EXPLAINING THE GOVERNMENT'S RESPONSE TO FIRST REPUBLIC BANK

If the writing is on the wall, why doesn't the government get on with the task at hand?

“A system like the banking system, in which the interests of all are so intimately interwoven, must be treated with great delicacy. A system dependent solely on public confidence should itself exhibit confidence. Any doubt thrown upon one member must excite doubt in regard to them all. This was finally proved yesterday.”

MONDAY, SEPTEMBER 28, 1857, THE NEW YORK TIMES

If there was any doubt about the dire state of First Republic Bank in recent weeks, the cat is officially out of the bag.

Its first-quarter earnings yesterday were something to behold. The crux of First Republic’s problem is that it experienced a $102 billion bank run, and has had to backfill that funding with a $30 billion lifeline from a consortium of big banks, an added $18.2 billion from the Federal Home Loan Bank, and $74 billion in short-term funding from a combination of the Federal Reserve and securities sold under agreements to repurchase.

That, my friends, is as acute as it gets. To say that it has little chance of surviving is to imply that it’s alive today. But while that may technically be true, just as someone with complete organ failure can be kept alive in intensive care, we all know how this story is going to end.

But that begs a question: Why have regulators let it survive until today? If it were a smaller, less prominent bank, it would have been given a viking funeral weeks ago. What’s different?

The best way to answer this question is to travel back in time to an incident that took place in the mid-1800s.

On May 24, 1844, a cryptic message traveled through a narrow wire from Washington, D.C. to a railroad station in Baltimore.

“What Hath God Wrought,” it read.

It was the first message dispatched via telegraph.

The answer came thirteen years later, on August 24, 1857 — itself by way of a telegraph addressed to the managers of a trust company in Cincinnati.

OFFICE OF THE OHIO LIFE AND TRUST CO. 

NEW YORK, Aug. 24, 1857

The unpleasant duty has devolved upon me to state that this Company has suspended payment. This event has been mainly brought about in consequence of making loans in this city to parties who were unable to respond at this time. I would add that the capital of the Company, two millions, is sound and reliable, exclusive of such loss as may arise from the insufficiency of securities pledged for loans above referred to. 

C. STETSON, President.

“The news took everybody by surprise,” wrote The Cincinnati Dispatch. It acted as a clap of thunder in a clear sky.” 

The Ohio Life and Trust Co. had been regarded as among the safest and most substantial banks in the country. Capitalists placed perfect confidence in its soundness. It was the favorite place of deposit in Ohio. Large sums were held for widows and orphans.

It would take years before anyone learned what caused the venerable institution to fail, and even then the chain of causation left much to be desired.

But regardless of the cause, the telegraph acted simultaneously as an accelerant and a long-distance transmission agent. Microscopic electrons raced outwards through narrow black lines in all directions from Cincinnati.

Before long, the financial districts in every city were besieged by desperate citizens hoping that somebody else’s money, not theirs, would go that day to money heaven.

An initial wave of failures happened immediately. These were typically banks with some sort of relationship with the Ohio Life & Trust.

The most prominent of these was John Thompson at 2 Wall Street, who would later go on to found both the First National Bank of New York and later the Chase National Bank.

An uneasy calm then set in for a month. It was like that point in a Western gunfight when the sheriff's posse is squared off against the bank robber’s posse, each with their guns drawn and pointed at the other, but none willing to make the first move.

But eventually the hammer falls.

In this case, it was the biggest bank in what was the country’s most important financial center.

The news came by way of a note secured to its front door:

BANK OF PENNSYLVANIA

Philadelphia, September 25, 1857

This Bank, having been compelled to temporarily suspend specie payments, the board of directors assure all persons having claims against the bank, whether of circulation, deposit, or otherwise, that no loss can possibly occur.

By order and on behalf of the Board of Directors, 

THOMAS ALLIBONE, President

As soon as the news got out, runs upon the other banks commenced.

The Girard Bank was next.

By the end of the day, every bank in Philadelphia was besieged, with similar scenes unfolding in Baltimore, New York and elsewhere.

“Instead of arresting the difficulty, the distrust of the Bank of Pennsylvania was only transferred to the others,” wrote The New York Times on September 28th.

“They showed their want of confidence in one bank, and the public at once declared their want of confidence in them all. It is useless now to lament the unfortunate decision of yesterday morning by the other Philadelphia banks, but there can be little doubt that this might have been averted if a different course towards the Bank of Pennsylvania had been adopted.”

So goes the narrative of all nine of the major financial panics we’ve suffered since gaining independence from Great Britain.

Fortunately, we’ve learned along the way of the importance to nip burgeoning panics in the bud.

It seems unfair at the time, and in hindsight, for the government to grant indulgences toward particular institutions whether or not deserved. Yet it’s even less fair to subject the whole of society to the errors or infirmities of a few.

For once a panic gets out of control, it’s unlikely to dissipate until it has fed on all the capital that lays in its path.