Although many people have hailed Ben Bernanke’s response to the current financial crisis for going outside of the box and using unorthodox policies to avoid a financial collapse, in reality, similar policies were used by Tiberius during the Financial Crisis of 33 AD, almost 2000 years ago. Tiberius ruled the Roman Empire from 14 AD to 37 AD. He was frugal in his expenditures, and consequently, he never raised taxes during his reign. When Cappadocia became a province, Tiberius was even able to lower Roman taxes. His frugality also allowed him to be liberal in helping the provinces when, for example, a massive earthquake destroyed many of the famous cities of Asia, or when a financial panic struck the Roman Empire in 33 AD.
The Florida Land Bubble of the 1920s has been hailed as a precursor both to the Stock Market Bubble of the late 1920s and the real estate bubble of the 2000s. Unlike the stock market crash of 1929 or the real estate bubble of the 2000s, there is insufficient evidence for the price fluctuations, so most of the data are anecdotal. One of the stories, possibly apocryphal, that illustrates the impact of the Florida land boom was this story. An elderly man in Pinellas County was committed to a sanitarium by his sons for spending his life savings of $1,700 on a piece of Pinellas property. When the value of the land reached $300,000 in 1925, the man’s lawyer got him released to sue his children. Global Financial Data has data on just such a candidate: The Land Company of Florida. Although it doesn’t track the rise in Florida real estate prices, the company was formed in 1924 and does track the fall in real estate prices that occurred. The Florida Real Estate Bubble was the most egregious example of a trend that had started during World War I. The commodity inflation of World War I encouraged many farmers to borrow against their farms and buy additional property anticipating further increases in both food and real estate prices. This led to a general increase in real estate prices during the 1920s throughout the United States before foreclosures started becoming more common in the late 1920s, culminating in the massive foreclosures of the 1930s caused by the Dust Bowl and Depression. In the middle of this real estate boom was the Florida bubble. In the 1920s, Americans had more money, more leisure time, were more willing to speculate, and were able to use their automobiles to travel to Florida and other places creating markets that hadn’t existed before. All of these factors enabled Florida to take advantage of these trends to promote the Florida land boom. The Florida Legislature in 1924 passed laws prohibiting state income and inheritance taxes to convince wealthy visitors to make Florida their permanent residence. Land developers then promoted real estate by building cities where none existed before. The most spectacular developments were in Southeast Florida where Henry Flagler’s railroad caused direct access to New York City. Other factors attracting investors was the influx of motorized tourism which brought both rich and poor visitors, and the rum runners who were able to bring in alcohol from Nassau and Grand Bahama to help visitors avoid Prohibition. About two-thirds of all Florida real estate was sold by mail to speculators who never visited Florida. Many of them tried to flip the land through ads in the Miami Herald. For those who actually went to Florida, binder boys were hired to expedite purchases. The binder boys got down payments with thirty-day financing and once the checks cleared, the binder boys received their commission. When there is money to be made, people find ways to make a quick profit. What started out as an undervalued market turned into an overvalued bubble. Then reality set in. A serious of events made investors realize how fragile the price increases were. Forbes magazine warned about the overpriced real estate in early 1925. In October 1925, the “Big Three” railroad companies operating in Florida called an embargo due to the rail traffic gridlock, permitting only foodstuffs, fuel, perishables, and essential commodities to enter or move within the state. Although the railroads lifted the embargo in May 1926, disaster then followed in the shape of the September 1926 Miami hurricane which killed over 400. A market where there were mainly buyers became a market in which there were mainly sellers and the real estate market collapsed. The evidence for this bubble is the Land Co. of Florida incorporated on June 16, 1924. The company was a subsidiary of Florida Western & Northern Railroad Co., and was organized to purchase upwards of 160,000 acres of land along the right-of-way of the Florida Western & Northern Railroad. The stock was a real estate investment trust trying to profit from the real estate bubble and provides a useful proxy for the Florida real estate market. After acquiring the land, the company would then sell the land when its value had been enhanced by the easy accessibility afforded it by the new railroad. Or so things were in theory. The stock traded on the New York Curb (later the American Stock Exchange) and traded in September 1925 at 93. After the train embargo was announced in October, the price fell to the 60s, and continued to fall, decreasing to the 20s by February 1926. One would expect that the hurricane of September 1926 would have caused a further collapse, but in reality, the stock price rose after September, hitting 41 in December. Perhaps the impact of the hurricane should be reevaluated, but it was downhill from 1927 on. By the time the stock market crashed in October 1929, the price had fallen to 5 and by the end of 1930, the stock was at $0.50, never to recover. The stock stopped trading on the Curb in May 1931.
The benefit of stock prices is that they provide a consistent record of market behavior. It is surprising that the stock for the Land Co. of Florida has been overlooked as a proxy for the Florida Real Estate Bubble. As could be expected, the stock IPO’d at the height of the bubble, otherwise, the stock would have had no reason to exist as the railroad took advantage of speculators. The stock may not have charted the rise of the bubble, but it certainly charted the collapse. The fact that the railroad was willing to market their land to investors, just as shoe shine boys were to give stock market tips at the top of the 1929 stock market bubble, should have been a clear sign to sell.
Once again, the government has cut a deal to avoid defaulting on its debt by raising the debt ceiling. The chance of the United States defaulting on its debt has been avoided, at least until January 15, 2014. The reason for these dramatic battles over the debt ceiling is that originally, each bond issue by the government had to be approved by Congress. When the United States entered World War I, instead of requiring that the government approve each and every bond issue, the government changed tack and set a general debt limit, enabling the government to issue new bonds at will up to the limit that was established. It may surprise you, or probably not, but even when the government had to approve each bond issue, prior to World War I, the United States almost defaulted on its debt because of political wrangling. OMG! How shocking. This happened in 1895 when the United States was on the Gold Standard as Jean Strouse related in her book, Morgan: American Financier. In 1895, the United States was suffering through the recession that followed the Panic of 1893. Foreigners were selling their stocks and bonds and were converting their dollars into gold which was sent out of the United States. Between 1890 and 1894, foreigners had redeemed $300 million in gold. By the end of 1893, US gold reserves were down to $60 million and about $2 million in gold was being redeemed each day. By February 1894, the US government had about three weeks of gold left in its vaults. After that, the US would have to technically default on its debts because it would be unable to redeem the demand for gold that foreigners would make. Sound familiar? Congress was aware of this problem and knew of the possibility of default, but many Representatives thought this “emergency” was being created by the money interests in New York, and in particular, J. P. Morgan, to force the government to issue bonds and put the government further in debt. President Grover Cleveland, a Democrat, knew this, but wanted to avoid default. He contacted Nathaniel Mayer Rothschild to help, who in turn contacted J.P. Morgan. One problem was the Secretary of the Treasury, John G. Carlisle. Carlisle thought the bond terms were too tough, and he wanted Congress to issue bonds directly to the public. The problem was there wasn’t enough time to do this without the government going into default, and whether the bill could get through Congress was questionable. Do you have a feeling of déjà vu all over again? Although Secretary Carlisle was a staunch Agrarian Democrat, similar to William Jennings Bryan, he eventually responded to the economic downturn caused by the Panic of 1893 by ending silver coinage and opposing the 1894 Wilson-Gorman Tarrif Act bill. By 1896, Carlisle was so unpopular that he was forced to leave the stage in the middle of a speech in his home town of Covington due to a barrage of rotten eggs. Those were the days. Realizing that time was of the essence, J. P. Morgan took a train to Washington D.C. At first, Cleveland didn’t want to meet with him. Even though most members of the cabinet favored the bond issue, Carlisle was against it. In reality, the government was technically in default. There were $12 million in warrants for gold outstanding with only $9 million in the vaults. Unless something was done immediately, the United States would be in default for the first time in its history. J.P. Morgan, however, had a trick up his sleeve. During the civil war, Congress had authorized then Treasury Secretary Salmon P. Chase to issue bonds that could be offered for coin. By calling this a bailout for coin, the government could do an end run around Congress and issue the bonds without Congressional approval. Attorney General Olney investigated, found the clause was still valid, and gave his approval. President Cleveland asked that the international bailout team of Morgan and Rothschild keep the gold in the United States. The government agreed to buy 3.5 million ounces of gold from the bailout team at $17.80 per ounce, in exchange for $62.3 million worth of 30-year bonds paying 4%. Since the price of gold was $18.60 per ounce, the government ended up paying $65.1 million in gold for $62.3 million in bonds, earning the bailout team $3 million. Twelve days later, the bond offer was made, and it sold out in 20 minutes. The data for this bond shows that purchasers of the bond did well. Not only did the US pay $3 million extra for the bonds, but the price shot up to 125 after issue, yielding 3.2%, so the US could have gotten a better coupon yield as well as a better price. The 30-year bond was redeemed in 1925 at 100, trading above its par value, particularly during World War I, during the entire time of its issue. Whether the issue is establishing a first or second Bank of the United States, issuing bonds to make sure the United States doesn’t run out of gold, raising the debt ceiling to make sure the government can pay its bills, or any other government financial crisis, the players are the same and the result is the same as well. As the saying goes, I’ve seen this movie before. It’s the Washington version of Groundhog Day. One hundred years from now when the US government has its twenty-second century version of potential default with only days and hours before the United States defaults on its debt for the first time, the movie will be the same, as will the ending. Be sure and re-read this blog in January 2014, and in 2015, and in 2016, and…
The Mississippi Bubble, or How the French Eliminated All Their Government Debt (So Why Can’t Bernanke?)
The government is running a large deficit and it can’t cover its expenses. The government debt exceeds the GDP of the country. The central bank’s balance sheet is exploding as the government buys its own debt. Sound familiar? This was France in 1719. Everyone has heard of the South Sea Bubble, but few have heard of the French version, the Mississippi Bubble, which happened one year before. Not only was the Mississippi Bubble bigger than the South Sea Bubble, but it was more successful. It completely wiped out the French government’s debt obligations at the expense of those who fell under the sway of John Law’s economic innovations. The Compagnie du Mississippi was chartered in 1684 at the behest of Renee-Robert Cavelier who had been appointed Governor of Fort Frontenac, at the mouth of the Mississippi. After getting his charter, he went to Mississippi with four vessels full of inhabitants, but the venture floundered, and Renee-Robert Cavelier died there, killed by a party that mutinied against him. In August 1717, Scottish businessman John Law acquired a controlling interest in the then-derelict Compagnie du Mississippi and renamed it the Compagnie d’Occident. The company’s initial goal was to trade and do business with the French colonies in North America, which included much of the Mississippi River drainage basin, and the French colony of Louisiana. As John Law bought control of the company, he was granted a 25-year monopoly by the French government on trade with the West Indies and North America. In 1719, the company acquired the Compagnie des Indes Orientales, the Compagnie de Chine, and other French trading companies and combined these into the Compagnie Perpetuelle des Indes. In 1720, it acquired the Banque Royale, which had been founded by John Law as the Banque Generale in 1716, and which was the source for the quantitative easing which enabled the government to eliminate its debts. John Law then schemed to create speculative interest in the Compagnie des Indes. Reports were skillfully spread as to gold and silver mines discovered in these parts. Law exaggerated the wealth of Louisiana with an effective marketing scheme, which led to wild speculation on the shares of the company in 1719. This was the way Gregor McGregor was to generate interest in Poyais one hundred years later. Law had promised the French regent that he would extinguish the public debt. To keep his word he required that shares in the Compagnie des Indes should be paid for one-fourth in coin and three-fourths in billets d’Etat or public securities, which rapidly rose in value on account of the foolish demand which was created for them. The speculation was further fed by the huge increase in the money supply introduced by John Law in order to stimulate the economy. The South Sea Company and the British government learned from John Law and imitated these techniques in 1720. The shares traded around 300 at the end of 1718, but rose rapidly in 1719, increasing to 1000 by July 1719, 5000 by August 1719 and broke 10,000 in November 1719, an increase of over 3000 percent in less than one year. By contrast, South Sea Company shares rose by 900 percent in 1720. The Comagnie des Indes shares stayed at the 9000 level until May 1720 when they fell to around 5000. The fall in the price of the stock increased, and at the end of 1720, John Law was dismissed by Regent Philippe II of Orleans.As the creditors bought shares in the company with their bonds and debt papers, the whole government debt became property of the company. The company then became property of the former creditors, now the shareholders, and the effective control fell into the hands of the government that paid an annual 3% interest to the company, which amounted to 48 million livres. Through these transactions the French government successfully unloaded their whole gigantic debt (perhaps 200% – 400% of GDP) and became basically debt free. The company sought bankruptcy protection in 1721. It was reorganized and open for business in 1722. In 1723 it was granted fresh privileges by Louis XV. Among these were the monopoly of sale of tobacco and coffee, and the right to organize national lotteries. Compare this outcome with that of the South Sea Company, which was unable to find any business that enabled it to make a profit for its shareholders after its collapse in 1720, but relied on the government bonds the South Sea Company held to provide income to its shareholders. From 1726 to 1746 the Compagnie d’Inde flourished from its overseas trade and domestic business. It brought wealth to the port cities it was operating from: in Bordeaux, Nantes, Marseille, and, in particular, its home port of Lorient (initially called L’Orient). During this period the company lost its trading rights for the western hemisphere, but it kept trading with the east and prospered from that business. Its main goods of trade during the period were porcelain, wallpapers, lacquer and tea from China, cotton and silk cloth from China and India, coffee from Mocha (Yemen), pepper from Mahe (South India), gold, ivory and slaves from West Africa. After 1746 the spendthrift policies of the French Government began to hurt the Company, and the Seven Years’ War brought severe losses. In February 1770 an edict required the Company to transfer to the state all its properties, assets and rights, then valued to just 30 million livres, quite a decline from the 5 billion livres the company had been valued at in 1719. The king agreed to pay all the Company’s debts and annuity (rente) obligations. The company was officially dissolved in 1770, although its liquidation dragged on into the 1790s.
The number of outstanding shares of the company was probably around 500,000 in 1720. A stock price of 10,000 livres would have given the company a market capitalization of 5 billion livres. By comparison, the French government expenses in 1719 were 150 million livres in 1700, and the French government debt in 1719 was 1.6 billion livres. At its height, the capitalization of the Compagnie des Indest was greater than either the GDP of France or all French government debt. With the demand for company shares being high, the government and John Law set out to buy back the whole 1.6 billion livres government debt for shares in the company. The plan was successful, and in 1720 the whole government debt was acquired by the company.
The debt-laden governments of today probably wish they could create a scheme similar to the Mississippi Bubble to unburden themselves of the debts they have accumulated over time. With many western government debts equal to or greater than GDP, it would provide a great relief. No one knows how the huge expansion in the Fed’s balance sheet caused by quantitative easing will end, or if there were another recession, if it might even expand. Might the Fed end up buying the debt of Detroit or Puerto Rico or California or Illinois? Might the Fed even buy corporate debt during the next financial crisis, or even shares in companies? Perhaps Ben Bernanke and Janet Yellen should summon John Law’s ghost for some advice on how to get out of their current predicament.