In the two generations following the publication of Adam Smith's Wealth of Nations Britain underwent an economic and technological transformation so thorough that it was almost immediately christened the Industrial Revolution. Like all good revolutions, it had a vanguard; albeit a rather unexpected one. For an astonishing number of the entrepreneurs who created Britain's industrial supremacy were members of one marginal Protestant sect: the Religious Society of Friends, or, to give them their more familiar name, the Quakers. …
An exclusive commercial club, knit together by implicit trust and bound to an ulterior ideology, is the dream environment for private monetary networks to flourish in. …But the greatest of all the mid-nineteenth-century Quaker banks no longer exists…. This was the famous Quaker firm of Overend, Gurney and Co., or the 'Corner House' as it was known to a generation of Victorian financiers, because it stood as a rival to the Bank of England itself, not only metaphorically in the financial markets, but in hard reality on the corner of Lombard Street and Birchin Lane in the heart of the City of London.
The Gurney family had begun as wool merchants in the prosperous farming district of East Anglia, and had evolved naturally into merchant bankers by borrowing on their good name in London and lending to the local sheep-farmers. As Britain's economy grew and diversified, the opportunity to capitalise on this generic line of business - connecting the local capitalists in need of credit at the base of the pyramid to the London banks in its higher echelons - became more and more attractive. Eventually, the Gurneys of Norfolk decided to seed a London operation, and in 1807 they acquired the small London firm of Richardson, Overend. In the beginning, the firm's business was brokerage pure and simple. A potential borrower in the provinces would bring his bills to Overends for scrutiny. If Overends liked the credit, they would find a London commercial bank that would lend against security of the bill - a procedure called 'accepting' it. The more practised in this art brokers like Overend, Gurney became, the more readily were their recommendations accepted by the banks. Bill-broking became big business, and the market in debt securities that they intermediated became the governing mechanism of the Industrial Revolution. …
By the 1830s, Overend, Gurney was the greatest bill broker in all of Europe. By the 1850s, it was the greatest in the world, turning over £170 million a year, taking deposits from every bank in the City, and discounting bills of industrialists and merchants from Lancashire to Lahore. The firm returned annual profits of more than £200,000 to its partners, and had a balance sheet ten times larger than those of the two biggest banks in Britain combined. Never in history had there been so uniquely important a banking house or one whose name and credit were so synonymous with the credit of the nation's - even of the world's - economy. As Walter Bagehot attested, the reach of the credit of the greatest bill broker in London was such that '[n]o one in the rural districts (as I know by experience) would ever believe a word against them, say what you might'…. It is just such unquestioning confidence in credit that is the essential ingredient of liquid financial markets, as the Governor of the Bank of England knew: '[b]anking...depends so much on credit', he concluded, 'that the least blast of suspicion is sufficient to sweep away, as it were, the harvest of a whole year.'
This was a lesson that had been learned time and time again in the course of the preceding half-century. The year 1825 had seen the first financial crisis of the industrial era, following a speculative bubble generated by the over-expansion of the new country banks. When it burst, it had brought the country to 'within twenty-four hours of a state of barter'. Thereafter crises had occurred with alarming regularity. In 1836, a bubble in railway bonds burst. A decade later, there was another boom and bust; and in 1857 the end of the Crimean War sparked an investment boom that again ended in distress and panic. Many a bank had been laid low by one or other of these successive crises; but Overend, Gurney and Co. had survived them all, and prospered. The crisis of 1857 forced two momentous changes to the 'Corner House', however.
The first was a regulatory development. Ever since their transformation into dealers carrying risk on their own balance sheets after the crisis of 1825, the bill brokers had enjoyed access to loans from the Bank of England in times of crisis. But in the Bank's view, the crisis of 1857 … [t]here was much talk of the fact that access to the emergency facilities was encouraging the brokers to invest in over-speculative bills. The Bank's Directors therefore resolved in March 1858 to end the bill brokers' access.
At the very same time that its business environment was changing in this way, the house of Overend, Gurney and Co. faced a second challenge. The original managing partners retired, and a younger generation took the reins. It quickly became apparent that they lacked some of the distinctive Quaker qualities of their illustrious forebears. In contrast to the stern solidity of the fathers, the sons were precipitous in their decision-making, ambitious for the trappings of wealth, and - the most dangerous flaw of all in a banker - credulous. …
The intention of the Bank's withdrawal of its lender of last resort facility from the bill brokers had been to discourage the riskier end of their discount business. At Overend, Gurney, however, it had exactly the opposite effect. The new partners lost no time in filling the firm's portfolios with a succession of speculative, long-term, and high-risk investments.
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In the space of two years, Overends' annual profit of £200,000 had turned to a loss of £500,000. The new managers attempted to regain profitability by taking more risk. They made a bold foray into emerging market bonds, financed a port development in Ireland, and made a host of other long-term, speculative investments, the only unifying feature of which was that everyone was funded, as was the way with the bill brokers' business model, by deposits from the commercial banks that could be withdrawn on demand. If, heaven forbid, there was to be a market panic, and the banks were to demand those deposits back, there was now no question that without support the firm would be exposed as insolvent.
By April 1865, the situation was becoming desperate, and the partners met to weigh up the options. It was clear that new capital was needed to make good the losses and supply the means to rebuild the firm's fortunes. …[I] n the end, it was the oldest trick in the City's books that was chosen: an initial public offering that would transform the partnership into a public company and thereby offload the problem on to that perennial saviour of the City insider's bacon - the general public.
For the first few months of its existence, shares in the new limited liability company, Overend, Gurney and Co. Ltd., traded at a premium. But late in the year, the Bank felt it needed to put another squeeze on the market. Bank Rate was raised to 8 per cent, and at the beginning of January 1866 the first sign of distress appeared in a most unfortunate quarter. A middling boutique railway bond arranger went into default on liabilities of £1.5 million. As bad luck would have it, the name of the quite unrelated firm was Watson, Overend and Co. Now the ignorance of the market worked against Overends. A connection was assumed, and - just as a precaution - withdrawals began. It became known that the old partners were having to sell assets. The withdrawals accelerated. In two months, £2.5 million worth of deposits streamed out of Overends, even as loans continued to go bad and the general panic spread. In a final gamble, on 9 May, the management made an urgent and humiliating appeal to the Bank of England for emergency support. But a general crisis was in prospect, and to bail out one firm alone would open the Bank to unanswerable charges of encouraging moral hazard. The Governor's response was therefore swift and unequivocal. There would be no lifeboat. At 3:30 p.m. on Thursday, 9 May 1866, Overend, Gurney and Co. Ltd. suspended payment. ….
[A]s always, the real ramifications of the crisis were felt far beyond the medieval wards of the City of London and long after the acute panic had subsided…. More than a hundred and eighty bankruptcies were recorded in the three months following Black Friday. Unemployment rose from 2.6 per cent in 1866 to 6.3 per cent in 1867, and rose again in 1868 before a proper recovery took hold. Sectors that relied particularly heavily on credit, such as the global shipping industry operating from the wharfs of London's East End, were especially badly affected. … All in all, it had been the greatest financial crash since 1825 - indeed, if only by virtue of the far more advanced development of the City and its international importance compared with that time, the greatest crash of all. Little wonder, then, that the editor of one contemporary journal, surveying the wreckage seven years later, called the collapse of Overend, Gurney which had sparked the catastrophe, 'the model instance of all evil in business.'
Reproduced with permission
MONEY: THE UNAUTHORISED BIOGRAPHY
Author: Felix Martin
Publisher: Bodley Head, Random House
Pages: 336
Price: Rs 599
