Responding to a Shadow Banking Crisis: the Lessons of 1763

Stephen Quinn, TCU

William Roberds, FRB Atlanta

Presented in Honor of Warren Weber

February 18, 2012

Motivation

To better identify

the persistent properties

of shadow bank instability

Method

To reconstruct a historical episode

that is similar to,

but not identical to the recent crisis.

Similarities

1763 2007-8

Securitization Bill of exchange Many (ABCP)

Shocking failure Neufville Lehman

Rollover crisis? Yes Yes

Central bank Bank of Amsterdam Federal Reserve

CB Lender to guarantors? Yes Yes

CB Emergency facilities? Bullion Numerous

Differences

1763

2007-8

Regulation

Settlement Prudential

Bailouts

None Too big to fail

International liquidity

None Currency swaps

Open Market Operations None Quantitative Easing

Outline

1. Shadow Banking 2. Data 3. Shock 4. Run and Response

Table 1: stylized ABCP conduit

Period 0: (a) D creates and sells an ASSET to B (b) B creates and sells ABCP1 to C1

Period 1: (a) B creates and sells ABCP2 to C2 (b) B repays C1 for ABCP1

Period 2: (a) D repays B for ASSET (b) B repays C2 for APCP2

   

Shadow Run

Period 0: (a) D creates and sells an ASSET to B (b) B creates and sells ABCP1 to C1

Period 1: (a) B creates and sells ABCP2 to C2 (b) B repays C1 for ABCP1

Period 2: (a) D repays B for ASSET (b) B repays C2 for APCP2

Table 2: stylized acceptance loan, 1763

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1

Table 2: stylized acceptance loan, 1763

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Table 2: stylized acceptance loan, 1763

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1

Table 2: stylized acceptance loan, 1763

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2

Table 2: stylized acceptance loan, 1763

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg

Period 2: (a) D accepts BILL2

(b) B settles BILL1 with C1

Period 3: (a) D settles BILL2 with C2

Numerical Example Period 0

• C1 gives 100 Hamburg thalers for BILL1. • BILL1 obliges B to pay 165 bank guilders in two months at the

Bank of Amsterdam. The exchange rate is 1.65:1.

Period 1

• B sells BILL2 to C2 for 166 bank guilders. 165 will settle BILL1 and 1 is a service fee.

• BILL2 obliges D to pay 101.8 thalers in Hamburg in two months. The exchange rate is 1.63:1.

Period 3

• D pays an annualized 4-month rate of 5.4 percent

Phase 1: Rollover Crisis

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg

Period 2: (a) D accepts BILL2

(b) B settles BILL1 with C1

Period 3: (a) D settles BILL2 with C2

Phase 2: Acceptance Collapse

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg

Period 2: (a) D accepts BILL2

(b) B settles BILL1 with C1

Period 3: (a) D settles BILL2 with C2

Phase 3: Securitization Collapse

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg

Period 2: (a) D accepts BILL2

(b) B settles BILL1 with C1

Period 3: (a) D settles BILL2 with C2

Outline

1. Shadow Banking 2. Data 3. Shock 4. Run and Response

Recorded at the Bank of Amsterdam?

In Hamburg In Amsterdam Period 0: (a) D draws BILL1 on B

(b) D sells it to C1 C1 travels to Amsterdam

Period 1: (a) B accepts BILL1 (b) B draws BILL2 on D (c) B sells BILL2 to C2 C2 travels to Hamburg

Period 2: (a) D accepts BILL2

(b) B settles BILL1 with C1

Period 3: (a) D settles BILL2 with C2

Bank of Amsterdam Balance Sheet August 1, 1763, in bank guilders

Assets Liabilities Metal 21,895,124 Accounts 22,660,145 Under Receipt (“Repo”)

21,606,690 Unencumbered

288,434

Loans 527,264 Capital -237,757 Total 22,422,388 Total 22,422,388

Data for 1763

• Weekly gross payments between

o each of the 8 largest merchant bankers

o each banker with the rest of the Bank of Amsterdam

o each with the Bank of Amsterdam’s master account

• Week-start balances of the same.

Data Shows

• New bills financed acceptances before the crisis.

Table 3. Bank of Amsterdam transactions, January-July 1763 Weekly Means in Thousands of Bank Guilders

Merchant bank Starting balance Total

Payments Payments/ Balance

Hope & Compagnie 439.3 473.9 1.12 Andries Pels & Zoonen 359.7 245.8 0.70 George Clifford & Zoonen 277.1 392.3 1.49 Gebroeders de Neufville 103.3 241.3 2.69 Vernede & Compagnie 99.0 179.5 2.75 Raymond & Theodoor de Smeth 77.7 164.5 2.57 Horneca Hogguer & Co. 69.7 146.7 2.51 Charles & Theophilus Cazenove 68.7 227.7 4.25

Total 8 large banks 1,494.5 2071.7

(Rest of the Bank accounts) 21,686.0 1925.31                                                             1 Sum of coin withdrawals plus transfers to eight most active accounts.

Data Shows

• New bills financed acceptances before the crisis.

• The failure of Neufville caused a sudden drop in bill

creation.

• Liquidity creation prevented additional failures.

Outline

1. Shadow Banking 2. Data 3. Shock 4. Run and Response

May 1763

1. decline in commodity prices. 2. demonetization of Prussian coins.

Debtors suddenly lacked means to pay bills.

May 1763

1. decline in commodity prices. 2. demonetization of Prussian coins.

Debtors suddenly lacked means to pay bills.

So debtors draw and sell new bills on Amsterdam. Silver bullion follows in hopes of paying the new bills.

Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders.

Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders.

Lehman Moment

Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders. Neufville’s average weekly funding requirement? 241,000 guilders.

Lehman Moment Aron Joseph fails on July 28. Neufville’s exposure? 163,000 guilders. Neufville’s total assets? 10 million guilders. Neufville’s average weekly funding requirement? 241,000 guilders. Neufville suspends payments on July 30.

Too Big to Fail?

This morning … we received a fatal express, with the terrible news that you, the gentlemen of Amsterdam, would leave the Neufvilles to sink, by which we were all thunderstruck; never dreaming that so many men in their senses in your city could take such a step … which will infallibly plunge all Europe in an abyss of distress, if not remedied by you whilst it is still time.

--- Petition from Hamburg, August 4, 1673

From Tooke (1838, 149-150).

Consequences of Neufville Failure

Direct

Consequences of Neufville Failure

Direct

Indirect

Scramble for coin Run on deposit banks

Rollover crisis

Rollover Crisis Payments value by source, 1763:1-1764:1

3-week moving averages. Source: Stadsarchief Amsterdam 5077.

Mill

ions

Ban

k Fl

orin

s

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan1763

0.0

0.5

1.0

1.5

2.0

2.5LARGEST_BANKS

PARVENUS

ROB

Metal inf lows

Outline

1. Shadow Banking 2. Data 3. Shock 4. Run and Response

Run and Response Weekly position of Horneca Hogguer

-300-200-100

0100200300400

25-J

ul-6

3

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

ep-6

3

3-O

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3

17-O

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3

31-O

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28-N

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12-D

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26-D

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Tho

usan

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uild

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Balances CUM Transfers CUM Coin

Run and Response Weekly position of Hope

 

0

200

400

600

800

1,00025

-Jul

-63

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

ep-6

3

3-O

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26-D

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uild

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Balances CUM Transfers CUM Coin

 Additional Response

• Open Market Operations? • Ad hoc bullion repo window

o unlimited amounts o low interest rate o large haircut

Run and Response Weekly position of Cazenove

-1,000-800-600-400-200

0200400600

25-J

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3

8-A

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3

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3

5-Se

p-63

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Tho

usan

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Balances CUM Transfers CUM Coin CUM Bullion

Run and Response

Weekly position of Smeth

-150-100-50

050

100150200250

25-J

ul-6

3

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

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3

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ands

of B

ank

Gui

lder

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Balances CUM Transfers CUM Coin CUM Bullion

Non-Bank Response

Weekly cumulative positions for the rest of the Bank 

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25-J

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3

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3

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CUM Coin CUM Bullion

Lessons

1763 confirms that a shadow run is a rollover crisis.

Lessons

1763 confirms that a shadow run is a rollover crisis.

1763 suggests that a smaller scale of central bank response

can be sufficient for local effectiveness.

Weekly Central Bank Assets in 1763 and 2008

Sources: Federal Reserve and Stadsarchief Amsterdam 5077

0.50

1.00

1.50

2.00

2.50

3.00

0.50

1.00

1.50

2.00

2.50

3.00

-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22

Ass

ets S

cale

d to

Wee

k 0

Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008

AMS: Traditional

FED: Traditional

Weekly Central Bank Assets in 1763 and 2008

Sources: Federal Reserve and Stadsarchief Amsterdam 5077

0.50

1.00

1.50

2.00

2.50

3.00

0.50

1.00

1.50

2.00

2.50

3.00

-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22

Ass

ets S

cale

d to

Wee

k 0

Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008

AMS: Bullion Window

AMS: Traditional

FED: Lending to Non-Bank CreditMarkets

FED: Traditional

Weekly Central Bank Assets in 1763 and 2008

Sources: Federal Reserve and Stadsarchief Amsterdam 5077

0.50

1.00

1.50

2.00

2.50

3.00

0.50

1.00

1.50

2.00

2.50

3.00

-26 -23 -20 -17 -14 -11 -8 -5 -2 1 4 7 10 13 16 19 22

Ass

ets S

cale

d to

Wee

k 0

Weeks Before and After Major Failure0=1 August, 1763 and 0=10 September, 2008

AMS: Bullion Window

AMS: Traditional

FED: Central Bank Swaps, AgencyDebt & MBS, AIG Rescue

FED: Lending to Non-Bank CreditMarkets

FED: Traditional

 

 

 

Questions?

Weekly “funding gap” with non-banks

-1-0.5

00.5

11.5

22.5

3

28-J

an

21-F

eb

21-M

ar

18-A

pr

16-M

ay

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11-J

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8-A

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5-Se

p

3-O

ct

31-O

ct

28-N

ov

26-D

ec

Mill

ions

of B

ank

Gui

lder

s

Net Flow Payments from Others to BanksPayments from Banks to Others

Figure 10: Simulated balances with no bullion window + 2 failures

Horneca, July 1763-January 1764

Thou

sand

s B

ank

Flor

ins

August September October November December-100

-50

0

50

100

150

200

250

300

HornecaScenario

Hope, July 1763-January 1764

Thou

sand

s B

ank

Flor

ins

August September October November December300

400

500

600

700

800

900

1000

HopeScenario

-2,000-1,500-1,000

-5000

5001,0001,5002,0002,500

Tho

usan

ds o

f Ban

k G

uild

ers

Figure

0000000000

24-J

an-6

3

21-F

eb-6

3

Balance

6: Wee

with a

21-M

ar-6

3

18A

63

es CU

ekly tota

accumu

18-A

pr-6

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ulation b

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8-A

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nces in 1

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CUM

1763

31-O

ct-6

3

28-N

ov-6

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M Bullion

26-D

ec-6

3

Figure C3. Weekly balances of Pels

-200

0

200

400

600

800

1,000

1,200

25-J

ul-6

3

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

ep-6

3

3-O

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3

17-O

ct-6

3

31-O

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3

14-N

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3

28-N

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3

12-D

ec-6

3

26-D

ec-6

3

9-Ja

n-64

Tho

usan

ds o

f Ban

k G

uild

ers

Balances CUM Transfers CUM Coin CUM Bullion

Figure C4. Weekly balances of Clifford

   

-600

-400

-200

0

200

400

600

800

25-J

ul-6

3

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

ep-6

3

3-O

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3

17-O

ct-6

3

31-O

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3

14-N

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3

28-N

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12-D

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3

26-D

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3

9-Ja

n-64

Tho

usan

ds o

f Ban

k G

uild

ers

Balances CUM Transfers CUM Coin CUM Bullion

Figure C6. Weekly balances of Vernede 

 

-250-200-150-100-50

050

100150200250300

25-J

ul-6

3

8-A

ug-6

3

22-A

ug-6

3

5-Se

p-63

19-S

ep-6

3

3-O

ct-6

3

17-O

ct-6

3

31-O

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3

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3

28-N

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3

12-D

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3

26-D

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usan

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k G

uild

ers

Balances CUM Transfers CUM Coin CUM Bullion

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