Although much has been made of the October effect, September has statistically a much worse month for the world of finance. This week in financial history marks its fair share of bailouts, financial chaos and much more. (Missed last week's article? Check out Wall Street History: Steve Jobs Returns To Apple.)
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On September 20, 1873, the NYSE closed its doors for 10 days to try and wait out the panic of 1873. The panic was touched off by the failure of a large Philadelphia bank, Jay Cooke & Company. The bank was a victim of several circumstances, including too much credit extended to speculative railroad ventures and changes in the money supply. The panic touched off a depression that was known as the great depression until the depression of the 1930s took over the title.
No Longer as Good as Gold
Speaking of the Great Depression, one of the pivotal events of it occurred on September 21, 1931, when Britain pulled out of the gold standard. This prompted a bank run in the U.S. that broke over 800 banks. A very large part of the damage in the U.S. was self-inflicted. Under the rules of the gold standard, the U.S. was accepting transfers of gold from Britain. This drain was shrinking Britain's money supply because the monetary float had to be backed by the gold and, when gold is flowing out, credit supply dwindled.
This was bad, but the U.S. made it worse by not issuing more money, despite the growing surplus of gold. This had the effect of not only crippling Britain's ability to issue currency, but also shrank the world supply of credit. In this sense, Britain's exit from the gold standard was the result of the Federal Reserve failing to follow the rules set out by the gold standard. The U.S. followed suit in 1933. In 1971, the U.S. received its comeuppance as France and other nations used inflated dollars to drain U.S. gold reserves.
Born Again Banks
On September 21, 2008, Goldman Sachs and Morgan Stanley joined the retail banking side of finance. These former broker dealers made the switch in order to access the Feds' credit lines that were only open to deposit-taking banks. The incentives also included different accounting rules that would take some of the pressure off toxic assets on the companies' balance sheets. Many of the formerly independent investment banks met their end during the meltdown - either by switching sides or being bought up by retail operations.
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Returning to the theme of gold shenanigans, On September 23, 1869, the U.S. Treasury sold $4 million worth of gold to break a corner in the market. The corner was built by Jay Gould and a group of speculators/manipulators. They bought up gold and entered contracts with contrarians seeking to short gold, thus controlling much more gold than there was in circulation. With the help of an insider in the Treasury, Gould escaped with millions in gains. However, he neglected to mention the impending sale by the Treasury to his fellow manipulators. The sale shaved $25 off the price of gold in 15 minutes, ruining many - including Gould's partners.
The market shock was remembered as Black Friday until a similar day of bloodletting during the Great Depression once again took over the title. There is no shortage of black events in Wall Street's past, but the supply of days to name them after is limited to seven.
On September 23, 1998, the Federal Reserve orchestrated the bailout of Long-Term Capital Management (LTCM). Essentially, a hedge fund run by early quants, the fund was invested in emerging markets, MBS, swaps and much more. The fund had net assets of $4 billion, but was controlling well over $100 billion via leverage and even more through swaps. A Russian debt moratorium caused many investors to pull out of LTCM at the worst possible time, causing a liquidity crunch. The fund's equity shrank to just a little over half a billion.
The fund refused deals from Goldman Sachs, AIG and Warren Buffett, forcing the Fed to arrange a bailout of the fund. This marked the first Fed bailout on the grounds of "systemic risk".
The Biggest Bank Failure
And, capping off a very negative week in financial history, is the biggest bank failure ever - and not by any small margin. On September 25, 2008, JPMorgan agreed to buy up Washington Mutual for $1.9 billion. WaMu boasted deposits of $188 billion and assets over $300 billion, making it much larger than the $40 billion Continental Illinois collapse.
That's all for this week. Next week, will look at a rare budget surplus, a massive bailout package and more.
For the latest financial news, see Water Cooler Finance: Poverty Rates Increase – And So Do Millionaires.