Saving the City: The Great Financial Crisis of 1914

320 Pages·2014·1.31 MB·English

by  Richard Roberts

SAVING THE CITY
Praise for Saving the City
‘A timely reminder that if we don’t want to repeat the mistakes of the past
then we fi rst need to understand them.’
George Osborne, Chancellor of the Exchequer
‘A fascinating insight into a half-forgotten crisis. Written with a verve and
clarity that any reader can savour.’
Sebastian Faulks, author B irdsong and A Week in December
‘A masterly account of the fi nancial crisis that brought the fi rst great age of
globalization to a close. Richard Roberts's narrative is fi nely wrought and
wholly absorbing.’
John Plender, Columnist, Financial Times
‘Richard Roberts is an authority on the history of the City of London. He
has brought his great expertise to the hitherto largely unexplored fi nancial
crisis of 1914. A masterly study brought to life with extensive quotation
from contemporaries.’
Forrest Capie, Professor Emeritus of Economic
History, Cass Business School
‘This is a superbly researched, calmly authoritative, and fi nely told account of
a momentous episode in modern fi nancial history. Richard Roberts has a
formidable grasp of the technical intricacies but is also fully alive to the
human dimension, as politicians, mandarins, bankers, and others jostle in not
always seemly pursuit of self-preservation as well as the greater good. The
drama of 1914 may until now have been the “unknown” fi nancial crisis; that
is assuredly the case no longer.’
David Kynaston, author The City of London, 1815–2000
SAVING THE
CITY
the great financial
crisis of 1914
R R R R
ICHA D OBE TS
1
3
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For
Sarah, Lilian, and Nancy
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Foreword
When the realisation that the fi nancial crisis which started in earnest in
August 2007, and continued through October 2008, was of major propor-
tions, many looked for historical parallels. For most, it was the Great Depres-
sion of the 1930s. But this comparison is misleading in two important
respects. First, the policy responses were very different, and for a while that
defl ected attention away from an analysis of the similarities and differences
of the causes of the two crises. Second, there was, unlike the United States,
no banking crisis in Britain in the 1930s, and the immediate nature and
required response to the recent crisis was very different to the issues raised
in the 1930s.
A more interesting parallel is with the international fi nancial crisis that
accompanied the outbreak of the First World War in 1914. There is much we
can learn from the events of 1914. As Richard Roberts writes, ‘the fi nancial
crisis of 1914 was the most severe systemic crisis London has ever experi-
enced’. And at that time, London was the dominant international fi nancial
centre, even more important than New York in 2008.
My own interest in the crisis of 1914 stemmed from a meeting of the
Financial History Dining Club (which I had founded with Charles Alding-
ton, then Chairman of Deutsche Bank UK, shortly before I became Gov-
ernor in 2003) in October 2006. That evening, devoted to a discussion of
the events of 1914, was one I recalled frequently over the following fi ve
years.
In order to bring home the seriousness of the crisis in 2007-2008, without
raising the spectre of a downturn in output and employment as large as in
the1930s, I referred in my own speeches to the fact that the banking crisis we
were experiencing was the most severe that the UK had suffered since the
events of 1914. Yet I found that few people knew much about the fi nancial
crisis of 1914.Richard Roberts has performed a great service in explaining
those events, at home and abroad, in a lucid and masterly fashion—one that
is particularly important as we mark the centenary of the Great War. For
viii foreword
there is a risk that the many otherwise excellent new books on the origins,
nature, and consequences of that confl ict will do inadequate justice to the
signifi cance and impact of the fi nancial events of the summer of 1914.
The origins of the fi nancial crisis of 1914 were certainly very different
from those of other episodes, including the recent crisis. But the unfolding of
the crisis and its management by the authorities drew obvious comparisons.
Immediately prior to the crisis, complacency was evident in the failure
of both policy-makers and markets to take seriously the likely consequences
for the economic outlook of a war in Europe. Even after the assassination of
Archduke Franz Ferdinand in Sarajevo on 28 June 1914, there was barely a
ripple in London markets.
It was almost a month before fi nancial markets woke up to the signifi -
cance of those political events, and it was the ultimatum from Austria to
Serbia on 23 July which fi nally changed sentiment. European stock markets
fell sharply, and several were closed. There was a fl ight to safety, and espe-
cially to cash, and market liquidity dried up in all major markets, including
those for foreign exchange, the discount market, and stock markets. Three-
month money market rates more than doubled. As accurate pricing became
impossible, the London Stock Exchange was closed on the morning of Fri-
day 31 July, followed later in the day by the New York Stock Exchange.
Britain declared war on 4 August. During that fi rst week of August, a
series of unprecedented crisis measures were introduced by the Treasury and
the Bank of England. The UK government decided to intervene and risk
taxpayers’ money on an unprecedented scale in a mission to ‘save the City’.
And this is where the comparison with our recent fi nancial crisis comes
to the fore. There are four main parallels with the management of the fi nan-
cial crisis in 1914.
The fi rst and most important of these was the realisation early on in 1914
that the problem facing British fi nancial institutions—discount houses,
accepting houses, and banks—was not a problem solely of liquidity, but, at
heart, one of solvency. The provision of liquidity by the Bank of England
did not resolve the position of the accepting houses (the forerunner of
investment banks) and the banks. It became increasingly clear that in war-
time conditions many debtors on the Continent would be unable to repay,
and that as a result many of the assets held by British fi nancial institutions
(in particular, bills of exchange) would fall in value, leaving those institu-
tions insolvent.
foreword ix
Although the crisis measures taken early on enabled the banks to re-open
on Friday 7 August, after a week-long bank holiday, the crisis at that point
was merely ‘contained’. Over the next fi ve months, the Chancellor, Lloyd
George, and Treasury offi cials essentially recapitalised the City. The Bank of
England purchased a large volume of bills held on bank and other fi nancial
balance sheets in London with all potential losses indemnifi ed by the Gov-
ernment on behalf of the taxpayer. The Bank bought one third of the entire
discount market, some 5.3 per cent of GDP.
Roberts describes this period as a ‘revival’ rather than a ‘resolution’ phase
because no major institution failed. But in large part that was because the
British Government took over the assets of the banking system. So that
when the Stock Exchange re-opened on Monday 4 January 1915 (with the
singing of all three verses of the National Anthem) the fi nancial crisis ‘was
over’.
The second parallel between 1914 and today concerns the reluctance of
fi nancial institutions to accept state support because of the ‘stigma’ entailed
as other institutions discover that one of their brethren has required support.
Roberts describes the concern expressed in 1914, ‘about the potential repu-
tational damage of borrowing from the Bank of England’ if it became
known to others that advantage had been taken of such a facility. This turned
out to be a major problem in Britain and elsewhere in 2007, when attempts
to provide liquidity led to great caution on the part of borrowing institu-
tions. There is no simple, or for that matter complex, solution to this prob-
lem which continues to trouble the designers of central bank liquidity
facilities.
The third parallel is that, despite massive state support, the state of crisis
and associated change of mentality led banks to be extremely cautious about
lending to the real economy. This produced a major political debate in the
years after 2008 when banks which had benefi ted from taxpayer support
proved reluctant to expand lending. It also proved controversial in 1914
when Lloyd George expressed concerns about the reluctance of banks to
support the economy. Roberts relates the complaints of industrialists about
the shortage of bank fi nance and the withdrawal of normal banking facili-
ties. Businessmen also complained about the alleged preference by the Gov-
ernment to support banks rather than businesses. Lloyd George responded
to those concerns in the House of Commons, ‘I think we have done for the
banks as much as ever they could have expected of us. We did not do it in
order to strengthen their position or to increase the dividends. We did it in