Yesterday's trip down memory lane (#847595) obviously had me dig out some other academic works from back in my university-dwelling days. Here's one piece of Oxford-accepted coursework that I turned into an The Daily Economy article a few years ago
Back in ~2018 or something I did a deep dive down the balance sheets of various British banks during the 1800s, and realized that they looked awfully conservative. It's like they're prepping for disaster at any point, holding so much liquid short-term assets and deposits with other banks that they make Circle or Tether look risky.
Among Walter Bagehot's many contributions to banking, his conviction that the central bank operate merely like a small bank on a large scale is among the least appreciated. From Bostun Uni prof Perry Mehrling's review of James Grant's biography of Bagehot a couple of years ago:
In this context, Bagehot’s Principle, which urged free lending against securities that would be good in normal times, can be seen not so much as a radical expansion of central bank responsibility but rather as a conservative banker’s reassertion of the central position of traditional banking in the brave new world of capital finance that was emerging.
Stuckey's, the bank that Bagehot and his family ran, survived over the long haul probably because they ran their ship so conservatively, holding structurally more cash and liquid assets than their competitors.
Anyway, I'm straying off topic, but my argument was that the Bank of England thoroughly and credibly became a lender of last resort at some point in the latter half of the 19th century, stretching Bagehot's life. Not necessarily in response to his prolific writing but hardly unaffected by it either. The Bank of England learned gradually, from crisis to crisis, how to manage the monetary system they sat at the base of:
The Bank’s history was always one of experimentation, of gradually learning its craft and adapting to changing economic and institutional environments. It was established in 1694 by royal charter but with private shareholders, with the explicit purpose of raising revenue for the government, and over the 18th century established its private business. For all intents and purposes, it was just another company — albeit with certain government privileges.
The dating is trixy. Three banking historians recently tried to show that, using granular data for various market spreads. Following their methods, we get a rather murky outcome:
Here's what I discovered during my grad school days: A credible LOLR standing ready to support illiquid banks would induce commercial banks to
- (a) hold less equity as the default risk from illiquidity-induced fire sales is smaller, and
- (b) reduce their holdings of liquid assets, such as cash and easily sold British consols (long-term government debt) since the purpose of liquid assets is to insure against illiquidity, which the Bank is now meant to provide.
In the second half of the 19th century we see neither of those tendencies. Indeed, following each of the financial crises in 1866, 1878, and 1890, when the Bank was allegedly well-established as an LOLR, commercial banks increased their liquid positions to permanently higher levels. We see the opposite of what we would see had the commercial banks trusted the Bank’s newfound liquidity assistance.
Loved doing that work, as well as writing this piece: Not sure that it translates well for SN but we'll see whatcha think.