eBusiness Weekly
Dr Alfred M Mthimkhulu
By the time the Argentine finance minister quit in July 1890, a financial meltdown of global proportions was inevitable.
The minister had had enough of the president’s populist policies which were driving inflation through the roof.
The president himself would flee the country not so many days later as a revolution crystallised.
Further afield in Amsterdam, London, Moscow, New York and other financial centres, the wheels of commerce screeched for attention.
Trouble was in the air.
In London, many bankers had that eerie feeling of trouble looming, very big trouble looming.
In Moscow, government was worried and now pushing hard to withdraw its deposit from the bank, a bank that once upon a time was the biggest bank ever in the western hemisphere, the House of Barings.
In 1890, it housed the looming problem.
A number of alert bankers and analysts had seen the chaos coming: Barings was too exposed to Argentina and Argentina had so many problems of her own to cry herself to sleep, Financial Economics aside.
By 1890, Barings had long been eclipsed by another as the biggest bank ever. In 1815 for instance, the equity capital of Barings was £375 000 while the House of Rothschilds was £500 000.
By 1828, Rothschilds’ capital had swelled to £4,3 million while Barings was £310 000.
Even factoring in the fact that the House of Rothschilds retained almost all its earnings while the other paid out dividends aggressively, Barings was, by all accounts, a shadow of its former illustrious self.
Nonetheless, it still was one of the major banks in the world.
In 1890, its capital stood at £2,9 million with liabilities of £21 million giving a capital to liabilities ratio of 14 percent against 39 percent for the House of Rothschilds and therein lurked the problem underpinning the meltdown.
Barings’ loans were mainly to Argentina. Early in 1890 for instance, the bank had floated a £2 million bond for Bueno Aires Water and Drainage Company to, as economic historian Niall Fergusson writes in The World’s Banker, “modernise the city’s water and sewage system.
Not only did the bank fail to place more than £150 000 of these with the public” but the project itself was slow to take off and when completed, consumers did not pay for the modernised services in hard currency thus robbing bondholders of envisaged returns.
Naturally, this exerted justifiable downward pressure on bond prices such that default was a certainty than a likelihood.
As the political crisis gathered in Argentina, the Bank of England descended on Barings’ books and found out that things were much worse than thought.
Contagion would without a doubt ensue if the Barings problem was not sorted.
So huge were the losses that Alphonse Rothschild in Paris said the financial state of Barings was “a catastrophe (which) would put an end to the commercial habit of transacting all business of the world by bills on London”.
His brother in London concurred saying if Barings had “been allowed to collapse, most of the great London houses (ie, banks) would have fallen with them’.
Clearly, there is nothing new about the phrase “too big to fail” which so often graces international financial news headlines in our times.
Interestingly, the manner in which the Bank of England went about rescuing Barings is a striking replica of what we read as shrewd manoeuvrings by regulators of our times in averting financial tsunamis like the recent so-called global financial crisis.
In the book “Firefighting: the financial crisis and its lessons,” Ben Bernanke, Timothy Geithner and Henry Paulson give a first-hand account of how they tackled the financial crisis.
The trio’s strategy, like that of the Bank of England in 1890 was to shore up banking reserves (in 1890, this meant ensuring availability of actual gold so that in the event of there being a bank run on Barings and others, all notes would be honoured by specie as was practice).
The Bank of England also set up a guarantee fund financed a little bit by itself and mainly by Barings’ competitors so that Barings and the financial system as a whole could meet its obligations in the short term.
These measures quelled the fire. However, Barings would limp to 1894 when it eventually managed to liquidate the toxic Argentine assets.
But, by then, another crisis was about to rock the world and yet another and another and another would follow.
A century later, a twenty-eight-year-old Nick Leeson would “bring down” the centuries old Barings after taking excessive positions from his Tokyo trading floor.
His bets became Barings’ Armageddon and for a notional dollar, Dutch bank ING scooped some units of the troubled centuries-old banking giant. The rest, as they say, is history.
Why is it important for us in this part of the world to know and reflect on these things?
Because these things help us nurture a non-partisan perspective of our actions as we labour to shape better futures.
These things help us avoid problems and, should the problems still arise as they tend to, we can deal with them from an informed place than always try to reinvent the wheel or repeat our own mistakes.
These things remind us that while size, scale and depth of a bank matters in delivering services to a people and a peoples’ governments, it is bank management’s meticulousness that matters most.
For these reasons and more, it is unfortunate that Financial History is completely missing in our curricula when we train bankers, economists and future regulators.
“Nobody knows exactly what the next financial crisis will look like, but historically, crises have followed a similar mania-panic crash pattern of excessive risk taking and leverage” writes Bernanke, Geithner and Paulson further remarking that “policy makers need to have humility about their ability to identify and correct dangerous contagious beliefs, or to prevent them from sparking panics”.
Rather than letting own experiences whip humility into bankers, regulators and policymakers, Financial History does that gently and oh for the fun therein.
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