Panic of 1857

America was still an agrarian country in the 1850s. Nothing could stimulate its economy as much as high prices and demand for agricultural products. Favorable conditions for farmers existed in the middle of that decade. During the boom years, gold production and a railroad building spree also stimulated demand. Financial institutions like banks and exchanges prospered with these conditions but the boom dissipated in 1857, giving way to a crash and credit crunch that saw numerous banks and other firms fail.

Gold, Grain, and the Good Years

The early-to-mid 1850s were prosperous times in the United States. This was the product of an investment boom funded from grain and gold. The gold rush in California that began in 1848-49 contributed to the internal migration that encouraged the development of new westward railroads.

The middle of the next decade also saw higher exports of grain boost farm incomes. These exports were partly the result of the Crimean War in Europe which disrupted production there. High grain prices also encouraged the settlement of western territories, particularly the prairie states where public lands were auctioned off and developed into farms. The income from gold and grain supplied some of the capital required for railway development which took off in this period.

Railroad Shares

Capital for the railroads was raised in the capital markets, particularly in New York. Railroad company shares were the most actively traded securities in the country. On the New York Stock Exchange specifically, the most active shares were those of the Erie Railroad, the New York Central Railroad, and the New York & New Haven Railroad. By count, railroads were also the most common issuers of securities listed on the exchange. Canals and mining companies comprised most of the rest at this point. Trading volume was rising during the boom years; one million shares changed hands in one month in 1856.

Much of the trading was conducted with ‘time contracts’ which proved popular with speculators on the exchange. These allowed a speculator to pay for the shares he was buying at a later date, typically between ten and ninety days after the purchase. There was also a lot of trading on margin, with borrowed money. The standards that restricted listings were quite loose then; lack of disclosure and poor management were common among the railway companies with securities listed on the New York Stock Exchange.

While domestic earnings from precious metal and grain exports provided some funds for investment, the massive investment intrinsic in railway development was funded with foreign money as well. Foreign investors had bought, or financed others’ purchases of, more than half of the $400 million in railroad bonds outstanding by the middle of the decade. Net foreign capital inflows more than quadrupled to reach $240 million in 1856, from $56 million in 1853. At approximately mid-decade, British investors held an estimated $80 million in American stocks and bonds, and these primarily comprised of securities issued by railroad companies whose share prices were very high and rising.

Ohio Life

An active buyer of railroad securities was the Ohio Life Insurance and Trust Company. This was nominally an insurance company but was, in reality, more of a bank. While its headquarters were in Cincinnati, it conducted financial operations out of New York City. Still, it operated without much oversight by the New York Clearing House which was then a recently established clearinghouse and regulator of New York banks. Ohio Life possessed $2 million in equity capital, $4.8 million in assets, and a good reputation in the financial markets.

Unfortunately, this reputation was unwarranted. Several of the more cautious voices at Ohio Life had resigned or transferred out of direct managerial roles. During the period of prosperity, Ohio Life bought or lent against railway securities. It invested $3 million, about 62% of the company’s investible capital, in railroads. One railroad by itself, the Cleveland and Pittsburgh Railroad, made up a quarter of its capital or just over 10% of its assets. The bank also made loans to speculators in stocks. Some 72% of the value of collateral for its loans were railroad company securities.

Crucially, Ohio Life was constantly running short on liquid funds. The bank was filling these gaps by borrowing money in New York when it was short of ready cash. The firm was looking for longer-term investment, but efforts were stymied by its unwillingness to publish financial information, pay interest over 5%, or dilute shareholders by issuing more stock. The bank was also engaging in some rather dodgy dealings; at one time, it was borrowing money against bonds it was marketing for sale but which it hadn’t yet paid for and therefore didn’t rightfully own. Despite these troubles, the firm decided to increase in dividend from 4.0% to 4.5% in January 1857.

Recession

In 1857, American agricultural exports began to fall and in turn so did migration westward, and this shaved down railway company earnings. The change in the fortunes of farmers was at least partly caused by the end of the Crimean War which improved grain output in Europe. This created an agricultural recession as wheat prices fell. Western farms were foreclosed, and they weren’t the only casualties; the railroads suffered and some went bankrupt.

Helping depress the market was growing uncertainty in the United States as to the future of the west particularly with regard to whether slavery would be permitted there. At the time, the advocates for slavery seemed to have the upper hand and the prospect of this weakened investment which generally favored ‘free soil’ government in the west.

Railroad stock prices quickened their slide in the late spring of 1857. The share price of the Cleveland and Pittsburgh Railroad had slid from over 60 cents per share in mid-1856 to below 50 by spring 1857 and below 40 in the summer. Banks had been selling securities as gold reserves were becoming scarce in the face of growing withdrawals. However, despite all this, the credit market was relatively calm until August.

Panic

Ohio Life failed on August 24. It surprised most people. The bank’s shares fell from close to their par value of $100 to $20 when they suspended withdrawals into precious metal specie in August and then lower from there. Final trades in October were at $4 per share. The firm failed because a few short-term funders pulled out their money. The panicked communications of the bank’s cashier, Edwin Ludlow, to Ohio Life’s trustees suggest the firm was short no more than $500,000 but it had almost no margin of safety.

The bank had incurred losses of $5 million. Remarkably, the loss-making investments which consumed so much of its capital were blamed on the rogue activities of Edwin Ludlow. Unsurprisingly, some at the time thought Ludlow was a scapegoat and that Ohio Life’s management and directors were very aware of the investments and likely approved of them. Hard to believe they weren’t.

The bad news did not stop there. The SS Central America, a ship carrying $1.5 million of gold from California, sank in September. Banks continued liquidating their securities holdings, causing prices to fall further. From start to finish, stock prices fell 50% on average but some fell by more; Cleveland and Pittsburgh Railroad shares were trading at just 10 cents in the second half of September.

After the collapse of Ohio Life, other banks continued in operation for a couple more months, but they were insolvent and postponing the inevitable served no good end; no salvation ever came. Then, a large securities firm, Corning and Company, failed on October 10. When markets reopened on October 13, a bank run got underway that saw $4-5 million in bank deposit withdrawals; $10 million had been withdrawn since the start of the month. Banks were forced to cease making withdrawals of deposits or redemption of banknotes into specie. Such a suspension had actually first happened outside New York, in other Eastern cities like Philadelphia, Baltimore, and Washington. However, in the end, all New York banks except the Chemical Bank and Trust Company had suspended specie payments. Other banks in the country did the same and the panic even spread to Britain around this time.

On both sides of the Atlantic, credit was withdrawn, and ordinary companies were driven to bankruptcy. Some nine hundred New York mercantile firms were bankrupt and more than five thousand companies across the United States went out of business. There were also over one hundred firms in Britain driven to insolvency in the last three months of 1857 alone. Unemployment and civil unrest grew, particularly in New York.

Resolution

The banks that had suspended payments in specie resumed operations in December. Indeed, most banks re-commenced business. However, operations at the stock exchange and the banks did change. Time contracts were temporarily abolished and even when brought back, daily settlements remained more popular than these long-dated settlements. Also, margin requirements rose so that while trading on borrowed money remained, the speculator was required to put up more of their own capital to increase the collateral available to their broker. Lastly, the New York Clearing House implemented reforms to limit the damage done by future bank runs, like creating reserve requirements and limiting interest paid on demand deposits that could be withdrawn at any moment.

Lesson

In time, railways would transform the country and their securities would prove to be good investments for decades. In the 1850s, their success might have seemed like a sure thing. Nevertheless, at least in the short run, their success was driven by a surge in agricultural exports and migration that would in short order be arrested. In 19th century America, though infrastructure projects and financial firms were multiplying, their success still rested considerably on conditions in an overwhelmingly rural economy in which the prices of commodities like grain and cotton and their output volumes meant almost everything.

More from the Tontine Coffee-House

Read about the San Francisco financial panic that immediately preceded that of 1857 and another American railroad panic in 1873. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.