Politics Magazine

Passing Judgement (Preview)

Posted on the 14 November 2019 by Devondb @Devon_D_B

Passing Judgement (Preview)

Source: Financial Times




Note:
I am currently researching into the history of credit rating agencies, which has led me on a journey to the economic beginnings of the United States. While researching I decided to create a series on the topic, rather than have one article which would have been extremely lengthy.
Looking into this matter has led me to the infant years of the United States and the push to establish a formal federal bank and the political and economic battles and interests that surrounded it. I wanted to present some of my findings here. I'm still working on this first part but (hopefully) will have a finished version soon.
- Devon Bowers
Passing Judgement: A History of Credit Rating Agencies
Part 1: Formation
Credit rating agencies can be useful institutions, allowing lenders to know the likelihood of a borrower repaying loans or if they should even be loaned to at all. Ideally, that is what they would be used for. However, such agencies now have global power and can effect economies the world over, most notably giving bundled mortgages that were junk, AAA ratings.[1] Given that, it would be prudent to understand their history, how they operate, and the effects that they have had, both past and present, especially as a new financial crisis may be looming.[2]
Credit scores began to form somewhat in the 1800s as loaning out money was rather risky. This led a number of experiences where the standardization of judging creditworthiness was attempted. One of the most successful experiments occurred in 1841 with the formation of the Mercantile Agency, founded by Lewis Tappan. Tappan wanted to “systematize the rumors regarding debtors’ character and assets,”[3] utilizing correspondents from around the nation to acquire information, report back, and then that information would be organized and sent out in reports. Yet, this was done in response to the Panic of 1837, a panic that would have wide-reaching effects not only for Tappan, but the nation as a whole.
The Bank of the United States
Before delving into the Panic of 1837, there needs to be an examination of The Bank of the United States [BUS], as it is directly related to the Panic itself.
Established in 1791 as to deal with Revolutionary War debts owed by the US and to put the new nation on a good financial footing, the BUS was charted by Congress for 20 years. During that time, the bank’s purpose was to “make loans to the federal government and [hold] government revenue.”[4] (This was all in the context of a gold and silver-backed currency system.) When state banks were presented with notes or checks from the BUS, state banks would exchange the amount noted in gold and silver which was rather unpopular due to making it more difficult for state-based banks to issue loans.
Many in the business community supported the BUS on the grounds that it kept state banks in check by preventing them from making too many loans “and helping them in bad times by not insisting on prompt redemption of notes and checks.”[5] New businesses would finance themselves by borrowing money from the BUS and when economic hardships occurred, the businesses would have some breathing room as the government didn’t demand repayment on scheduled times.
The Bank was re-chartered a second time in 1816 as debts had piled up during the War of 1812 and there were difficulties managing the nation’s finances without a national bank, but was set to expire in the late 1830s. During this time, Nicholas Biddle, a supporter of the BUS would become president of the institution in 1823 and Andrew Jackson, who was against the BUS, even going so far as to question its constitutionality, would become President of the United States in 1829.
In his earlier years, Jackson had a business situation involving paper currency go south, leaving him with a bad taste in his mouth. In 1795, Jackson sold 68,000 acres to a man named David Allison in hopes of establishing a trading post, taking his promissory notes as payment and then using the notes collateral to buy supplies for the trading post. When Allison went bankrupt, Jackson was left with the debt of the supplies.[6] It would take him fifteen years to finally return to a stable financial situation.
There were also deeper reasons for his anti-bank stance than personal animosity. Jackson was among those people who thought that banking
was a means by which a relatively small number of persons enjoyed the privilege of creating money to be lent, for the money obtained by borrowers at banks was in the form of the banks' own notes. The fruits of the abuse were obvious: notes were over-issued, their redemption was evaded, they lost their value, and the innocent husbandman and mechanic who were paid in them were cheated and pauperized.[7]
This mistrust of banks would put him in a direct, confrontational path with the BUS, specifically in the form of Nicholas Biddle.
Nicholas Biddle was a former Pennsylvania state legislator who became President of the BUS in 1823. Considered a good steward of the bank, he ensured that it “met its fiscal obligations to the government, provided the country with sound and uniform currency, facilitated transactions in domestic and foreign exchange, and regulated the supply of credit so as to stimulate economic growth without inflationary excess.”[8] However, he was also undemocratic as he “not only suppressed all internal dissent but insisted flatly that the Bank was not accountable to the government or the people."[9] This was in direct contradiction to Jackson, not only regarding the existence of a national bank, but also helps to reinforce his suspicions about such an institution.
Furthermore, Jackson became extremely against the Bank in 1829 when Biddle, in an attempt to gain Jackson’s friendship, attempted to strike a quid pro quo with the President: the Bank would purchase the remaining national debt, thus eliminating it, something Jackson greatly wanted done. In exchange, the bank would be re-charted years earlier than expected. There was a more at play for Biddle than re-charting the Bank as achieving that would allow for stocks to grow and thus provide a major increase in the dividends of the shareholders.[10] Instead of seeing this as an olive branch, Jackson viewed it as the institution attempting to utilize bribery and corruption to ensure its continued existence, turning Jackson wholly against the Bank.
It was in 1832 where both these individuals would come to a massive clash over the continued existence of a federal bank.
The Bank’s reauthorization was to be in 1836, however, it would come sooner. The National Republicans, a group that split off from the Democratic Party due to anti-Jackson sentiment, nominated a Kentucky Senator by the name of Henry Clay as their presidential candidate in 1831. Convinced that he could utilize the issue of the Bank to beat Jackson, Clay convinced Biddle to seek renewal of the Bank’s charter in 1832 rather than 1836. Clay did have some backing in that both the House and Senate respective financial committees issued reports in 1835 “finding the Bank constitutional and praising its operations-Biddle himself had drafted the Senate report. The Bank paid to distribute the reports throughout the country.”[11] Clay supporters and allies pushed a bill through in both the House and Senate which would reauthorize the bank, but on July 10, 1832, Jackson vetoed the bill, with the Senate failing in an attempted override.
The Bank was now no more, but what of the Treasury surplus?
After the re-chartering of the Bank of the United States was successfully vetoed, Jackson decided to take the Treasury surplus and split it up among certain favored banks, ‘pet banks’ as they came to be known. However, such a term isn’t fully accurate as while funds did go primarily to banks that were friendly to the administration, “six of the first seven depositories were controlled by Jacksonian Democrats,”[12] there were also banks that whose officers were anti-Jackson that received funds such as in South Carolina and Mississippi.
This divvying up of the Treasury’s surplus funds would set the stage for the Panic of 1837.
Endnotes
1: Matt Krantz, “2008 crisis still hangs over credit-rating firms,” USA Today, September 13, 2013 (https://www.usatoday.com/story/money/business/2013/09/13/credit-rating-agencies-2008-financial-crisis-lehman/2759025/)
2: Larry Elliot, “World economy is sleepwalking into a new financial crisis, warns Mervyn King,” The Guardian, October 20, 2019 (https://www.theguardian.com/business/2019/oct/20/world-sleepwalking-to-another-financial-crisis-says-mervyn-king)
3: Sean Trainor, “The Long, Twisted History of Your Credit Score,” Time, July 22, 2015 (https://time.com/3961676/history-credit-scores/)
4: Jean Caldwell, Tawni Hunt Ferrarini, Mark C. Schug, Focus: Understanding Economics in U.S. History (New York, New York: National Council on Economic Education, 2006), pg 187
5: Federal Reserve Bank of Minneapolis, A History of Central Banking in the United States, https://www.minneapolisfed.org/about/more-about-the-fed/history-of-the-fed/history-of-central-banking
6: The Leherman Institute, Andrew Jackson, Banks, and the Panic of 1837, https://lehrmaninstitute.org/history/Andrew-Jackson-1837.html
7: Bray Hammond, “Jackson, Biddle, and the Bank of the United States,” The Journal of Economic History 7:1 (May 1947), pgs 5-6
8: https://lehrmaninstitute.org/history/Andrew-Jackson-1837.html
9: Ibid
10: Daniel Feller, “King Andrew and the Bank,” Humanities 29:1 (January/February 2008), pg 30
11: John Yoo, “Andrew Jackson and Presidential Power,” Charleston Law Review 2 (2007), pg 545
12: Harry N. Scheiber, “The Pet Banks in Jacksonian Politics and Finance, 1833–1841,” The Journal of Economic History 23:2 (June 1963), pg 197

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