, leader of the Liberals in Bagehot’s time, “viewed limited liability as a force for democracy in capitalism and for equality of opportunity between the rich and the aspiring rich.” Hans-Hermann Hoppe’s critiques of democracy immediately come to mind and apply: the increase in the rate of social time-preference (emphasis on the short term), creation of a new power elite and ruling class, ever higher taxes, a never-ending flood of legislation, and increased legal uncertainty. Grant’s thorough chronicling of the debate makes clear the corporate structure with limited liability is no outgrowth of natural law but a privilege bestowed by state fiat, as Jeffrey Barr explained in his presentation at the most recent Austrian Economics Research Conference (AERC) entitled “An Austrian Attack on the Corporation.”
Perhaps not coincidentally, the limited liability debate is intertwined with a voting measure in Grant’s telling. At issue was the requirement that, since 1832, to vote one must pay at least ten pounds (the typical bribe rate) yearly in rent. The Liberals wished to expand the voting franchise to the masses with a lower threshold.
“One of the greatest pains to human nature is the pain of a new idea,” wrote Bagehot. “It is, as common people say, so ‘upsetting’; it makes you think that, after all, your favorite nations may be wrong. . . . Naturally, therefore, common men hate a new idea, and are disposed more or less to ill-treat the original man who brings it.”
Bagehot believed if restless speculators could just stay idle for four hours rather than using debt in an attempt to achieve more during the remaining four hours “they would have been rich men.” Also on the issue of idleness, Bagehot believed a life of the mind left less energy for reproduction. Bagehot was for less speculation and less sex.
The author wonders if Bagehot’s belief that “the good times too of high prices almost always engender much fraud” pushed John Kenneth Galbraith’s concept of the “bezzle”—“the pregnant interval between the commission of an embezzlement and the victim’s discovery of his loss.” In that regard, the respective panics of 1825, 1847, 1857, and the failure of Overend, Gurney & Company are given considerable attention, making Grant’s richly footnoted book a must for those researching these events.
Winding toward the close, Grant writes that his subject’s world was “one of institutionalized discipline,” while today’s world is “one of institutionalized indiscipline,” or as Ludwig von Mises wrote, each government intervention leads to another. The lack of discipline means more money creation and government control. Even Bagehot, who wrote in favor of central bank intervention so long ago, would be dismayed.